May 9, 2001 4:50 PM PDT

GoTo gains amid Web pains

Just when things were looking especially dire for advertising-reliant online businesses, GoTo.com Chief Executive Ted Meisel realized his Web search company was finally on the road to profitability.

"For us, the turning point came in March as our strong first-quarter results rolled in," said Meisel, whose Pasadena, Calif.-based company has just completed three consecutive quarters of 30 percent revenue growth and seven quarters of 20 percent growth.

GoTo's performance in the first quarter, vaulting well past analysts' expectations, has raised the company's profile as Web content companies in general and search providers in particular examine their businesses in an attempt to survive the online ad bust and an overall dot-com shakeout.

But the company's success has also heightened concerns that its search results are biased. GoTo bases its rankings not on independent measures of relevance but on advertisers who pay for top billing. While GoTo makes its commercial relationships clear on its own Web site, the paid listings are not always clearly disclosed by its growing list of distribution partners, which include companies such as AltaVista, AOL Time Warner's America Online and News.com publisher CNET Networks.

The company's stock has rebounded significantly after falling with the rest of the high-tech market. Now trading around $19 per share, GoTo is up 171 percent since the beginning of the year, though still well off its 52-week-high of $34.75.

"We've been saying this is one model that is working," said Safa Rashtchy, an analyst with U.S. Bancorp Piper Jaffray who rates GoTo a "strong buy." "Now we have more confidence than ever that they're closing in on profitability. It's particularly surprising and interesting that in this time, in the last few quarters, where advertisers were cutting back everywhere, they got more advertisers and more money from each advertiser."

In its first quarter, GoTo reduced its net loss to $6.4 million, or 13 cents per share, compared with $9 million, or 20 cents per share, for the same quarter last year. That handily beat analysts' expectations of a 33 cents per share loss, according to First Call.

In response to the earnings, analysts have rallied behind the company with upgrades. Merrill Lynch raised its rating to "near-term accumulate" from "near-term neutral," and Lazard Freres pushed its rating up to "buy" from "outperform."

The secret to GoTo's success has also earned it the scorn of some search mavens. With GoTo's system, advertisers bid for a keyword, agreeing to pay GoTo a certain amount of money every time someone clicks through from the search results to the Web site. Advertisers who bid more rank higher.

Biased search results?
Purists argue that such a system skews search results toward the Web pages of companies with generous marketing accounts, rather than pages that most accurately match the searcher's interests.

"The results are biased," said Scott Pope, founder of Noesis Strategy, a strategy consulting and market research firm in Boston. "As someone who's looking for specific information, I don't need tainted information based on the highest bidder. In the case of vendors, it's often the least popular vendor who wants to get in front of you first. So you're getting the exact opposite of what you're looking for."

As an example, Pope pointed out that a search on "men's health" turns up a top result of Africanfly.com, hawking a "Powerful New Man Sexual Health Formula."

"That's not what the bulk of visitors are going to be looking for when they search on 'men's health,'" Pope argued.

In contrast, Google uses a method derived from traditional citation analysis, examining the linking structure of the Web to bump up pages that other sites have linked to. That has made it the darling of search aficionados.

"I doubt few searchers are actively thinking that they want GoTo results," said Danny Sullivan, editor of SearchEngineWatch.com. "These are paid advertisements, linked to keywords...GoTo has done a lot of work to try and ensure that the ads that appear in response to a particular keyword are relevant, and that can benefit consumers, but I wouldn't see the addition of GoTo listings to a search engine as some new helpful 'feature' that they are sometimes positioned as."

GoTo's paid listings are not walled off on its own site. Because its links generate revenues, the company has been very successful in signing up partners.

GoTo's search results typically do not replace its partner's search results but are added to them as featured sites that appear at or near the top of other search results.

Many of these partners do not make it clear that featured results come from GoTo, or that they are paid links.

For example, iWon uses Inktomi technology for its basic search engine, but through a deal with GoTo it also offers "partner search results" that sit on top of the Inktomi results.

It does not expressly identify these sites as paid links from GoTo's service.

Similarly, AltaVista offers links provided by GoTo on top of its own search results, identified only as "featured sites."

AOL offers its GoTo search results under the heading "sponsored links." While it does not mention GoTo by name, it offers the caveat that the results "are provided by a third party and are not necessarily endorsed by AOL."

Market-driven results
But GoTo defends the quality of its results, citing both its policy of inspecting every keyword-link match and external research. In one study the company cites, Lazard Freres determined that the relevance of GoTo's results were second only to Google's.

