Wednesday, November 7. 2007
Ad based revenue models worry me
The vast majority of new services that have launched in the Web2.0 space depend on advertising fro their revenue. All the major blog sites, social media and services such as Facebook, Digg or Engadget receive no direct revenue from their users. Some services such as SecondLife offer premium content for a subscription, but generally there needs to be a richness of experience or a tangible deliverable to attract direct revenue.
Advertising has long been a stable alternative revenue model. Old media, such as television and radio have been able to survive and thrive purely on this base. This does not directly translate to the Internet medium though. TV and radio advertising has matured over a long period, it knows what it is about, has a good idea of its audience and is relatively expensive. The cost is the most pertinent issue, the expense of a TV spot means that advertising in that medium requires greater thought. This drives both greater quality in the message content, and a greater trust level in the audience.
The difference in price to time slot on television advertising gives a good example of this phenomenon. Take away all factors regarding the product itself and consider the company that is advertising. Are you as a consumer more likely to trust the company with a well produced ad shown in a national prime time slot, or the cheap infomercial playing late at night on the local feed. In the overwhelming majority of cases, the message delivered in the prime time slot will be perceived as more trust worthy. The cost of the spot means that there needs to be a greater return to justify the spend. There becomes a direct correlation between the cost of the ad spot and the chance that the advertiser is reputable.
In the Internet space, ads are cheap and the places to put them are plentiful. Because of the small value per individual impression to a website owner, in most cases it is not feasible to manage advertising contracts directly, this creates the need for the ad buy consolidators. This tactic allows the advertising model to succeed in giving a return to the site hosting the ads, but removes a level of control over what gets shown. This created the vacuum for Google to enter the fray and build a business model on improving the relevance of ads. Using search they are able to link the subject of the ad to the content on the site the advertising appears on, which is better than random.
This does not fix the issue of trust. While there is a greater chance that the product being advertised is related to the viewers interest, there is no accurate method except familiarity to judge the trust of the ad. Even the quality of the ad gives no trust information, a slick ad does not cost much more to produce than a cheap one. There are also techniques to game the system upon which a whole business strategy (SEO) is born. And in the web space the consequences of following an untrustworthy link can be dire, through fraud, trojans and worms, and there is little hope of recourse if you are wronged. If the TV ad is untrustworthy you end up with a crappy product, and the regulators of TV and consumer affairs have power to either address the issue with the supplier or force the ads off the air. If an Internet ad is untrustworthy you could end up with a trojan that records your bank account details and passwords.
The dynamic and unregulated nature of the Internet significantly reduces the chance that any of these issues can be solved. Changing the Internet to reduce this effect is not realistic technically, and would have negative consequences that outweigh the benefits. This leaves an Internet advertising model where ad trust in viewers
- Cannot be enhanced by the brand of the site it appears on
- Only exists where the Brand is already known (which limits the mediums use)
- Is not enhanced by the perceived quality of the ad
- Is further impeded by a potential real cost
This is a screenshot of the ads displayed on the Digg homepage at the time I was writing this article. The context of these ads is probably determined by the stories on the homepage at that stage. I have no reliable method by which to determine if any of these advertisers represent a reliable or trustworthy company. As these ads are all for a similar service, even if I was interested in the product this has actually contributed to my confusion rather than reducing it.
The way in which Internet and TV ads are similar is that it is the content that brings in the viewers, which in turn enables the advertising to be seen. I believe that this creates the illusion that advertising as a business model can be sustained on the Internet.
The whole Internet advertising paradigm appears to be a house of cards. At this stage there is no stable base on which to rely. That does not mean that it is impossible for one to exist, only that it does not exist now. In this environment a company that bases its whole business model on advertising revenue is on shaky ground. To be certain of any future life then there needs to be a direct revenue stream. This direct stream is also required to ensure that there is a stickiness to the site as well, otherwise the fickleness of the average Internet user can see the revenue of a site plummet dramatically. A user is more likely to stay with a service that they are willing to spend their own money for. This has been very evident in Secondlife where dissatisfied users have stayed and complained when Linden Labs have acted outside their desires. The real money they had spent on the site tied them to it in a very real way. It is only zeitgeist that ties me to Digg, and the lack of stickiness makes their future ad revenue uncertain.
Advertisers of quality product and reputable brands recognise this. They are trying to take the same road that old media has taken; towards product placement as a more reliable means of getting the message out. The result is that site owners like my friend Todd at Geek News Central get barraged by email from corporate PR reps trying to get their product mentioned in his blog. Chris Anderson from Wired recently posted a list of PR people that sent him email. And this was only the subset that did not follow his directions of emailing to the relevant sub-editors.
