Why Google Can't Afford for Advertising Partners To Be Too Successful

(MoneyWatch)  My colleague Jim Edwards at BNET Advertising had an interesting post on Google (GOOG), noting that it had no choice but to continue courting antitrust action from the FTC because of its acquisition strategy. At issue is that most of Google's revenue comes not just from advertising, but advertising on its own sites. In other words, Google's revenue base is even narrower than you might have thought. And that fact is driving much of Google's current strategy.

At the heart of the discussion is this chart from Silicon Alley Insider showing the split between ad revenue from Google's own sites, ad revenue from other sites, and non-ad revenue:

Those who look at Google's FY2009 10-KFY 2009 10-K may find this confusing because that lists 30 percent of the company's revenue as coming from member sites of Google's network. But that is revenue before deducting traffic acquisition costs, which is the money Google pays its partners. Take those out and the remaining money is 3 percent of net revenue. A huge difference, and one that potentially spells danger for the company, as the 10-K notes:

Our operating margin will also experience downward pressure if a greater percentage of our revenues comes from ads placed on our Google Network members' web sites compared to revenues generated through ads placed on our own web sites or if we spend a proportionately larger amount to promote the distribution of certain products, including Google Toolbar.

Google can't afford to expand its network overly because the action would injure Google's bottom line. In fact, the company could drop all of net revenue from non-Google partners and it would be nothing more than a rounding error.

There is one thing that Google gets from partner sites: influence. When you spread around that amount of money, you get on your side a lot of companies that could otherwise complain about you. But Google must restrain the portion of its revenue from other sites. There are only two ways that happens: increase non-ad revenue, or restrict ad revenue from partners. Revenue from other product lines would help, except the total is as anemic as non-Google web advertising. The company plans to experiment with providing high speed broadband access, but it faces entrenched and large competitors.

Thus, it must push to grow the native part of the business, ads, while ensuring that the real growth stays with Google's own web sites. Acquisitions of additional ad networks may not be Google's only choice. Android might eventually channel advertising through a large number of handsets, although consumers might not put up with ads, and handset vendors might alter Android code to prevent them. Or perhaps if Google Chrome can get significantly above 5 percent market share, Google will deliver ads through it. But as things now look, Google will only increasingly become an advertising company. And that may mean creating more enemies going forward.

Image: RGBStock.com user lusi, site standard license.