Monday, August 08, 2005

Will Advertising Sponsored Content Remain A Viable Business Model?

On the surface, you might look at the success of Google, Yahoo and others with their advertising sponsored business models and conclude that this model IS the future. I believe that this business model faces serious near-term challenges. Let me explain why.

Yes Google, the bellwether of the advertising sponsored business model, is making money hand-over-fist. But let’s look under the covers (as far under as Google will allow us to look). Here are some basic facts:

Google’s ad views are growing considerably through: (1) increased use of their search engine; (2) expanded services (e.g. Gmail, local search, etc.) which add ad inventory; (3) an expanding base of websites carrying ads syndicated through AdSense. In short, more people are seeing more ads.

In speaking with webmasters, VCs and businesspeople I am hearing that aggregate ad views are growing much faster than ad revenue. At the same time, the prices of keywords, through the bidding process, are increasing.

What does this mean? It tells me that more people are seeing more ads, but the click through rate (CTR) per ad is dropping. The growth in number of ads displayed and the price per click of ads are growing fast enough to mask an underlying weakness in CTR on a per ad basis.

The dropping CTR is going to get worse, here’s why:

Users Are Trained to Ignore Ads:
Users know that clicking on some Internet ads can result in nothing but trouble. These ads can install adware, spyware, change your browser home page, increase your spam and result in endless pop-ups or pop-unders. As a result, users quickly learn to ignore the ads around the border of the page and focus instead on the actual content in the middle.

Granted, the branded ads like those served by Google and Overture are free from these annoyances, so the impact on these types of ads is lessened. But with users being trained to ignore all ads, even these safe text ads suffer.

Technologies Are Removing Ads:
Software such as AdBlocker removes ads on the client side, enabling users to view websites without even seeing the ads. If you cannot see the ads, you certainly cannot click on them. Clearly, this technology undermines advertiser sponsored business models.

The biggest threat, however, is the hottest wave on the Internet today, RSS. RSS is an abbreviation for Really Simple Syndication (others have begun calling it Really Simple Stealing, for a completely different reason). RSS enables individuals to extract the latest content from a website without the graphics, layout or ADs! Yes there are some programs for inserting ads into RSS feeds, but their CTR is 1/10th that of the same ads on websites.

While RSS decimates web advertising (actually killing 9 out of 10 instead of 1 out of 10 as in the etymology of the word decimate), it will get even worse. The 90% decline in CTR is based upon today’s RSS usage which is largely through RSS readers that are read by people (versus applications). What happens with Microsoft’s upcoming Vista OS where RSS becomes part of the platform and an increasing number of desktop applications consume web data, automatically stripping the ads and removing the human reader? Very simply, the CTR will drop precipitously.

Imagine, a Windows Vista desktop application that scours blog feeds and news feeds and caches the information locally as a personalized newspaper. It won’t pass through ads, those will all be stripped out. How do those content providers get paid?

Fortunately, the web is a breeding ground for innovation, and some smart people will figure out a solution. Here are a few ideas:

Other Forms of Advertising:
1. Product placement: As TiVo and other TV recording devices make it easier to strip ads from TV , advertisers have increased their use of product placement. I expect this to increase on the Internet.

2. In-situ advertising: Content creators will increasingly add hyperlinks directly into their content. Companies like Vibrant Media will embed paid links directly in the main content. However, these ads could be stripped out if they carry the important tracking code, in the same way that virus and spam Much like affiliate IDs, any sort of tracker code will alert anti-virus and anti-spam software remove hyperlinks with affiliate code.

3. Paid placement: More bloggers and websites will take money for favorable articles about companies or products. This model has been used in traditional publishing, but it typically bears the “Advertising Section” label. I’m not sure blogs will use this same mechanism, but by not using such a label they will undermine their credibility, and credibility is the lifeblood of blogs.

4. Coupon-based advertising: Coupons are the one form of advertising people actively look for. In fact, more than 43% of Sunday newspapers are purchased primarily for the coupons. There were 350 BILLION coupons distributed in the US last year. I believe that you will see the rise of coupon-based ad syndication networks on the Internet in the near future, because people won’t want to strip out coupon ads, they’ll want to find and use them.

So, using the example above where a desktop application assembles a personalized newspaper for you, it might actually add coupons for items you buy regularly. Full disclosure: My company will release a beta of our coupon syndication network solution in the August/September timeframe.

I realize that the advertising sponsored business model is hot right now and it is demonstrating significant growth. I don’t suggest that it will go away any time soon. What I am suggesting is that we are in the early phases of advertising on the Internet and what we see in a couple of years could be very different that what we see today. It has taken the PVR a long time to hit critical mass, where it is reshaping advertising, but by definition, the Internet is accessed through computing devices (of all sorts) that have the ability to filter ads just as the PVR does. I’m sure that this capability is keeping entrepreneurs, VCs and Internet strategists awake at nights…or maybe it’s just me.

Tags: RSS, Google, CTR, PPC, Internet, Business, Ads, coupon, adblock