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Google Push to Sell Ads
On YouTube Hits Snags
Video Site Is Key
To Diversification;
The Lawsuit Factor
By KEVIN J. DELANEY
July 9, 2008; Page A1

Wringing ad revenue from YouTube is proving to be a challenge for Google Inc.

Although users of the popular video-sharing site view clips more than one billion times on most days, the site hasn't been as popular with big corporate advertisers. World-wide revenue from YouTube ads has fallen short of Google's expectations this year, and is likely to total about $200 million for the full year, according to two people familiar with the matter.

YouTube is critical to Google's campaign to extend its advertising reach far beyond text ads tied to Web searches, its revenue powerhouse. Google wants to sell more video ads and display ads on YouTube and elsewhere. It also wants to crack the television, radio and newspaper ad markets. Its target: the 90% of global ad dollars that don't currently flow to the Internet.
Tim Armstrong, an advertising executive at Google, says a sketch drawing -- stick figures and all -- is guiding the Internet giant toward a new ad model. WSJ's Kevin Delaney reports. (July 9)

"Most advertisers are still testing the waters on YouTube," says Sean Muzzy, media director at Neo@Ogilvy, a digital ad agency owned by WPP Group's Ogilvy & Mather. Some big advertisers, he says, haven't been comfortable that their ads might appear next to amateur videos. Google Chief Executive Officer Eric Schmidt has acknowledged that the company hasn't yet found the best formats for video advertising.

Copyright litigation has complicated the YouTube ad push. Viacom Inc. sued Google last year in connection with clips of television shows and films posted without authorization by YouTube users. Although Google says it hasn't broken copyright laws, it significantly cut back on the number of clips it would sell ads against, so as not to sell them against infringing material, according to one person familiar with the matter.

Tim Armstrong, Google's head of advertising and commerce in North America, is helping to lead the diversification push. When he dug into complaints from salespeople about Google's system for selling YouTube ads, he uncovered another part of the problem: a sales system hamstrung by inefficiencies.

Some YouTube advertisers, for example, had to pore over three separate legal contracts. Before Google salespeople around the country could propose certain deals to YouTube advertisers, they first had to get approval to do so from a temporary worker in California. And lacking a fully automated billing system for YouTube, Google staffers had to calculate some bills manually.

By May, Mr. Armstrong and his colleagues had identified some 105 problems with YouTube's ad sales, according to one person familiar with the matter. The ad difficulties extended beyond YouTube. In its successful search-ad business, Google recently counted 24 separate internal systems for helping advertisers come up with search terms to have their ads displayed alongside. "Barnacles started to build up on the outside of the process," says Mr. Armstrong.

Twenty months after Google bought YouTube for more than $1.7 billion, Mr. Armstrong and his colleagues have begun to untangle the problems with its advertising operations -- which generated 98% of Google's revenue in the first quarter. The initiative is code-named "Project Spaghetti."
[The Advertising Pie]

The effort could affect how successful Google is at expanding beyond advertising tied to online searches. If Google is to maintain its torrid growth rate in the years ahead, it needs to tap other forms of ad revenue.

In the first quarter, Google's U.S. ad sales were up 31% from the year-earlier period to $2.5 billion. (Google doesn't break out revenue by category of ads.) That growth rate would thrill most companies, but for Google, it's a slowdown. In the first quarter of 2007, U.S. ad sales jumped 49%. Still, Google exceeded analysts' estimates for revenue and profit in the first quarter, partly because of strength outside the U.S. Google's shares have dropped about 25% from their November closing high of $741.79.

It isn't the first time Google has wrestled with advertising problems. Six years ago, it changed its sales model for so-called search ads: When Google users conduct a Web search, ads related to the search words pop up next to the results. Google began charging advertisers only when users clicked on the ads, not every time they appeared on a user's screen.

That new advertising model was hobbled initially by overlapping sales databases and disparate billing systems. In 2002, Google launched "Project Drano" to overhaul the operation. Problems instituting a new system -- many ad campaigns were inadvertently shut down -- "nearly killed" Google, said Mr. Schmidt, the chief executive, in a 2005 interview. It took Google about six months to get it right, and the search-ad business exploded. (Google has a deal with MySpace to sell ads on that social-networking site, which is owned by News Corp., owner of Dow Jones & Co., publisher of The Wall Street Journal.)

Mr. Armstrong, who is 37 years old, describes Project Spaghetti as an effort to fix the plumbing behind all of Google's ad initiatives. The inefficiencies, he says, are a product of Google's rapid growth and its innovation. Streamlining the systems and developing new ad formats, he says, should eventually improve the company's bottom line.

Mr. Armstrong, a seven-year Google veteran, says the company's traditional search-ad business is still gaining market share, and has plenty of room for growth. Nevertheless, he's been working for several years to develop ways to sell ads in other media, believing that Google could help advertisers better reach target consumers and measure the results.

In 2005, Google began trying to broker ads sales for magazines. To branch into radio advertising, in 2006 Google bought dMarc Broadcasting Inc. of Newport Beach, Calif., which ran an online system for advertisers to buy radio time. Google tested placing TV ads on a small cable system near its headquarters, then signed an ad deal with satellite-TV provider Dish Network Corp.