U.S. Bancorp Piper Jaffray's Rashtchy suggested that, rather than "dumbing down" GoTo's results, the market-driven approach has actually enhanced their relevance.

"By making the market determine where things are listed, GoTo has created a system that lets users find things very quickly," Rashtchy said. "If I type in 'Indian tea' to a traditional search engine, I will find a number of sites that have to do with Indians, or tea, or any number of other things. If I go to GoTo.com, the first listing I will see is one who sells Indian tea."

With one proviso--that a seller of Indian tea has purchased the keyword "Indian tea." Recently, five GoTo advertisers had paid for the privilege of appearing at the top of GoTo's Indian tea results, with United Nature USA topping out the bidding war at 8 cents per click-through.

The sheer number of advertisers using GoTo--42,000 at last count--helps insulate the company against potential competition now that its business is showing promising signs of success. For one thing, any newcomers trying to ape the GoTo model will have a long haul ahead of them creating an engine comprehensive enough to include five paid links for Indian tea.

Several rivals are already seeking to mimic GoTo's model.

"The two biggest would be FindWhat.com and Sprinks.com, in my opinion," said SearchEngineWatch's Sullivan. "FindWhat recently cut a distribution deal with Excite, giving them a better shot at being a GoTo competitor. Sprinks.com is popular because it is owned by About.com, and they have so much traffic that they can position it well."

But unlike new competitors, GoTo has the flexibility to risk alienating some advertisers, as it did in March when it increased its minimum bid to 5 cents per click-through from a penny. The move raised a firestorm of controversy, but GoTo's Meisel said advertiser adoption rates have remained steady through the transition.

One of the company's challenges will be to raise the average bid, something it has no direct control over apart from moves such as increasing the minimum. For the first quarter, that average was 16 cents per bid. Analysts are looking to see that average rise over the course of the year to 20 cents per bid if GoTo is to meet its goal of profitability in the fourth quarter.

"They could compensate for that, which they did in the fourth quarter 2000, where they missed our click-charge but blew away our number because of increased traffic and increased number of advertisers," Rashtchy said.

Other keywords draw considerably higher click-through values. "Microsoft," for example, rents for 42 cents per click-through. The winning bidder: Microsoft's MSN HomeAdvisor. The high bid on "insurance" is now $2.08.

GoTo employs about 500 people at its headquarters in Pasadena, as well as in offices in San Mateo, Calif.; Raleigh Durham, N.C.; and its recently launched London operations. International expansion lies ahead with offices to open in Germany in the first quarter 2002. Meisel expects to move on France and Italy later in 2002.

Different from the start
Founded in April 1998 by Bill Gross through his Idealab incubator, GoTo launched with the premise that the search and advertising model common to Web portals such as Yahoo was fundamentally flawed. Rather than serving graphics-rich advertisements on search results pages, GoTo proposed to sell the listings themselves in such a way that paid placement was openly acknowledged.

"The success of GoTo is not just due to the pay-for-performance model--although in this environment, it helps," Jupiter Media Metrix analyst Marissa Gluck wrote in an e-mail interview. "The success of the model is due to the contextual relevancy it affords the advertiser and, ultimately, the consumer. The key here is transparency. It's obvious to the consumer that the listings are paid for, and the only potential pitfall a site can run into is the temptation to make that less transparent...Consumers don't like to be played a fool--they need to know what is paid for and what is not."

Another key premise of Gross's idea was that GoTo would not become a destination in an of itself but would provide its results to distribution partners with whom it would share revenue. Ninety-five percent of GoTo's audience sees its results through a partner, according to the company.

Part of the company's recent success has to do with its swift accumulation of well-trafficked partners. The company has added AOL Time Warner's America Online, AltaVista, iWon, NetZero and Go.com since September.

As a result, click-throughs on GoTo links have been skyrocketing. The company reported 114 million in the third quarter, 228 million in the fourth, and 314 million in the recently reported first quarter 2001.

CEO Meisel says the company has reached a critical mass in terms of the number of advertisers and the reach through distribution partners that puts it beyond the reach of serious competition, much like eBay sewed up the online auction market before Amazon.com's or Yahoo's attempts could pose much of a threat.

"As more revenue comes into the system, that allows us to build distribution, which attracts more advertisers," Meisel said. "The more revenue, the more we have to share with distribution partners. So we have network effects like those written about in the eBay example. Think about how Yahoo and Amazon entered auction business. People expected them to get traction, but nobody knew that eBay had reached critical mass and had become impossible to catch."

 

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