There's strong competition among search-engine makers for their share of the advertising pie; researchers say the U.S. market for search-linked advertising will grow about 26 percent this year.

01:00 AM EDT on Sunday, May 2, 2004

BY ADAM STEINHAUER
Bloomberg News

John Pezzullo favors Google Inc.'s Web site for personal Internet searches. To attract customers to his Wheaton, Ill., tax accounting firm, he advertises on a Google competitor, Yahoo! Inc.

"We do use Google," Pezzullo said. "Whenever I search the Web, I find it gives the best results. But not for our advertising."

As Google prepares for its initial public offering of stock, which it announced Thursday in regulatory filings, it is facing growing competition from Yahoo, Microsoft and other companies. They're trying to take a larger share of the $2.5-billion search-engine advertising market after sales of such ads almost tripled last year. That may make it hard for Google to maintain a stock market value that investors say could top $20 billion immediately after the IPO.

"Competition out there could be fierce," said Greg Tuorto, who helps manage more than $3.5 billion with Guardian Park Avenue Funds in New York. "This puts the bull's-eye on their back and makes it a lot larger when they come public."

Pezzullo, 47, buys ads for his firm, Jonlyn & Associates, that appear next to the results of Web searches on terms such as "tax" and "Internal Revenue Service." Yahoo's Overture Services unit places sponsored search ads on Yahoo's Web site and on other companies' search pages, such as Microsoft's MSN.

Google's competing service, called AdWords, puts sponsored search ads on Google and on Web sites including Time Warner Inc.'s America Online.

Pezzullo said he tried Google's service and found that Overture brought more customers.

Google, founded in 1998 by Sergey Brin, 30, and Larry Page, 31, remains the world's most-used search engine, according to the market research company ComScore Networks. The firm wouldn't disclose global statistics except to say that Google's share is larger outside the United States.

Google, based in Mountain View, Calif., has done well so far, according to the filing Thursday that shined a light on the privately held company's finances for the first time.

Depending almost entirely on revenue from advertising linked to online searches, Google earned $105.6 million, or 41 cents per share, on revenue of $962 million last year. The company got off to an even better start this year, with a first-quarter profit of $64 million, or 24 cents per share -- more than doubling its earnings of $25.8 million, or 10 cents per share, at the same time last year.

Google's Web site was used for 34.7 percent of Internet searches in the United States in February, according to ComScore Networks. Yahoo was used for 30 percent of searches and MSN for 15 percent.

The U.S. market for search-linked advertising will grow about 26 percent to $3.2 billion this year, the New York-based research firm eMarketer Inc. estimates. That follows a 174-percent rise in search advertising sales last year.

Google chief executive officer Eric Schmidt, 49, says that the potential market is large enough for Google to thrive along with its competitors.

"It makes perfect sense to me that the different players are going to find different approaches, and they're all going to do well because this is a very big space," Schmidt said. "Advertisers want to work with multiple partners."

Yahoo, based in Sunnyvale, Calif., introduced a new search engine in February, using technology it gained when it purchased search-engine developers Overture and Inktomi last year. Previously, Yahoo provided search results with technology it had licensed from Google.

Owning its own Web-searching technology has allowed Yahoo to develop new search-related services for its group of Web sites, bringing a larger audience for its sponsored-search advertisers. New Yahoo services so far include a "product search" function on Yahoo's shopping page. Its service that provides street maps now also delivers search results about local businesses.

Microsoft, meanwhile, has said it will introduce its own search engine by year-end.

"Probably the thing I feel worst about in the last few years is us not making the R&D investments up front," CEO Steve Ballmer, 48, said last month in a reference to Internet-searching technology. He made the comment at Microsoft headquarters in Redmond, Wash., at a gathering of customers who buy advertising on the MSN Web site.

MSN currently licenses technology from Yahoo's Inktomi unit to provide search results. Microsoft, the world's largest software maker, can afford to spend more than Google to advertise a new search engine.

"Google used to be leaps and bounds ahead technologically, and what they have now is a lot of momentum," said Eric Martinuzzi, an analyst at Craig-Hallum Capital Group LLC in Minneapolis.

If Google can't maintain the momentum, he said, the company may find itself pressured by Microsoft's marketing spending and its market power as the major source of desktop-computer operating systems.

Brin and Page began working together on Web-searching technology in 1995 as graduate students in computer science at Stanford University. The system they developed gives higher prominence in search results to Web pages that are linked by multiple sites. It essentially interprets a link as a vote of confidence in the value that a Web page offers.

They started their company before most Web sites had discovered sponsored-search advertising. Yahoo, MSN and others generated little revenue from searches, so instead of developing better search technology they focused on adding features such as e-mail, news and online shopping. That brought more users and a bigger audience for so-called banner advertisements across their pages.

Google began offering sponsored search ads in 2000. It has since emerged as the fastest-growing form of advertising on the Web.

"Their determination to make search a viable alternative to advertisers for paid placement was very important," said Ryan Jacob, manager of the $80-million Jacob Internet Fund, which doubled in value last year.

Advertisers say sponsored search services provide an inexpensive way to reach consumers who have shown an interest in their products.

Pezzullo said he pays prices ranging from 40 cents to $1.50 each time someone clicks on one of his ads.

The price of sponsored-search advertising "is not out of anybody's reach," Pezzullo said. "It more than pays for itself."

Today, Google's search engine doesn't necessarily provide better results than competitors such as Yahoo or Ask Jeeves' Teoma.com, as those companies have invested in advanced technology, said Danny Sullivan, a United Kingdom-based consultant and editor of SearchEngineWatch.com. Many consumers only perceive it to be better because of past experiences, he said.

"Google first rose in popularity when they really were that much better than the other search engines," Sullivan said. "Now there's a question of if that will start to change."

Still, many investors say the sponsored-search advertising market is large enough for several search engines to prosper. Google's real competitors are older advertising media, such as telephone directories, and Google is winning that competition, said Larry Haverty, an analyst at State Street Research & Management Inc., which held 1.48 million Yahoo shares at year-end.

"We've got three years of just monstrous growth in this business category," he said. "You're talking about hundreds of millions of dollars that are going to migrate to the Internet. In 10 years, you're not going to have any Yellow Pages. You're going to have the Internet."