Click Fraud could undermine the boom in Online Advertising

Internet advertising is booming. The industry has gone from $9.6 billion in revenue in 2001 to $27 billion this year.And it is still early days. The internet accounts for only 5% of total spending on advertising, but that figure is expected to reach at least 20% in the next few years. The single largest category within this flourishing industry, accounting for nearly half of all spending, is "Pay-Per-Click" advertising, which is used by firms both large and small to promote their wares.

It works like this. Advertisers bid on keywords that they believe potential customers will be interested in. This enables internet firms such as Google, the market leader, and Yahoo!, its smaller rival, to display advertisements alongside the results of internet searches. Somebody searching for a particular type of wine, for example, might see advertisements from wine merchants. Google, Yahoo! and other firms also place ads on affiliates' websites, so wine merchants' advertisements might also appear on a wine-appreciation site. The advertiser pays only when a consumer clicks on an ad; the owner of the website where the ad was displayed then receives a small commission.

The benefits of the pay-per-click approach over traditional advertising (television, radio, print and billboards) are obvious. Since advertisers pay only to reach the small subset who actually respond to an advertisement, the quality of the leads generated is very high, and advertisers are prepared to pay accordingly. The price per click varies from $0.10 to as much as $30, depending on the keyword, though the average is around $0.50. "Mesothelioma", for instance, the name of an asbestos-related illness, is an especially valuable keyword, because lawyers are prepared to pay a lot to make contact with sufferers in the hope of representing them in a lucrative compensation lawsuit. Google made most of its $6.1 billion in revenue last year from pay-per-click advertising.

But as pay-per-click advertising has grown into a huge industry, concern has mounted over so-called "click fraud", bogus clicks that do not come from genuinely interested customers. It takes two main forms. If you click repeatedly on the advertisements on your own website, or get other people or machines to do so on your behalf, you can generate a stream of bogus commissions. Click fraud can also be used by one company against another: clicking on a rival firm's advertisements can saddle it with a huge bill. Bogus clicks are thought to account for around 10% of all click traffic, though nobody knows for sure.

In the wake of these legal challenges, Google and Yahoo! recently joined a working group at the Interactive Advertising Bureau (IAB), a trade association, which will establish standards for pay-per-click advertising, including the introduction of industry-funded auditing and certification, by the middle of 2007. In February Snap, a search engine launched "pay-per-action", a new model in which advertisers pay only if a click on an ad is followed by an action such as a purchase or a download. Google is testing a similar model and Turn.com, another ad network, adopted the pay-per-action model a few weeks ago.

Update by Sunny: Will the Pay-Per-Action put an end to click fraud? Pay-per-action will be a niche, since converting a click into an action depends on a variety of factors such as the ease of use of the advertiser's website. Google and its peers will be reluctant to be so dependent on factors outside their control. But I think pay-per-action could become a real alternative to pay-per-click. As bigger companies spend more on internet advertising, they will demand more accountability and a wider range of options. At the very least, that means clamping down on click fraud, but it also presents an opportunity for entrepreneurs to invent new models that are less vulnerable to abuse.