Is Yahoo! Sleeping With the Enemy?

Yahoo!'s (Nasdaq: YHOO) no stranger to strange bedfellows, but yesterday's announcement -- that the search-engine giant would team up with Click Forensics to share data and help tackle click fraud -- turned heads.

If the name Click Forensics rings a bell, you may be thinking of the market researcher's shocking revelation two years ago that 13.7% of the clicks generated through online advertising were bogus.

The news rattled the industry, despite objections by many of the companies -- like Yahoo!, Microsoft (Nasdaq: MSFT), and Google (Nasdaq: GOOG) -- that generate pay-per-click leads.

The findings were more troublesome to smaller players than to the big boys. Click Forensics' findings pegged click fraud at low-tier sites as high as 30%, while it was closer to 12% for the dot-com juggernauts. The report insinuated that click fraud was a bigger problem for smaller players like MIVA (Nasdaq: MIVA), LookSmart (Nasdaq: LOOK), Local.com (Nasdaq: LOCM), and Marchex (Nasdaq: MCHX).

Why is click fraud such a widespread problem? Most believe that it's primarily done by sponsor rivals trying to drain their peers' marketing dollars. Mean-spirited users can also be a factor. However, the real challenge these days lies in keeping third-party publishers honest.

Google and Yahoo! both offer online advertising programs that allow website owners and even bloggers the money-making opportunity to show contextual ads on their own pages. The search engines then pay the publisher the lion's share of the generated revenue.

The temptation for unscrupulous webmasters to repeatedly click the ads showing on their own sites -- or encourage their users to do so -- can be great. Google and Yahoo! weren't born yesterday. They boot black-hat publishers from their programs all the time. There's just too much at stake for them to put up with the malfeasance.

Let's take Google's AdSense program, for example. It's the undisputed top dog since its 2003 launch. 34% of Google's $4.8 billion in revenue this past quarter came from ads displayed on its partner pages. However, $1.44 billion of the $1.64 billion derived through AdSense goes right back into paying for the program, mostly in the form of payments to publishers.

So AdSense is an important top-line contributor, but a miniscule producer on the bottom line. Why bother running the program? Well, it's a great way to clear up unused inventory, attract new sponsors, and keep competitors away.

It's worked for Google, since third-party publisher-generated revenue actually fell by 13% at Yahoo! this past quarter (whereas it rose by 37% at Google). That may explain Yahoo!'s move to team up with Click Forensics. Now that it is losing relevance as an ad platform with third-party publishers, it has less reason to be concerned about click fraud (and more to gain if Click Forensics spouts off about shortcomings elsewhere).

In the end, click fraud isn't as big a problem for advertisers as it sounds; it's a self-correcting crime. Since online ads are fully accountable, sponsors just tweak their bid prices lower if they're not getting the expected return.

Then again, that may be the best reason for Yahoo! to sleep with a grim soothsayer. Sponsors will have greater confidence when signing up with Yahoo!, even if -- at the end of the day -- they wind up spending more at the search engine that delivers the best bang for their marketing buck.

For more on Yahoo!:

• Will Cash Be King for Microhoo?
• Yahoo! Doesn't Get the Joke
• Yahoo! Tries to Fend off Unwanted Advances