Google earnings: Cracks begin to form in key metrics

It's a classic case of looking in the shadows for the real story.

A quick look at the basic revenue and earnings components of Google's quarterly results confirms what everyone already knew: that Google is a juggernaut and it continues to generate cash:

• Revenue of $10.65 billion, which is up 24 per cent year-over year and significantly above analyst expectations of $8.1 billion.

• Net income of $2.89 billion, an almost 38 per cent boost over the $1.80 billion generated during the year-ago Q1 period.

• Both figures are up over the previous quarter, as well, from $10.58 billion revenue (0.7 percent) and $2.72 billion (6.3 percent) in net income.

• That strength was across-the-board, with revenue generated by Google-owned sites surging 24 percent, and partner site revenue jumping 20 percent compared to the same period last year.

All is not rosy at the Googleplex, however, as cost-per-click data continues a worrying downward trend. This all-important metric measures how much money is generated every time a user clicks through on a Google-provided ad, and is the most important indicator of efficiency for search-based revenue.

For the second straight quarter, CPC was down — by 12 per cent year-over-year after an 8 percent drop in the last period. This was also down 6 per cent over the previous quarter, a period also marked by a rare misstep by the search giant, when it fell over 9 percent short of analyst earnings expectations.

While Google, which doesn't release revenue or income guidance figures before reporting, seems to have recovered from its unexpected stumble last quarter, the CPC trend is concerning because it calls into question the very foundation of the company's business model.

Google's key strength has always been its unique ability to generate greater amounts of revenue from search-based advertising. The lack of CPC traction may be good news for advertisers, as it costs them less to reach customers through Google search advertising, but it means Google's unique differentiator is becoming less effective.

Don't worry, says Larry

CEO Larry Page told investors on yesterday's call that he isn't concerned about the soft CPC results. He said they stem from challenging foreign exchange rates, growth in mobile use and changes in ad quality. Page also singled out Apple as another reason these costs are increasing, as Google pays its archrival for the right to be the top search engine on iPhones and iPads.

"If anything, lower CPCs give better return on advertising spend," Page said on the call. "It's a lower cost so a better return on investment for advertisers."

Page's spin notwithstanding, most analysts have dismissed the relatively rare miss, saying lower per-click figures aren't much of a concern given continued traffic growth, as well as expansion of emerging advertising segments such as mobile and display-based advertising.

This may mask the issue in the near term, but longer term it puts the company in a vulnerable position. When overall growth eventually begins to flatten out — as it inevitably will as online advertising markets reach maturity — Google's differentiating competitiveness will become eroded.

In many respects, it's easy to understand why some analysts and observers remain bullish. Google has been such a consistently growth-focused story for so long that it's something of a no brainer to give the company a pass for a quarter or two. As long as the overall business continues to grow at a consistent pace, the conventional wisdom goes, lukewarm performance in a fundamental area like cost-per-click can be temporarily overlooked.

An industry in transition

Looking beyond Google, however, it's a troubling evolution for the entire online advertising community. Google isn't just a dominant competitor; it's an industry pioneer and a bellwether. And if this company is beginning to experience difficulty in converting traffic into revenue, then perhaps the sector in general could be heading into a period of ad rate realignment.

This isn't unexpected, as Google's traditional playground, web-based advertising, is rapidly going mobile as end users spend less time on their laptops and more time using smartphones and tablets. Mobile users tend to use search differently, and traditional methods of advertising delivery don't necessarily work on devices with smaller screens. Consequently the revenue models that drove growth in traditional computing need a major rethink for mobile deployment. As the industry wrestles with this transition, observers look to Google to set the trend, and any signs of wobbling from the frontrunner will send shivers through the entire space.

As long as Google posts top- and bottom-line growth figures like these, none of this will matter much. But as soon as the headline-grabbing numbers begin to soften, everyone's going to be asking why CPC had been overlooked for so long. For a company — and an industry — built on revenue-generation efficiency, the time to start asking and answering these questions is now.

Carmi Levy is a London, Ont.-based independent technology analyst and journalist. The opinions expressed are his own. carmilevy@yahoo.ca