So, if you haven’t heard by now, AOL is receiving their own version of Google Adwords (Private Label deal).

I’m not going to rehash the background and deal info, referenced at SearchEngineLand, but instead, I’ll try to explain what I see the market impact as being.

I’ve long argued the point that we should be able to price keyword by partner on all the major search engines, as they all have quite different conversion rates and “Not every click is created equally”, to paraphrase. The AOL deal has forced Google to make this move, and I think it will probably hurt their margin numbers and not just their revenues. Overall, it’s probably close to a zero sum gain as the money will flow to AOL, but their cut will just reduce. I haven’t done the math, but they might be just slightly worse off on revenues, but definitely down on margin.

Also, this impact will hurt many of Google’s partner sites that relied on high conversions from AOL to “slip” clicks through the door at higher than market value (respective earning or value per click), because of the fact that marketers cannot price each partner differently.

This is quite a complicated post, so please bear with me – I’ll try to explain this as simply as possible.

Currently, when buying Adwords ads, you pay a single price for a click & keyword that goes to Google’s distribution network.

For example (and I’m using hypothetical, BUT REALISTIC numbers here), let’s say that a keyword received 100 clicks and the breakdown by partner is as follows:

25 Clicks from AOL – 5 Conversions
50 Clicks from Google – 4 Conversions
25 Clicks from Google Partners – 1 Conversion

Total Clicks = 100 x CPC of 25c = $25 in costs
Total Conversions = 10 divided by $25 in costs, leaves us with a $2.50 CPA (Cost Per Acquisition)
Assume an average position of 3 and as you can see from above, AOL has the better conversion rate.

Let’s assume that your breakeven point is $2.50 CPA. Now, because Google runs a single blind marketplace, there is no price discrimination, which means that there is cross subsidization of keyword value (you pay an average price for everything, yet some clicks are worth more and others are worth less).

For the record, our logs indicate that AOL has the best conversion rate across all Google partners, and this simple means that if there is a separate marketplace for AOL, that prices across the Google Adwords network (especially direct) should fall, IN THEORY (see conclusions).

Now, let’s assume that we removed the AOL numbers:

50 Clicks from Google – 4 Conversions
25 Clicks from Google Partners – 1 Conversion
25c CPC x 75 Clicks / 5 conversions = $3.75 CPA

By AOL moving out of the marketplace, this would effectively mean that the remaining traffic would become too expensive, because AOL would not be cross subsidizing it (and obviously, they know this already, and that’s why they want their own marketplace). This would mean that prices would drop in order to offset the drop in traffic quality.

What would this mean for AOL?

$2.50 CPA x 5 Conversions = $12.50 / 25 Clicks = 50c CPC – almost DOUBLE what Google was raking in for them by cross subsidizing, is what the merchant would be willing to pay direct on AOL, because of the higher conversion rate.

Now, here are the possible conclusions vis a vis Google CPC’s:

1. Google CPC’s will drop as marketers move their spend directly onto AOL and adjust ROI’s according on Google. This will impact Google’s financials, as they will have to pay out a lot more money to AOL.

2. Google CPC’s will increase as dumb money floods the market because marketers are either too lazy or overworked to load AOL campaigns (highly unlikely in the long term) and instead they make it more profitable for Google to show Adwords direct ads for AOL, than AOL marketplace ads. I doubt this would occur though, but it’s a possibility.

3. Google CPC remain unchanged as AOL take-up rates are too low to impact the overall conversion number in the short to medium term.

So, logically speaking, by removing the “bane of mankind” *according to me* (Cross Subsidization) from the Adwords system, we as marketers will be able to align ourselves far more closely with the value per click.

Where do I get this insight from? Well, as an affiliate marketer, we have to watch the earnings per click very closely. EPC is a key metric and we are also able to distinguish (using our proprietary technology) the different conversion rates and therefore effective EPC’s per network partner for all the search engines. This data allows us to derive very accurate statistical models and also understand how the market is interpreted (well, as best as possible) by other players.

Every cent we spend is our own, so we have to ensure that we’re as closely aligned to value per click or EPC as possible, and therefore we’re very excited about the AOL prospects, but realise equally that it’s a lot of work.

I think this is a great move by Google and I applaud them. They’ve thrown the gauntlet down to the other search engines, and let’s see how they respond!