Click fraud is a huge threat for Google (and Yahoo!)

MarketingExperiments.com reports that Google is capable of identifying only a tiny fraction of all fraudulent clicks as such.

The survey concludes that 29.5% of all clicks may be fraudulent. The risk to providers such as Google (which almost entirely relies on this source of revenue) and Yahoo! (which has a more diversified revenue stream) is that advertisers may get frustrated and turn to different forms of advertising (ranging from search engine optimisation to traditional banners). This could undermine Google's growth prospects and stock valuation.

What is click fraud? When advertisers run campaigns on the internet by bidding on search terms, a small ad will appear on the right hand side of the results page. The advertiser making the highest bid, will see his ad appear at the top position. Google (or Yahoo! and now also Ask Jeeves) run an ongoing auction for search terms. The advertiser only pays once surfers actually click. Google gets the revenues, and in many cases shares these with distribution partners (sites that have the Google search engine installed, e.g. Planet Multimedia). Sometimes the price per click can be as high as almost $100 (as in the case of such terms as 'Vioxx', that US law firms are very much interested in).
The problem of click fraud arises when people click (and thus make the advertiser pay) who have no commercial interest. It can be disgrunteled former employees, or competitors who try to waste another company's marketing dollars. Or it can be a distribution partner, that has no other purpose for its web site than to collect revenues from Google or Yahoo!.
Google is both a victim and a beneficiary, judging by ongoing law suits. Google benefits because it receives the ad dollars. It is vulnerable to court cases when advertisers claim that the company isn't addressing the problem as much as it should. On the other side, Google fights fraudulent distribution partners, trying to make a living off click fraud. Google recently actually won a case.