Will Google Sites KO AdWords Hosting Revenue?

Lew Moorman from Rackspace has a fascinating analysis of Google's relationship with the web hosting industry, as part of a broader look at Google Sites and whether it will help or hurt Google's revenue from hosting. Lew dives into the cost of acquiring a hosting customer using Google AdWords, which is one of the primary ways that web hosts find new accounts (along with affiliate referrals). His conclusion: that Google makes more from hosting-related AdWords keywords than it could make with Google Sites.

Lew's math suggests an interesting possibility: that each hosting signup through AdSense makes more money for Google than it does for the hosting company that winds up with the client. His assumption is that one in 10 AdWords clicks will convert to a sale. At the current pricing of up to $15 a click, Google makes $150 on the 10 clicks required to produce a sale, which could easily be more than the host makes in profit margin during the customer relationship. And Google bears none of the associated expense for resources and support.

"Who would you rather be?," Lew asks. "Google has the ultimate model. They get paid for leads in an auction process and can deliver those leads at super low cost. Why are they making this trade?"

I think Lew's basic math about the profitability of AdWords versus hosting accounts is probably right. Here's the missing variable: how much revenue can Google make from Google Sites? The new service is part of Google Apps, which is available in a free version or as a premium product at $50 a year for each user. The economics of the premium plan are clear. But how does Google get revenue from the free Sites accounts, other than pre-qualifying a percentage of users for premium accounts?

One way is by converting those new Sites users into advertising or e-commerce customers who will use AdWords or Google Checkout. When it introduced its Checkout service, Google offered discounts to AdWords customers, enticing them to buy AdWords text ads to generate sales that would be processed through Google Checkout. Google Sites than becomes the bottom layer in the pyramid, as promotions for AdWords convert a percentage of Sites users into customers for AdWords and Checkout.

Hosting's Margin Challenge

Lew's analysis illustrates the larger problem for web hosting companies: acquiring customers is really expensive and profit margins are squeezed by competition. This isn't just on hosting accounts, either, which complicates the model in which the hosting account serves as the doorway to profitable add-on services.

This model took a hit when hosting companies began using discounted domains and SSL certificates as promotions to win hosting customers. These offers created pricing pressure on SSL certificates, which trended lower in price. That's one reason certificate authorities moved to create Extended Validation SSL certificates, which sell at much higher prices and have helped heal CA margins.

In the hosting ecosystem, your bread and butter can be commoditized by the hosting company down the street - or across the world. Go Daddy built a nice business by selling private domain registrations at $9 a pop, only to have 1&1 Internet offer private domains for free.

Not to mention the fact that an Internet giant can invade your turf. Amazon recently launched WebStore by Amazon, which offers a turnkey online store and e-commerce operation for $59.99 a month. Amazon can now handle shipping and fulfillment for you as well. As a customer, who do you choose to host your store: your web host, or the folks running world's largest online store?