The Future of Online Advertising is Performance

For most of the past 10 years, online advertising has been dictated by the publisher or ad network (the website that is displaying the ad). Advertisers were willing to pay significant money and while receiving little in return with regards to performance, conversions, or measurable results. The Internet was the wild west of 21st century advertising, and no advertiser wanted to be left out.

In the late 1990’s, publishers charged on a CPM (cost per 1000 impressions) basis for display ads (the “punch the monkey” type banner ads). It did not matter if the user clicked on an ad or even looked at the ad, as long as the publisher loaded the banner on their webpage, you were charged. Initially display ads were the main revenue stream for companies like Yahoo, as advertisers ended up paying $20 CPMs for “brand awareness.” On average CPM display ads have a click trough rate of less than .20%, which comes out to an average of $20 for a total of 2 clicks. In addition to a low click through rate, an advertiser would have to face the reality of an even lower probability of a sale once someone landed on their site. Display ads charged on a CPM basis were thus considered “brand” spend. For marketing managers the idea of “Brand Awareness” would likely end up being their main motive and justification for spending so much for such little user engagement.

Google changed standard online advertising when they came out with CPC (Cost per click) text ads. Though Overture was technically the first to charge for ad performance, Google is attributed with mass implementation of charging only if someone actually clicked on something. Advertisers were then able to measure their cost and return on an investment more accurately. An entire industry popped up overnight, each claiming to better manage and convert clicks to sales. Since Google made an emphasis on preventing click fraud (even today, 30% of all ad clicks are the result of click fraud), they became the only reliable place for advertisers to spend their money and be able to actually turn a profit.

From 2005 to September of 2008, the online ad industry grew exponentially. It seemed as though a new ad network was popping up every day as brand advertisers were willing to pay an arm and a leg for display ads on quality sites. Similar to CPM ads, even if a CPC ad never resulted in a sale, the idea of branding still appealed to advertisers. Since their ads were actually measurable and generating sales for advertisers, Google grew faster than their competitors. Even with Google’s growth, smaller ad companies found success.

However, the ad industry took a major hit this past September. When the financial meltdown happened, many display advertisers like Ford and Tiffany’s decided to cut their display ad spend. It did not make sense for advertisers to spend on branding for something where results could not be easily calculated. Within 15 days of the crisis, CPM display ad spending dropped by 20% across the web. In relying heavily on display ad revenue, the meltdown was a major reason why Yahoo had such a disappointing quarter.

Most people thought that Google would not have the same issues as other companies since they do focus on CPC opposed to CPM. Yet data is starting to show that even they are feeling the impact of the economy.

What made Google initially attractive was its ability to generate a high sales rate. If I sell a product for $10, and it costs me 10 cents for every click that Google sends, then I only need to have a 1% conversion rate in order to break even. This model has allowed thousands of advertisers to spend billions of dollars on Google and feel confident that they can turn a profit or at the very least break even.

However, with consumer online spending taking a significant dive, people are less likely than ever to spend online. Thus, while Google is still charging me 10 cents per click, the users who do come are much less likely to use their credit card. If all of a sudden I’m losing money on Google ads, then I’d naturally cut my ad spend, something many advertisers have already done. With advertisers dropping out, Google has in turn lowered its bid price on keywords for remaining advertisers.

So, if Yahoo and Google are both dependent on the economy at large and are feeling the pinch, is there an online advertising model that is recession proof? The answer is yes!

One area that has remained strong in online spend is performance based advertising. Commonly known as CPA (Cost per Action). In CPA ads, an advertiser only pays if someone comes from a publisher and actually purchases a product or performs some other function on your site. Netflix is a company that almost exclusively uses CPA campaigns. Offering a fee to an ad network for every lead generated, Netflix makes a profit on nearly every signup. With a guaranteed profit, Netflix can use an unlimited ad spend. Thus, with a CPA model, everyone wins. For a CPA Network, they in turn are able to make a decent profit by allocating funds to publishers that generate a leads. The CPA approach is the only advertising model on the web that is not subject to click or page impression fraud and gives the potential for high payouts for everyone involved. With fewer concerns as to legitimacy of a lead, it’s no surprise that ad dollars are being taken out of CPM and CPC ad networks (like Yahoo and Google) and going to CPA Networks.

Going forward I see the future of online advertising favoring a performance based model. In order to not be left behind, key players such as Google and Microsoft have already taken the appropriate steps for this transition. Google recently launched a service called the Google Affiliate Network, their version of a CPA Ad Network, while Microsoft has made a big push to get advertisers like eTrade onto their platform by promoting a CPA model. It’s very likely that Yahoo will follow suit.

That’s not to say that all advertising will switch to CPA. While I expect to see CPM ad spend continue to fall, there’s still a place for CPC or a combination of CPC/CPA model advertising. At Spock, we realized CPM display ads were not right for us. Switching to a combination of CPC text ads and CPA campaigns for signups, we were able to successfully direct better targeted traffic.

On the publishing side, being a search engine, our utilization of CPC and CPA enables us to make direct deals with advertisers to either pay per click, or pay based on their own sales. This has made getting advertisers on Spock significantly easier. Similar to the early days of Google, by offering a targeted search experience to users, advertisers can feel confident that they can once again at the very least break even. In most cases, since a user is already looking for people, Spock can target accordingly. Thus even with less traffic than other sites, the ads on Spock will actually outperform ads on places like Yahoo or Microsoft. While Spock may be unique as a search engine, other sites such as blogs or shopping sites could easily emulate a similar formula.

Even with a slumping economy, online ad sales still has a bright future. While it won’t quite be the same as the early days of few sites and thousands of advertisers, there should end up being a better balance between advertisers and publishers. What this means is that advertisers will not only have more choice on where to advertise, but also more choices on specialization. Though this will inevitably lead to missed opportunities, much like any other type of advertising medium, results will ultimately decide who and what succeeds.

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