Why Digital Due Diligence is Good for the SEO Industry

Aaron Wall, one of the smartest SEO consultants around, is scandalized by Digital Due Diligence. And in a sense, he’s right: by compelling Google to take action on Milanoo, we’re hurting a small, VC-backed company, and helping established retailers. Moreover, we’re helping Google (a company with its own moral conflicts) by doing their dirty work for them. And if we had some kind of grudge against Milanoo, or knew someone who did, this would be exactly the right way to get revenge.

But that’s not quite the story here. At Digital Due Diligence, we share a lot of Aaron’s premises—and not just because we’ve learned a whole lot from his site. For example, I’d agree that:

• The SEO industry has a bad reputation, and we need to do what we can to fix it.
• Google is not a champion of all that is pure and holy: they’re a business, and they happen to have great PR. Lots of individual Googlers do want to make the world a better place, but many of Google’s decisions are best explained by the bottom line.
• Nobody wants to work in an industry where people are constantly calling one another out for misbehavior, rather than constructively engaging in good behavior.

A Market For Lemons, And How to Avoid It

Aaron’s best criticism is that we’re perpetuating a “market for lemons”: if nobody can be confident in the value of SEO services, they’ll naturally pay a lower amount. And if clients are paying less money, the people who profit the most are the corner-cutters.

But economists who study markets for lemons know that there are ways out. The two big ones are confluences of interest and better information. A confluence of interest is when a startup hires someone in-house to do their SEO, or pays their agency with equity and success fees. It’s hard to think short-term when your compensation is long-term.

But better information is a more scalable solution. A market for lemons only lasts when there’s asymmetric information. And at Digital Due Diligence, we are very much in the business of making information more symmetric. Take a hypothetical financial transaction: let’s say a brick-and-mortar retailer is buying out an online competitor. The brick-and-mortar folks know all they need to know about inventory management, effective discounting, and customer retention. What they need to know is whether or not that online competitor has a sustainable business position.

Enter Digital Due Diligence. We’ll assess the company’s online positioning, figure out where they’re getting their links and how sustainable their online growth is, and help the buyer come up with a solid financial model for how things will perform in the future. In a world where that’s not possible, you’ll see persistent markets for lemons: the people who want to sell will be the ones who either a) think their traffic is unsustainable, or b) are willing to take a low price because the buyer has to assume that a) is true.

That’s not good for buyers: it turns every purchase into a gamble. And it’s not good for sellers: white-hat SEO practitioners should be able to reap the financial rewards commensurate with becoming literally synonymous with whatever it is that they sell.

Not Fanboys, Not Character Assassins

To some people, black-hat SEO is a matter of good versus evil. On the good side, you’ve got Google, and folks noble enough to follow their guidelines. On the bad side, you have evil people gaming the system.

It’s not so simple. Google is an engineering marvel, but a hundred years from now they will be remembered for their PR coup: they managed to be the first company in history to turn their terms of service into a moral code. There is nothing immoral, per se, with paying for a link. In fact, pestering people for a link that you could just pay for is probably a lot worse.

But it’s hard to run a search engine if people can buy links. And it’s really hard to monetize a search engine if you don’t have a monopoly on “selling” page-one results. Remember that: even if Google is doing the right thing by cracking down on paid links, they are perpetuating a monopoly. It’s a really useful monopoly; Google has made my life way easier. But still: Google is a business, and they have found an easy way to squash or neuter the biggest threat to their business.

So why call people out for paid links? Simple: this is something investors need to be aware of—and they need to know that it’s a risk they can manage. Google’s penalties are applied somewhat arbitrarily; plenty of big sites get away with stuff that smaller sites can’t. But I haven’t ever heard of a purely white-hat site that got penalized by Google. If you’re selling a site, and that site’s SEO is done entirely within Google’s guidelines, you’ll only get credit for that if it’s something that the buyer can determine for themselves.

Many other businesses use due diligence, and people who do their due diligence are often the bearers of bad news. When a bank merges with a competitor, they want to know what that competitor’s lending standards are. There’s nothing actively immoral about lending to less creditworthy customers—but it makes a difference in how much that bank is worth, and it makes a difference in what kind of financial results they’ll expect in the future.

Why We Love Startups

We don’t do due diligence on banks. We do due diligence on online companies. Since the Internet as a commercial enterprise has existed for about a decade and a half, and since search-dependent business models are almost universally less than ten years old, this means we’re primarily scrutinizing startups.

Does this mean we hate startups? Not at all.

It means that we think it should be possible to value a startup properly—to know that a site with a million monthly visitors should be valued differently if those visitors come from banners, PPC, Facebook clicks, or natural rankings.

There are startups that have built up incredible businesses through natural search. Would OKCupid be worth $50 million if it didn’t rank #1 for the term “free online dating”? Hardly. Moreover, would it be worth $50 million to a buyer who didn’t understand the self-reinforcing nature of that ranking—that with a constant stream of new visitors, OKC can produce some of the web’s best linkbait?

Startups are fascinating. I never would have thought that a company could turn commoditized data, affiliate deals, and a good sense of design into a $170 million acquisition. But it happened, and it happened thanks to great SEO.

Frankly, a business built on link-buying (or affiliate marketing, or traffic arbitrage) is pretty boring compared to a company that has gotten great organic rankings. The legendary investor Warren Buffett says to look for businesses with an “economic moat,” and there’s no online moat quite as deep as SEO.

Of Link-Buyers and Martingales

In gambling and in trading strategies, there’s a concept known as a “martingale bet.” It’s a bet that delivers pretty good, pretty consistent returns—until a single disaster comes along and wipes the strategy out.

There were plenty of martingale-loving investors a few years ago: they’d buy CDOs to get a tiny premium over treasury bonds, in exchange for the minuscule chance that an economic crisis could wipe the CDOs out. We all know how that happened.

The big problem is that until there’s a crisis, the returns from a martingale strategy look better than anything else out there. And that means martingales attract lots of money from investors looking for the next big thing. As the quant-turned-entrepreneur-turned-VC Roger Ehrenberg explains, martingales are the best way to rob a bank. They attract more and more money until they blow up.

How do you avoid a martingale? You have to understand the fundamentals of the strategy: not just what happens when you extrapolate what’s already going on, but why such a strategy should produce predictably high returns. It’s easy to tell why Warren Buffett makes money; it’s possible to understand, in principle, why a secretive fund like Renaissance Technologies makes money (one investor told me he knew they were legitimate because “they lost money when it made sense for them to lose money.”)

Black-hat SEO is the martingale strategy of online marketing. In the short term, even a barely-competent practitioner is going to beat out the best of the sterling white-hat guys. But it’s always a matter of time before the strategy suddenly and viciously stops working.

Nobody wants to invest in a martingale. Investors should be able to avoid it. Due diligence is critical, and it’s going to make the world a better-informed place.

(One last note: there will always be black-hat SEO. It’s a game theory kind of thing; the more people abandon it, the more it pays off for the folks who do it right. We’re not on a crusade to get rid of link-buying or anything else, but we do think that the value of an online business is in some way related to the way it built its traffic, and to how long that traffic will last. As long as we do our job right, people will get the right rewards for the traffic they generate—whether it’s white-hat, black-hat, or some as-yet-determined shade.)