The Small Fry Sour On Search Ads

Priced out by brand giants, the outfits that pioneered the medium are looking elsewhere

For years, running those little four-line text advertisements on Web search engines brought in a profitable stream of new customers to BabyAge.com. But last year, search suddenly turned sour for the eight-year-old online baby products store, which posted about $20 million in sales. Even as BabyAge's $1.2 million worth of search ads got more clicks in 2006, they netted fewer actual buyers, effectively doubling their cost. "We're out of business at this rate," fumes Chief Executive Jack Kiefer. He plans to cut back on search ads this year.

Kiefer isn't the only one casting a more skeptical eye on what has been the fastest-growing and most lucrative Internet ad market. So are midsize online retailers such as jeweler ICE.com, luggage seller eBags, and consumer-electronics store eCOST.com. Search ads, which run alongside query results on Google Inc. GOOG , Yahoo! Inc. (YHOO ), and other search sites when someone types in "diamond necklace" or "DVD player," used to be the marketing weapon of choice for these outfits. They reached more targeted audiences and could be measured for effectiveness. Now the price per click on those ads is rising--by an average of 31% from a year ago in the third quarter, according to DoubleClick Inc. Some merchants are looking seriously at alternatives--even, of all things, print and radio spots.

Think of it as fallout from a new online land rush. Brand giants from Best Buy Co (BBY ). to Zale Corp (ZLC ). are diverting more and more of their marketing budgets to search ads. They're driving up prices and stealing customers from some of the smaller businesses that have bought the bulk of those ads. Web users have learned to shop around more, and now, instead of clicking on ads from the little guys and buying from them on the spot, they're often buying from the big brands they know well. If many of the small and midsize companies that pioneered this ad medium get disillusioned, search ads could lose their luster.

For the time being, Google's not worried. The rush of ad dollars from big brands into search is more than making up for any cutbacks by smaller outfits. National marketers from General Motors Corp. (GE ) to Wal-Mart Stores Inc. (WMT ) are for the first time dedicating branding budgets to search, says Matt Greitzer, search director at Web marketing firm Avenue A/Razorfish. And Google and Yahoo say that even small companies with the right products and message can still trump big brands online. "We're not seeing any erosion of ROI [return on investment] across the board by our customers," says Richard Holden, Google's director of product management for advertising.

Still, many small and midsize marketers are buying far fewer "keywords" and phrases. Merchants are also trying out ads on MySpace and YouTube, or advertising on blogs and niche shopping sites. Says consultant Andy Beal of Marketing Pilgrim: "The free lunch is over."