To give me any confidence of their value, web services need to either provide a source of direct revenue, or to have a level of stickiness for their users that would prevent them from leaving. If these do not exist then I consider any revenue they make or claim to be transitory. I would personally value them on a P/E ratio of 1 or less, i.e. their value is equal to their current earnings. Anything greater than that is pure hype.
In trying to research the actual statistics on the effectiveness of web advertising I was unable to penetrate the barrage of SEO promises. I intend to research this in more detail, and maybe create a research project of my own, no promises. There is a huge business opportunity for the company or individual that can fix the problems of web advertising. Whomever cracks it will earn their fortune as it is not an easy problem to fix. In the meantime I will shy away from over optimistic valuations of companies with advertising revenue as their core business model.
Advertising has long been a stable alternative revenue model. Old media, such as television and radio have been able to survive and thrive purely on this base. This does not directly translate to the Internet medium though. TV and radio advertising has matured over a long period, it knows what it is about, has a good idea of its audience and is relatively expensive. The cost is the most pertinent issue, the expense of a TV spot means that advertising in that medium requires greater thought. This drives both greater quality in the message content, and a greater trust level in the audience.
The difference in price to time slot on television advertising gives a good example of this phenomenon. Take away all factors regarding the product itself and consider the company that is advertising. Are you as a consumer more likely to trust the company with a well produced ad shown in a national prime time slot, or the cheap infomercial playing late at night on the local feed. In the overwhelming majority of cases, the message delivered in the prime time slot will be perceived as more trust worthy. The cost of the spot means that there needs to be a greater return to justify the spend. There becomes a direct correlation between the cost of the ad spot and the chance that the advertiser is reputable.
In the Internet space, ads are cheap and the places to put them are plentiful. Because of the small value per individual impression to a website owner, in most cases it is not feasible to manage advertising contracts directly, this creates the need for the ad buy consolidators. This tactic allows the advertising model to succeed in giving a return to the site hosting the ads, but removes a level of control over what gets shown. This created the vacuum for Google to enter the fray and build a business model on improving the relevance of ads. Using search they are able to link the subject of the ad to the content on the site the advertising appears on, which is better than random.
This does not fix the issue of trust. While there is a greater chance that the product being advertised is related to the viewers interest, there is no accurate method except familiarity to judge the trust of the ad. Even the quality of the ad gives no trust information, a slick ad does not cost much more to produce than a cheap one. There are also techniques to game the system upon which a whole business strategy (SEO) is born. And in the web space the consequences of following an untrustworthy link can be dire, through fraud, trojans and worms, and there is little hope of recourse if you are wronged. If the TV ad is untrustworthy you end up with a crappy product, and the regulators of TV and consumer affairs have power to either address the issue with the supplier or force the ads off the air. If an Internet ad is untrustworthy you could end up with a trojan that records your bank account details and passwords.
The dynamic and unregulated nature of the Internet significantly reduces the chance that any of these issues can be solved. Changing the Internet to reduce this effect is not realistic technically, and would have negative consequences that outweigh the benefits. This leaves an Internet advertising model where ad trust in viewers
- Cannot be enhanced by the brand of the site it appears on
- Only exists where the Brand is already known (which limits the mediums use)
- Is not enhanced by the perceived quality of the ad
- Is further impeded by a potential real cost
Ads from the Digg homepage
This is a screenshot of the ads displayed on the Digg homepage at the time I was writing this article. The context of these ads is probably determined by the stories on the homepage at that stage. I have no reliable method by which to determine if any of these advertisers represent a reliable or trustworthy company. As these ads are all for a similar service, even if I was interested in the product this has actually contributed to my confusion rather than reducing it.
The way in which Internet and TV ads are similar is that it is the content that brings in the viewers, which in turn enables the advertising to be seen. I believe that this creates the illusion that advertising as a business model can be sustained on the Internet.
The whole Internet advertising paradigm appears to be a house of cards. At this stage there is no stable base on which to rely. That does not mean that it is impossible for one to exist, only that it does not exist now. In this environment a company that bases its whole business model on advertising revenue is on shaky ground. To be certain of any future life then there needs to be a direct revenue stream. This direct stream is also required to ensure that there is a stickiness to the site as well, otherwise the fickleness of the average Internet user can see the revenue of a site plummet dramatically. A user is more likely to stay with a service that they are willing to spend their own money for. This has been very evident in Secondlife where dissatisfied users have stayed and complained when Linden Labs have acted outside their desires. The real money they had spent on the site tied them to it in a very real way. It is only zeitgeist that ties me to Digg, and the lack of stickiness makes their future ad revenue uncertain.
