Growth At Google Requires Managing the Cost of Clicks

Amazon and Facebook have grown faster in the past year, while Apple has held Google hostage over the cost of maintaining access to iPhone customers, all of which are pressuring Google/Alphabet's margins. JL

Dan Gallagher reports in the Wall Street Journal:

One challenge unique to Google is the sums it spends to drive the traffic that feeds its advertising business. Such traffic acquisition costs, or TAC, totaled $16.8 billion last year. That is up 17% from the year before and was the largest jump in five years. Rising TAC can hurt the company’s growth and profitability if total ad revenue doesn’t outpace it.That puts pressure on Google as more of its traffic is coming from mobile devices that carry a higher cost.
The fact that Google is free to use belies the fact that there is a substantial cost to driving all those clicks.
Clicks, of course, are how Google generates advertising revenue that now totals nearly $80 billion a year. Growing such a huge business is no easy feat—especially at the double-digit rates the company has been reliably pulling off for years. But grow the company must, especially if it is to regain favor with investors who have shown a preference for other internet names of late. Alphabet , Google’s parent company, has gained 12% so far this year. Amazon and Facebook are up 21% and 27%, respectively.
One challenge unique to Google is the sums it spends to drive the traffic that feeds its advertising business. Such traffic acquisition costs, or TAC, totaled $16.8 billion last year. That is up 17% from the year before and was the largest jump in five years. Analysts typically measure Google’s revenue on a net basis—minus those costs. But rising TAC can still hurt the company’s growth and profitability if total ad revenue doesn’t outpace it.
That puts pressure on Google as more of its traffic is coming from sources such as mobile devices that carry a higher cost. Apple, for instance, generates traffic for Google when iPhone customers use the search bar in its Safari mobile web browser. Neither company will discuss the terms of their current arrangement, but a document from a lawsuit unearthed by Bloomberg last year indicated that Google paid Apple about $1 billion in 2014 to keep its search bar in Safari. Mark Mahaney of RBC Capital believes renewal of the Apple deal was a big driver of Google’s higher TAC last year.

What Google pays to drive traffic to its own sites is particularly important as these make up about 70% of Alphabet’s total revenue base. Google’s outlay to distribution partners for that traffic last year totaled $5.9 billion or 9.2% of its total sites revenue. That is up from 7.8% of revenue the year before. Eric Sheridan of UBS projects that distribution TAC will total about 10% of Google’s sites revenue this year.
That is why Google can ill-afford obstacles to growth, such as the departure of high-profile advertisers from YouTube that The Wall Street Journal reported last month. The impact from that remains unclear and is unlikely to be reflected in the company’s first quarter report due Thursday. But even if that proves to be just a short-term problem, Google over the long haul will need to show that it can keep the clicks coming—at the right price.