Analysis: Google’s Q3 Profit Doubles, but at Who’s Expense?

In yet another testament to the growth of search and online advertising, Google reported a 70% jump in profits and nearly doubled revenues for the third quarter. The company has already proven that it is possible to make money, big money, on selling advertising online. The next step is to apply those skills to new areas like music and video.

“We seem to be able to produce new ways of monetizing our products all the time”, says Sergey Brin, co-founder of Google, during a conference call on Thursday.

The positive news from Google’s Mountain View, CA headquarters comes on the same day that NBC Universal announced it will overhaul operations, cut about 700 jobs and slash annual costs by $750 million from its traditional media operations.

NBC executives said some of its savings would be invested in new growth areas of media. The company expects revenue from digital operations like online and mobile entertainment to exceed $1 billion by 2009. Is it possible? Well, looking at Google’s revenue, which totaled $2.69 billion, there was a 70 percent increase from $1.58 billion last year. And that is just for the last quarter. So, it seems like anything is possible right now in the digital space.

“We are entering a new era of what is possible to do on the Internet. We are going from search advertising to digital entertainment”, said Google Chief Executive Officer Eric Schmidt during the conference call on Thursday.

So, we have seen that the industry has come to realize that the future of media and entertainment is digital and online. Even the giants of “old media” have come around. What conclusion can we draw from that?

First, digital entertainment and search advertising are about to become a very crowded space. Yes, Google keeps on growing its profits at an incredible rate. But we must remember that it was just a few days ago that its rival Yahoo! reported a 38 percent decline in profits. Digital media and entertainment are not as easy to monetize as Google might make it seem. And many of the new entertainment and technology companies springing up in Silicon Valley are basing their business models soley on advertising. Will there be enough ad spending to go around, especially if the housing bubble bursts and the general economy takes a dive?

Second, the legal issues in the digital realm are far from resolved. This creates a lot of uncertainty for both content providers, aggregators and distributors. No one wants to be the next Napster, but no one wants to be Universal Music or Sony BMG either. I’m confident that these issues can be resolved and already we have seen some indications of that in the recent YouTube deals with the labels. But uncertainty is never good for business.

Finally, Web 2.0 is a game changer. As Hal Varian, a professor of business, economics and information management at the University of California, Berkeley, advices “old media” executives in a recent NYT article: “You have spent a lot of time worrying about piracy, but the biggest threat you face is the falling cost of producing and distributing digital content.” Yes, but it is also “old media’s” biggest opportunity. User generated content on YouTube, virtual worlds like Second Life and social networks like MySpace represent new ways to engage an audience. Google has showed that it is possible to monetize these opportunities. But to some extent it is a zero-sum game. That is why companies like NBC Universal should be worried about Google expanding into video with YouTube, armed with the proven capability of delivering advertising solutions that are much more effective than the 30-second spot.