Google is Demand Media’s Biggest Ally — and Its Biggest Threat

Demand Media (s dmd), the newly public content company that’s doing everything it can to avoid the term “content farm,” has been engaged in a head-to-head battle with Google (s goog) since just before Demand issued its public shares. That battle got jacked up a notch or two recently, when the search engine tweaked its algorithm to crack down on what it calls “low quality content” and Demand’s eHow unit got caught in the crossfire. Demand says this isn’t a big deal, but the reality is that its biggest partner is also its biggest enemy, and that’s going to dog the company — and the stock price — for the foreseeable future.
Google’s first content-farm related algorithm update in February (known as the “Panda” update, the nickname of one of the engineers involved in designing it) hit a number of content companies fairly hard, pushing down results from Associated Content and Suite101, among others. But Demand’s eHow site — which represents a large proportion of the company’s content business and also a substantial chunk of its revenues — escaped with very little impact, which came as a surprise to many. In fact, some estimated the site’s pages were actually showing up higher in search, not lower.
That changed dramatically with Google’s latest algorithm tweak, however. It’s not clear whether the search giant rolled out its latest update specifically to target eHow and others who were missed in the first go-round, but according to at least two tests — one from Sistrix and one from Cnet (s cbs) — eHow pages are now showing up as much as 65 percent lower in Google results. And the new algorithm changes were based in part on feedback from users about what webpages they found least useful.

Demand Media published a blog post late Sunday night saying the Google algorithm change did affect eHow’s rankings, but that estimates of the severity of the decline were “significantly overstated.” In the kind of careful language befitting a newly public entity, the blog post — which included a legal disclaimer almost as long as the post itself — said Demand expects to generate year-over-year page view growth “comparable to or greater than the year-over-year page view growth reported for Q2 2010,” which was 25 percent. The company also reaffirmed its financial guidance for 2011. Despite those reassurances, however, the stock price fell by close to 10 percent in early trading on Monday.
In other words, as far as Demand is concerned, things are just fine. But investors shouldn’t be quite so sanguine. For one thing, Google continually tweaks its algorithm, and there’s no reason to believe this is the last update related to content farms. And the big picture for Demand remains the same: namely, it relies on Google for an estimated 40 percent of its traffic and about 30 percent of its revenue, as described in its IPO securities filings, and therefore, the search giant holds the keys to its ongoing success in that market. Google has made it clear that “content farms” are a problem that needs fixing. As Demand said in the “risk factors” section of its prospectus:

Google may from time to time change its existing, or establish new, methodologies and metrics for valuing the quality of Internet traffic and delivering cost-per-click advertisements. Any changes in these methodologies, metrics and advertising technology platforms could decrease the amount of revenue that we generate from online advertisements.

Demand has said it’s working on boosting the quality of its content (something other “crowdsourced” content distributors such as are also doing in order to avoid the wrath of the great and powerful Google), but this is also likely going to increase costs at the company, another thing investors should be aware of. That and the need to constantly look over its shoulder at what Google is doing with its algorithm are going to be the biggest challenges facing Demand for some time to come.
Post and thumbnail photos courtesy of Flickr user Crystaljingsr