Google Profit Misses Estimates As Search Ad Prices Decline

Shift to Mobile Searches Is Hurting Pricing, But Volume Keeps Going Up

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Google is still an advertising juggernaut, but the search giant continues to grapple with ad-pricing declines that could endanger future earnings.

Google hasn't posted an annual increase in the average cost-per-click since the third quarter of 2011. It hasn't posted a quarterly boost since the second quarter of that year. Both streaks remain intact.

On Wednesday Google reported that the average amount advertisers paid for someone to click on their ads in the first quarter dropped by 9% from last year and remained flat compared with the fourth quarter of 2013.

In the past Google execs have repeatedly said this is the result of more people clicking from mobile devices, which typically fetch lower ad rates per click. Eventually the mobile ad rates will catch up, they say. In the meantime, they point to the booming number of clicks, which has seen double-digit annual growth each quarter since at least 2007. And as long as ad volume goes up, so will revenue.

On that front, Google is still booming, with ad revenue up 17% in the most recent quarter to $13.9 billion. So too is overall revenue, which hit $15.4 billion on 19% annual growth. Google's net income was $3.45 billion, up from last year's $3.35 billion but missing analyst estimates. The stock dropped 3% in after-hours trading.

Google's bigger problem is whether a company that relies on advertising for 90% of its revenues can sustain its current success. The company's ad volume isn't growing like it used to, as the chart atop this article shows. That puts more importance on price improvements to drive future ad revenue growth. With mobile ad volume gaining share on desktop volume, mobile ad rates will need to catch up to and eventually exceed the currently pricier desktop placements.

In the long run, "mobile pricing has to be better than desktop pricing," said Google's chief business officer Nikesh Arora during the company's earnings call on Wednesday.

Over a year ago Google announced how it plans to boost mobile pricing. Called Enhanced Campaigns, the system tied together desktop and mobile ad rates by having advertisers set their mobile bids as a percentage of how much they'd be willing to pay on desktop. The thinking went that advertisers would forced to consider how valuable advertising to someone on the go would be compared to someone sitting on their desktop. As a result, they might stop devaluing mobile and pay more for the ads that were becoming a larger share of the ads Google served each quarter.

Google completely transitioned advertisers that pay per-click to Enhanced Campaigns last summer. However the program has yet to reverse the pricing declines, though Google execs maintain that they're seeing progress.

"Enhanced Campaigns are working. It was a necessity that we had to do them… We don't have any un-Enhanced Campaigns anymore," Mr. Arora said.

To be fair paid click and cost-per-click rates are becoming an odd way to judge Google earnings. The company has been on a big push to attract money from brand advertisers who prefer to pay for eyeballs instead of clicks. That's one reason it dispatched its most senior ad executive, Susan Wojcicki, to run YouTube, which is making a case for TV ad dollars.

Last fall the company tested large banner-like ads on its search results pages. But Google doesn't break out brand advertising or its display business separately from search.

It's also hard to judge how much Google is to blame for the pricing declines. The bulk of the company's ad revenue comes from its own sites, like search pages, and continues to see strong growth. Revenue from Google-owned sites grew by 21% year-over-year to $10.47 billion. But revenue from Google's network of third-party sites on which it serves ads has downshifted in the past year. In the first quarter of 2014, revenue from network sites inched up by 4% from last year to $3.4 billion.

Google CFO Patrick Pichette said the company will start breaking out results from its owned and network ad businesses in future reports.

"We'll begin disclosing paid clicks and CPC growth by property in Q2. To be clear, this means that we will disclose CPC and paid click growth rates for both our sites and our network businesses," Mr. Pichette said. He added that the company will continue to also report the aggregate paid click and CPC growth rates.

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