Big Ambitions

Google's 2006 acquisition of YouTube signaled that it had big ambitions for online video advertising. YouTube's revenue was only about $15 million that year, Bear Stearns analysts estimated. But Google believed YouTube would be attractive to traditional TV advertisers and others.

Mr. Armstrong and his team had to persuade skeptical advertisers to start spending chunks of their ad budgets on Google's new offerings. At a September 2007 meeting of Google ad executives in New York, Eileen Naughton, who heads Google's display and video ad sales, illustrated the magnitude of the challenge with photos of Mount Everest and Sherpas.

Last fall, Mr. Armstrong says, he began to realize that internal problems were interfering with progress. Newly acquired companies such as YouTube and dMarc Broadcasting had their own sales systems, and Google was building others piecemeal. The end result was overlap and inefficiency.

In March, after salespeople complained that selling YouTube ads was taking longer than it should, he kicked off Project Spaghetti. In order to get a closer look at the problems, he moved that month to a cubicle in the middle of a YouTube ad team, two floors above his New York office. He says he was determined to find out exactly how YouTube ad sales worked.

In May, Google held "weeds days" for YouTube -- it wanted to get everyone into the "weeds," or details, of the ad-sales process. The result was the list of about 105 fixes, says one person familiar with the matter. Mr. Armstrong characterizes some of them as very minor.

One of the top five suggested short-term fixes was to allow ad salespeople to discount YouTube ads by 10% without securing management approval, the person familiar with the matter says. Another was to eliminate a requirement that a certain temporary worker -- she's referred to only as Miriam in an internal presentation -- had to sign off on YouTube ad proposals, which created a bottleneck. Mr. Armstrong says that step now has been largely automated, and the worker only gets involved later in the process. He declines to comment on discounting policies.

Project Spaghetti, Mr. Armstrong says, should be completed by the end of the third quarter. But even if the internal problems are ironed out, Google still has to persuade advertisers to spend more on its new ad offerings.
[Searching for Growth]

One complaint from mainstream advertisers is that YouTube -- where clips uploaded by users range from raunchy to heartwarming -- lacks enough content alongside which they want to run their ads. New Line Cinema, for example, created an ad campaign on YouTube last summer to promote its movie "Hairspray." The ads performed well, New Line said, but it had a hard time finding enough YouTube videos where it wanted to put the ads.

General Motors Corp. has been a regular buyer of Google search ads. More than a year ago, it experimented with advertising its Cadillac brand on YouTube. Since then, it hasn't significantly boosted its YouTube ad buying, says Mike Devereux, GM's executive director of digital marketing and customer relationship management. He says GM is watching Google's ad-diversification plan closely. "As they get their platform ready for other media, we will get there with them," he says.

Mr. Schmidt, Google's CEO, said earlier this year that "it's taken longer than I thought for us to find the right combinations" of YouTube advertising formats. He added that he believed it "will ultimately be very, very successful for us and the industry."

The Viacom suit has complicated matters. Fearful of fueling allegations that it is profiting from copyright infringement, Google will only sell ads against YouTube clips that have been posted or approved by media companies and other partners -- roughly 4% of the total, says one person familiar with the matter. A Google spokeswoman declined to comment on how the litigation has affected where ads are placed. Last week, the federal judge overseeing the Viacom case ordered Google to turn over some data about YouTube users and viewing records, stirring privacy concerns.

Google plans to begin accepting "preroll" and "postroll" ads, which will run before and after some YouTube video clips, according to one person familiar with the matter. The plan under consideration, this person says, would give companies that post video clips the option to sell such ads, and share the revenue with Google. YouTube has long forsworn such ads because consumers don't like them. But advertisers consider them highly effective.

Google began offering Internet display ads several years ago, but they haven't gained as much traction as many at Google had expected. The display ads bring in a few hundred million dollars annually, according to one person familiar with the matter.

Acquiring DoubleClick

Google is hoping that its recent $3.2 billion acquisition of Internet ad services company DoubleClick Inc. will boost display-ad sales. Internet publishers pay DoubleClick to insert ads onto their Web sites as users visit the sites. DoubleClick also offers a system to ad agencies for managing and tracking online ads. Google wants to leverage DoubleClick's relationships with Web publishers and ad agencies to sell more display ads.

In radio and TV, where Google collects commissions for brokering ad sales, the company still doesn't reach enough top markets and consumers, some advertisers say. Sales of TV ads generated around $25 million in revenue for Google last year, while sales of radio and newspaper ads brought in even less, says one person familiar with the results.

Others in the ad industry are skeptical about whether Google's forays into these advertising categories will ever be as profitable as the company's stronghold, search ads, where it holds a major lead over rivals.

"They will do some good business, but not at the [profit] margins" the company has with search ads, said Maurice Lévy, chairman and chief executive of advertising giant Publicis Groupe SA, late last year.

Mr. Armstrong says it will take Google another five or 10 years to realize its advertising vision. He says advertisers are getting on board, but he acknowledges that the company's main rivals have adopted similar approaches. "The next five years of the Internet is about execution," he says.

Write to Kevin J. Delaney at kevin.delaney@wsj.com
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