The Google Guys (12 page)

In March 2003, Google launched a new advertising program that would place ads on other Web sites rather than relying entirely on ads that accompanied its own search results. This was the business that LinkExchange was in when Microsoft bought it in 1998, but it did not become part of Microsoft's business model.

Google's system used its computer algorithms to analyze the data on a Web site and choose which ads people visiting that site were most likely to click on. But it turned out that another company, Applied Semantics, in Santa Monica, had a very similar third-party advertising system, called AdSense: its specialty was also extracting information from a Web site in order to deliver more relevant ads. A month after it launched its own unnamed third-party advertising system, Google announced that it had acquired Applied Semantics. In a press release about the acquisition, Sergey said, “This acquisition will enable Google to create new technologies that make online advertising more useful to users, publishers and advertisers alike.” From then on, Google's system was called AdSense.

The final element that made AdSense popular was Google's deciding to make it more profitable for the AdSense partners. Google started splitting revenues fifty-fifty with sites that carried its ads, instead of eighty-twenty, as was common at the time. The reason for this, says one former Google executive: “It just didn't seem right to Sergey.” The split today is even more favorable, and competitors have had to follow Google's lead.

The result is that AdSense is also by far the most popular advertising system of its type. And, it turns out, Google can afford to sacrifice a high percentage of the revenues from AdSense. Its true value is in the fact that it creates a bigger inventory of sites showing Google's ads. This creates a virtuous cycle: with more places for ads to appear, more advertisers want to use Google's advertising systems, which makes more Web sites interested in using Google's ads. No other system can match the sheer number of eyeballs that will look at a particular ad, and there is little reason to go elsewhere.

After Google set the pace, competitors tried to follow, but they were several laps behind. Microsoft started a project to create a new search engine and search advertising system in 2003, code-named Moonshot. Its search engine was launched in late 2004 and the advertising system in 2006. But by then it was too late. Advertisers were dedicated to Google.

It is now extraordinarily difficult for any competitor to catch up to the infrastructure and design of Google's advertising system. Google had too much of a head start and never stops refining and advancing its system. The system was obviously doing something right and filling an unmet need; Google has captured the overwhelming share of all advertising revenue on the Internet, and regulators and competitors are warning that it has become an Internet advertising monopoly.

Both Yahoo's and Microsoft's ad systems seem to be racing on broken legs by comparison. By the end of 2008, Google had captured about 75 percent of Internet search advertising dollars, while Yahoo held on to about 20 percent, and Microsoft just 4 percent. Google's revenue from advertising came in at $5.5 billion in the third quarter of 2008, Yahoo took in $1.8 billion, while Microsoft's online revenue was just $770 million.

In early 2008, Microsoft CEO Steve Ballmer finally decided the solution was to buy Yahoo, combining the two companies' search and advertising market share. Larry, Sergey, and Eric Schmidt didn't want to see Yahoo fall into the hands of Microsoft, a company that, despite its fumbling in the online world, all three executives are wary of as a potentially fearsome competitor. “The Internet has evolved from open standards, having a diversity of companies, and when you start to have companies that control the operating system, control the browsers, they really tie up the top Web sites, and can be used to manipulate stuff in various ways,” Sergey has said in a clear reference to Microsoft. “I think that's unnerving.”
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It took another meeting between the top three Google executives to decide on a proposal. Yahoo didn't have enough ad volume to fill all the slots it had available, so Google offered to fill those slots with ads from its own inventory, with almost all the revenue going to Yahoo. The Google executives saw this as a way to save Yahoo from Microsoft's iron grip. It seemed like a good idea at the time.

But they also knew that the deal could cause some consternation among government regulators. Microsoft was prominent among the competitors complaining that Google already had a de facto monopoly on Internet advertising. So the Google executives decided to approach the U.S. Department of Justice proactively in order to explain why the deal would not decrease competition and would be a benefit to Yahoo. There was no legal requirement to approach DOJ with the proposal. The Department of Justice normally takes on antitrust cases only when there is a complaint or when a merger might reduce the number of competitors in the market. The Google executives felt that their proposal was by far the better option, since a purchase of Yahoo or its search engine by Microsoft would clearly reduce the number of independent search engines by one. Google's deal would be limited in scope, nonexclusive, and temporary.

They were surprised by the response. Microsoft lobbied heavily against the deal as anticompetitive. Newspaper advertisers complained that it would raise the price of ads at Yahoo, since Google's ads tended to get higher bids than Yahoo's. Critics argued that if Google's advertising system displaced Yahoo's, there would be less competition, forcing more advertisers to just go with AdWords and AdSense, thus driving up bids even higher. The Department of Justice cast a skeptical eye on the deal.

The Google executives still don't understand the complaints. Craig Silverstein expresses this view: “That argument makes no sense to me at all,” he says. “I don't want to say anything bad about those people, but I wonder how they justify it.”

Silverstein points out that an auction system is the most direct way to match supply and demand. “Having more auction systems does not increase the supply [of ads or of places to put them]. It just increases the number of auction systems. It shouldn't affect the price of ads at all. This is very basic economics, the law of supply and demand.”

But Google's arguments fell on ears that were primarily listening to other voices. And Microsoft spoke with a very loud and influential voice. It had already spent a decade learning how to lobby Washington while defending itself against federal lawsuits over abuse of its own monopoly. It knew how to play the game. Larry and Sergey did not.

