Blue Nile and Paid Search

What do Blue Nile and FTD have in common?

Both have recently complained very publicly – during earnings calls in the last several weeks –  about the rise in online marketing costs – especially paid search. From their conference call (courtesy of Seeking Alpha’s transcript):

Second, during December, we saw extremely aggressive increases in the cost of online advertising. Our cost per click on Google, for example, rose by over 50% from a year earlier. While the cost of online marketing grew significantly in Q4, we remain disciplined in our spending in order to maintain profitability on new customers rather than to chase unprofitable growth, as some of our competitors have done.

Our marketing efforts during the fourth quarter were skewed toward search engine advertising. Given our experience over the past few years with paid search, this seemed like a prudent decision entering the quarter. However, with increased costs for paid search in Q4, we were unable to drive as much profitable traffic as we would have expected. Given these results, we will be looking to broaden our marketing efforts beyond search in the future. As we seek alternative marketing vehicles to complement our efforts in paid search, I would expect growth to be relatively conservative as we ramp our efforts toward broadening our marketing outreach.  

Two points start to make a trend. It is clear, as Nick Carr has said, that competition is starting to hurt the paid search market. Keyword prices are clearly going up, at least in a few areas (diamonds, jewels, flowers…) people are starting to get hurt by it, and are talking about moving dollars away. That will bring keyword prices down again, but at the expense of paid search revenues.

 

UPDATE:

I just got to the Q&A part of the transcript – blogged too quickly – and saw this very interesting explanation of the paid search dynamics. From the same source:

As far as who is out there bidding, it’s slightly different in Q4 as opposed to Q1. I think in Q4, you asked about Amazon. We haven’t seen them at all in the online search market. We saw a couple larger players; I think Zales was pretty aggressive, Macy’s was pretty aggressive. And then we see just a tremendous number of small players, and these are very small companies. And they don’t play for very long. They will come into search for a week or a couple of weeks. And I think there’s just a lot of, and then I think they burn through their budget fairly quickly and fall off the screen. But we just saw a lot of those types of players coming out. And then, just in Q1, we’re seeing some odd search behavior. A couple weeks back, you know I think, if anything, this is the time that there’s a little bit too much aggressiveness in search. A couple of weeks back, we saw MSN Shopping appear on Google. And that’s in our category; it’s also in a number of other categories. MSN Shopping began bidding to take customers from Google over to MSN Shopping. And for those of you who understand the cost per click on a Google, which is very targeted, versus a shopping channel, those economics are not going to make sense. So we see things like that, and we just feel like there’s something going on here; it’s a little too frothy.

As far as conversion rates, we continue to be able to convert quite well when we bring people in. I think, to some extent, there may be some downward pressure, and the conversion from every single channel is different. If you look at our overall conversion rate in Q4 versus last year, the conversion was quite good. But within channels it will differ. Within search, what we’re seeing, a slight downward pressure on the value of any customer coming out of search, if that makes sense. If you look at, the measures we’re looking at is revenue per visitor or gross margin per visitor over time, and then isolating that down to a single channel. So, for those of you don’t follow the search market, as well, the way as a merchant you really try to understand your numbers is look at the gross margin or contribution margin per customer coming off the flow of traffic, and you simply weigh that against the price to acquire those customers. And as you go up higher in search, you’re trading off perhaps more volume from higher placement with lower profitability from the stream of traffic.

So an important matter is how well you can convert. Over time from search, we see slight declines, and it’s not tremendous but slight declines in the conversion rate. I think, to some extent, that has to do with the search engines placing more ads. So, when you went to a search term a year ago versus going to it today, you are going to see more paid search placements today than you did a year ago. And as there’s more people there competing for the same traffic, if one consumer is shopping, so if you’re shopping for a plasma TV, you are probably going to go to many merchants, or at least a handful of merchants, before you make your purchase. And so you will be clicking on multiple ones of those, but only buying one plasma screen. And the more paid placements there are, probably the more click-throughs you’re going to have.

So what that results in for merchants is downward pressure on the value of those customers. So just as bidding is going up, you’re seeing downward pressure in conversion. Again, this points to our desire in the channel to be less aggressive with our bidding. And if that means giving up some volume to other people who perhaps are not measuring that and doing that ROI calculation, as well, we will do that until it rationalizes somewhat.