Revenue from Adwords made up 96% of Google’s total revenue in the first three quarters of 2011. As they continue to blitz every business publication with “free” Adwords credits, more and more businesses are giving it a try. However, the irony is that the more Google grows, the more likely they are to cause their own demise. 

In their Q3 financial report, Google made some points that illustrate what I’d call a self-defeating prophecy.

The increase in advertising revenue for Google websites and Google Network Members’ websites resulted primarily from an increase in the number of paid clicks through our advertising programs and, to a lesser extent, an increase in the average cost-per-click paid by our advertisers.

The increase in the average cost-per-click paid by our advertisers was primarily driven by the increased spending from advertisers and a general weakening of the U.S dollar compared to foreign currencies (primarily the Euro and the British pound)

Source: Google Financial Report Q3 2011

Do you see my point? Google’s Problem Is Their Success

“The increase in the average cost-per-click paid by our advertisers was primarily driven by the increased spending from advertisers”

So what they are saying is that the more they grow, the harder it will be for their advertisers to make money using their services. It’s already a gigantic challenge for most businesses to figure out how to use Google Adwords profitably. It’s also why there is an entire economy of businesses focused solely on helping companies make money using Google Adwords. If you don’t know what you’re doing it’s next to impossible. Also, if you aren’t paying attention, you’re giving away money and getting nothing in return.

The more Google grows through companies seeking to make money advertising on Google, the more difficult it is for companies to make money advertising on Google. How is this a sustainable business model?

If I told you I had a great business idea that allows people to make money playing games on my site but the more people who play games on my site, the less money people will make. Eventually, if I’m successful enough, nobody will make any money. Would you invest? Probably not, right?

In their quarterly report, Google also said:

Average cost-per-click on Google websites and Google Network Members’ websites increased approximately 5% from the three months ended September 30, 2010 to the three months ended September 30, 2011 and 8% from the nine months ended September 30, 2010 to the nine months ended September 30, 2011.

When Google started selling ads in 2000, bidding started at $.05 per click. Let’s assume however that the increase in cost per click has been 8% annually from 2002 – 2011. That would equal a 112% increase in click costs. Do you know any company who has increased their prices 112% in the past 10 years? If not, the only way for a company to do as well with Adwords as they did 10 years ago is to increase their conversion rate 112%. That is a nearly impossible feat for many companies. The realistic scenario is that companies are spending more and getting less… and less… and less on Adwords.

How long will it take before clicks are too high for businesses to get a positive ROI? For many industries, we’ve already hit that point. Let’s say you sell t-shirts for $18.00. Clicks are likely $1.00 and the average site converts traffic at 2%. So you’d pay $100 for 100 clicks. You’d sell 2 shirts for $36. Hmmmm.. not good math. The only way Adwords would work in this scenario is if the conversion rate was earth shatteringly high or the average transaction includes at least 6 shirts purchased.

The scenario above applies to any business who has an average transaction value that is less than $50. If you don’t make at least $50 per transaction, GOOD LUCK getting clicks from Adwords for less than $1.00.

My point is that 10 years ago, even businesses with lower average transaction values could make money with Google. Those days are gone… and each year that Google allows the cost per click to inflate far beyond actual infation, the more likely they are to isolate themselves from the market that currently accounts for a large majority of their revenue.

One last reference to Google’s Q3 2011 quarterly report shows that Google is aware of the importance of its advertisers getting a good “return on investment.”

We believe the factors that influence the success of our advertising programs include the following:
• The advertisers’ return on investment from advertising campaigns on our websites or our Google Network Members’ websites compared to other forms of advertising.
• The total advertising spending budgets of each advertiser.
• The number of advertisers and the breadth of items advertised.

The only way to ensure a good ROI for advertisers is to control click costs. Since that is a key part of their revenue growth, I don’t see that happening anytime soon.