There are many businesses who find themselves in the pay-per-click trap and at the end of the day most of their profits are paid to Google for the advertising they rely on to sustain their businesses. Getting to the bottom of this “pay-per-click trap” and how you could be working for Google will take a little explanation.

Media outlets and other sources of advertising have always charged based on the number of impressions/viewers/listeners/readers and set their pricing based on what the market will bear. So what’s wrong with that?  Well, traditional media is different from Internet advertising, specifically the pay-per-click model and how it affects pricing and competition, and this changes everything. (check out “Do We All Work for Google?“)

Let’s step back and explore the basic economics behind PPC advertising and its relationship to Internet commerce. PPC advertising is setup in a bid/auction model where the more you are willing to pay, the higher your ad will be placed in the sponsored results for your target keywords. Using free-market economic principals you would assume that over time competition for these keywords will naturally increase the cost per click. So again, what’s wrong with that? What’s wrong is that the very nature of the Internet permits hyper-competition, therefore creating sustainable profit in markets where significant barriers to entry or competitive advantage do not exist is virtually impossible.

Using a recent headline bankruptcy to illustrate the point, Circuit City for most of its life was a 100% traditional retailer, it had physical locations, sales people on the floor, and used lots of traditional advertising to bring customers in the door. If someone wanted to compete with them they had to also have a physical location, sales people, and use traditional advertising to bring customers in the door. So at least on the surface Circuit City and any competition that entered the market such as Best Buy would face similar challenges and would expect a reasonable profit margin to make the creation of the enterprise worthwhile. If there are already a couple of competitors in the market that aren’t making unreasonable profits or running inordinately sloppy operations, it’s unlikely that would-be competitors would jump into the fray lightly.

By contrast can you even count the number of online retailers who sell most or all of the products that Circuit City once carried in their stores? Searching for a particular model of LCD TV yields thousands of online retailers offering the product up for purchase. So what is the competitive advantage of one online retailer over another? For some shoppers it might be service or product information, however most shoppers will use whatever sources they can find to narrow down their selection but will make the purchase from whoever has the lowest price. So the only tangible advantage an online retailer has over another is cost and how readily they can be found on the Internet.

This brings us back to the PPC model and the underlying economic principals it relies on to generate staggering profit and growth for Google quarter after quarter. Anyone who wants to jump into online commerce can setup a Yahoo! store and a Google AdWords account and be ready to sell merchandise in a few days with very few barriers to entering the market. This new merchant has virtually no overhead outside of his or her basic living expenses such as food, rent, and advertising.

The cost per click will naturally increase as each new competitor enters the market and the only thing that will stop the increase in PPC bids is the inability for the market to bear anything higher. This happens in nearly real-time as advertisers adjust their bids based on sales conversions, and in the very back of their minds the profit they are making on those sales. Businesses with the best converting websites and the slimmest overhead and profit will ultimately prevail and at the end of the day Google very well might be making more profit from your business than you do. If Google is making more profit from your business than you, then like it or not you’re working for Google.

You might be thinking that Internet commerce is hopeless at this point, but that’s not the case. The key to competing on the Internet is that you MUST find ways to carve out competitive advantages or you will be doomed to work for Google and eke out whatever meager profits the market will bear.

Areas you might consider exploring for competitive advantage are search optimization, building a better Website, creating a very focused niche with exceptional knowledge within that area, increasing the value of each customer through repeat purchase programs, customer referral programs, or partnerships.