PENNIES FROM HEAVEN
Two items that are easy to miss on a first-read, struck me the most in a terrific Sunday New York Times article on Google by Saul Hansell. The piece clarifies how Google found it's way to dramatically change the world of marketing and advertising through standing on the shoulders of predecessors.
As occurs in most remarkable accomplishments, luck, serendipity, some unique insights and a LOT of heavy thinking, programming and lifting lead to a uniquely technology-driven approach to making "advertising" really hum on the internet.
Broadly, the article explains the role technology plays in re-making advertising and the complexity involved:
"Google has already created what it says is one of the most sophisticated artificial intelligence systems ever built. In a fraction of a second, it can evaluate millions of variables about its users and advertisers, correlate them with its potential database of billions of ads and deliver the message to which each user is most likely to respond."
These technologies are increasingly bringing more efficient markets to bear on the prosaic world of direct marketing first, and mainstream advertising second. Contrary to what might think generally, the former is several times bigger than the latter both in the US and around the world. In fact, the article quotes Google CEO Eric Schmidt at the end as saying,
"Our model is likely to affect television last," he said, while expressing optimism that a formula for useful, targeted commercials could be found. For now, he quickly added, the market for various forms of direct marketing is three times larger than that for television ads. "I was shocked by this," he said. "All of us are so conditioned to television as the height of advertising.
"We are in the really boring part of the business," Mr. Schmidt concluded, "the boring big business."
The whole article is worth reading, and John Battelle, author of the best-selling book "Search", about Google, has a post that excerpts the choice sections.
But the two items that I mentioned above have to do with the old-adage of "watching one's pennies". It's been more important for Google's success than one might think.
First, when Google decided to re-purpose paid-search as first conceived and implemented by Bill Gross of Idealab fame, the company made a crucial design change. The Times article explains this history:
"In early 2002, a Google employee, Salar Kamangar, now 28, convinced Mr. Schmidt and the founders to switch to an auction-based system like the one set up by Bill Gross, the head of IdeaLab. Mr. Gross had created Goto.com, a search engine made up entirely of ads, where advertisers paid only if their ad was clicked on, and the advertiser who bid the most per click was listed first. (Goto was later renamed Overture Services and then bought by Yahoo, an early Google backer that has become its fiercest rival.)
Mr. Kamangar, though, had an important improvement on the model. Rather than giving priority to the advertisers that bid the most per click, as Goto did, he realized that it was better to save the front of the line for ads that brought in the most money - a combination of the bid and the number of clicks on the ad. This was not only more profitable, but it also linked readers to ads that were more relevant to them. He also figured out that the system should use what is called a Vickrey auction - that is, to charge the winner only one cent more than the second-highest bidder. That gives advertisers an incentive to bid high, knowing that they will not be penalized if they are far higher than the rest of the market."
The Vickrey auction twist of charging a penny more ends up being an important driver of the company ramping from nothing in paid-search revenues in 2002 to almost $10 billion in expected revenues by 2006, putting it fourth amongst global media companies, ahead of Time Warner and NBC Universal in advertising revenues.
The second item re-inforces this importance. The articles goes onto explain:
"The smartest thing that Google did was getting smaller advertisers to buy in," said Ellen Siminoff, the chief executive of Efficient Frontier, an agency that helps advertisers manage their campaigns on search engines.
She estimates that Google has two to three times as many advertisers as Yahoo does, largely because Yahoo has a 10-cent minimum bid. This lets Google earn money on more obscure search terms for which rivals have no ads."
One needs to re-read this a couple of times to get the enormity of it. "Google has two to three TIMES" as many advertisers as Yahoo! because Google allows minimum bids in pennies rather than denominations bigger than a dime!
This is one of the first large-scale, real-world empirical validations of something many have argued since the earliest days of internet commercialization over a decade ago. That is the notion that micro-payments in pennies could be very big for commerce on the internet (aka e-commerce). Ten years later, we have yet to making this a reality on the e-commerce side of the web, both on PCs and on wireless devices like cellphones, the success of eBay's Paypal notwithstanding.
The path to fame and fortune from nickels and dimes is not new in America. Frank Woolworth hit on the formula back in nineteenth century, when he founded the F.W. Woolworth "five and dime" chain of stores. It lead to one of the largest retail fortunes in the land, selling "discounted general merchandise at fixed prices, usually five or ten cents, undercutting the prices of local merchants" (from Wikipedia).
It's ironic that the value of penny-driven commerce on a large scale is first illustrated on the advertising/marketing front rather than the e-commerce front, as long expected. I daresay it might be equally powerful in the third major form of Internet revenue streams: subscriptions. That is, the notion that one can subscribe to something for pennies over a period may be very powerful for content, commerce, and web services on the internet.
It remains to be seen if this hypothesis is correct, but from now on, we should be definitely watching for pennies in business models all over the internet.