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The Yahoo-Google Deal: Will it Really Make Yahoo Money?

Published: June 17, 2008

Author: David Rodnitzky

Ever since Microsoft’s attempt to acquire Yahoo ended, the pressure has clearly been on Yahoo executives to do something to justify their existence as an independent entity. As expected by many, Yahoo’s first salvo across the bow was to create a paid search partnership with Google. Yahoo has reportedly said that it “expects that deal to generate between $250 million and $400 million in incremental operating cash flow in the first 12 months, with the opportunity to earn $800 million in annual operating revenue in the U.S. and Canada.”
The predicted increase in revenue comes from Yahoo’s ability to leverage Google’s superior advertiser base to improve CPCs on some terms (through increased advertiser competition) and to begin to monetize others where no monetization currently exists. On the Yahoo blog, CEO Jerry Yang wrote:

It does not signal that Yahoo! plans to exit paid search. Quite the contrary. Through the financial benefits of better monetizing our search traffic, we’ll be investing in search services and ad platforms, including Panama. An independent search business is critical to our future. We will retain complete flexibility and will call the shots on where and how often Google ads will appear. While Google has better advertiser coverage in some query areas, we still have the ability to provide Panama ads where they are most valuable.

In theory, this sounds like a perfectly logical – albeit desperate – strategy for Yahoo. Yahoo doesn’t need to lift a finger to acquire incremental revenue – they can just sit back and ride Google’s coattails to the bank. Of course, whenever any company outsources what is supposed to be a core competency to a competitor, you also have to question the long-term viability of the business. If Yahoo – after having spent billions to develop the Panama paid search advertising system and rejected billions from Microsoft’s coffers – has to come hat in hand to their chief competitor for money, that’s a big problem.
But the real question that needs to be asked here is this: why exactly does Google outperform Yahoo on CPCs and paid click coverage? Generally speaking, I see two possible answers to this question: 1) Google just does a better job of monetizing their traffic or 2) Google’s traffic is better and therefore justifies the higher monetization.
To me, the answer to this question determines whether Yahoo is just a poorly-managed company that can be revitalized through better management, or a sub-par Web site moving slowly toward the grave.

Theory #1: Google has Out-Flanked Yahoo

There’s a lot of compelling arguments to justify this theory. For starters, Google’s user interface, tools, and technology have made it infinitely easier for all advertisers to participate in Google’s paid search auctions. For novice advertisers, the Google UI and the Google Desktop Editor are easy to use, logically designed, and filled with helpful tutorials to get advertisers where they need to go. For sophisticated buyers, Google’s API beats Yahoo’s API, and the variety of advanced filtering functionality (geo-targeting, day-parting, targeting, site exclusion, placement targeting, image and video ads, etc) gives ROI-focused advertisers plenty of granular options to buy the right ads for their business objectives.
Yahoo, on the other hand, has consistently underwhelmed their users with their interfaces and tools. It took four years too long to switch from the legacy Overture platform over to Panama, and frankly, Panama is good but not great. Yahoo would have been much better off licensing Google’s UI and tools instead of spending over one billion dollars building their own inferior system. Simply put, even if advertisers wanted to spend more on Yahoo, the UI and tools make it pound for pound more difficult to do so. As such, I am sure there are many advertisers who have decided that they’d rather optimize their Google accounts than struggle through building a Yahoo account.
Another argument to support Google out-flanking Yahoo is Google’s continual innovation in bid yield management. Yahoo was perfectly content with a straight cost-per-click bid model until Google revolutionized the search industry with their “CPC X CTR” yield management scheme (effectively a cost per thousand system). Similarly, by the time Yahoo had switched to the Google CPM system, Google had already moved on to a new system by introducing Quality Score into the mix. And by the time Yahoo came around to Quality Score, Google was already experimenting with advanced broad match algorithms as well as more sophisticated Quality Score measures. In other words, Google’s bid algorithms are consistently a step ahead of Yahoo’s – both from a monetization and user relevancy perspective.
Finally, let’s not forget Google’s overall superior brand. Few ad agencies get angry calls from clients asking why ‘we’re not #1 on Yahoo’ but every agency gets similar calls about Google. Advertisers simply care more about showing up on Google than on Yahoo. Indeed, with Google’s massively dominant market share and far superior branding, it is getting to the point that Yahoo, MSN, and Ask are almost “second tier” engines in many people’s eyes.
Combine better tools, better UI, better algorithms, dominant market share and dominant branding and it’s easy to see how theory #1 might be the right answer to the question. And incredibly, this would be good news to Yahoo, because all of these problems are fixable with the right management and strategy (though that in itself is a big assumption).

