Most people don’t care how search engines make money. They are free, right? This “free” attitude is similar to a home buyer that tells you that they didn’t care how much the real estate agent made because “the seller paid the agent’s commission.” But most people realize that the commission is factored into the price of the house they just bought. In other words, that 6% commission just came out of their bank account. Score one for the intermediary.

Now consider what technology is doing to the traditional residential real estate broker. The “For Sale by Owner” (FSBO) industry has used the power of the Internet to create a more efficient intermediary to match buyers and sellers of homes. New intermediaries like Fsbo.com, forsalebyowner.com, and a host of others charge significantly lower flat fee rates to market a home. The rationale: you don’t need to pay 6% of the sales price because technology allows us to be much more efficient in finding a buyer for your home. Even with the real estate industry controlling the MLS database, this new intermediary has been extremely successful. Experts estimate that close to 20% of all home sellers now go the FSBO route. ForSaleByOwner.com, for example, says in a recent Washington Post article that it has helped sell more than 90,000 homes since 1997, saving about $1 billion in commissions in the process. The residential real estate industry makes strong arguments for the value they provide, but new services continue to chip away (Zillow for pricing expertise, for example). I think the 6% commission will continue to go the way of the dinosaur.

Like FSBO for real estate, Internet search engines make money by selling advertising-they connect buyers and sellers on an incredible range of products and services. So the question I have is this: are these search engines using technology to lower transaction fees (and ultimately end prices) like the FSBO intermediaries claim to have done? Have Google or Shopping.com, for example, saved companies billions of dollars of advertising fees that are no longer built into the prices consumers pay for products and services?

Pay per click search advertising started out with this kind of promise. The engines used technology to efficiently harness the value of consumer attention and created tremendously targeted connections between buyers and sellers in the process. Lots of extra value was created. In the early days of paid search advertising, the transaction cost of matching up a buyer and a seller (e.g., advertising/customer) was dramatically lower than the cost in other media, creating lower customer acquisition costs for advertisers. But paid search pioneer Goto.com set this system up in a brilliant fashion; they lured advertisers into paid search in an auction environment, often at really low initial pay per click fees. Thus, as the advertising got better and competition for it increased, the advertisers began paying higher and higher fees to the search engine intermediaries. The existing auction system is very efficient at moving these fees to ensure the intermediary gets maximum benefit.

What does this mean? It means that as paid search advertising becomes ever more targeted and powerful, the intermediary will continue to soak up all of the value in the form of higher and higher advertising fees. At a macro level, the result is that even if search advertising becomes dominant, advertisers aren’t going to be saving money in any predictable, industry-wide fashion that would allow the added value created by technology to find its way back to consumers in the form of lower end prices.

Let’s turn our attention back to the FSBO analogy. Consider what would happen if the FSBO sites used the advertising auction system used by most search engines instead of a flat fee. Wouldn’t this system go something like this: you can advertise your house for sale in San Francisco by agreeing to pay us $$ each time someone looks at your house on our site, and the more $$ you agree to pay us, the more prominent you will be on our site, the more buyers will see you, and the faster you will sell. If this system took off and became mainstream (think Google/Yahoo) by creating a really fast and easy way for you to find a qualified buyer, everyone would start to use it and that competition would drive up the cost to advertise very quickly (the efficiency of markets). Ultimately, that increasingly expensive advertising would again get factored into the price of homes at a macro level. The system may not go all the way back to average 6% of the sales price (or would it as it became more powerful?), but I’m guessing it would be more than the low flat fee you pay on a FSBO site today. This analogy isn’t perfect because over time the FSBO’s of the world will also raise their prices if they gain market share, but right now home buyers and sellers are getting lots of extra $’s in their bank accounts.

You may be able to poke holes in my analogy (please do!), but I hope it gets you thinking about the inherent misalignment of interests at play here. The simple fact is that the more powerful, targeted and valuable paid search advertising becomes in the existing ppc auction system, the more $$’s search engines will extract from the system. The increased value is very efficiently soaked up before it can find its way to end-consumers in the form of lower prices.

Think about what would happen if Google became so powerful it could predict with 99% accuracy what advertising you wanted to see. Advertisers would compete to get their message in front of such a pure targeted audience (you). Fees would be incredibly high. Would you get any of that extra value? You certainly would obtain relevant advertising, but is that enough? And to make it worse, this system is hidden from you (you have no idea what a business paid for your click). It is like you are buying a home, but you can’t tell whether you are talking to a fully commissioned broker or someone who is getting a $90 flat fee. But don’t worry; you can take the attitude of our home buyer at the beginning of this post that doesn’t worry about the broker commission because he isn’t paying it. Search engines are free, right?

At Jellyfish, we think consumers need to be brought directly into this value chain. Technology can make consumers an equal participant in the advertising ecosystem. We look forward to showing you how when we launch.

This entry was posted on Friday, May 26th, 2006 at 9:48 am and is filed under Transparent Advertising. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.