Short-term profits might not be found by search engines

Yesterday my plan for today's blog post was to congratulate SoundCloud for winning Music Ally / MidemNet New Business Showcase at the music industry gathering Midem and add some reflections on startups.

However, the news (longer for subscribers at WSJ) that Efficient Frontier, one of the largest SEM agencies in the world with $750 million in annual spend, says that search advertising spend declined 8 percent in the last quarter of 2008 got me to change the subject.

Some people have argued that search is insulated from the recession as it is measurable, an assessment I've disagreed with.

Google reports its Q4 revenues on Thursday, and then we'll see if Efficient Frontier's numbers are representative for the market. With the November chatter about Google reducing its contractor workforce with up to a few thousand people (unconfirmed), the layoffs of in-house recruiters and closing of peripheral services, I guess Google has seen weak revenue growth (but not necessarily negative) and is trying to manage profitability by cutting costs.

The beauty of AdWords -- for Google

The beauty of Google's AdWords system is that its auctions pits advertisers against each other, driving them to increase bids at the expense of their margins to grab market share. When consumption is strong (resulting in lots of searches with commercial intent), web sites are getting better an monetizing users (the underlying value of a click to the advertiser increases) and corporate strategies aim for growth (if the last search is bought with poor ROI, no-one will get fired) revenue growth explodes! And revenue surely exploded for Google.

Times are bad and Google's customers are hurting

Times have changed. Consumer confidence is at an all-time low and to firms cashflow is more important than growth. Adding to that, it is industries that have been spending heavily on search that are hurting the most:

* Finance. (All the large international banks are losing money like their is no tomorrow and are on governmental life support.)

* Automotive. (U.S. sales in December was down 22.4 % year-over-year)

* Travel. (U.S. consumer confidence was at an all-time low in December)

* Retail. (U.S. retail sales were down 9.8 % year-over-year in December)

Advertisers do measure their return on search spend and can still improve their monetization of visitors (via) from search campaigns, both which are positives for Google, Yahoo and Microsoft's search engine even in a down economy.

However, I see three big negatives for search marketing that I think outweighs those two positives:

Three reasons search could be hurting in the recession

1) the search engines and their customers (the advertisers) have to fight lower consumer interest the resulting lower search volumes in previously very attractive industries like the ones above.

2) as deep discounts ravage the profitability of retailers and cheap credit has gone away, life-time values and average order sizes are going down, negatively affecting what advertisers want to pay per click.

3) as firms cut costs, I believe CFOs around the world are imposing stricter standards on the return on investment marketing, including search, should have, which is negatively affecting the average cost per click.

In addition, for Google as a public company with a large international presence, the stronger dollar should weigh on the Q4 results.

Regardless of search marketing growth in Q4 and in 2009, in a few years time search marketing will be significantly larger industry as consumer usage and advertiser adoption grow. Short-term it might be rockier than most of us expected, though.