Leverage

Google’s long known that scale means leverage in its search results, and it’s also getting very good at doing the same in its financial results. Check this note from Bill Morrison at JMP Securities:

Google Inc. (GOOG – $508.60): Google increases monetization without sacrificing search quality or user experience; reiterate Market Outperform rating and $625 price target. On August 8, 2007, Google announced a significant change in its formula for determining when ads can be promoted to the top (north) position – above the organic search results – from the slots to the right (east) position of the organic search results. Our analysis, detailed in the note below, suggests that the new monetization algorithm could drive Google’s gross revenue 2-4% higher. Google only promotes ads from the east to the north position when ads meet both a minimum quality score (CTR estimate) AND a minimum effective CPM (eCPM) threshold, which is calculated as follows: CTR * CPC * 1000. Previously, when checking whether an ad’s eCPM exceeded the threshold for north promotion, Google used the advertiser’s actual CPC paid, which is typically $0.01 above the next highest bid in the auction, in the CPM calculation. The actual CPC paid is often well below the max CPC bid by an advertiser. Under the new system, Google will change its eCPM calculation by using a CPC that is equal to, or less than, the advertiser’s max bid CPC. This change will result in increases to advertisers’ actual CPC paid when a CPC that is equal to or less than the advertiser’s max bid CPC generates an eCPM that exceeds the threshold eCPM required for north promotion. In addition to the CPC increase, there will be a CTR increase associated with this ranking change that should have an even greater monetization impact. Our research suggests that ads in the north position can generate 2x the CTR of ads in the east position.

In short, fiddling the dials just a bit can mean much better financial results.