Majestic Research

The Wall Street Journal

Web Ads Vulnerable to Slowdown

By Kevin J. Delaney
Published: February 26, 2008

Internet advertising is showing itself more vulnerable to a consumer slowdown than many in the industry had hoped, according to new search-ad data released this week.

The report from research firm comScore Inc. showing a decline in the number of consumer clicks on Google Inc. search ads in January amplified existing concerns about the effect of a broader economic slowdown on the Internet. Many online-ad experts have played down such worries, predicting any economic weakening will be offset by a continued shift in ad spending from traditional media to the Internet. Google Chief Executive Eric Schmidt said the company hadn’t seen any impact from macroeconomic softening when the Internet company reported earnings on Jan. 31. But some investors and analysts have grown anxious in recent months that any pullbacks in consumer spending would hurt online ads.

ComScore on Monday released data to clients showing a 7% decline in the number of times U.S. consumers clicked on ads appearing alongside Google’s search results in January compared with December; clicks were 0.3% lower compared with January 2007. That follows a 7% decline from November to December. Google only charges an advertiser when a user clicks on one of the small text ads for, say, digital cameras, that appear when a user searches for “digital camera.”

ComScore also reported a 1% decrease in U.S. search-ad clicks for Yahoo Inc. for January from December, with clicks increasing 4% for Microsoft Corp. over the same period.

Google shares lost 4.6%, or $22.25 on the news, falling to $464.19 in 4 p.m. Nasdaq trading Tuesday, having dipped more than 8% lower earlier in the day. Google is trading 38% lower than its 52-week intraday high.

Some analysts say comScore’s latest numbers may exaggerate any slowdown in clicks. J.P. Morgan Internet analyst Imran Khan in a research note pointed to divergences in the comScore click data and Google’s reported results in the past.

RBC Capital Markets Internet analyst Jordan Rohan called investor reaction to the data “overblown,” saying that it fails to take into account any increases from revenue per search due to factors such as higher pricing. Mr. Rohan said that RBC checks with search advertisers indicated a pickup in spending in February following weakness in January. “It may not be a great first quarter, but it’s not going to be as bad as the numbers from comScore suggest,” said Mr. Rohan in an interview.

The concerns about the online ad outlook come amid indications that Internet advertising hit record levels in 2007. The Interactive Advertising Bureau trade group and PricewaterhouseCoopers on Monday estimated that U.S. online ad revenue hit $21.1 billion last year, a 25% increase from 2006.

Google declined to comment. When it reported fourth-quarter revenue and profit that fell short of Wall Street expectations last month, Google said clicks on ads increased 30% in the fourth quarter from a year earlier, compared with a roughly 50% average increase during the previous four quarters. At the time, executives cited Google changes that lowered the click growth rate, such as a modification to site design that makes it harder for users to accidentally click on ads.

But some analysts say new data suggest the trends in ad clicks indicate Google is feeling an impact from a consumer slowdown in the first quarter, so far at least. The risk is that, if consumers are spending less overall, they’re less prone to click on search ads. Google has said that it could benefit from comparison shopping by price-sensitive consumers, who conduct more searches and click on more ads to find the best deal. But, over time, such behavior could lead advertisers to rein in online ad spending if they’re notching fewer sales for each ad click.

John Aiken, managing director of Majestic Research Corp. in New York, says his analysis suggests that’s exactly what’s happening, with small- to medium- sized advertisers pulling back on search advertising as the return on their ad-spend investment drops. When that occurs, Google has fewer ads to display, generally reducing the likelihood a consumer sees one he wants to click on. “It’s been a trend that’s been getting worse over the last four to five months,” says Mr. Aiken.

Tepid electronic-commerce data have added to concerns, given a link between online sales and advertising. U.S. e-commerce spending in January fell 17% from December, and was up a modest 11% compared to January 2007, according to comScore. They had fallen 14% in January 2007 from December 2006, and risen 19% in January 2007 compared to a year earlier.

Some others say they’re not seeing a consumer pullback in online data. Consumer visits to retail sites from Google.com have increased 11% so far this year compared to the same period a year earlier, according to research firm Hitwise, a unit of Experian Inc. “I’m not seeing necessarily any signs of recession in terms of consumers curtailing their visits to retail from search,” said Bill Tancer, general manager of global research at Hitwise.

The anxiety about online advertising comes as Microsoft is pursuing Yahoo with an unsolicited cash-and-stock offer valued at $41.7 billion based on Microsoft’s share price in Nasdaq trading Tuesday. It’s unclear whether the concerns could affect the outcome of that takeover standoff, though a bleaker Internet-ad outlook could potentially increase pressure from shareholders on Yahoo to accept the offer, and decrease Microsoft’s willingness to raise its bid. Yahoo has rejected the bid on the grounds that it undervalues the company.