October 12th, 2006

More Evidence That Media 2.0 May Be Less Profitable Than Media 1.0

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There is now macroeconomic data to support the theory that Media 2.0 won’t be as profitable as Media 1.0 (from MediaPost):

In a break from historical patterns, the equities research team at Merrill Lynch says the rate of advertising price inflation now trails the overall rate of economic inflation. “Interestingly, advertising growth seems to be tracking real [gross domestic product] growth instead of nominal GDP growth, as it did in the past plus some,” writes Merrill Lynch ad industry analyst Lauren Rich Fine in a report released early this morning. “This supports our belief that media no longer enjoys the benefit of above average rate inflation, rather the opposite where increased competition & measurement is putting pressure on rates.”

“Increased competition & measurement” is one explanation, but there’s also this (familiar) explanation:

Neither Merrill Lynch nor TNS have explained why this is happening, but other economists, including GroupM Futures Director Adam Smith have suggested that at least part of the change may be due to the increasing efficiencies of digital media, which may be taking pressure off overall media inflation, especially in the traditional media, as marketers begin shifting budgets to lower priced online inventory.

The “increasing efficiencies of digital media” — indeed. As I pondered back in April:

What if the Internet has fundamentally lowered the marketing and advertising costs for big companies as it has for small companies? What if large companies can achieve the same sales objectives for a fraction of the cost of traditional mass media advertising?

Andy Kessler has an explanation for this phenomenon in the second installment of his must-read Media 2.Uh-Oh series (via Paul Kedrosky):

My definition is quite simple: Media is about control of a pipe.

But therein lies the problem. Senator Ted Stevens notwithstanding, the way the Internet is architected, there ain’t no pipes to control. No “end to end” pipes anyway.

But what about Web 2.0 and the second coming of the Internet, with its $1.65 billion all-stock acquisitions? Or Andy says:

Hey, how about Web 2.0? How about it – APIs, mashups, user content, hyperlinks, Mentos. Oooooh! Co-o-o-ool. We can just simulate a pipe. Google did it, right? $10 billion in ads. Yeah maybe. But without a pipe, is their platform precarioius?

Precarious indeed.

Andy put his finger on the deep structural problem that I’ve previously highlighted: the loss of control. Web 2.0 works great as an ideology, but maybe not so great as the basis for a media economy. Less control = less profit.

I’m intrigued by Andy’s suggestion that Google may lose control of its “simulated pipe” and thereby lose control of its profits. Already, Google can’t control the exploitation of its “pipe.”

Why did Google buy YouTube? Because they have to own it to control it, and they need to control it in order to monetize it. But on YouTube and other user-driven content platforms, the users control the network. If they don’t like the ads or other commercialization, they will just jump to another node in the network — or jump to another network.

Think of it like this:

Pipe = one way in and one way out

Network = infinite nodes, infinite entry and exit points

Why does everyone assume that MySpace and YouTube will eventually be wildly profitable? Because in the past, no who controlled that much attention failed to make money. The problem is that MySpace and YouTube don’t control anything. They are networks, not pipes. Many ways in, many ways out, many alternatives. Even worse (from a media economics standpoint), they are networks within networks (within networks).

No control, no profit.

Ceding control to consumers was the dominant theme of the Association of National Advertisers conference — but if consumers are in control of your brand, the best way to increase sales is not by advertising in the traditional sense, but by making better products and providing better service.

As far as I can see, Google is the only media company that has successfully profited from the new network paradigm, and only through the herculean effort of controlling the network (fighting search engine spam, click fraud, arbitrage, etc.).

You can feel good about the loss of media control, if that suits your ideological sensibility, but I’m still not seeing the scalable business models.

  • While I admit enjoying the loss of control that was bought by a few to serve the mass lowest common denominator and consequently, as scarcity means margin, margins have declined and so has profitability, as a "ideological sensibility," I think you're looking the wrong direction to find "the scalable business models."

    Its about lowered cost of entry, reduced costs, diseconomies of scale (in the upward direction) and the loss of Coase's transaction cost benefits. IE, the scale is about many small business models rather than the hit-mentality of the past.

    Honestly, if I'm reading you right you sound *concerned* that organisations with "problematic" behaviour cannot white-wash themselves with "axe in the head" media branding? That its a *bad thing* "the best way to increase sales is not by advertising in the traditional sense, but by making better products and providing better service?"

    You think it better the market operate on how much sh*t business models can wipe off themselves and their products with advertising rather than actually behave and serve the customer?

    I guess if you're peddling the toilet paper, that would be the POV.

  • Sam

    As advertisers use their marketing budgets to more specifically target their customer, and waste less of that "80%", what happens to television? As ad rates in TV decline, do television production standards get lower? Does capital dry up?

  • Scott -

    I think your thesis (as I understand it) is a sound one. However, I'd challenge the notion that Google is the only company that has made significant profit in networked media. What about eBay? What's different about eBay than Loot or any of the free classifieds papers? A significant amount of eBay's money comes from listings - not just from the transaction component.

    I say this because somewhat inherent in your statement that "Google is the only media company that has successfully profited from the new network paradigm" is the notion that Google is a fluke. What is inherent in some of the succesful business-models is the ability to create difficult to replicate communities and layer on top of that tools and information that create true lock-in - i.e., a situation in which consumers choose to stay within the network. As much as people are upset with eBay's fees, people continue to list there and to make money on eBay. Similarly with Google. Alternatives to each exist (and, in some cases, Google and eBay are alternatives to each other), but users / advertisers choose to remain with both.

  • I've worked in advertising, and it's an open secret that most ad dollars are completely wasted. The internet allows much narrower targeting, and much better tracking of ROI, the result cannot be anything other than less ad dollars are going to be spent, simply because companies won't be throwing away 80% of their budget.

    If internet companies can create ways to capitalize on extremely narrow niches and matchmaking between consumers and the advertisements they want to see, they may be able to capture some of that 80% and turn it into something useful now that it is no longer being wasted. Instead of buying airtime, corporations will pay to have interactive web games made, or short entertainment pieces. Traditional advertising's slice of the pie is going to shrink, but rather than disappear the rest is going to be eaten by methods of reaching consumers that are entirely new.

  • Scott, we don't disagree that 2.0 is less profitable. However, your attack on Google is unwarranted. Media 1.0 had many different huge providers sharing from a larger pie. 2.0 at the moment has one company dominating a smaller pie. Google's profit is larger than any of the 1.0 media giants individually, even though it may not be larger than the totality of their profit. Does that mean Google's position is precarious? Hell no.

    In fact, Google's upside is not in the long tail, they've already cornered that market (which is still growing, btw). It's in the short rump. I'm sure you've seen the studies saying that advertising on the Net is lagging the audience shift from TV. Many of those fat contracts with the TV stations will get transferred to the Google system - for less money than TV charged, but what does Google care? 100-X per cent of a cubic assload is still a lot.

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