Internet advertising and the decline of Google?

Has Google passed its peak? Last November its share price hit an all time high, since when the firm’s shares have lost 40% of their value. Is this just down to turmoil in the world’s financial system or something more significant?

The scare started when comScore, a research firm, reported in late February that Google’s “paid clicks” had decreased by 7% during January, and were flat compared with the same month a year earlier. In other words, surfers who searched the web via Google itself, or who visited websites that belong to Google’s advertising network, clicked slightly less frequently on the little text advertisements that Google often places on these pages. The numbers for February were no better.

What does it mean when people click on Google’s ads less often? The Economist newspaper have a few interesting ideas. The first possibility could have been that web users performed fewer web searches, leading to fewer results pages, ads and clicks. But web searches on Google grew in January, and dipped only slightly in February. Google’s market share of searches also continues to grow.

Maybe the world’s mortgage mess and fear of recession among consumers have caused a downturn in advertising? That is possible, but unlikely, at least so far. eMarketer, another research firm, projects that online advertising in America should grow by 23% this year because of the popularity of the medium in the world of marketing. And it hasn’t happened at Yahoo! or MSN.

Maybe the likeliest explanation – according to comScore - is that Google itself is to blame by increasing the quality of its ads. Google does this in two ways. First, it offers fewer ads on each results page, and often none at all. This reduces visual clutter and pleases both users and any remaining advertisers. Second, Google seems to be trying harder to weed out those advertisers who bid low for ad space. Low bids probably show that advertisers do not expect the ads to generate much business. With less space devoted to ads, and only higher-bidding advertisers getting through, there are fewer ads to click on.

Google interprets lots of clicking without subsequent purchasing to mean that its ads are not very good. So if the drop in paid clicks turns out to coincide with more conversions into actual sales, Google’s revenue for each individual click ought to shoot up, since the marketers would be prepared to pay more.

Is this happening? Google reports on its first quarter of 2008 on April 17th. Until then, the case of the mysterious missing clicks remains unsolved.