Editor’s note: Even as Google’s total revenue continues to flourish – overall revenue climbed 20.1% year-to-year in 3Q14 to $16.5 billion – there are signs that it is struggling to adapt, ironically, to the increasingly mobile-first advertising environment it created, says analyst Jack Narcotta of Technology Business Research. So what’s happening? Our Insiders get the detailed analysis.

HAMPTON, N.H. – Google’s (Nasdaq: GOOG) healthy revenue growth showcases its dominance in digital advertising, but lower operating margins reveal its struggle to monetize mobile

Google is primarily focused on sustaining revenue growth that ultimately fuels free cash generation, allowing Google to invest to bolster its own business units or acquire new technology or companies it believes will provide it with a competitive advantage in digital advertising markets against Microsoft, Yahoo and Facebook.

Even as Google’s total revenue continues to flourish – overall revenue climbed 20.1% year-to-year in 3Q14 to $16.5 billion – there are signs that it is struggling to adapt, ironically, to the increasingly mobile-first advertising environment it created. Cost-per-click fell 4% from 3Q13, illustrating that even as the volume of advertising revenue grows, a larger mix of less-lucrative mobile ads threatens to return less profit and dent margins. However, TBR believes margin growth remains a secondary concern for Google.

Google remains focused on expanding the breadth and depth of its advertising services, particularly those supporting its YouTube, Maps, AdWords and Performance Display platforms. The company’s 3Q14 results highlight how augmenting these core services are paying off in terms of revenue growth. However, TBR expects continued margin decline through 2015 even as revenue and absolute profit increase in tandem into 2015, largely due to due to the combination in investments to expand the infrastructure that supports its advertising business and the company’s expansion into markets beyond its core advertising business. While lower margins are not an indication of long-term weakness or gaps in Google’s portfolio, TBR believes they do highlight an area in which Google is struggling to capitalize on the sustained proliferation of mobile devices, and smoothly shift the focus of its business model from desktop search to mobile devices.

  • New, expanded advertising services will further cement Google as the standard mobile advertising platform but will fail to triage declining cost-per-click

Google’s cost per click (CPC), a metric that calculates the price paid each time a website visitor clicks on an ad, has been steadily declining over the last two-and-a-half years. Additionally, recent trends illustrate that mobile devices are generating more than 55% of all internet traffic, and the decline in mobile ad prices – and corresponding decline of CPC – indicate that Google is still grappling with responding to the growth in search volume driven by mobile devices. Cost per click decline on a year-to-year basis is slowing, but is still shrinking even as Google’s total revenue, especially from ads driven through its YouTube and Maps platforms, continue to grow in excess of 20% year-to-year.

While total ad revenue will grow in tandem with the increase in mobile devices, TBR expects desktop CPC to slowly decline through 2016 as less lucrative mobile advertising accounts for a larger portion of Google’s revenue mix. TBR believes mobile advertising is less lucrative for Google since, as TBR research shows, it is more difficult for users to complete transactions on mobile devices, making the leads generated by mobile ads less profitable compared to PC websites that benefit from larger screens, putting pressure on the price of mobile search ads as users click less on them. New cross-platform campaigns have stoked demand for mobile ad words, and advertisers are bidding more frequently for them, especially as advertisers seek to make it easier to run ads across all types of devices and search platforms. Additionally, Google’s new Enhanced Campaigns aim to help advertisers create opportunities to interface with customers, providing tools that allow advertisers to more accurately track customer conversion and boost engagement after a customer views an ad.

TBR expects demand for Google’s new platforms to continue into 1H15, and the company to report growth in mobile ad revenues. However, while Enhanced Campaigns will increase the total number of clicks on Google’s search ads, because there are more mobile search ads, CPC will continue to fall.

(C) TBR