Andrew Chen Archives

I was recently pondering Google’s acquisition of Doubleclick, and what it meant for the advertising industry. What happens when Google controls the advertising ecosystem, and what are the implications for smaller websites and competitors?

It struck me that this control very much reminded me of another company: Wal-Mart. Here’s a summary of the critical points that define the similarities between the two:

 

 

 

 

 

 

 

 

 

 

Advertisers dependent on huge base of search queries	Retail suppliers dependent on huge customer base
Constrained search ads drives competition	Constrained shelf-space drives competition
Auction system enabled by massive scale	"Everyday low prices" enabled by massive scale
Dominates retail in remnant advertising areas	Dominates retail in rural areas

A quick clarification before I jump into this discussion – most of this analysis takes the standpoint of the business partners for both of these companies. This means that for Wal-Mart, I’m talking about suppliers, and for Google, I’m talking about advertisers.

The power of Wal-Mart
Wal-Mart‘s business is built on massive scale, supported by dominance of suppliers and customers. A couple years back, there was a great article about a supplier being forced to sell gallon pickle jars at a loss, so that they could sell other products as well. Definitely worth reading.

Here’s a summary of some of the key issues below:

• Retail suppliers dependent on huge customer base: Wal-Mart has 100 million people going to their stores every week, which creates a fully dependent ecosystem of suppliers. These companies can’t live without Wal-Mart’s distribution.
     
• Constrained shelf-space drives competition: Unlike the internet retailers, Wal-Mart’s store shelves are governed by the Economics of Scarcity, which means everyone competes for limited shelf-space. This creates a dynamic where everyone chases Wal-Mart shelf-space, rather than Wal-Mart chasing for hot products.
     
• "Everyday low prices" enabled by massive scale: Because Wal-Mart is huge and everyone competes for shelf-space, they can pressure their suppliers to constantly lower prices. Without this uniqley massive scale, they are just another retail store.
     
• Dominates retail in rural areas: And finally, one key to Wal-Mart’s success is their dominance of rural areas. This dominance means that customers are forced to shop there, as other stores close around it. And rather than go head on against the large stores in the cities, Wal-Mart can aggregate all the customers in these "low-value" areas through their massive scale.

Wal-Mart is fundamentally enabled by a virtuous cycle that is built on their behemoth size. Because they have so many customers, they can ask
suppliers to lower prices to gain access to their people. And through
their lower prices, they can outcompete other players in the ecosystem. And after that, both customers and suppliers are dependent on their stores.

The power of Google
Living in Silicon Valley, it’s impossible to escape the success of Google, as well as their meteoric rise as a startup. It’s exactly what any entrepreneur would hope for. It’s been particularly interesting watching them grow in the advertising space, where I’ve been focused for the last 4 years.

Ultimately, the question on my mind is how the online ecosystem will change if Google continues to dominate advertising. But before we head into that, let’s more clearly define what I mean by control of "advertising." What I mean by that is:

• Control of who comes to your site: Through organic search, SEO, and advertising programs, every online company is dependent on Google’s Adwords product
     
• Control of how you make money on your site: Similarly, an entire ecosystem of companies is solely dependent on AdSense (and in the future, DoubleClick), to make money from their sites

In other words, Google has a significant amount of control over both the eyeballs that come in, as well as the money that comes in. Pretty interesting! (for them)

Now let’s go through the same analysis of how Google’s control of advertising affects their ecosystem:

• Advertisers dependent on huge base of search queries: Because ~50% of searches go through Google, inevitably a huge number of advertisers spend time wondering how minute changes in the index (aka the Google Dance) will affect them. Same with their ad products.
   
• Constrained search ads drives competition: Although the internet allows for Long Tail distribution, the truth is that the higher your ad, the more clicks it’ll get. Once you get past the top couple ads, people don’t click as much, which creates a natural scarcity between the first couple.
   
• Auction system enabled by massive scale: Given that there are so many keywords to bid on, one of the key considerations of search engines is how to get people to bid on the same terms to drive up the prices. Given Google’s hundreds of thousands of advertisers, who are all there to bid on the traffic, they’re able to combine raw volume of bids with keyword matching to drive up prices. These prices, in turn, create higher monetization for publishers.
   
• Dominates retail in remnant advertising areas: And finally, it’s important to note that Google didn’t start their control of advertising in the big company brand advertising areas – instead, they focused on aggregating all the "remnant" inventory on the internet. These were the random small companies out there that needed small bits of traffic, or wanted to monetize their small sites. Once they rolled all of those folks up, Google now has the sheer mass to take on much larger companies.

How is Google more powerful than Wal-Mart?
In many ways, Google is a far more powerful force than Wal-Mart when it comes to their partners, because of two factors:

• Cost-per-click auction system
• Goods and services, not just goods

When Wal-Mart buys goods from suppliers, in many cases, they are trying to get lower prices which they then pass onto their customers. That is at the heart of "Everyday Low Prices." Google, on the other hand, has a much more interesting play – because they have a real-time auction system, all the advertisers involved are incented to bid their maximum price. This maximum price is just under the rate that they need to make money. Ultimately, the auction becomes a systematic way to transfer profit margin from advertiser to Google.

(Here’s a great article for more detail on the rising cost of keywords, and their effect on small business owners)

Another way in which Google is far superior to Wal-Mart is that Google can broker both goods and services. Whereas Wal-Mart has to make a living on the margins of jars of pickles, Google can make money on mortgages, online education, and other services that pay $10+ per click. In this way, Google has a significantly larger array of products, and can extract higher premiums on these goods and services.

What does this mean for online advertising?
Ultimately, both Google and Wal-Mart provide incredibly useful services to millions of people at low prices – this cannot be denied. There’s no doubt that Google continue to grapple with multiple competitors that will keep them releasing additional generations of useful products.

That said, for the Web community at large, the important implication from this analysis is that one company’s consolidated dominance of both distribution, pricing, and monetization cannot possibly be good for overall market. This holds true for Wal-Mart, Microsoft, or Google. If they do it, the companies automatically inherent a significant amount of monopolistic powers that impact a huge ecosystem of players that are dependent.

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