Google Inc (NASDAQ: GOOG) has made some sweeping changes to Adwords over the past week. Adsense is considered the crown jewel of Google (although some believe that the most valuable property of Google could be Youtube, we have a big post on that topic coming up). The changes to Adwords are likely due to the increasing use of mobile for internet browsing. Additionally, Google has announced a partnership with Yahoo! Inc. (NASDAQ: YHOO). Since Google is the most visited site on the globe, and Yahoo is number four, this is a pretty fascinating topic regardless of whether one is an investor in either company, or if one is in the advertising/publishing industry.

Yahoo Partnership

Yahoo announced that it is partnering with Google on contextual ad placements globally. The quick conclusion is this should be a positive sign for both companies, as it’s the first partnership, and could signal an increased willingness to work together going forward, not surprising given the new management team at Yahoo.

The blog posting on Yahoo’s site is light on details, but Deutsche Bank state that based on their channel checks Google is changing its Adsense for Content, or contextually targeted text-based ads are replacing Yahoo’s legacy Content Match ad technology. Yahoo has not disclosed the size of Content Match, but it’s likely a small revenue stream that dates back to Overture’s technology and historically has been managed at times by other third party providers. Analysts at Deutsche Bank don’t think Microsoft Corporation (NASDAQ: MSFT) had an equivalent contextual product, so this is not a substitution, but an upgrade of a legacy Yahoo business.

For Yahoo, it should improve yield on a low-yielding area of their sites, especially in international regions where ad network coverage is low and Google’s coverage is high. Google AFC generally outperforms most of the equivalent products in the marketplace in terms of yield, including Yahoo Content Match, especially in international.

For Google, it adds a high volume and high quality partner to its network, which has lagged of late from other partner clean up. Many investors are optimistic that the companies could work together on other products like graphical ads or programmatic display down the road, but this initial partnership appears limited to contextually targeted text ads. However, this is likely lower margin as the majority of revenue goes to YHOO. While this does not compete or replace YHOO’s search deal with MSFT, it could be viewed as negative for MSFT as this is arguably business that it should have won.

New AdWorks “Enhanced Campaigns

google adwords changes summary

Google recently announced that it will roll out a new “enhanced campaigns” initiative for its AdWords service where it will be optional over the next few weeks but with the plan to be phased entirely in by mid-2013. From analyst conversations with advertising industry sources, this will require advertisers to pay for ads on mobile devices even if they are not using them.

First, advertisers’ desktop and tablet keyword CPC bids will now be bucketed together and treated equally. In essence, Google is merging the desktop and tablet auction markets and forcing advertisers that bid on desktop to bid on tablets as well. This will increase the ad dollar liquidity and bidding competition in the tablet auction market, which is crucial to Google’s overall search monetization given the ongoing rapid growth of tablet search volume (at times cannibalizing desktop). Analysts at Nomura research predict that this desktop/tablet convergence (forcing tablet bidding) will put added pressure on advertisers to develop tablet optimized websites to improve overall conversion.

Although some advertisers may adjust their desktop/tablet max CPCs downward, given the (at times) lower conversion on tablets than desktop – over the long-term, higher ad liquidity in the tablet ad auction market could be positive for Google as the mobile transition continues.

Google Inc (NASDAQ: GOOG) is also making it easier for advertisers to manage cross-device ad campaigns, as advertisers’ mobile handset CPC bids can now be set separately from the desktop/tablet bids within the same master ad campaign. Further, “enhanced campaigns” will make it easier for advertisers to adjust the actual ad unit served given different contexts of search activity…such as the device on which the search is done, when the search is performed, and the location of the searcher. These targeting capabilities aren’t new, but Google Inc (NASDAQ: GOOG) has simplified the process of creating, bidding for, and modifying relevant ads across platforms.

Making it easier for advertisers to manage and customize cross-device ad campaigns should lead to increased mobile experimentation and adoption. Also, serving more search results with customized context (such as a restaurant serving an ad with a link to a menu for a desktop search query but showing a click-to-call and restaurant locator ad for the same search query done on a mobile phone when the searcher is within walking distance) should lead to higher conversion and advertiser ROI. This too may further accelerate ad dollar flows into the search market.

Industry metrics show that mobile advertising is only 20%-30% as effective as PC advertising likely because of much smaller screens of mobile devices, particularly smartphones. Higher ad prices should help in reversing the decline in CPC’s (cost-per-click) but the risk with raising prices is that it is almost never a pleasant experience for customers. Mobile ads are far cheaper than desktop ads.

Is this why Google bought Android? Analysts at Morgan Stanley believe so. They state:

Google invested heavily in developing Android from 2005 in order to prevent early smartphone competitors such as Microsoft and RIM, and later Apple, from dominating the emerging mobile ecosystem. Google likely feared a world in which a dominant OS provider and a handful of carriers controlled access to the mobile web, and the potential for these entities to extract ever-higher payments from Google in exchange for access to its services.

Desktop versus mobile ads CPM

Shaw Wu, an analyst at Sterne Agee notes that the industry feedback he has gotten is that there will be ‘resistance’ from advertisers. However, he believes that there may not have much of a choice given the alternatives aren’t that strong. We will have to wait and see what changes this brings for Google Inc (NASDAQ: GOOG), competitors, and the internet itself.