I’ve never been blown away by the way Google’s management communicates with shareholders.
- The 10-K presents “Cost-per-click” and “aggregate paid clicks”, both of which are terrible metrics.
- The shareholder letters largely gloss over Google’s cash cows: its search advertising and display advertising businesses.
Why “Cost-per-click” and “aggregate paid clicks” are terrible metrics
Google intentionally hides ads for most of its search results. It presumably does this in situations where ads would bring in very little revenue on a per-impression basis. By doing so, it throws away a small amount of revenue to improve the user experience. Suppose that Google stopped doing this. Its aggregate paid clicks would go up. Its cost-per-click would likely go down because these are generally low-quality clicks that are fairly irrelevant to the search query. Clearly, the two metrics (CPC and paid clicks) are not particularly helpful in understanding whether or not Google is better off by hiding ads. In my opinion, Google should be measuring:
- The size of the search advertising market. Obviously, this depends on how many people use the Internet. However, I would also argue that it depends on how many people are using the Internet to shop online (this usually requires a credit card) and to research offline purchases. Because most ad revenue is from people actively researching their purchasing decisions via search, the growth in this behaviour is very important Google. Google benefits from more people becoming comfortable with online shopping, old people learning how to use a computer, online stores providing a greater selection, etc. etc.
- Google’s share among search engines. While Google dominates English-language searches, it does not dominate for other languages like Chinese (Baidu), Japanese (Yahoo Japan), and Russian (Yandex).
- The quality of its user experience and search results versus other search engines.
- Google’s ability to generate value for its advertisers through better ad targeting (e.g. retargeting), helping advertisers optimize their campaigns (bidding tools, Google Analytics, etc.), etc.
It is pretty obvious that Google has put a lot of thought into the items I’ve listed above. Having played around with Google Adsense and Adwords, I’m extremely impressed by how the search engine and advertising tools are constantly improving. Within Google, I’m sure that the employees have developed tools and metrics to measure what they are doing (e.g. quantifying improvements to the user experience). It is disappointing that management has glossed over the performance of its core business and has provided somewhat misleading metrics in CPC and aggregate paid clicks. This is all a little bizarre given how much care and effort their employees have put into improving Google’s profitability.
These letters generally do not inform shareholders about the performance of Google’s two key businesses. On the display advertising side, I want to know how well Google is monetizing ads. What is the trend in revenue per impression? If Google is doing a good job in innovating through techniques such as ad retargeting, then this metric will go up. I’m sure that Google is keeping track of improvements in revenue per impression and is performing split-testing on ways to improve monetization. Unfortunately Google management has not given shareholders much insight into the operating performance of its businesses.
In general, management does not seem to think like capitalists. It seems that their corporate strategy is to build useful new technology and hopefully figure out how to monetize it in the future. While this may not be a terrible strategy and may work out well for shareholders, I feel like Google shareholders would make more money if there was some capital discipline at Google. My guess is that Google shareholders would make a lot more money if management measured and cared about the returns on:
- Big acquisitions (e.g. Motorola).
- Acquiring hot new startups.
- Working on glamorous projects such as self-driving cars.
- Share repurchases, returning capital to shareholders, etc.
- Expanding into adjacent businesses such as gaining search engine market share for other languages.
- Focusing on the core businesses.
Overall, I don’t think management is exceptionally brilliant or exceptionally awful. Despite this, I think that Google shareholders will do quite well simply because the core businesses are so wonderful. The search advertising business is a wonderful cash cow that is somewhat like a royalty on the growth of e-commerce. Search advertising revenues will grow organically and only requires minimal capex in additional data center capacity. The economics of this e-commerce ‘royalty’ are extremely attractive due to the power of compounding.
*Disclosure: No position in Google.