Google Primer

How "contextual advertising" could be the death knell for traditional media outlets like the New York Times.

Brandon Clay

For anyone doubting new advertising mediums, let your fears be assuaged.  Google (GOOG) reassured the market that its way of doing business brings in solid revenues - consistently.  Bear in mind, this is at a time when the New York Times Company posted one of its worst quarterly losses in history.  The old media is dying, but the new media is picking up where they left off.

As Patrick discussed several weeks ago, Google (GOOG) is not a technology stock, anymore than News Corp (NWS) is a technology stock.  Although they've learned to leverage the internet, and will continue to do so, Google makes money in a revolutionary advertising medium called "contextual ads".  For those unschooled in the still-developing ad scheme, here's your two-minute tutorial:

When you 'Google' a word or phrase, you get two types of results.  On the left hand side of the page, you see Google's organic results.  These are 'free' links that companies or individuals earn by simply providing content in the manner Google deems commendable.  It takes awhile for companies to earn a top spot on the left-hand side of the page, but it's possible. 

However, the right hand side of Google is a different matter.  When you search for something at Google, this thinner section displays advertisements from different companies.  Called "Adwords", "Contextual Ads", or "Targeted Advertising", companies pay money for placement on the first page of Google, immediately.  Each time somebody clicks on these paid links, these companies get traffic to their websites.  These ads can cost companies or individuals $.01 or $100 dollars.  Cost is determined from an auction between competing advertisers.  It's a very targeted and effective advertising method.

Contextual advertising makes billions of $$ for Google every quarter.  In Q1-2008, Google generated 91% of $5.19 billion from contextual ads.  Ninety-one percent!  That's a lot of money in advertising revs.  Plus, it's the object of envy for dying media types like the New York Times.  Just think about it: a company can drop a few thousand bucks for a section-placed ad in the Times -- or they can invest a few thousand dollars at Google directly in people searching for their products.  Hmmm...as a business owner, which one would you choose?

Investors should keep this in mind when digesting Google's latest bounce up the chart:

Google's performance is less a statement of the health of the market, and more a statement on the health of a model.  That is, the advertising model.  Companies like Google are becoming increasingly adept at matching ads to internet users.  This is attractive to businesses that thrive on finding customers searching for their products and services.  If Konterra, and Chitika can match the business savvy of Google, look out!  These sorts of contextual advertising companies will grow at the expense of media-types dependent on old-school advertising.  Then we'll see even worse results from hemorrhaging dinosaur newspapers.