Google and the Disintermediation of Search

This week, the growing amounts Google pays phone makers and other companies to carry its search engine have been in the news as financial analysts have expressed concern over margin pressure. The growth in those traffic acquisition costs is certainly worth watching, but I’d argue that by far the larger strategic threat to Google comes from the growing disintermediation of search, something that’s also been in the news this week.

Google’s Growing Traffic Acquisition Costs

There’s no doubt that Google’s traffic acquisition costs have been growing, not only in absolute terms but as a percentage of revenue. By far the biggest driver of that increase is the increasing cut Google has to pay to Apple, Samsung, and others who give the Google search engine prime placement in their browsers. The chart below shows the percentage of revenue from Google’s own sites which it has paid out in TAC to these partners:

As you can see, that number has risen in various phases, notably from 2011-2013, and again starting in 2015 and continuing through the first half of this year. Overall, the percentage has nearly doubled from 6% to 12% during this eight-year period, and the trajectory continues to be dramatically up and to the right. That reflects the fact that an increasing proportion of Google’s search traffic and revenue now comes through smartphones and especially the iPhone, which likely constitutes a big chunk of its overall TAC payouts.

Disintermediation May Be the Bigger Issue

However, all of this only affects the search revenue Google actually generates and the margins it can drive off the back of that. Certainly, if TAC continues to rise in this way, that should squeeze margins, but the threat of disintermediation could undermine the revenue base on which those margins are generated in the first place. What do I mean by disintermediation here? The fact that many of what would once have been Google searches are now pre-empted by other apps and services before the user ever reaches Google. Here are just a few longer-term examples:

• Apps: whereas users once used Google as a starting point to reach a variety of websites, they’re far more likely today to visit smartphone apps associated with those sites. To the extent that there’s any searching going on, it likely takes place within the narrower confines of those apps or perhaps an on-device search engine.
• E-commerce: for online retail specifically, past studies have shown that some 55% of searches now originate not on Google.com but on Amazon.com, again cutting Google and its search and ad revenues out of the picture (and in the process allowing Amazon to quietly build its own search advertising business.
• Voice: people are increasingly using voice interfaces to search for information they once used a text search for, both on mobile devices and increasingly on smart voice speakers like Amazon’s Echo and Google’s own Home products. In many of these cases, even on Google’s platform, there’s currently no ad revenue opportunity associated with that.
• Bots: Facebook and Microsoft have now both announced integration of AI-based virtual assistants into their messaging platforms, with Microsoft finally launching Cortana in Skype this week after trailing it at last year’s Build conference. These bots will increasingly pre-empt searches because they give users the information they need when they need it in proactive ways.
• Contextual information: even if AI-powered bots aren’t serving up this information in a messaging context, there are a variety of other ways in which information previously provided reactively is now being provided to users proactively. Snapchat’s addition of Context Cards this week is the latest example of this, offering up restaurant reviews and ride sharing services in the context of Snaps with location tags.

Google clearly recognizes all of this, which is why it’s been one of the biggest proponents of progressive web apps and other approaches which try to reassert the pre-eminence of the web, though it hasn’t had much success with that approach against the continued growth of native apps. But it’s also clearly aware that it may as well try to play in secondary roles where it can, which explains its recent reappearance as the back-end of Apple’s Siri search functions in iOS and macOS, which likely resulted from a bigger financial incentive, which in turn will drive up traffic acquisition costs further. But such concessions are going to be increasingly necessary if Google is to maintain its search and ad revenue growth in the face of these multi-faceted threats.