Are these guys making too much money?

The blows were unexpected for two premier online brands. Jeweler Blue Nile Inc. and florist FTD Group Inc.—both of which should benefit greatly from holiday gift giving and both among the 50 largest web merchants—found themselves coming up short in 2005’s fourth quarter online sales and wondering why.

Fourth-quarter orders at FTD.com were 4% below Q4 2004, while Blue Nile’s sales fell short of management’s expectations and were up 13.5% in a market that grew 25%. Both ultimately fingered the same culprit: High bid prices had spoiled their expectations for how many sales search marketing would drive.

“In December, we had three weeks of sales that were below expectations,” Blue Nile CEO Mark Vadon said in a conference call with stock analysts for the fiscal first quarter, which ended Jan. 1. As it had in the past several years, ever since search marketing had replaced portal advertising as its preferred advertising channel, Blue Nile placed most of its ad dollars into search for the 2005 holiday season.

While the season started out strong in November, by December, “irrational competition,” in Vadon’s words, in search keyword bidding had pushed up Blue Nile’s cost per click on Google to more than 50% over the prior December. The price of its top five keywords rose by over 80%. As prices surged, a more crowded search market converted fewer searchers into buyers, he added.

Paid-search marketing had suddenly lost its shine as the jewelry retailer’s most effective means of bringing in new customers. “We were surprised at how aggressive search marketing got,” Vadon said.

Aggravating the situation for many retailers is the habit they’ve built up over the last several years of over-relying on search to maintain traffic and sales, experts say. “Three years ago, Internet search was a good value for any retail category, but now it’s not always the value it was,” says Aaron Kessler, senior research analyst who follows e-retailers for investment research firm Piper Jaffray & Co. “It’s a great marketing channel when it works, but many retailers have become too reliant on it.”

In December, Blue Nile learned the limits of search engine marketing, Vadon admitted. “Our marketing skewed toward search engine marketing, and given our experience, it had seemed like the prudent thing to do,” he said. “But we were unable to drive traffic as we had expected.”

As Christmas approached, Vadon figures, more jewelry retailers jumped on the paid-search wagon, hoping to hit the peak of the shopping season at or near the top of search rankings. “A tremendous number of small players play in the market for a week or two,” he said.

That not only sent keyword prices sky-high for popular terms like “diamonds,” “pearls” and “jewelry,” but it also crowded the paid-search listings with additional advertisers. And when consumers click through more paid-search listings to check out offers, it leads to lower conversion rates, Vadon said. “As bidding goes up, it causes downward pressure on conversions,” he said.

The beat goes on

Strong competition among search marketers continued into the first quarter of this year—even among companies that provide search platforms, Vadon went on. “We saw MSN Shopping appear on Google, bidding to take customers from Google to MSN,” he said. “Those economics just don’t add up.”

An indication of the popularity of search can be found in Google’s financial reports. Google’s revenue and profits have surged steadily over the past several years. Revenue grew 14-fold from 2002 to 2005, with last year’s $6.14 billion up 98% over 2004. Net income grew nearly 15-fold over the same period, to $1.47 billion from $99.67 million, as it grew to 24% of revenue last year, Google reports.

Whether Google may be in for a market resistance that could temper its growth depends on how many more retailers like FTD and Blue Nile pull back on search engine marketing, analysts say. “As long as retailers can get ROI out of search, they don’t care how much money Google makes,” says Piper Jaffray’s Kessler. “But it remains to be seen how many retailers will be able to get the ROI they need.”

As Google’s numbers show, Internet search continues to be a major force in advertising, often accounting for 50% or more of traffic and sales acquired through online advertising, experts say. A study by web marketing and analytics firm WebSideStory Inc. found that the average fourth-quarter 2005 conversion rate for customers who arrived at a site via a search engine was 2.3%, more than double the average 0.96% from other online advertising sources such as affiliate sites and banner ads. And web search is appearing more among mainstream advertising, as shown by recent Pontiac TV commercials that show a Google search page, with a voice-over advising consumers, “Don’t take our word for it. Google Pontiac and discover for yourself.”

Retailers continue to be attracted to search because that’s where Internet users are. In December, the number of searches conducted across some 60 Internet search engines grew 55% year-over-year to nearly 5.1 billion, according to researchers Nielsen/NetRatings. Meanwhile, the number of people connecting to the web grew only 3% over the same period.

