One of the big mysteries in Google's last earnings call was why cost-per-click -- the price advertisers pay whenever a user clicks on a Google ad -- was down 12% from the previous year. This is the second quarter in a row where this has happened.
On the earnings call, Google cautioned investors that it was too complicated for them to figure out, citing a combination of foreign exchange rates, growth in mobile and developing countries, and new ad types.
But we spoke to a person familiar with Google's ad business, and he has another theory.
(This person asked not to be named because he does not want to jeopardize a business relationship with Google.)
Google has added a bunch of new display advertising inventory in the last couple of quarters, but it hasn't been very successful yet in getting small and mid-size businesses to buy it.
Specifically, he pointed to Google's acquisition of AdMeld, which closed in December. That's exactly when Google's CPCs started to drop.
AdMeld is a real-time bidding platform for publishers, which allows them to sell ad space on exchanges in a real-time auction format.
AdMeld works with a bunch of large publishers, and now those publishers are all in Google's ad system.
So here's the problem: when advertisers win a bid to place an ad on Google, they do not pay the price they bid. They pay a tiny bit more than the second-highest bid.
With Google's traditional search advertising, which still makes up the vast majority of its ad sales, a lot of small and mid-size businesses bid on keywords. This tends to drive prices up.
But display ads still have fewer bidders -- mostly larger companies, since smaller companies don't see the immediate and obvious return on investment that they do with search. It's harder to track, for instance, the many times a user has seen a display ad before they actually click to buy something. Search is "at the bottom of the funnel" meaning that it's the last ad customers click on before they make a purchase. (That's why it's the greatest ad invention of all time, and why Google keeps growing at more than 20% per year a decade after pioneering the model.)
So relatively speaking, CPCs for display ads are lower than CPCs for search ads. Adding a bunch of new display inventory will drive average CPCs down a bit.
This person said that Google needs to do a better job convincing smaller businesses to buy display ads, and suggested that Google is working on new systems that will help track the effectiveness of these ads.
He also agreed that more mobile ad inventory is probably also a factor.
All of this is actually good news for the Google's long term health as a business -- it has to diversify beyond its core of search advertising. Plus, adding inventory is one way to ensure that the total number of paid clicks continues to rise.
But as it makes this transition, CPCs might drop for a while.
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