go-Digital Blog on Digital Marketing

the economics of advertising sucks, but it will suck a lot more soon

it’s a simple matter of supply and demand. Let’s do a thought exercise.

1.  eMarketer forecasts that retail e-commerce will grow roughly 10% per year for the next few years. This means that the total “pie” of people spending online will only grow by an average of 10% per year. Note that sales is (or should be) the goal of advertising. So that’s why we are looking at e-commerce sales and comparing it to online advertising because both are completed in the same medium and we can eliminate cross-media uncertainties and breakdown of tracking.

2. online advertising is still exploding with trillions of pageviews per month, thanks to social networks which throw off ungodly numbers of pageviews when people socialize with others. The Compete chart below shows the top social networks which rely on banner advertising (impression-based advertising) to make revenues. Notice that just Facebook and Myspace alone generate 115 BILLION pageviews a month. And if you consider that Facebook shows 3 ads per page, that would be 250+ BILLION impressions per month served by Facebook alone. Furthermore, the rate at which pageviews grow is 250% – 1,000% per year, depending on the site in question.

3. In the online medium, we have end-to-end tracking from the advertising (banner impression) through to the sale (e-commerce). The banner is served (impressions); a percent of users click on it to go to a site (click through rate – CTR); a percent of those make their way through the site and end up completing a purchase online (conversion rate). Those users who are looking for something and who are considering buying something will be online searching and researching. Those are the ones who are likely to click on banner ads, compared to others who are online to do something else, like write email, socialize with friends, etc.  And if the purchase is their ultimate end-goal (to make a purchase) we have a farily reliable indicator of the growth in not only such interest but also the completion of the task — namely, e-commerce, which grows at 10%.

4. Now, if the number of people who will click grows that 10%, but the number of advertising impressions grows at a slow 250%, the ratio of clicks to impressions drops dramatically because the denominator is growing 25X faster than the numerator. Serving more ads simply will not get the amount of e-commerce to grow significantly faster. The point of diminishing returns has been reached and passed, so incremental ad impressions are ignored and useless. The number of people who will end up buying will not increase significantly faster. And given the tough economic climate the amount of sales may actually decline before it goes up again.

5. If we generalize this back to all retail commerce, it grows at an EVEN slower pace than ecommerce. When you compare this to the dramatic increase in ad impressions and the shift from traditional channels (TV, print, radio – whose impressions and audience sizes are dwindling) to online channels (portals, news sites, social networks – whose impressions and audience sizes are skyrocketing) again the ratio of sales to available advertising drops dramatically. This is a measure of the effectiveness of advertising (sales  divided by advertising spend). It was already small — it sucked — and it will get dramatically smaller soon — it’ll suck more soon.

A way to mitigate this “sucking” is to peg advertising expenditures on a success metric which is an indicator of user intent — cost per click — versus a traditional indicator of reach and frequency — ad impressions served — which from the above is NOT an indicator of consumers’ intent to purchase.  This way, advertisers only pay when someone clicks. Those “someones” click when they are looking for something and are more likely to complete a purchase than those who don’t click.

“CPC banner advertising” anyone?

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