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I was walking down the street last week and a charming young lady came up to me and asked “is click fraud a major problem for search engine marketers?” OK, it was actually a co-worker that sits next to me who asked the question, but I thought it sounded more intriguing the other way. I digress . . .

Click fraud does get a lot of hype these days, especially in reference to Google’s seemingly inflated stock price. To me, click fraud is like any other type of online fraud – it is manageable, but it will always be around.

Right now, savvy advertisers take click fraud into account whenever they place a bid on Google or any other PPC advertising network. This is apparent when you look at the bid prices for the same exact keyword on different networks. Let’s say you want to buy the word “refinancing.” If you went to Google (search only) or Yahoo (search only), you’d pay around $6.00 for the top bidded position. Move onto Google or Yahoo contextual, and your bid moves to around $3.5. Try a “second-tier” search engine like Miva or Kanoodle and your bid drops to $1. And at the bottom of the barrel, there are some search engines that would cost you no more than $.10 a click.

Why the difference? In essence, the level of click fraud. The price of a CPC bid is largely determined by the ROI achieved by the advertiser. Every fraudulent click reduces ROI and thus reduces bid price. Thus, if something seems to good to be true (like a $.10 click cost on one engine versus a $6.00 click cost on another), it probably is.

If click fraud gets out of control on Google, bids will drop. If click fraud is contained, prices will rise. A real-life example of this scenario revolves around the word “mesothelioma lawyer.” A person would type this term into a search engine if they were diagnosed with mesothelioma – lung cancer caused by exposure to asbestos – and they wanted to sue an asbestos company for their illness. Lawyers know someone diagnosed with this horrible disease could easily have a claim worth $1,000,000 or more to their lawfirm.

As a result, bidding on this term became red hot a few years ago. So hot, in fact, that the top bids exceed $100 per click. Then, the media caught on and identified this term as one of the most expensive PPC terms around. Suddenly, lots of people without a mesothelioma diagnosis were typing in this term – either out of curiosity or for malicious purposes. Either way, the click quality dropped fast. Today, the top click on Yahoo for this term is “only” $15.25 – a reduction of over 90%.

So Google and Yahoo have a clear incentive to stop click fraud, right? The less click fraud, the more advertisers will pay for click, which means more money for the search engines. Well, not exactly. While it is true that smart advertisers reduce bids as click fraud increases (and ROI decreases), there are still plenty of less smart (to put it nicely) advertisers who don’t have the capability to truly measure their ROI. For example, if you can’t track the performance of every keyword you buy, you can’t measure the ROI for that keyword, you can only measure overall ROI for your accounts. This inevitably means that you will pay too little for some keywords and too much for others. And this often results in high bids on keywords with lots of click fraud.

As a result, there are plenty of situations where click fraud exists and yet bids keep going up, up, up. This results in smart advertisers sitting on the sidelines, leaving the other advertisers to fight for top position. Over time, the dumb advertisers will either run out of money and disappear, and the smart advertisers may be able to get the keyword for the correct price. Right now, however, this is often a short-term victory, because the moment one group of dumb advertisers disappear, another group sprouts up to take their place.

In other words, because PPC markets are so immature, the big search engines really don’t have to worry too much about click fraud or ROI, because there are plenty of unsavvy marketers ready to buy clicks. So, right now, Google and Yahoo probably make more money with click fraud than without.

This will eventually change, probably in the next year of so. As less and less new and inexperienced advertisers sign up for PPC campaigns, search engine revenue will become concentrated in an elite group of top marketers. These are the marketers with highly advanced tracking systems that can detect multiple clicks from the same IP address, or too many non-converting clicks from a particular content site. These advertisers will pay the efficient rate per click – i.e., the rate that makes them money.

At that point, the search engines interests will be aligned with the marketers’ interests. Eliminate click fraud and marketers will pay more; let click fraud fester, and marketers will allocate their budgets elsewhere – either to other search engines or other mediums.

So am I concerned about click fraud – sure, I adjust bids downward every day on keywords where I suspect click fraud. Will this be the demise of Google? Probably not – Google has lots of other problems to deal with – from competitor movements, loss of top employees, customer service and now a Government subpoena – that could be much more detrimental.