True to form, Google announced another bumper quarter last night. But one statistic causing some hand wringing is the continual fall of CPC prices.

Google say this isn’t a problem and not a concern for their business. Not only do I agree with them, but I think Google are the cause of the decrease in CPCs. Here’s a simple thought experiment to show why.

Let’s imagine a scenario where an advertiser gets 100 clicks a day from a search query. Let’s say 20 come from a paid ad and 80 come from an organic listing. Also, let’s assume that clicks from both convert at an equal rate (5%).

So our SEM report for day 1 looks like this:

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So the advertiser is happy, hitting his/her CPA target.

However, Google, in the quest for higher revenues, decides to increase the paid ad space on the page. Overnight, sitelinks, product ads etc appear, pushing the organic listings further below the fold. As a result, more traffic goes through the paid ads. The SEM report for day 2, to the advertiser’s horror, looks like this:

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At this point, the advertiser does what anyone would do to get back to their target. They reduce their bids.

Satisfyingly, this prompt action means day 3’s report reveals this:

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As Google increases the supply of paid ads and the demand stays the same, then the price will fall. That’s simple economics.

Google isn’t resting on its laurels. Many macro factors (e.g. spread of the internet in developing markets) and controllable factors (e.g. better targeting, more network partners) mean they can increase the revenue from paid ads despite the fall in CPCs.

The real stat, which Google doesn’t reveal, is the growth of monetisable impressions. That is, search queries that have ads against them. If that increases, all is good.

Update

Google have been releasing paid clicks and CPC variance data since Q2 2009. I’ve taken that to produce an indexed view of change over time.

As you can see since Q2 2008, although CPCs have declined about 19%, the number of paid clicks has increased by 130%. That’s not a bad trade-off.