Make Online Ads Accountable

Setting ad prices based on the number of times someone looks at a page is misguided. Let's charge based on whether a message is effective

By Jeffrey F. Rayport

North of Boston, there's a town called Lynn that was once associated with an unfortunate tagline. As the saying went: "Lynn, Lynn: the city of sin. You never come out the way you went in."

The phrase comes to mind as I consider during this deepening recession a topic near and dear to me: online advertising. How the industry emerges from this slump has become a matter of fierce debate.

Gloomy Statistics for Online Ads

One interpretation of data from the online ad market points to doom and gloom. Warning signals have emerged since at least mid-2008, when a study by the Interactive Advertising Bureau and Bain & Co. indicated remnant inventory—the ad space Web sites are unable to sell directly and turn over to ad networks, often for resale at bulk rates—had increased to 30% of sold inventory in 2007 from a mere 5% in 2006. The upshot is that a lot of ads are getting sold for a lot less.

To understand why, consider the difference between direct ad sales and those that are sold through ad networks. Hint: It's a lot like the difference between retail and wholesale. Ad networks sell remnant space at about 60¢ to $1.10 per 1,000 times the page on which the ad appears is viewed, or what's known in industry circles as a cost-per-thousand (CPM) basis. Ads sold directly can fetch $10 to $20 on that same basis. Mind you, this price range was standard for the industry before the demise of Lehman Brothers and the ensuing financial market collapse.

Now, researchers and media blogs are abuzz with reports of more apocalyptic developments, with newer data to support their arguments. EMarketer has knocked down numbers for 2009 online ad growth to the single digits. So have many Wall Street analysts. Most alarming, pricing for remnant inventory fell to an average CPM of 26¢ in the fourth quarter, a penny below the third quarter, across the more than 5,000 sites that work with PubMatic, which consults with companies on ad placement. The fourth-quarter CPM rate was down 48% from a year earlier.

Rethinking the Problem

The Lynn Dictum would suggest that online advertising went into this recession one way (alive) and will come out another way (dead or dying). So maybe we should just call it a day.

But this conclusion overlooks another angle that is no less sobering, but a lot more encouraging. The change we're experiencing may be radical, but it bodes well for the medium. As many have argued throughout the history of advertising in general, it's high time we change how we evaluate and set prices so that they're based on effectiveness of an ad. For online advertising, that means relying less on the number of times the page containing the ad is viewed, and more on the ad's ability to elicit a response, or action, from the person viewing it.

Let's start by clearing up misconceptions about why online ad prices are dropping. It wasn't so long ago that high-priced management consultants were advising clients of an imminent shortage in online ad inventory, saying that before long there would be too few opportunities to place online ads! Turns out, they were flat-out wrong. The reason online display advertising is losing its pricing power is because there's too much of it, not too little.

According to comScore's (SCOR) 2008 Digital Year in Review, the number of display ads served to consumers in the U.S. last year was down slightly from the year before, but the total still came to 4.5 trillion. Pity the poor online user!