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If you’re a search marketer and don’t know the meaning of the word “arbitrage”, btter pull out that old Econ 101 textbook and brush up on your financial terms. Arbitrage in search marketing may be leading you to spend more on clicks than you’re getting in return, according to some professionals in the field.

Basically, arbitrage means exploiting a price imbalance between two markets in any commodity. The concept has been around for centuries in finance: It translates into buying something cheaply in one place and selling it for a higher price somewhere else, without doing anything to add value along the way. Foreign exchange markets do it all the time, due to differences in the currency conversion rates in, say, London and Tokyo; so does anyone who’s ever bought an item at a discount outlet and then sold it on eBay for $5 more.

Arbitrage has appeared as a business model in search marketing too, because the cost of clicks on general search pages—through Google AdWords or Yahoo! Search Marketing—can sometimes be much lower than the cost of clicks through the search engines’ contextual publishing networks. So a Web page operator can buy Google search ads for one cost-per-click price, then sign that page up as part of a search engine’s publisher network and populate it with contextual ads that pay much more per click, making a profit off the difference.

Of course, the word “contextual” gets stretched here, because in many cases there is no context on the page other than the ads; usually, the only other content on the page is a set of links, many of them pointing to other ad-heavy pages. Advertisers in the search engines’ contextual ad programs don’t have any say in where their ads get placed; if the context fits, their ad is liable to show up, and there’s not a lot of direct action they can take to prevent that.

There are implications from arbitrage that go beyond simply making Web search more complicated or frustrating for the user. Advertisers who take part in search engines’ contextual networks can feel the effects of search arbitrage too.

For one thing, in some very competitive categories such as financial services or mortgage lending, arbitrage can draw lots of bidders who aren’t directly involved in the industry sector but are interested in capitalizing on its SEM profitability. Frank Watson, head of search marketing at Forex Capital Markets, an online currency trading market, told an audience at Search Engine Strategies San Jose last month that while there are only 40 companies in the space FXCB occupies, he’s found 162 bidders for the keywords that point to his category.

Those keywords already average about $15 a click, Watson said, and allowing participants to bid on them who have no interest in the traffic other than leading them to another more expensive ad creates upward pressure on keyword prices, Watson told the crowd. “They’re pushing the price a lot higher for everyone else who’s trying to make a legitimate income from the business,” he said. Letting affiliates bid against you on keywords may be a cost of doing business, he said, but letting in bidders who aren’t in the sector is just “a nightmare.”

FXCM’s case might be somewhat specialized; after all, most keyword categories don’t draw anything like $15 bids. A lot of arbitrage actually occurs at the lower end of the price spectrum, with bids on very generic keywords that command very low prices.

Tim Daly, director of marketing and strategy at St. Petersburg FL-based interactive marketing firm SendTec, lays out the pitfalls for marketers in this strategy. (Daly was also on the SES arbitrage panel but spoke to SearchLine after the event.) Basically, he says, some of the worst offenders in this arbitrage group buy ads on general, authoritative-sounding keywords that don’t convert very well to sales, such as “floors” or “rugs”. They then direct that traffic to more specific and often more lucrative contextual ad terms.

That can have the effect of taking a visitor who’s doing a general search into an inappropriately deep landing page on a marketer’s site—one where they can’t easily find the product category they’re looking for, and from which they’re likely to leave without clicking any further.

Daly says he’s seen the effects of this practice in action, with a SendTec client in the flooring category. Only about a fifth of its sales are hardwood floor products. Some customers looking for the client’s products were being pulled through an arbitrager’s search ad on “floors”, which sold for about 50 cents a click, and being directed to the client’s site for “hardwood floors”, a term that went for about $4 a click. The problem is that only about a fifth of the client’s sales came from hardwood floors, so most of those visitors were being brought into the site at an inappropriately deep landing page, Daly says. As a result, bounce rates for that traffic—the ratio of visitors who arrived on the site and clicked away without exploring any other page-- were running at 70% to 80%, rather than the industry standard of 30% to 40%.

The tactic can be deployed in reverse too, depending on the product category. Another SendTec client sells motorcycle parts and accessories. Daly reports that an arbitrage site was bidding for search ads on a highly specific term such as “motorcycle spark plugs”. Visitors who clicked on that ad eventually found their way to the client’s Web site—but through a more general contextual ad for “motorcycle parts”, and landing on the client’s home page, not the spark plug product page. That cut substantial into conversion rates and investment return for the client’s contextual ad. That can make arbitrage particularly noxious to direct marketers, of course: Brand marketers don’t care so much about delivering visitors to specific landing pages, just so long as they’re on the site and absorbing the brand.

“It’s not necessarily stopping marketers from getting the sale, but they could very well be paying twice to get the same visitor,” Daly says.

Sometimes arbitragers will run search ads that seem to promise very specific product offers at the next click. Kim Malone, director of operations for Google AdSense, showed the SES San Jose audience an ad that promised a carbon monoxide alarm for $29 but instead led to an arbitraged page full of more ads.

Daly says user expectation is what distinguishes these arbitraged pages from legitimate directories and comparison-shopping engines, which after all also bring visitors to pages full of ads and links.

“The difference is that their marketing copy appropriately suggests what they do,” he says. “If their ads say, ‘Click through to find the best prices on a range of products,’ that’s good enough. But if you suggest that you have deals on your site and then offer up just a page of ads, I consider that fraudulent advertising.”

“It’s perhaps unfair to call it a form of click fraud,” he says. “It’s really more con artistry, but it acts like a subtle form of click fraud in the way it affects advertisers. They’re not getting the quality of clicks they expected to pay the search engines for.”

While stopping short of using the f-bomb, Google apparently doesn’t care for it either. In July the search engine updated its landing-page quality ranking mechanism so that low-quality “Made for AdSense” pages now have to pay a higher minimum bid price for AdWords search terms than marketers with landing pages that Google deems more valuable. That change makes the arbitrage business model that much less viable, at least within the Google network.

That update decision was made in the context of improving the search user experience, Malone told her SES audience last month. “We put one thing first: to give the users what they want the first time, every time,” she said. “There’s nothing wrong with buying low and selling high, as long as it creates long-term value for the user.” But search ads that promise $29 CO2 alarms and deliver only ads, or long strings of useless interstitial pages that stand between users and their target results don’t create that value. In fact, they can “pollute the water” for the search marketing industry generally by making users reluctant to click on future ads, she said.

Complaining blog posts from some Web operators and affiliates aside, most commentators seem to think Google’s most recent move has pretty effectively narrowed the arbitrage window. Attention has now turned to Yahoo!, and Daly says that, by his lights, Yahoo!’s distribution partner agreement contains language that could be used to help stamp out arbitrage abuses on its own network.

He maintains that pages flagrantly created just to house more ads violate a section of Yahoo!’s distribution partner agreement against creating a fraudulent impression on any page that carries Yahoo! paid search ads. “Such a fraudulent impression creates an invalid click, and therefore you [the Web publisher] don’t get paid,” he says.

As a result, Daly says, he’s encouraging SendTec’s clients, and any other marketers who find their ads have been getting less-than-qualified traffic due to arbitrage, to file for click-fraud reimbursement from Yahoo! SendTec has already done that for the motorcycle-parts client, Daly says, and been told by Yahoo! that since there was no sign of “irregular activity” on the account, no reimbursement would be made.

“Irregular activity is not a precursor to click fraud,” Daly says. “Just because they’ve overlooked something for a long time until it’s been established as ‘regular activity’ does not make this quality click traffic.”

Next week’s SearchLine: Search arbitrage from the perspective of an unapologetic practitioner. Arguing Search Arbitage, Part 2