Google the Traffic Cop

Google’s mission is to, “organize the world’s information and make it universally accessible and useful.”  That’s all well and good, but someone has to foot the bill.  Currently, the advertisers of the world are footing the bill.  Google places ads on its search engine results and on a network of sites.  When a web surfer (which mistakenly implies physical exertion) clicks on a link in an ad, the advertiser pays an agreed upon “cost per click.”  In 2007 65% of its ad revenue came from clicks on Google.com and 35% came from its network of sites (from Google Investor Relations).  What are advertisers really paying for and what is Google providing?  Web traffic rerouting.

Imagine the web without advertisements for a moment.  It would be a gigantic, pristine network of sites connected by links.  You would traverse this utopia guided only by your inclinations.  If you were researching new cars (which of course had extremely high gas mileage), you might go to the manufacturers’ sites and look at pictures and gather information.  What is different about this utopian web is how you go about perusing these sites.  In utopian web you click in the absence of outside influence.  The utopian web would thus have a unique set of links connecting every site and a traffic flow between them.

Enter Google and advertisers.  Firms have an incentive to change the flow of this web traffic.  If I am General Motors, I would be willing to pay someone to alter the flow of this traffic, so that the majority of people researching cars end up at my site.  In 2007, firms were willing to pay $21.1 billion to place ads on the web to alter the flow of traffic, of which Google garnered a whopping $16.4 billion or 77%.  Placing ads alters the links and traffic flow relative to the utopian web.  Google is the great enabler of this process, which, when boiled down to its essence, is simply traffic rerouting.  This is also the job description of a traffic cop.  Hence the title of this post.  Larry and Sergey didn’t know that a Stanford PhD would get them into the traffic cop business!

It is worth noting that this traffic copping is no small task, which required a great deal of ingenuity on behalf of these two guys, namely with regards to Google Search, the centerpiece of this rerouting.  However, there is some simple economics behind Google’s success.  Again, suppose I’m General Motors, I want to spend my scarce rerouting dollars as effectively as possible.  Google offers me the ability to reach the most people, since its share of search is so high.  The reason people choose to search on Google, besides the good results, is they know that the network of advertisers is huge, so Google will show them all of the firms vying for their attention.  These are what economists call network effects, which means that the value of a network, like a social network, increases in value as the number of people using it increases.  The New York Times has a good article on this.  It is hard for any company competing against Google to offer a traffic rerouting system with a similar scale.  This will ensure that Google sits atop its perch for a long time to come.

We shall see whether Google follows a similar path to Microsoft in that as Microsoft created a large network of developers and increased the cost of entry into the operating system business, it increased its prices and engaged in anti-competitive activity to keep its status.  Google is already showing signs.  To thwart Microsoft’s attempt to acquire Yahoo, it struck an advertising deal with Yahoo.  This has frustrated Microsoft, which must know that to grow a network as big as Google’s will take much more money without Yahoo.  It will be intersting to watch, no doubt.