Google's Ad Biz Finally Cracks

Google says it has only benefited from the economic downturn. Bargain-hunting Americans are using the search engine to scout out deals, according to chief economist Hal Varian. "One thing that we think at Google is that when there is a recessionary environment, people are counting their pennies, are going to be researching their purchases, looking […]

GooglelogoGoogle says it has only benefited from the economic downturn. Bargain-hunting Americans are using the search engine to scout out deals, according to chief economist Hal Varian.

"One thing that we think at Google is that when there is a recessionary environment, people are counting their pennies, are going to be researching their purchases, looking for bargains, and this potentially has something of an upside for Google, where we referred to this last time I called it the Wal-Mart effect," said Varian, in a conference call last month.

It's a fine argument, but it can't hold for long -- as consumer spending dries up, businesses won't be able to justify buying ads if they don't get a return on it. That's bound to catch up with Google at some point.

And now, the signs are on the wall now that the financial crisis is taking its toll. Sponsored ad sales -- or Cost-per-click ads that are paid for by advertisers only when people click on them -- are softening, according to Collins Stewart analyst Sandeep Aggarwal. His research suggests that CPC ad rates have held up so far because of the number of advertisers bidding on keywords and quality scores demanded a minimum bid for low-quality key words. But now, says Aggarwal, bid density, or the number of bidders on keywords, is softening and delivering smaller returns.

"Going forward, bid density will deliver 2 percent to 4 percent year-over-year lift in CPC, and quality scoring, perhaps 1 percent to 2 percent versus the average of 6 percent year-over-year for the past six quarters," Aggarwal said in a note to investors.

The upshot: Although search ad budgets are holding up better than many other forms of advertising, Aggarwal thinks Google's fourth-quarter revenue will come in closer to $4.26 billion, versus his previous estimate for $4.37 billion. The analyst also trimmed his adjusted earnings estimate to $2.54 billion from $2.58 billion.

Shares of Google took a hit in a pretty dismal trading session, falling more than $7 per share, or 2 percent, to $303 per share by midday.

*Photo: *Flickr/mark knol