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Intermediate Microeconomics for Google

Google recently released a PR campaign called ‘Google’s Economic Impact’ in a video at YouTube and a PDF file at their website. In it, they claim that in the US they “generated $54 billion of economic value in 2009.” How did they arrive at that figure? Well, they added together the impacts of four aspects of their business:

  1. Free advertising given to non-profit organizations
  2. The economic activity from sponsored links
  3. The impact from the ‘natural’ listings in their search results pages
  4. Payments made to websites that host AdSense ads.

Unfortunately, something about their math doesn’t quite add up, so let’s consider each estimate.

Non-Profits get .5%

To non-profit organizations, Google gives up to $10,000 in advertising space per month. Combined, this accounts for about 0.5% of the impact that they claim. Google is to be commended for their generosity, but assumptions they make elsewhere in their calculations affect their final estimate by much more than 0.5%. So, this quantity amounts to a proverbial drop in the bucket compared to the other points. Every engineer and scientist knows that when one or more large pieces of an estimate are very uncertain, the effect of an insignificant piece does not affect the overall estimate. It is strange for Google to report this contribution to so many digits when most of those digits are not significant.

With sponsored links, advertisers pay Google whenever one of the search engine’s users click an ad the advertiser has placed. When a click happens, the retailer pays Google a few dollars and the user gets directed to one of the retailer’s pages. Most people who visit the page probably will not buy anything, but those who do will make up for the cost of those who do not. Google’s chief economist, Dr. Hal Varian, himself has demonstrated that a profit-maximizing advertiser should be willing to pay about as much to Google as she makes in profit.

For example, if the retailer spends $1,000 on Google advertising, then she must have made at least $1,000 in profit herself, or else she simply would have bid less, paid less, and gotten less traffic.

Google Gets Credit for Advertiser Profits

Google’s mistake in their calculation is to count the advertiser’s profit as if Google deserves credit for it. The US economy in 2009 amounted to about $17 Trillion dollars, about 10% of which was spent on food. Without food, though, Americans would starve to death and the other 90% of the economy would have not happened. So, perhaps we could say that American farmers deserve the credit for all $17 Trillion. Without doctors, teachers, electricians and police our economy would certainly be much worse off, so perhaps these people deserve credit for trillions too. And without the Treasury we might have to resort back to ‘bullae’, the little clay tokens used in antiquity. So maybe the Treasury deserves credit for most economic activity, too.

The problem here is obvious: we are double- and triple-counting economic activity. If every company used the same logic as Google, the combined impact of every industry in the US would be many times greater that the US economy as a whole. We cannot give Google credit for business done by the companies who advertise with them any more than we can give every industry credit for all the activity they cause outside of their industry. When a company designs and builds a product, advertises it on Google and makes a sale, the company deserves credit for that economic impact, not Google. Google deserves credit for the ad cost that connected the seller to the buyer, but not for the entire sale.

In addition to the benefit AdWords has had for the small businesses the report cites, a fair accounting must also consider those who have been hurt. Where in Google’s accounting are the newspapers that are hurting in part because of advertising moving from print to the web?

I’m not bashing Google here. If web-based advertising is more efficient than print-based, then it makes sense why money would move from one to other. A fair assessment of Google’s impact includes both the value created by Google and the value destroyed by it. Google has chosen to do only one side of this calculation.

Value of Natural Listings

Now let us consider the value of the ‘natural’ listings at Google’s search engine. In their estimate, Google counts the value of clicks on the natural listings as some multiple of the value of the paid listings on their site. For each click on a paid advertisement there are about 5 clicks on natural listings and each of those clicks is worth about 70% (Google reasons) of a paid ad click. But again, they are double-counting, as if the natural listings are some sort of gift that Google gives to businesses. Google offers natural listings because they know that some percentage of searches will result in clicks on paid links. In other words, the existence of their paid traffic depends entirely on the existence of their natural traffic.

If they showed only ads, no one would visit them and they would make no money. If they showed no ads, no advertiser would be able to pay them in exchange for traffic, so again they would make no money. There is a fine balance between too many ads and too few, and Google has found what appears to be a happy medium.

By independently counting organic clicks as part of Google’s ‘economic impact’, they could be seen as giving away valuable traffic for free, when in fact they are not. The quality of their natural results is integral to the quantity of paid traffic they generate. The paid ads are the way they monetize their natural listings. The natural listings attract people to the site. To assert otherwise is disingenuous.

What about the AdSense payments Google makes to small websites who host ads and get paid each time a user clicks on one? Does Google not deserve credit for the economic impact of giving away all that money? Again, one must realize that the money that Google distributes as payments came from the advertisers – it is the advertiser, not Google, who gives the website owner some money for that transaction. Google just acts as the middleman and takes a cut for themselves.
How, then, do we then correctly calculate Google’s contribution to the economy?

The same way we determine the economic impact of other companies: the value of the goods and services produced, minus the value of all of resources consumed. Google generated revenue of $23.65 Billion in 2009 and by their own reckoning, their expenditures were about $17.13 Billion, which means that Google’s worldwide value addition was about $6.5 Billion. Google does just under half of its business in the US, so their US economic impact in the US was about $3.2 Billion, far less than the $54 Billion they claim.

If the purpose of Google’s study was to generate attention, a higher value is better. But if the purpose was to make a fair and honest assessment of their economic impact on the US, they need to go back and re-check their numbers.

 Intermediate Microeconomics for Google
Bradd Libby is Manager, AdMax™ R&D at The Search Agency and a frequent contributor to The Search Agents blog.
 Intermediate Microeconomics for Google
 Intermediate Microeconomics for Google

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