Analysing the AdWords business model

Nov 13, 2013

Table of contents:

Why does the AdWords business model work?
The core components of the AdWords model
How to apply the AdWords model
Conclusion

It’s hard to underestimate the impact that Google’s AdWords has had on the growth of the Internet over the last 10 years. Not only has it fuelled the growth of Google into a online juggernaut, but it was really the first credible form of online advertising with real transparency in Return of Investment.

Clearly Google would not be the company it is today without AdWords. The ability to generate that much revenue from a single product is enabling the Search Engine giant to take moon shots like self driving cars and free ubiquitous internet.

It therefore seems strange that the AdWords model has yet to really be implemented within a different vertical. Instead, you often see new startups going after the same business model, even when countless others in the past have failed to make it work.

In this post I’m going to be analysing the core components of the AdWords product, showing how it works and how the same business model can be a huge opportunity for any number of new online startups.

Why does the AdWords business model work?

Whilst there are many driving forces behind why the AdWords business model works, I believe the underlying reason is it perfectly aligns with the inherent objective of the open and neutral Internet.

It’s hard to remember now, but before Google and AdWords rose to prominence, online advertising sales were handled in much the same way as the offline world. Transplanting an offline model to the Internet has failed in countless industries so it isn’t really surprising that it was a model that flows with the tide of the Internet that was the one that really took off.

Instead of using the archaic processes of the offline world, AdWords relied on marketplace bidding, automation and the depths of targeting that the offline world could only dream of. By reimaging how the model should work instead of trying to migrate what has traditionally “worked” from the offline world, AdWords was able to get such a jump on the competition that Google remains the absolute outlier over a decade later.

The core components of the AdWords model

The AdWords model is, on the surface, a beautifully simple application of marketplace bidding. However I believe there are 6 main components that work together in unison to provide such a simple and effective model.

In order to truly understand how the AdWords model works and how it can be applied to other industries, we first have to analyse the 6 key components.

1. Self serve

The first key component is the customer’s entire experience with Google and specifically with the AdWords product is self service. This is complete contrast to the old world of offline advertising sales where each client would have an account manager and a sales broker.

Whilst self service seems so obvious in retrospect, it actually shows how early Google were to stumble upon the long tail of the Internet. Google realised that the long tail of the Internet would be much more lucrative than the highly competitive head.

Instead of trying to compete with the traditional big ad agencies and try to convince large corporations to spend their ad budget online instead of offline, Google democratised advertising to any human on the planet with a credit card.

The choice to go completely self service rather than recruiting sales and account managers is total genius on the part of Google. Instead of trying to transplant the old model of advertising online, Google leveraged the long tail and the open democracy of the Internet to create an ad network that intuitively fits with the ethos of the online world.

2. Market determines price

The second beautiful component of the AdWords business model is that the price of any given advertisement on the network is determined by the market. This means that any company wanting to use AdWords won’t pay a penny more or a penny less than the real value of the spot.

Market price is determined from fluctuating values of supply and demand. When the demand for a given keyword rises, the price of that spot rises. Conversely, when the demand falls, so to will the price.

AdWords therefore is a perfect implementation of the classic economic model of a marketplace.

Why is this so important? One of the biggest gripes with advertising in the offline world is the price of an advert is determined at the discretion of the host and not on the true value of that advert.

Market pricing also allows opportunities to find pockets of low demand advertising opportunities that can be leveraged at a lower price than what the market would value it at. Although this is much more difficult to find now, for many years thousands of early online companies plowed money in to Google AdWords to acquire customers at a very attractive cost of acquisition rate.

3. Clear incentive to bid more

Whilst Google have created a beautiful implementation of the perfect economic marketplace, the market pricing is only one piece of the puzzle.

Google is also able to place advertising in more prominent locations throughout their products. The area before the first organic search result or the top advertising on the right of a normal search results page are two such examples.

This gives aggressive marketers a clear incentive to bid more in order to secure the most prominent spots in the network for the desired keyword. So effectively, Google has not only perfected market place pricing, but they have also created many different spots for each keyword and then used market place pricing to determine the cost of each of those spots on the ladder.

When you give an incentive such as a more effective outcome, customers of the system will naturally want to pay more to increase their return.

This is good for two reasons.

Firstly, anyone can take part in the network no matter how small their budget is. You can get on the ladder on the bottom rung because there will always be a spot for you.

Secondly, companies that want to be more aggressive with their spending to expedite their results are free to continue to plow as much money as they want into the network.

In this situation, Google has created a marketplace that welcomes everyone on the ground level, but has no ceiling as advertising continue to plow more money in.

4. Direct ROI

Google is known for creating amazing online products and giving access away for free (supported by ads of course). GMail, Google Maps and Google Docs are three amazing products that Google has invested a lot of money into over the years.

Google Analytics is another great product that Google allows open access to. Google Analytics really quite quickly became the de facto software for tracking engagement on websites (although that has changed recently).

However the real reason why Google Analytics is free to use and continually updated is because it integrates so well into Google AdWords. Google Analytics provides all the tools straight out of the box to track the effectiveness of your AdWords campaigns.

A cliché from the world of offline advertising is “Half the money I spend on advertising is wasted; the trouble is I don’t know which half”. Another beautiful component of the AdWords model is that all of the tools you need to track every penny of your ad budget spend are freely available at your disposal.