An article in the
New York Times
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in 2008 noted that Microsoft had collected some strange bedfellows in its battle against the deal, including the National Association of Farmer Elected Committees and the National Latino Farmers and Ranchers Trade Association. Presumably, since farmers use the Internet, they were worried about a Google/Yahoo monopoly. The
Times
confirmed that the Latino Farmers and Ranchers took a stance after talking to the Raben Group, a lobbying firm that received $30,000 from Microsoft to lobby against the deal.

Google had put its own lobbyists in Washington in 2005, but inexperience and hubris made them ineffective. Larry and Sergey have a tendency to believe that, since they're clearly in the right, the merits of the deal would speak for themselves, and Google's efforts echoed Larry's and Sergey's attitudes toward dealing with outsiders. In the
New York Times
article, one technology lobbyist who has worked for both Microsoft and Google said of the latter, “They're renowned in this town for not returning phone calls and not showing up to political events.”

The Department of Justice came down firmly against the deal and signaled to Google that it was going to file a lawsuit to stop it. Schmidt and chief legal officer David Drummond met with Larry and Sergey to give them the bad news. “I told [them] we were going to have to make a hard decision,” says Schmidt. “I knew what the endgame was going to look like.” They agreed to concede defeat, although all were unhappy about it. At 10:00 A.M. on November 5, just an hour before the Department of Justice was scheduled to file the suit, Drummond issued a press release announcing that Google would no longer pursue the deal with Yahoo.

After the Yahoo deal fell apart, Microsoft announced a new program that has been widely viewed as a desperation move. It is paying customers to use its search engine to find and buy items online. Web shoppers who sign up for an account and buy items found using Microsoft's Live Search “cashback” site will receive a percentage of the purchase price deposited into their account. When the total reaches five dollars, the shoppers can redeem their cash via eBay Inc.'s PayPal.

Google has made it almost impossible for other companies to compete with its advertising volume. It cemented its position in April 2007, when it bought banner advertising firm DoubleClick for $3.1 billion.

At the pinnacle of advertising success, Google is in a precarious position. With the overwhelming share of online searches and online advertising, it has seemingly become a monopoly, and government regulators don't like monopolies. Right now, its advertising dominance is only online. At the company's 2008 annual meeting, Sergey used an argument that mirrored Bill Gates's claim during Microsoft's own antitrust problems that Microsoft was not a monopoly because the computer business is much bigger than just PCs. Asked about Google's apparent advertising monopoly, Sergey replied, “You are narrowly focused on search advertising. Advertising as a whole is much broader, and Internet advertising is much broader.”

But Google wants more. Federal regulators are now keeping an eye on the company as it diversifies into other forms of advertising. And the company is as ambitious in making those plans as it is in anything else. Larry, Sergey, and Schmidt are now diversifying the company into print, radio, television, and cell phone advertising.

The obvious question is whether Google can leverage its online technology into something that makes sense in other media. But there's already a lot of experimentation going on under Sergey's purview as president of Technology.

The most promising new advertising medium for Google may be television, an area that gets particular enthusiasm from Sergey. In a conference call in 2007, he said, “The remarkable thing about television is, it's surprising, but in fact, [among] offline advertising, it's the one that's closest to Internet-level accountability and we feel we can bring much greater ROI-type accountability to television advertising, much as we've done online.”

How would that work? Google has set up a relationship with EchoStar, which makes controller boxes for satellite and cable companies. EchoStar's boxes are tracking when and how frequently people change channels, and Google is analyzing that data. They're finding some interesting things about viewers' habits during commercials. Between 5 and 15 percent of viewers, for example, change channels as soon as a commercial break begins. Google can also keep records of individual commercials, tracking how many people switch channels after the ad starts and how quickly they do it. Google is using these data to figure out which ads are more relevant to viewers of which programs.

As Google learns how to apply its analytical technology to other forms of media, it stands a chance of revolutionizing many types of advertising the way it has done with online advertising. On one hand, this could revive a moribund ad business. On the other, it could make Google an even more powerful monopoly, and a more fearsome intruder into everybody's habits and business. But Larry and Sergey have no qualms about upsetting the status quo.

Statistician: A man who believes figures don't lie, but admits that under analysis some of them won't stand up either.

 

 

G
oogle's initial public stock offering in August 2004 was supposed to be the event of the decade for Silicon Valley, the way a lavish party at Jay Gatsby's house was a not-to-be-missed walk on the wild side. The year before Google went public, word had leaked out that it had already reached a profit of $100 million, a blazing contrast to the IPOs of the dot-com boom, when profitless companies went public on little more than venture capital and a prayer. By the time Google filed for its IPO in the summer of 2004, its profit was over $300 million. Wall Street needed the brightness of Google's financial picture to help boost the market and raise its own sunken bottom lines, and they lined up at Google's door like drunken sailors moored on the shores of Tahiti after three years at sea.

In October 2003, Bloomberg summed up the sentiment about the rumored IPO, quoting Kevin Calabrese, an analyst at Argus Research in New York: “The demand is going to be someplace between very good and extraordinary,” he said. “Google is one of the premiere names in the Internet.”
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All that seemed to change almost overnight. By the time the IPO took place in August 2004, it had become the most derided IPO in memory. The price had been knocked down to $85 from an original range of $108–$135 when it was first announced, and the public and many large institutional investors avoided the stock as if it came with anthrax.

No wonder the public was skeptical. In the few months before the IPO, the press made the biggest turnaround in coverage of a company I've ever seen. The event was described with such phrases as “an extraordinarily high premium,” “sky-high multiples,” “based more on the hype factor than business fundamentals,” and “harkens back to the late '90s boom” and the “excesses of the [dot-com] bubble.”