Late last year, Baird analyst Colin Sebastian called Google an "e-commerce powerhouse." He expected Google Shopping to make efforts to win over more merchants and shoppers following the hiring of former PayPal Chief Operating Officer Bill Ready. That would make Google a serious competitor to Amazon (NASDAQ:AMZN)

And Ready is doing his best to prove Sebastian right.

Over the last few months, the Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) search engine has made several major changes to Google Shopping. Merchants can now list items for free, and those listings will show up in general search results as well.

Ready's next step is removing commissions for merchants using its Buy on Google checkout service. Google previously charged commissions up to 12% for sellers that use the feature to complete a sale directly from Google's search results. Offering the service for free ought to help Google build out a substantial product catalog.

People in color-block shirts standing in the shape of the Google logo's G as seen from above.

Image source: Google.

Building a network

One of Amazon's biggest competitive advantages is its network of merchants and consumers. As Amazon grew the number of items available on its marketplace by courting sellers, shoppers found Amazon was able to fulfill practically all of their shopping needs. The company amplified that network effect through the introduction of Prime and Fulfillment by Amazon.

Google's now focused on building its own network of sellers on Google Shopping by offering them free tools to make more sales. Even if Google doesn't have the same number of shoppers on its platform as Amazon, offering merchants additional exposure with minimal investment is a good value proposition.

To be sure, Google isn't starting from nothing. It's the second-most popular place to search for products online, trailing only Amazon. But Amazon has built out a substantial lead over Google -- nearly twice as many shoppers start online product searches on Amazon as Google.

Moreover, Amazon searchers usually have more intent to buy. Google isn't as much of a destination for people looking to buy as it is a place to research products.

But changing that consumer behavior starts by making Google Shopping a better destination to find and buy products. That means more product listings that are easier to buy. Offering merchants free listings and no commission for Buy on Google should make Google Shopping a more appealing shopping destination. And Google can funnel shoppers into the experience through its main search product.

How will Google make money?

Google is sacrificing revenue in the near term, but creating a much greater long-term opportunity. There are three factors that will drive value for Google shopping.

  • Reclaiming share of product searches. If Google is able to surface better and more relevant results by increasing the number of products in its listings, consumers will gravitate toward the search engine.
  • Providing more value to merchants. One way Google can provide more value is if Buy on Google increases sales for merchants compared to driving traffic to the merchant's website to complete sales. 
  • Increasing the competition. The harder it is for a merchant to stand out in organic search results, the more likely they are to pay for placement at the top of the results.

These are the same three factors that led Amazon to build a $13 billion advertising business in the U.S. alone. And that business is still growing extremely quickly.

Importantly, Amazon's advertising business only started taking off after it built a substantial network of buyers and sellers. Amazon's "other" revenue line item, which now consists mostly of advertising, totaled less than $3 billion in 2016, but it had over 20 million Prime-eligible items. It's more than quintupled since, and Amazon now counts over 100 million Prime-eligible items and 150 million Prime members as it's continued to grow both sides of the network.

Google needs to copy Amazon's road map and build up the network before working to take back share of the e-commerce advertising market. Ready is pushing Google in that direction, and investors in the FAANG stock should look for management commentary around merchant signups, product searches, and successful checkouts to see how the efforts are paying off.