Why Google Could Be In Serious Trouble

The company’s leaked earnings have sent its stock tumbling — shares have even been halted.

In a bizarre and unprecedented leak on Thursday, Google’s quarterly earnings were posted on the SEC’s website. The report is both worrying and incomplete — it starts with the phrase “PENDING LARRY [Page] QUOTE” — and it has sent the company’s stock into a tailspin.

This might seem odd considering that the report says Google made $2.74 billion in income last quarter. But that’s lower than expected, and lower than the same quarter last year. Google’s overall revenues, on the other hand, are up 45% from the same time last year, which means that its income is far less in proportion to how big it is: 19% of revenues last quarter, vs 37% in 2011. Google is growing, but its profits are shrinking.

This alone is enough to explain why the stock market is going crazy, and why tech watchers are nervous that Google, search engine monopolist and one of the most powerful tech companies in the world, is in trouble.

But what’s really alarming about the leaked report is this sentence:

Average cost-per-click, which includes clicks related to ads served on Google sites and the sites of our Network members, decreased approximately 15% over the third quarter of 2011 and decreased approximately 3% over the second quarter of 2012.

Google makes virtually all of its money from contextual advertising in its own products, such as search and Gmail, and through partners that use its ad product, AdWords. That entire business model is based on the value of user clicks. (I click an ad in Gmail, Google gets a penny. I click on ad on a website that uses Adwords, the site owner and Google each get a half a penny. Repeat billions of times.)

The value of those clicks is going down, and there’s no reason to believe it will go back up: this type of unintelligently targeted advertising is not popular on social networks, which are luring away advertisers, and AdWords specifically has no place on social networks that Google doesn’t own.

This is a startling reminder that no tech company’s position, no matter how towering, is permanent. And a clear illustration of why Google has been so, so insistent on making Google+ work, even to the detriment of its current, non-social users.

Google’s approach to social media is instructive in understanding almost everything it’s done over the last few years. Google, the tech company, seems unfocused, scattering resources in such a way that suggests a lack of leadership. But Google, the advertising company, is organized and focused: It’s moving into social for social ad dollars; it’s moving into mobile because advertising data collected from smartphone users is valuable; it’s moving into TV because TV advertising is a largely undisrupted industry worth tens of billions of dollars; even Project Glass, Google’s wearable computer, could be described as an effort to install an advertising layer over daily life.

The problem, of course, is that only one of these has worked — mobile. But mobile advertising as Google has implemented it is basically just AdWords on a small screen. This is only going to get worse.