A good friend of mine (Let’s call him Sam Rothstein) is just finishing up a stint in the hedge fund business. He is a bit of a quant and an overall critical thinker, so I ran the Keyword Derivative Market idea by him. His verdict?
“It won’t work”
“Why not?”
“The risk– there’s no way to calculate the risk. You think you’re all smart and have worked out the percentages on the bell curves and all the possibilities of what might happen that would wreck your prices, then wham! That one-in-a-billion thing that could sink your risk hedges actually happens, because it turns out to be a one-in-a-thousand thing.”
“Yeah, but that’s why I pad the keyword bids a little.”
“By how much? What amount? That padding is your determination of the cost of the risk– you cannot calculate it, therefore you cannot come up with a price.”
“shit.”
Sam went on to describe the basic flaws in risk-based hedge funds. He complimented me on coming up with a business model that had recently bilked billions out of the market, but simultaneously reminded me that there are thousands of people trying to figure this out– many of them much smarter than me.
In the end, a keyword is an expungable commodity, but it also has something what I’ll call “high sucker elasticity“: Retail companies calculate the price they are willing to pay for a keyword position, usually based on some determined cost-of-acquistion equation. If the price of a keyword bid gets pushed too high (according to a rational cost/revenue calculation), there is always another sucker to buy that irrationally high keyword postion. Google’s profits are intrinsically linked to the irrationality of the market.
Keyword management software providers like efficientfrontier, kenshoo, marin, and others are making great headway in bringing rationality to this market, and are good for the long haul or large corporate spends– but the little man will always make keyword purchases with snap decisions based on insufficient information. He’ll get suckered.
To their credit, Google tries to explain this out as much as possible: they make their API open to the keyword management companies, they give away performance statistics for free, they try not to be evil.
The odds on craps are written right there on the green felt, too.