If current trends continue, U.S. spending on search engine marketing will outpace other forms of online advertising, growing from $4.2 billion last year to $7.5 billion in 2010, as the current online leader, display ads, grows from $5.1 billion to $7.2 billion, Jupiter Research reports.

But as important as search marketing has become to marketers, it has also become more complex and more challenging to squeeze out the ROI. Even major retailers whose powerful national brands bolster their marketing efforts say they’re putting more resources into search marketing, while keeping a more watchful eye on the payback. “We grew our SEM budget aggressively last year and we’ll continue to grow it aggressively this year,” says Sam Taylor, vice president of online stores and marketing for Best Buy Co. Inc. “But the bottom line is it has to be profitable on an ROI basis.”

FTD’s woes

Keeping search profitable isn’t easy, especially when it has become such a standard marketing performer, leading some to take for granted its impact and efficiency.

After FTD.com posted a 4% year-over-year decline in its 2005 holiday season orders, president and CEO Michael J. Soenen blamed the company’s decision to forgo its Christmas season paid-search marketing campaign to avoid surging click costs and announced that the company was looking for a new chief of marketing. “Online search engine costs increased significantly over the prior year and we made the decision not to pursue the resulting high-cost order volume,” he said in a special year-end statement.

FTD’s decision to drop paid search was the prime reason behind its meager 0.9% year-over-year rise in revenue for the usually busy fiscal second-quarter ended Dec. 31, to $109.2 million instead of the $118.4 million that Piper Jaffray had projected, Kessler says. By comparison, the year-earlier quarter had risen 17% year-over-year.

Soenen attempted to put FTD’s search engine marketing decision in the best light by noting that the move presented FTD with an opportunity to build a new marketing team and to fashion a “more diversified” marketing portfolio. “We believe these initiatives will enable us to retain our competitive position in the marketplace,” he said.

Blue Nile’s Vadon agrees. “We have to try new things and tactically change how we find new customers,” he said.

While retailers search for alternatives to search engine marketing, most are not forthcoming with their specific plans. The extreme competition in search engine marketing is pushing executives to keep their plans close to their vests.

Vadon and Soenen each declined several requests to be interviewed for this story, even though their search woes had already been revealed in their financial records. “We’re reluctant to go into details on what we’re testing,” Vadon told the analysts in last month’s conference call. “In the past we’ve seen a lot of our smaller competitors use this phone call and our 10K as their playbook for what they do.”

The online-offline axis

Although Vadon and Soenen aren’t ready to talk publicly about their new marketing strategies, many retailers are already deploying new paid-search and natural-search strategies and implementing broadened and coordinated marketing plans spanning offline and online advertising venues.

The key to successful search marketing, experts say, is to find a way to fit it into a complete marketing strategy. “Our SEM effort has been very profitable because we manage it as part of an overall online advertising portfolio and because of our strong brand, which we build through multi-channel national advertising and in-store service,” Best Buy’s Taylor says.

Best Buy also combines extensive research about how customers search and shop with new uses of marketing technology, including in-home visits to observe search habits, he adds.

Blue Nile’s and FTD’s experiences notwithstanding, practitioners believe the future of search marketing is as rosy as it ever was. “Search engine marketing is only going to grow in effectiveness,” asserts Fredrick Marckini, one of the early developers of search as a marketing tool and founder and CEO of search marketing firm iProspect. “As more consumers come online and search, search indexes grow, and searches are more successful, so it reinforces the value of search.”

“The only question,” he adds, “is if marketers are ready to pay the necessary price.”

That price isn’t only the going rate of a marketer’s desired keywords, which can range from pennies to several dollars, but the time and cost of deploying search effectively as part of integrated marketing campaigns and offering a web site that arriving searchers want to shop, he and other experts say.

Endless testing

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Moreover, effective search marketing requires what can be endless testing to find what works. The testing is not just in bidding on the right keyword or trying new content to optimize a site for natural search, but also in using new tools like algorithm-based bid management, optimizing landing pages to increase conversions and repeat traffic, integrating search with TV, print and other forms of advertising, and trying out new tools from the search engines themselves, including Google Analytics and MSN AdCenter, which is the first to offer the ability to target paid-search campaigns on consumer demographics.

