Is Yahoo a profit making company? If so how do you make your profit?

How Yahoo and Google Make Money

How do Yahoo and Google make money? This is a frequently asked question, so let me give a high level overview.

The short answer is targetted advertising. Why and how does it work?

What do you use Google for? Search. Let’s look at search. Say the user searches for “mountain bike San Diego”. Chances are he’s looking for a place to go mountain biking. Or, perhaps he’s looking to buy a mountain bike. Google will go and find the most relevant Web pages on that topic.

Now imagine you own a mountain bike store. If somebody told you they would let you show your advertisement to this specific user exactly at the moment he’s expressed interest in mountain bikes, while it’s foremost in his mind, would you be interested? Sure you would. That’s what Yahoo and Google do: not only do they find the most relevant Web pages, they also find the most relevant ads and show them to the user in the form of Sponsored Links.

The sponsored links are actually relevant, so some percentage of the people that see them click on them. Note that this is very different from Banner Ads - those are generic ads targetted at a demographic (or sometimes not targetted at all).

Each time a user clicks on your ad, Google or Yahoo has effectively sent you a lead, someone who’s likely to buy something from your mountain bike store.

This lead is valuable to you and you’re willing to pay for it. But how much?

Turns out you’re not the only mountain bike store in San Diego. I own a store too, and I want that same lead. I’m willing to pay for it too.

So how do we determine the price? Very approximately speaking, by bidding on it. It’s sort of an auction.

I want to advertiser my mountain bikes. I go to Yahoo or Google and tell them: every time somebody searches on “mountain bike”, show my ad. I do this by specifying a bunch of terms related to mountain bikes, and I provide the text for my ad, and a link to my Web page. Something like:

keyword: mountain bike, offroad bike, offroad bicycle

advertisement: buy my wonderful mountain bikes, they’re the best

url: www.mywonderfulmountainbikes.com

You own a mountain bike store too, so you do a similar thing.

Along with my advertisement, I specify how much I’m willing to pay for each lead. What is a lead? It’s defined as a click on my ad. So my bid says I’m willing to pay X each time someone clicks on my ad.

Note that I pay for clicks, not for my ad being shown (aka impressions). It’s a good deal - I only pay if the user is interested enough in what I offer to click on it.

I specify a bid. You specify a bid too. Approximately speaking, the higher the bid, the more prominently/more frequently the ad is shown. Other factors go into picking the actual ordering of the ads, but bids play a big part.

So there you have it. Lots of advertisers bidding on many millions of keywords, and hundreds of millions of users doing billions of searches, a small charge each time somebody clicks on an ad, and you get a big business.

There are also contextual ads, the ads you see on blogs and other random web pages. Same idea, except instead of using the user’s search term to select the ads, the contents of the page you’re looking at is used. So if you’re looking at a page about mountain bikes, you’d see ads related to mountain bikes.

There’s more to it than this, but to a first order approximation, this is the core of the business.