Google realised that the lack of clear Return on Investment was a huge stumbling block for many in the offline world. By investing in building the tools and systems to track the effectiveness of advertising spending, Google can provide detailed breakdowns of how each individual campaign is performing so advertisers can get the most from their investment.

The emphasis of building this kind of accountability is yet another reason why it was Google who built the undisputed online advertising network and not one of the traditional offline advertisers.

5. Massive inventory

As I’ve already mentioned, Google was one of the first pioneers to discover the huge potential of the long tail. Google has not only been a beneficiary of the long tail, they have been one of the driving forces behind it.

In the early days, Google effectively allowed a user to find the most relevant content based on a particular search query. However over the years Google has plowed investment into YouTube, Android, Gmail, Maps as well as many other initiatives to increase the inventory for their advertisements.

Google also opened up their marketplace to any website owner through their AdSense product. Now any website in the world can turn on monetisation and have relevant, targeted advertisements be presented to their visitors with just a simple snippet of code.

One of the greatest things about the Internet is the unending breadth of information and data that is universally accessible. In the offline world, there is only one Superbowl or one season finale of the hottest television series each year and so supply and demand are at their extremes making it extremely difficult to get an effective return on investment. With Google leveraging and driving the long tail of the Internet, they can bring cost effective advertising to anyone who wants it.

6. User intent

And finally, one of the most important components in the success of AdWords has been that searching for something through Google has a clear user intent. When a potential customer searches for a product or service, it is usually because they want to find that product and buy it. This is in contrast to other ad networks like Facebook’s where a user is not on Facebook with an intent to find something, rather, they are probably just there to waste time.

Google has been fortunate to find a business model that effectively encourages and earns value from servicing a user’s intent. If Google had landed on a business model that didn’t intuitively fit with how the product is naturally used, I don’t think they would have anywhere near the same kind of success.

How to apply the AdWords model

So how do you apply the AdWords model to your product? As I mentioned at the top of this post, many companies have tried to implement the same model but have failed for one reason or another.

I don’t think any company will truly be able to build the AdWords model for a particular vertical and have it be as effective as it has been for Google.

However, you don’t need to just clone AdWords to secure success. It is more important to look at the 6 core components that I’ve highlighted above in order to see where the opportunity lies.

1. Democratise the opportunity

The first key difference between Google and the traditional advertising industry is they democratised the opportunity by creating a self service product. This means anyone wanting to advertise on Google’s network must use the same interface, no matter who you are or what your budget is.

One of the key philosophies of the Internet is open and neutral access to everyone. Whilst this might not have been Google’s intention, I think it is one of the underlying reasons why AdWords has been so successful.

So the lesson is, open your product up to everyone and treat all customers with the same respect. Don’t create special one offs for certain customers and try to create a self service product because it will have a major impact in your ability to scale the company.

2. Create a marketplace

One of the most powerful opportunities for online business models are marketplaces. Companies like eBay have a solid competitive advantage because they have created a powerful network around their company.

Aim to build a pricing marketplace that determines the price of your inventory. Whilst this might mean that certain aspects of your inventory will be priced lower than you hoped, the market will return the true price based on supply and demand.

You might also be interested in these three Culttt articles:

3. Incentivise and Reward

You should always ensure that your marketplace is open to everyone, but you should also create a system that rewards users if they desire to spend more money.

Google has executed this beautifully by ranking advertisements based on bid, but the same principle can apply in many different types of markets.

With low barriers to entry you encourage the growth towards network effects, but with the right tools, you also allow certain users to cut their signal through the noise.

4. Provide clear ROI

If your product does not naturally give a clear indication into the return on your user’s investment, then build the tools they require to get the most from your marketplace.

Making your user’s feel accomplished and that they are getting value from your marketplace is incredibly important to building a customer base of repeat spenders.

Providing insights and analytics is really a given these days thanks to Google Analytics.

5. Scale your inventory

Monetising a tiny marketplace is always going to be difficult no matter what business model you choose. That is why scaling your inventory is always going to be incredibly important to the success of your company.

6. Align your business model with your user’s intent

And finally, if you are fighting against the tide of your user’s intent you will never win. You must create a monetisable product around the actions of your users and how your product is used, rather than chasing a model that promises the highest returns.

If the Internet has taught us anything, it is you should always swim with the tide, not against it. You won’t be able to take an existing business model and add it to your product if it does not fit with your product’s DNA. Instead, focus on the activity of your users, recognise their intent and build a product and a business model that intuitively fits into that gap.

Conclusion

I think Google’s business model will be taught in classrooms hundreds of years from now because of the monumental impact it has had on the early growth of the Internet. As I mentioned at the top of this post, it’s hard to wrap your head around how truly effective the model is and how it has kept Google as the undisputed industry leader for well over a decade.

Whilst there have been thousands of marketplace businesses in the time since Google launched AdWords, I can’t think of any that have really taken the AdWords theory and placed it in a different vertical. Whilst certain industry leaders have absolutely taken individual aspects, I still think there is an opportunity to take the 6 components I’ve outlined in this post and build a magnificently dominant business in any number of adjacent industries.

It is these types of nascent opportunities that make me so bullish on the future of the Internet.