“A search strategy has to be constantly updated,” says Zia Daniell Wigder, vice president and research director for Jupiter Research. “You can’t just wait for your ROI to come in because you think you did something right.”

Some marketers have seen success after trying out new content sister sites, a strategy that sent natural search traffic surging without increased keyword spending at Batteries.com, while others like Ice.com have boosted traffic and sales through the use of blogs that complement e-commerce sites with related content.

But while there are multiple approaches and tools for improving the effectiveness of search marketing, there are also many questions that can be difficult to answer: Having highly ranked paid and natural search keywords is usually considered ideal, but does it always support conversion rates, or will a marketer sometimes get more bang for a search dollar when keywords fall lower in rankings? Experts also say marketers need to better learn the search behavior of their targeted customers, who may start searching on generic terms and responding to top-ranked keywords, then refine their search over several queries before settling on a particular brand and responding to results further down in rankings. The typical consumer enters about five search queries over a week’s time before clicking on a keyword to make a purchase, experts say.

“Looking at what a consumer actually does during the search lifecycle is important to a retailer’s ROI,” says Stuart Larkins, vice president of search for Performics, the search marketing unit of DoubleClick Inc. “The first search is generic, but as the consumer gets closer to making a purchase, the search queries get more defined to a specific product. You want to make sure you’re in the first round of queries, but also make sure you’re in the last round.”

Getting specific

Best Buy, for instance, may pay more for generic keywords like “digital cameras” so that Best Buy appears high up in the initial queries. But it pays less for brand and model names that consumers search on when they are ready to buy. “We don’t always have to be in the top spot and pay a lot of money,” Taylor says. “We manage our portfolio so that we show up in search where we want to be.”

Another question is: If a search campaign isn’t producing the desired online traffic and sales, could some of the intended traffic be arriving at call centers or stores? “The Holy Grail is determining the multi-channel impact of search engine marketing,” Larkins says, adding that some marketers conduct point-of-purchase surveys to determine what motivated customers to shop, or place unique 800 telephone numbers or landing page addresses in search ads. Others use tools like Ingenio Inc.’s Pay Per Call, which runs on AOL and other advertising networks’ search ads and provides a toll-free number to the retailer’s call center. Advertisers’ Pay Per Call search rankings are based on the amount they are willing to pay for each call.

It’s also important for marketers to understand how certain keywords are more or less effective during particular seasons—and to be ready ahead of time with effective ad creative when it’s time to bid up a hot keyword. “A lot of retailers miss out on opportunities by not having creative ready,” says Dave Williams, chief strategist for search marketing firm 360i. “So late in the game they’re bidding up keywords.”

One of the biggest goals of many search marketers is to figure out how to get the best rankings in Google, the leading search engine. Google ranks paid-search results on both the keyword price and the relevancy of the web sites linked to keywords. Relevancy, of course, is also the basis for ranking in natural search. But Google has never said publicly exactly how it determines relevancy, though most marketers believe it’s a combination of domain names, links to and from a site connected to content pertinent to a keyword, metatags or codes that indicate a web page’s content, and, more recently, an indication that a site’s visitors engage in online communications about searched-for content.

“Now Google wants a site that conversationally uses that content,” says Jack Reynolds, co-founder of QuikDrop International, a chain of eBay drop-off stores that participates in new Google programs as soon as they become available, including its new Google Analytics, which enables marketers to track the cost of Google campaigns and compare that to conversions on individual pages.

No more gibberish

At the same time, he adds, Google is making it more difficult for web site operators to display redundant content in order to artificially boost their search rankings. “It’s getting harder to put up gibberish, because Google can tell if you’re using content in the proper context,” Reynolds says.

Still, getting better results can take several attempts—and force retailers to rethink what they do online.

When Batteries.com launched a new site in 2004, it inadvertently hurt its natural search rankings in Google by keeping many of its old pages active so as to avoid dead links, says Batteries.com president Dale Petruzzi. But that caused search engine crawlers to pick up an extensive amount of redundant content on the old as well as the new pages, causing a drop in natural search rankings. “The search engines saw us as trying to duplicate our content,” Petruzzi says. “That flagged them that we were trying to do something sneaky.”

Working with search engine marketing firm iCrossing Inc., Batteries has since revised its site for better search engine optimization, including the elimination of the redundant pages. Within four months, its number of pages indexed by Google grew from 320 to 61,000.

