Our Creative Destruction series has covered Financial Services, B2B Media, Scientific Technical Medical Publishing, Legal Publishing, Educational Publishing. Now we will cross over the church/state divide to look at advertising, specifically online advertising.

Online advertising is the only market in our series that is in Act 7 of the Creative Destruction 7 Act Play. Act 7 is when “the new old guard dominates” (Google in this case). As we wrote in the introduction:

Many entrepreneurs make the mistake of seeing how quickly the new guard arose and think that they can also be deposed quickly. The entrepreneurs who made it to this stage will be tenacious, paranoid and really hard to beat – until the next wave comes along.

Photo, courtesy AgilityNut on Flickr.

Online $$$ = Ads, Subs & Trans

There are 3 ways to make money online – ads, subs & trans:

- Ads = Advertising

- Subs = Subscriptions aka or magazines/sites or SaaS

- Trans = Transactions aka e-commerce aka selling stuff.

(If anybody knows any other ways, please tell us!).

During the Web 2.0 era, advertising became the default monetization strategy. Subs and trans are getting more popular now, since the recession put a damper on ad spending and publishers started to see that building a business on ads alone is tough.

But even if advertising becomes only one of three legs of the stool, it is still critical to the online business.

Therefore advertising matters to anybody who is creating cool services/content and wants to get paid for doing so.

Online Advertising Is Big And Getting Bigger

As attention shifts from traditional media to online media, the advertising $ will shift as well. There is a gap today between attention and $. That gap is “big enough to drive a truck through” as many entrepreneurs point out to their investors.

But that does not mean that all is rosy in the online advertising garden.

This chart (from eMarketer) shows where the $$$ are flowing:

That looks great. Search advertising is a great business. But here is the issue. Look at Google’s quarterly report for the quarter end March 31st 2010:

“Google reported revenues of $6.77 billion for the quarter ended March 31, 2010, an increase of 23% compared to the first quarter of 2009.”

Multiply that by 4 and assuming they don’t grow more in 2010, that is $27 billion going to Google in 2010. Hang on, as per eMarketer, all search advertising in 2010 is only $11.4 billion! OK, some of that $27 billion from Google is NOT advertising revenue (maybe 3-5% is apps) and Google sell display ads as well. And the eMarketer number are US only and Google’s numbers are global.

But it is not hard to see that Google has the lion’s share. And look up “lion’s share”, which comes from Aesops Fables. The scraps are not that good:

“In the fable, a lion, fox, jackal and wolf go hunting, successfully killing a deer. It is divided into four parts with the lion taking the first quarter because he is king of the beasts, the second quarter because he is the arbiter of which animals get what portions of the deer, the third quarter because of his help in catching the deer, and the fourth quarter for his superior strength.”

Remnants & Long Tail

In the last few years, innovation has largely focused on solving two problems:

1. Selling remnant inventory. This has usually involved an exchange or a marketplace. This work for some exchanges/marketplaces as the volumes are high enough and the cost of running an automated exchange/marketplace. But most publishers get such a tiny amount from remnants that it is a rounding error in their revenue line.

2. Selling ads for the long tail aka bloggers and small sites. They cannot afford to sell direct, so they use Ad Networks. This works fairly well for both parties. Small sites cannot afford their own sales team and advertisers don’t want to negotiate with lots of small sites.

The “elephant in the Ad Networks room” is Adsense. This is an $8 billion annual business for Google as per their latest 10Q (ie multiple the quarter by 4):

“Google Network Revenues – Google’s partner sites generated revenues, through AdSense programs, of $2.04 billion, or 30% of total revenues, in the first quarter of 2010. This represents a 24% increase from first quarter 2009 network revenues of $1.64 billion. “

Adsense is different from Google’s own search site. To compete with Google in that arena, you have to get hundreds of millions of consumers to change their habit and you need to invest hundreds of millions of $$$ in servers just to get a shot at doing that. That is why the only serious challenger left is Google with Bing. This is a game for seriously deep pockets or massively disruptive technology.

But going against Adsense is not quite as tough. You “only” have to persuade hundreds of thousands of publishers and advertisers that you have a better proposition – that is easier than persuading hundreds of millions of consumers. Although AdSense revenues are very, very strong today, there are some indications that publishers and advertisers are not totally happy with AdSense (as this post on Read Write Web describes). The problem is simply that there is not a viable alternative today that has any serious traction.

Social Media Ads: Still Unproven

The big white hope has been social media advertising. There are a number of big success stories but the case is still far from proven:

1. Sites such as Facebook have acquired so many users that even if they sell at incredibly low CPM rates via intermediaries they will make money. But in their attempts to justify nose-bleed valuations they are bumping up against the privacy wall.

2. Social media experts are the updated version of SEO experts. There are some great success stories and the consequent influx of charlatans. But this is not advertising.

3. Some big brands are doing well by mixing traditional advertising with social media campaigns. Some of this creativity was visible at Federated Media’s CM Summit last year. This is progress but not a big technical breakthrough that changes the game.

What Are The Big Challenges?

In the next post we will look at some of the innovation in semantic advertising. But first lets define the 6 big challenges that need to be solved:

1. Better relevance to enable better matching. Keyword matching alone leads to matches that are often hilariously wrong. Even when they are not crazy wrong, they are not relevant enough to change a user’s behavior.

2. Finding the user just in time to catch their intention. This is the hard part. The user habit of “googling” is hard to break. Any new alternative has to be ubiquitous and almost totally friction-free. That is probably what Facebook is attempting with Like.

3. Brand safety. The oft-quoted example is an attempt to sell Ginzu knives next to an article about a vicious stabbing. Brands take a long time to build and a horribly, hilariously bad ad placement can go viral and do massive amounts of damage. This makes ad buyers wary of any automated solution.

4. Ad blindness. Whether the ad blindness is technically created (by using something like AdBlockPlus) or just habit (“I don’t see ads any more, I just tune them out”) this is a problem for the online ad industry. Two “solutions” that will NOT work are a) flashing “in your face” gimmicks or b) crossing the church/state divide so that an ad is made to look like impartial editorial.

5. Getting recommendations without hitting the privacy wall. As everybody intuitively knows, we trust the recommendation of a friend far more than we trust an ad. But as Facebook has discovered many times, scaling that hits the real concerns about privacy and a sense of being taken advantage of.

6. Share of the cake. Publishers increasingly want transparency. They want to know what % of the ad $$ go to the intermediary or intermediaries. Google’s Adsense is opaque. Most Ad Networks are transparent, publishers get about 50%. But as publishers get more savvy online and as they need to scale their online revenues, they are demanding a bigger share of the cake. Intermediaries that can deliver this and still make money are scarce.

When we look at the semantic advertising innovators, we can measure them by how well they are doing against these challenges.

Are we missing any major challenges?

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