The online ad attack

Apr 27th 2005
From The Economist print edition

Online advertising is becoming a serious rival to the traditional sort. Google’s new advertising service could make the internet an even more valuable marketing medium

THIS year the combined advertising revenues of Google and Yahoo! will rival the combined prime-time ad revenues of America’s three big television networks, ABC, CBS and NBC, predicts Advertising Age. It will, says the trade magazine, represent a “watershed moment” in the evolution of the internet as an advertising medium. A 30-second prime-time TV ad was once considered the most effective—and the most expensive—form of advertising. But that was before the internet got going. And this week online advertising made another leap forward.

This latest innovation comes from Google, which has begun testing a new auction-based service for display advertising. Both Google and Yahoo! make most of their money from advertising. Auctioning keyword search-terms, which deliver sponsored links to advertisers’ websites, has proved to be particularly lucrative. And advertisers like paid-search because, unlike TV, they only pay for results: they are charged when someone clicks on one of their links.

Both Google and Yahoo!, along with search-site rivals like Microsoft’s MSN and Ask Jeeves (recently bought by Barry Diller’s InterActiveCorp), are developing much broader ranges of marketing services. Google, for instance, already provides a service called AdSense. It works rather like an advertising agency, automatically placing sponsored links and other ads on third-party websites. Google then splits the revenue with the owners of those websites, who can range from multinationals to individuals publishing blogs, as online journals are known.

Google’s new services extends AdSense in three ways. Instead of Google’s software analysing third-party websites to determine from their content what relevant ads to place on them, advertisers will instead be able to select the specific sites where they want their ads to appear. This provides both more flexibility and control, says Patrick Keane, Google’s head of sales strategy. Companies trying to raise awareness of a brand often want a high level of control over where their ads appear.

The second change involves pricing. Potential internet advertisers must bid for their ad to appear on a “cost-per-thousand” (known as CPM) basis. This is similar to TV commercials, where advertisers pay according to the number of people who are supposed to see the ad. But the Google system delivers a twist: CPM bids will also have to compete against rival bids for the same ad space from those wanting to pay on a “cost-per-click” basis, the way search terms are presently sold. Click-through marketing tends to be aimed at people who already know they want to buy something and are searching for product and price information, whereas display advertising is more often used to persuade people to buy things in the first instance.

Not too flashy

The third change is that Google will now offer animated ads—but nothing too flashy or annoying, insists Mr Keane. Google has long been extremely conservative about the use of advertising; it still plans to use only small, text-based ads on its own search sites. But many of its AdSense partners might well be tempted by the prospect of earning a share of revenue from display and animated ads too, especially as such ads are likely to be more appealing to some of the big-brand advertisers. Spurred on by the spread of faster broadband connections, such companies are becoming increasingly interested in so-called “rich-media” ads, like animation and video.

This could fuel online ad-growth even further. As advertising spending continues to recover from the slump that began in 2001 after the bursting of the technology bubble, the internet has become the fastest growing advertising medium. Worldwide ad revenue on the internet grew by 21% in 2004, and it is expected to continue at that pace for the next few years, says ZenithOptimedia, a research firm (see chart). As Google and Yahoo! are two of the most widely visited sites, this greatly benefits them. Google recently announced a net profit of $369m in its first quarter from revenue that soared to $1.3 billion, up 93% compared with the same period a year earlier. Yahoo!’s first-quarter net profits more than doubled to $205m on revenue of $1.2 billion, up 55% from a year earlier.

Terry Semel, Yahoo!’s chief executive, believes there is a lot more growth to come as companies become more familiar with online advertising. As he happily points out, many big firms still allocate only 2-4% of their marketing budgets to the internet, although it represents about 15% of consumers’ media consumption—a share that is growing. Many young people already spend more time online than they do watching TV.

If Google can prove that bidding for display ads works, then its rivals are bound to follow with similar services. This could shake the industry up even further. DoubleClick, an online-marketing firm from the early days of serving simple banner ads to websites, was sold this week in a deal worth more than $1 billion to a private-equity firm, Hellman & Friedman. Even though its prospects recently brightened, DoubleClick put itself up for sale after facing fierce competition.

Other innovations in online marketing are said to be in the pipeline. Local search and its associated advertising opportunities are one huge growth area. Sites such as eBay, the leading online auctioneer, and Craigslist, which hosts local sites, are soaking up large amounts of spending that might otherwise have gone on classified advertising—and for everything from used cars to job vacancies. Yahoo! is expanding heavily into entertainment, with film and video clips providing another avenue for advertisers. This week, Yahoo! appointed another top executive to its media group, fuelling industry speculation that the website may start to produce its own entertainment content. Television stations would then have a lot more to worry about than just losing ad revenue to the internet.

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