Changing Ad Market hits Google Earnings

Google shocked Wall Street last week by reporting quarterly earnings well significantly below expectations. Investors took flight as the market value of Alphabet, Google's parent company, dropped 7.5% on the wake of the announcement. Quarterly earnings still went up by 20%, but margins fell substantially, spooking investors who have often worried about the long term viability of the search giant's current business model. At the heart of their problem is the persistent drop in cost-per-click numbers that has been going on for years. The cost of the average Adword is falling and has been doing so consistently for the past decade. Google are making less money from every ad displayed, in a trend that most analysts believe to be irreversible.

Google have been making up for this by selling an increasing number of ads on mobile – total revenue from advertising went up again by 15%, but this is a far slower increase than in the comparable quarter in previous years. Ultimately, there is a limit in how many extra ads that Google can serve up to audiences. Their growth in previous quarters has come from mobile, particularly their own Android operating system. Every quarter has seen questions about how many ads Google can place on the typical 4" to 6" mobile screen. This misses the point – Google's increasing revenues have come more from the increasing number of screens rather than increasing the number of ads on the same number of screens. It is no surprise that Google's revenue growth is now slowing at the same time that growth in the mobile phone market is beginning to plateau.

That is not the only trend harming Google's advertising revenue. Amazon has reported record advertising revenues over recent quarters, as a result of agencies shifting ad spend for shopping ads from Google to Amazon over recent quarters reflecting better ROI for CPG firms on the internet retailer, and the declining relevance of Google Shopping. Other advertising destinations have seen sharp increases in revenue as well, not least Twitter and Microsoft owned LinkedIn. Even under fire Facebook is reporting faster revenue growth. Notably, both these platforms have reported particularly high revenues with video ads, which matches the success and high conversion rates reported by advertisers for video and carousel ads.

The Controversial Problem

Ironically, the one company struggling with video advertising is Google. In a conference call to investors, YouTube was named as the root cause for the search giant's slowing advertising revenues. The world's leading video sharing site has had a tough 18 months, with multiple scandals caused by controversial user generated content from a number of content creators. This is caused a consistent cycle of advertisers pulling their spend after each scandal over concerns that their ads could appear alongside the offending content, only to return to the platform once changes have been made by YouTube management to fix the underlying issue. There have also been changes to ad formats, which it is believed have reduced the number of clicks that ads are receiving.

Unfortunately, for Google, the problem of inappropriate content is still not a solved one. Already this year there has been a scandal related to comments against videos targeted towards children that led to YouTube banning comments against kids videos. So long as these problems continue to exist there will always be a certain level of reluctance to direct ad spend towards YouTube. This is despite the undoubted benefits of the platform to advertisers. It is the only place on the internet that has a video audience that matches the size of broadcast television. With 2 billion users the platform is too big to ignore for brands looking to target video ads at the demographics that don't typically watch mainstream television, but there is a definite trust gap that YouTube needs to close if it is to regain its lost advertisers. That's one of the reasons they've been promoting their original content efforts so hard; it gives advertisers a safe space to place their ads free from the threat of inappropriate or brand-damaging content.

The Algorithm Problem

Google's business is based on AI and algorithms. Their core search product is successful because it has the best search algorithm in the business. This has been applied to YouTube as well. YouTube's algorithms drive not just their own search features but also the content moderation features that are so crucial to advertisers in separating brand appropriate from brand inappropriate content. Sure the platform does have human moderators, but they only review a small proportion of the content uploaded to the platform. Instead, YouTube relies on machine learning to identify and remove or restrict controversial content. Videos containing copyrighted, illegal or harmful material are automatically removed. However, videos that are merely controversial or sensitive are instead demonetized, which means that advertising cannot be shown against them. This is controversial among YouTubers with accusations that the automatic demonetization of certain topics is discriminatory.

This is the underlying concern about any form of advertising on social media platforms. You can't control what content your ads are shown against. For some categories of advertising, this is an accepted risk – notably Google's core Adwords platform where targeting ads towards your competitors brand names is an accepted business practice. The problem comes when ad platforms rely on automation and imperfect machine learning algorithms to prevent this practice where it is inappropriate. Google's over-reliance on machine learning has caused many problems for them over the years – particularly when it comes to their consumer offerings. The reputation of their customer service is abysmal. Their content ID copyright protection system has come under heavy scrutiny too. They've been able to overcome these challenges by improving the algorithms that underlie them and will continue to do so. However, machine learning is still an evolving technology. Google are the best in the business at it and will continue to make huge profits from their AI leadership for years to come. But, there is still a place for human judgement and intuition. It is noticeable that even Google are relying on human moderation for the advertiser safe YouTube Originals. In fact, they've expanded human moderation across their platforms over the past year in response to their many scandals. Facebook have done likewise. Both AI and Humans have complementary skills - no market leading business can afford to rely on one exclusively.