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Google beats expectations - why I'm not surprised

There has been widespread discussion in the blogosphere about the rate of growth of paid clicks beginning to fall off at Google (GOOG). This has been a major factor driving the stock's price lower.

After the close yesterday, Google reported profits increased 30% and revenue moved up 46% to $3.7 billion. The company reported net income of $1.31 billion, or $4.12 a share, compared with $1 billion, or $3.18 a share, a year earlier. The EPS figure was well above analyst estimates.

Paid click growth was 20 percent year-over-year, much stronger than the anemic growth rate comScore was estimating.

Another reason --

In this post, however, I want to look at a feature of Google's advertising methodology that is probably less well known to financial bloggers but certainly more well known to search engine optimization (SEO) experts.

AdWords is the system that serves up the text ads that are viewed along side search results. Advertisers associate their ads with keywords that appear in searches. Google uses an auction-based system for its AdWords product that allows advertisers to bid on each keyword to define how much they will pay for a click on their ad.

In my own personal interaction with AdWords, I see continuous keyword inflation. In other words, bids for good keywords continue to rise. If an advertiser wants to be able to have their ad displayed on Google search result pages based on a keyword pertinent to their product offering, they need to continuously monitor the price of the key word and maintain a bid high enough to keep their ad active. Otherwise, the keyword is considered inactive by the AdWords system and the ad gets no impressions.

As competition for the best keywords increases, prices go up. Now that the system is in place, this takes virtually no investment on the part of Google. In this case, it is Google's customers that are driving the increase in ad revenues for Google. If advertisers want search ad exposure, they have no choice but to pay.

This is another reason why the company's business model is brilliant.

Disclosure: author has no position in GOOG

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