Google's Recession-Proof Armor Gets Dinged

This story was written by CNET's Stephen Shankland.

"No company is recession-proof. Google is absolutely feeling the impact," Google CEO Eric Schmidt said in a conference call Thursday after reporting first-quarter financial results.

The company, as is customary, reported results that most business only dream of, recession or not. Its net income grew 8 percent to $1.42 billion and its revenue, excluding commissions paid to advertising partners, grew 10 percent to $4.07 billion. It generated free cash flow of $2 billion for the quarter, the vast majority of it derived from money advertisers pay Google when people click on ads next to search results.

But everything is most definitely not coming up roses. Google's revenue, after ascending steadily quarter after quarter, peaked in the fourth quarter and declined 3 percent in the first quarter. Google's business is still relatively strong, and it's been hit by the recession less than many in the tech world, but it's been hit nonetheless.

Curtailed clicks

Why? In short, because people are buying less and advertisers consequently are advertising less. As an Efficient Frontier study released earlier this week showed, advertisers are getting more conservative by bidding for search terms where there is a proven return on investment (ROI).

Here's Schmidt's explanation, including his assertion that the company's overall business of showing ads next to search results is still intact:
Users are still searching, but buying less. What that means is the ads are converting less. There's more window- and comparison-shopping, purchasing lower-priced goods. In other words, users are doing the right thing. They're doing what you'd expect them to do given the enormous economic changes around us.

Advertisers are still spending, but they're lowing their bids to manage their ROI. They're behaving correctly in our view. One way to say that is our advertising model is working. The user and advertising behavior we're seeing is entirely rational, and the auction model is working for both.

In short, Google Chief Economist Hal Varian's "Wal-Mart effect," in which people under financial pressure would steer more of their purchasing behavior through search engines in an attempt to get the best deals, has its limits.

Creeping pessimism

To put this in context, let's retrace some history over the previous four earnings conference calls. The company's statements have grown gradually more pessimistic:

First quarter 2008: "We've looked at this really carefully, and we do not see an impact as of this time," Schmidt said. "We're well positioned should economics change. We continue to do well because our model is so targeted, and targeted (advertising) does well in most scenarios."

Second quarter 2008: "Despite the weakness in the economy, advertising revenue seems to be holding up remarkably well in most sectors. I think this illustrates the point that we have made several times: during periods of slow economic growth, the last thing an advertiser wants to cut is its spending on search-based advertising," said Google chief economist Hal Varian.

Third quarter 2008: "It's clear the economic situation is so fluid that we're all in uncharted territory...It's clear the global economic situation is worse than predictions just a month ago," Schmidt said, and Varian added, "When there is a recessionary event, and people are counting pennies and researching purchases, this potentially has an upside for Google...We think this kind of effect could work to Google's benefit potentially."

Fourth quarter 2008: "In some ways, the fourth quarter was the easy part," Schmidt said, when the economy was in "uncharted territory. Now it's clear we're in recession. We don't know how long this period will last. We're certainly prepared to get through this (with) no problem."

So yes, Google has been getting more cautious about the economy and its effects, but Thursday's assessment was the most sober by far. In contrast, other companies including Yahoo saw these effects sooner and issued cautionary statements earlier.

Through a Google lens darkly

One curiosity about the timing disparity is that Google, through analysis of search activity through what the company calls the "Google lens," has a view on the economy most other companies lack. Where a business such as Proctor & Gamble has to look at sales data and surveys to project consumer sentiment, Google can look directly at what people are searching for.

Searches on "bankruptcy" increased 53 percent in the last year, and those for "unemployment" more than doubled, said Jonathan Rosenberg, senior vice president of product management.

So what comes next? Google clearly isn't done with search advertising, and there are plenty of opportunities for more money: Google can improve search results overall, drawing ever more search traffic. It can show ads more often, as long as it maintains the quality standards to avoid showing irrelevant or inappropriate ads. It can draw more advertisers to search advertising, increasing the bidding for search terms.

And of course, the company is working on any number of other projects, from closely aligned ones such as ads on image search results, to more distant ones such as graphical "display" ads on YouTube that are targeted at users based on their Web-surfing behavior, to remote ones such as charging subscriptions for online office productivity tools. Such areas are subsidized by search results today, but there could come a day when they stand on their own.

Even though the recession's teeth took a bite out of Google's results, even though Google has trimmed a number of projects that didn't pass muster, and even though the company's employee count actually dropped for the first time, the company still has plenty of money to invest in its other areas.

"We think Google is now well placed for the recovery as it occurs It appears (advertisers') shift to online ROI...is outpacing, on a relative basis, any on loss of economic activity. We benefit from that," Schmidt said. "Our priorities remain unchanged. Basically, long-term growth."
By Stephen Shankland