Chris Zaharias (aka "Z") on the state of search advertising

I ran into Chris Zaharias of Efficient Frontier yesterday, one of the leading SEM service providers.  (Chris and I went to the same high school in Palo Alto.)  I've recently been wondering what would happen to the market if search advertising growth slowed, and he had some really interesting things to say about where things are going.  His position in the SEM world gives him a great vantage point for understanding how advertisers are spending with the search engines.  

I asked Chris what he thought of Google's preemptive performance warning the other day, and he said this was bound to happen:

"The additional knobs they had to turn in the past to outperform are largely gone.  They already have 3 ads on the top, they already have taken all the marketshare they’re gonna take, and the auction effect has already taken its upward toll on CPCs."

As a result, spending patterns are changing, too.  The combination of available terms, query volume, ad placement, user clicks, and affordable CPC's is starting to balance out into a more sensible ecosystem.  Advertisers are closing in on the upper limits of their market and understand how to get what they want out of a buy.

Despite a flattening effect on average, spending should still increase in higher value areas as marketers get more clever with their tracking.  The value differential between a relevant and an irrelevant keyword will start to matter more.  Brand will start to matter more, too:

"As well-known brands come in, they’ll get higher CTR’s than CPC’s by themselves don’t matter. What matters is CPC times CTR."

The trick for all the ad networks is to help advertisers reach all the way across the funnel.  They need to help advertisers track and analyze performance from impression to click to purchase.  There's huge potential in behavioral targeting.  And there's a lot of work to be done in lead capture.

"Advertisers are converting at 2.3% right now, yet good advertisers convert at 4-6%. As advertisers get higher conversion rates, they churn it back into the channel.  Behavioral targeting should add much value to search inventory as well, but Google isn’t in as good a position as Yahoo or MSN to get that data."

Chris backed up what we keep hearing from John Battelle about toolbar and desktop downloads.  That's how Google is going to make behavioral targeting happen.

The broader upside is that Internet advertising reached over $12B in 2005, according to IAB, an increase of 30% over 2004.  Internet advertising outspent radio for the first time, and that trend probably won't reverse for a long time.  Google and Yahoo! will obviously capture most of that revenue, but the opportunities are growing across the board.  Unlike the crash after the last bubble, a burst now could have a soft landing as revenues begin to spread out across the market.

I've been very dubious of offline market opportunities for Google, but Chris was very bullish on this opportunity:

"Google is kicking ass because they have a huge user base and a better auction system that nets 30-40% better monetization than Yahoo. When RFID readers and tags are cheap, in cell phones and offline media (5-10 years out), and sync’d with PCs, an advertiser will know if a user saw a billboard prior to making an online purchase and thus will be able to re-value the billboard ad on the fly -- leading publisher to auction billboard/print/TV/radio inventory in real-time, probably with Google, Yahoo, MSN’s systems at the middle of things."

Hmmm, I dunno.  Maybe I'm not close enough to what's happening to understand how that unfolds, but I don't think Google, Yahoo or MSN are capable of delivering on that vision any time soon.  

It sounds like business is booming for Efficient Frontier.  It makes sense that it would.  SEM is getting more and more complicated and simultaneously more and more critical.  I might revise my investment wishlist to include a play in this space, too.


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Posted:  Fri Mar 10 13:30:08 EST 2006
Chris Zaharias (aka "Z") on the state of search advertising