Batteries.com now typically appears high up on the first page of Google and Yahoo search results on battery-related search terms. But to further improve its appearance in natural search rankings, the retailer recently launched the first five of about 30 special content microsites carrying information about particular product categories, such as alkaline batteries or laptop batteries.

The microsites offer information about battery products and provide links to Batteries.com for making online purchases. Petruzzi figures that the extra content tied to Batteries.com will further lift its presence in natural search rankings while providing the retailer with additional listings within the rankings. “We almost fell off the search map, but we found a great formula to get back on it,” he says.

Ice.com had a similar experience with weblogs that it created as an information service for consumers (Internet Retailer, January, p. 10). “Through our blogs we’ve seen our keyword rankings go up,” executive vice president of marketing Pinny Gniwisch says. “That was not part of our plan for the blogs—we wanted them as a service to customers—but it happened.”

As retailers figure out new techniques to improve their search marketing ROI, the search engines say they’re also doing their part to make search more effective. Both Google and Yahoo offer programs for submitting content to help their crawlers catch the right information, and they continue to introduce products that marketers are invited to join as beta testers. And while Google and Yahoo are the established major search engines, others keep striving to offer something different. Kanoodle, for instance, offers an advertising network that lets marketers bid for contextual ads on major media sites such as MSNBC.com, where an ad for, say, women’s apparel, might appear in an editorial section about the latest fashions.

MSN, meanwhile, is hoping to gain ground on its larger competitors Google and Yahoo by offering something they don’t offer—at least not yet. MSN’s AdCenter provides marketers with data on search recipients’ age, sex and city. By offering various ways to analyze that data, AdCenter makes it possible for marketers to continuously modify their search campaigns to demographic groups with particular keywords, says Jed Nahum, director of product management for MSN AdCenter.

“We’re seeing better results on MSN than on Google or Yahoo,” Williams of 360i says. But MSN still needs to build its volume of search activity to compete on the same level as Google and Yahoo, both of which have indicated they may launch demographics services of their own. As of last December, Google controlled 48.8% of the search market, followed by Yahoo at 21.4% and MSN at 10.9%, Nielsen/NetRatings reports.

“I anticipate there will be continuing innovation among search engine competitors,” Nahum says. “We’re blessed with great competitors driving interest for advertisers. It’s not a situation in which any one of us will rest on our laurels.”

New technology tools

In addition, new tools such as algorithm-based automated bid management applications from Efficient Frontier and SearchForce are helping marketers to better manage keyword campaigns. SkyAuction, a site that auctions travel packages, uses SearchForce to handle the complexities of matching keyword prices with expected conversions on thousands of keywords, says SkyAuction’s search marketing manager Tom Rusling. Replacing a former system where his staff attempted to gather and analyze search engine and sales data in spreadsheets, the new tool not only has produced a marked improvement in search ROI but has also freed up staff to concentrate on what they do best: producing creative copy for search marketing ads, Rusling says.

To be sure, with all the changes in store for search marketing, no one’s talking about throwing search engine marketing into the dustbin of marketing history. “Search is still larger than any other channel, and we’ll not by any means stop advertising in search,” Vadon said, adding that it’s still Blue Nile’s top means of acquiring new customers outside of customer referrals. “But we can’t rely on that to be our only (advertising) channel.”

Moreover, Vadon says he’s taking the search marketing travails in stride. He scoffs at those who would suggest that losing the impact of search marketing could tarnish Blue Nile’s prospects for growth.

The $1 billion company

After Blue Nile surged to $44 million in its launch year of 1999, raising expectations among analysts that it wouldn’t take long to hit $1 billion, he recalled, the shine on its reputation dulled in its second year, when sales grew barely 10% to $48 million. But the slowdown coincided with the overextension of portal advertising—the marketing wonder tool of the web’s early days. As Blue Nile made the transition to other forms of advertising—search engines, in particular—sales once again started to grow steadily if no longer at a breakneck pace, reaching over $200 million in 2005.

Now that search marketing appears to have taken the route of portals in becoming less productive and less efficient as an advertising tool, Vadon says he’s confident that Blue Nile will develop new effective marketing strategies and channels. “We’re still on task to build a billion-dollar company,” he says.

paul@verticalwebmedia.com