Theory #2: Google’s Traffic is Just Better Than Yahoo’s

Savvy search marketers pay hugely variable CPCs for keywords that seem very similar to each other. One of my favorite examples of such a situation comes from the mortgage industry, where the keyword “mortgage rate” traditionally receives a much lower CPC than the plural of the same word – “mortgage rates.” This is mainly because users typing in a plural want a comparative shopping experience, perfect for lead generation companies who want to sell mortgage leads to mortgage companies. The singular version usually indicates a search for today’s current mortgage rate, a much less monetizable keyword.
And it goes without saying that any advertiser who pays close attention to monetization at the keyword level will also do so at the search engine level. To wit, there are countless ‘second tier’ search engines where you can buy millions of clicks for just a few cents each. Why? Because smart advertisers know that these clicks aren’t worth nearly as much as what they pay on Google, simply because they don’t convert.
There are still plenty of dumb advertisers out there who don’t track their clicks or who participate in vanity games of chicken to show up #1 for a top keyword, but it’s pretty much impossible to actually build a paid search business model off these advertisers these days (it was possible in the early 2000s). If you can’t provide quality clicks to smart advertisers, you can expect your CPCs to fall accordingly.
I recently saw some troubling data from Marin Software – a leading bid management company – that seems to suggest that Yahoo’s traffic falls into this ‘inferior quality’ realm of second-tier search traffic. The folks at Marin aggregated anonymous data from their clients and applied a pretty rigorous methodology to create a true apples-to-apples comparison between Yahoo and Google. They wanted to see if there was any difference between user behavior and search quality between the two sites.
Marin came up with two interesting conclusions. First, users on Google simply clicks on a lot more ads than users on Yahoo (e.g., a higher CTR). Wister Walcott, VP of Products for Marin noted:

The findings were stark and repeated client after client – when running on Google, the typical keyword has a higher click-thru rate, even when controlling for position and min bid (and it is true on exact/standard match as well, which controls for how words are matched to search queries). For whatever reason, Google users are more likely to click on ads. Even if this is a result of higher quality ads on Google, best-case, it’s the behavior of tens of millions of Yahoo users.

And perhaps even more interestingly, clicks on Google cost more than the same clicks on Yahoo, but also have a correspondingly higher conversion rate than Yahoo clicks. Again, Wister comments:

Keywords also had a higher conversion rate on Google than they did on Yahoo (30% higher). And, the clicks cost more (about 30% more). That is, the increased cost per click is fully accounted for by the improved conversion rate (another way to put it is that the cost per action is the same). This would suggest that the contention premium Google claims by virtue of having more crowded auctions is not playing a large factor. Advertisers are just behaving rationally.

Taken together, it’s possible to conclude that a combination of user demographics and increased user trust simply make clicks worth more on Google than on Yahoo. It may be the case that Google attracts users more likely to buy from advertisers, and that users who use both sites trust the Google brand more and thus trust advertisers more on Google than on Yahoo.
If true, this puts a bit of a wrench into Yahoo’s revenue assumptions from their Google partnership. If Yahoo users treat new Google ads the same way they currently treat Yahoo ads, you would expect that click monetization of Google ads on Yahoo would be lower than the monetization of same clicks on Google. While this may not entirely account for the 30% difference between Yahoo and Google conversion and CPC, it would no doubt have a big impact.
And as savvy advertisers start to see the revenue results come in from the new Yahoo-Google fusion ads on Yahoo – and see that they are perhaps 10-20% lower than the same ads on Google, they will of course reduce their CPCs accordingly (or perhaps even site exclude Yahoo entirely). To use a crass analogy here, Google ads on Yahoo may be like ‘putting lipstick on a pig.’

Conclusion: Win, Lose or Draw?

My sense is that both theories apply to this situation. There’s no doubt in mind that Yahoo could do a lot to even the playing field against Google through better management, technology, and tools (and I say this as a loyal albeit disgruntled Yahoo shareholder!). By the same token, Google has established a level of trust with users and advertisers that may result in Google ads on Yahoo underperforming vis-à-vis the same ads on Google in the short term (as users click on them less) and also in the long-term (as users convert less and advertisers reduce bids accordingly).
Whichever theory you support, there’s one thing you should have concluded by now: Yahoo’s in trouble and this deal is unlikely to provide the answer to the company’s problems.

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