Advertisers of quality product and reputable brands recognise this. They are trying to take the same road that old media has taken; towards product placement as a more reliable means of getting the message out. The result is that site owners like my friend Todd at Geek News Central get barraged by email from corporate PR reps trying to get their product mentioned in his blog. Chris Anderson from Wired recently posted a list of PR people that sent him email. And this was only the subset that did not follow his directions of emailing to the relevant sub-editors.
To give me any confidence of their value, web services need to either provide a source of direct revenue, or to have a level of stickiness for their users that would prevent them from leaving. If these do not exist then I consider any revenue they make or claim to be transitory. I would personally value them on a P/E ratio of 1 or less, i.e. their value is equal to their current earnings. Anything greater than that is pure hype.
In trying to research the actual statistics on the effectiveness of web advertising I was unable to penetrate the barrage of SEO promises. I intend to research this in more detail, and maybe create a research project of my own, no promises. There is a huge business opportunity for the company or individual that can fix the problems of web advertising. Whomever cracks it will earn their fortune as it is not an easy problem to fix. In the meantime I will shy away from over optimistic valuations of companies with advertising revenue as their core business model.
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Hi Matt, interesting discussion. I think you are right, but only up to a certain point. The issue of fraudulent activity regarding internet advertising is certainly one that has not been addressed with any kind of diligence, but I do not agree that the Radio /TV paradigm breaks down when applied to the internet.
The paradigm is broadly based on the premise that the value of an advertisement varies based on its proximity to higher value content. The higher the value of the content, the more people it attracts; which in turn attracts a greater audience and therefore potentially more punters to buy your product. I have seen nothing of substance that contradicts this.
In my view, all that has really happened is that the TV/Radio concept of prime time (a concept that is clearly not applicable to the internet) is being replaced by the concept of site reputation. The well known sites, and those that are perceived to be of high standing, are much more likely to attract potential buyers from advertising because patrons of those sites have intrinsically higher levels of trust. I feel this is particularly true of the bricks n’ clicks sites that already enjoy established reputation. In time these site will be able to demand advertising premiums because of the sites own brand profile.
Linked to this, I also believe that it in a sites best interest to vet their advertisers to ensure there are no nefarious nare-do-wells lurking in the pack (the Register copped some well published flack for this last year), and an organizations natural protective reflex of their brand will ensure some level of attention is applied to this, and this is turn will bring some stability into the business model.
Stickness of customers is a generic business issue and is the holy grail of many a business, particularly if they are in a market where the risk of substitution is high. But as you point out, this is offset by the comparatively meager cost of internet advertising. Advertisers can afford to spread the net more widely.
As a measure of thumb, I would suggest that the nascent internet advertising revenue model is about at the same level of maturity as the TV/ Radio advertising industry was in the 60’s. Certainly mature enough to attract some serious investment, but not mature enough to be able to present well tried and true business models. The bottom line is that internet advertising is a profitable venture, and this is not about to change any time soon. So while that holds true, then there will be people lining up for a piece of the action. Internet advertising really is like Chickman, he’s everywhere.
The paradigm is broadly based on the premise that the value of an advertisement varies based on its proximity to higher value content. The higher the value of the content, the more people it attracts; which in turn attracts a greater audience and therefore potentially more punters to buy your product. I have seen nothing of substance that contradicts this.
In my view, all that has really happened is that the TV/Radio concept of prime time (a concept that is clearly not applicable to the internet) is being replaced by the concept of site reputation. The well known sites, and those that are perceived to be of high standing, are much more likely to attract potential buyers from advertising because patrons of those sites have intrinsically higher levels of trust. I feel this is particularly true of the bricks n’ clicks sites that already enjoy established reputation. In time these site will be able to demand advertising premiums because of the sites own brand profile.
Linked to this, I also believe that it in a sites best interest to vet their advertisers to ensure there are no nefarious nare-do-wells lurking in the pack (the Register copped some well published flack for this last year), and an organizations natural protective reflex of their brand will ensure some level of attention is applied to this, and this is turn will bring some stability into the business model.
Stickness of customers is a generic business issue and is the holy grail of many a business, particularly if they are in a market where the risk of substitution is high. But as you point out, this is offset by the comparatively meager cost of internet advertising. Advertisers can afford to spread the net more widely.
As a measure of thumb, I would suggest that the nascent internet advertising revenue model is about at the same level of maturity as the TV/ Radio advertising industry was in the 60’s. Certainly mature enough to attract some serious investment, but not mature enough to be able to present well tried and true business models. The bottom line is that internet advertising is a profitable venture, and this is not about to change any time soon. So while that holds true, then there will be people lining up for a piece of the action. Internet advertising really is like Chickman, he’s everywhere.
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In the second half of his recent posting Robert X. Cringley talks about Google extending the metadata they collect so they can further refine their targetting in advertising, and continuing to increase the platforms they can supply targetted ads for. In
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