Here’s an exceptionally long post on the current (perceived state) of pay-for-performance advertising. So much more going on behind the scenes that I, unfortunately, can’t really comment on in a forum like this:

INFORMATION TECHNOLOGY

Search Engines Are Picking Up Steam

Mixing ads in with search results is paying off, and the big players are jostling to gain from the surge

When GoTo.com went public in June, 1999, it barely blipped on the radar screen. The obscure Web-search company — since renamed Overture Services Inc. (OVER )– was valued at about 3% of Yahoo! Inc. (YHOO ) Sure, search engines helped surfers locate Web pages. By typing a few words — Red Sox, Fenway, parking, for example — a user might locate a lot near the ball park. But could Overture’s searches make money? When Merrill Lynch & Co. analyst Henry Blodget began covering GoTo in January, 2001, a client asked what was interesting about it, besides investment-banking fees for Merrill. Blodget’s tart e-mail reply: “Nothin’.”

Wrong. Actually, the Pasadena (Calif.) outfit was hatching a business model that is now resuscitating the Internet advertising business. In 1998, Overture was the first to charge advertisers to be listed in its search results. Now, all the major search companies have jumped in. So-called paid-search revenue grew 40% last year, to $1.4 billion. It’s now up to 23% of the $6 billion Net advertising market, which shrank 17% last year, according to analysts’ projections. U.S. Bancorp Piper Jaffray forecasts that search-related revenues, mostly from advertising, will grow 43% this year, to $2 billion. “This is an enormous opportunity,” says Jeff Weiner, senior vice-president for search at Yahoo.

Placing ads near search results offers the simple appeal of the Yellow Pages, but with different economics. Search-engine companies such as Overture, Google, Ask Jeeves (ASKJ ), and LookSmart (LOOK ) charge most advertisers by the click. These ads can be presented among the search results, looking like any of the other Web links that have been rounded up. That’s known as paid inclusion. More often, other search-related ads are featured as “sponsored listings” at the top or side of the search results. Advertisers say that search-related ads, whether overt or camouflaged, attract far more interest than regular scattershot Internet ads. Why so? They give people what they’re already looking for.

Search advertising is also cheap. At an average of 35 cents a click, paid search undercuts the $1-per-lead average for Yellow Pages ads. The money is split between the portal, which generates the traffic, and its search-advertising provider. When a user clicks a search-related ad on Yahoo, for example, Overture keeps 14 cents and sends 21 cents to Yahoo. Pete Howard, vice-president for marketing at Staples.com, says the return on search-engine marketing “outpaces everything in print or online.”

Changes in Internet usage also power this trend. As Web surfers grow more sophisticated, they focus on specific tasks, such as checking mail or finding a recipe. More are using search engines to hurry through their to-do lists. The percentage of Web site visitors who arrived via search engines nearly doubled in the past year, to 13%, says analytics firm WebSideStory. Increasingly, says Jupiter Research analyst Gary Stein, “people are tuned out on banner ads and tuned in to search results.”

All this has fueled profits. Overture made $78 million last year on $668 million in sales, about half of the paid-search market. That’s more than Yahoo made on $953 million of revenue, largely from traditional online ads such as banners. Paid search also pushed search specialists LookSmart Ltd. and Ask Jeeves Inc. into profitability in the fourth quarter. And the biggest potential initial public offering of an Internet company this year is Google Inc., which began offering pay-per-click search last year. Piper Jaffray’s Safa Rashtchy says search ads will make up the lion’s share of Google’s revenue, which he estimates at $350 million to $400 million.

No wonder Internet companies are beginning to fight over this market. Search kings Overture and Google are grappling for leverage — with Google looking stronger, thanks to its immensely popular Web site and much-ballyhooed search technology. But search specialists don’t have the market to themselves. Internet portals such as Yahoo, MSN, and America Online (AOL ), which now split the spoils of paid search with search companies, are out for a bigger hunk of the pie. The wild card is cash-flush Microsoft Corp. (MSFT ), whose MSN online service looms as a potential acquirer of Overture, or even Google.

In the early days of the Net, pundits thought surfers would scoff at mixing advertising with search results. Instead, they’re seeing shoppers and advertisers in sync because up to 35% of searches are for products or services. “You’re finding a customer who’s looking for Las Vegas hotels. You can’t find a more qualified buyer,” says Jason Pruismann, promotions director at Travelocity.com.

Now, search engines and Web portals are jostling to gain from this surge. The keys to success are search technology, a big base of advertisers, and millions of loyal Web site visitors. Yahoo boasts the biggest audience, Overture the most advertising, and Google has the leading search technology. But the balance of power is shifting fast. All the major players are busy building or buying the pieces they’re missing. In December, Yahoo bought search outfit Inktomi Corp. for $235 million, beefing up its technology. In February, to get its hands on search technology, Overture snapped up also-ran search engine AltaVista Co. and the Internet-search division of Oslo’s Fast Search & Transfer for a total of $240 million. That same month, Google snapped up Pyra, a maker of software for personal Web pages known as Weblogs. This could extend Google’s reach to new frontiers, from pop journals to quantum physics.

Google is building its own search technology in-house — and for now is sitting pretty. Its popular Google.com Web site draws 39 million unique visitors a month, the fourth-highest on the Net. It doesn’t share search revenue from its own site with anyone. That lets Google make more money than Overture, even though analysts believe it has less than half of Overture’s revenue.

And Overture is facing a squeeze from the portals. Partners like MSN and Yahoo now demand about 63% of what advertisers pay Overture, up from 51% in late 2001. Those increases, together with expanded spending on technology, will mean a 50% fall in profits this year, analysts say — to $39 million on $1 billion in sales. But Overture has no plans to try to generate ad revenues by turning its own Web site into a major destination for surfers à la Google. “We have no intention of competing with our partners,” says Overture CEO Ted Meisel.

Yahoo and MSN are the best-positioned portals in search. Yahoo’s acquisition of Inktomi gives it technology to build its own paid-search services. It’s committed to carrying Overture’s paid-listings ads through April, 2005. MSN has been partnering with several search providers, including Inktomi, LookSmart, and Overture.

Though MSN won’t discuss it, analysts expect the portal to buy search capabilities. “We’ll have more clarity in six months,” says Morgan Stanley analyst Mary Meeker. “There’s a lot of activity because there are very high stakes.” Now that’s a welcome change for the battered Web advertising business.