The Economics of Online Advertising Industry

This is the summary of an article by David Evans. You can get the pdf of the behavioral targeting article here: The Economics of Online Advertising Industry.

Online advertising will definitely increase in a significant way, as more and more people have access to the Internet through various devices, including the current trend in mobile devices and even in televisions. In fact, Google’s market value increased five times from its 2004 value of 29 billion dollars, to 136 billion dollars for April 2008. Google’s innovative products have paved the way for this success, through ingenious products related to online payments, word processors, etc. During 2007, Google got a lot of attention from the most popular news media, and this was also the year it acquired DoubleClick’s technology to further improve its online advertising industry. This article is about how Online Advertising works.

The advertising business

Advertising is used as a promotion tool for selling services or products. This business grew during the 20th century as new technologies for mass communication were discovered and implemented. Worldwide, the amount spent annually for advertising is more than 625 billion dollars. It is primarily designed for generating sales of services and products using different strategies. Pricing ads also vary, but the most common is cost per viewer, or the cost of reaching one thousand viewers. As such, companies such as Nielsen Media Research gather data which is used by television ad rates used in the United States.

The online advertising industry sells ad space which can be viewed online. There are several kinds of this industry, the first is search advertising, second is display advertising, third is classified listings and fourth is email based advertising. Of these four, the most popular is search-based advertising which accounts for 40 percent, followed by display advertising with 32 percent. These are data from 2006.

Online advertising is different from traditional advertising in that new technologies available only within the Internet allow advertisers to accurately reach indivdual users, and collect information about these users to give them ads that are highly targeted to their interests. Furthermore, the Internet provides an avenue for intermediaries to make selling and buying ad space more effficient, such as keyword bidding.

Advertising on Search Results Pages

A web page generated from a search query is usually divided into three parts. The leftmost part is called the organic search results, showing the most relevant links to website containing answers to your search query. The right side shows you the paid search results, and the top left hand side may also show them. Viewers are attracted in a search ad platform from the organic search results, and space is allocated in a search engine results page for advertisers who are interested in buying them.

The keyword bidding system is one of the technological underpinnings used by Search-based advertising. Advertisers bid on keywords, and the higher an advertiser bids compared to other bidders, the closer they are displayed to the first entry at the top of the first page. But this placement is not only determining through the bids, but also through Click-through-rate (CTR), which takes into account the value of ads that generate many clicks. Google determines ads which generate many clicks through a quality score.

Economic Factors of Search-based Advertising

During the year 2007, Google has a majority of the share of search traffic. 61.3 belongs to Google, while only 20.2 percent belongs to Yahoo in second place. Third place goes to MSN, with 8.2 percent of the share. In personal computers, most of the browsers have pre installed Google search toolbars, which means that basically everyone has access to search engines.

Search ad platforms are a two-sided business, which face economic considerations that traditonal media platforms also face. But it is unique in many ways, such as the pricing of keywords. Advertisers use different platforms for search ads, so in each platform, the CPC or cost per click is determined through the auction for keyword bidding per platform. CPCs may be similar for different platforms if the bidders are the same, but platforms that are not as attractive to bidders may have lower CPCs for keywords compared to other platforms. For example, Google’s worldwide CPC is 2.00 dollars, while that for Yahoo is 0.75 dollars.

Online Display Advertising Business

More than 0.05 percent of the estimated number of unique Internet visitors have reached 19,000 websites, including traditional media company sites such as that for the New York Times, Facebook, blogs, etc. These published websites also have ad inventories like search results pages. This business is called online display advertising.

Web publishers edit their websites primarily written in HTML, to allow parts of the pages for ad insertion from various ad sources. Ad space in these web pages are usually sold based on pixel width and length. Various ads are sold, such as skyscraper ads, banner ads, and rectangle ads. Some websites have higher value than others, value of ads depend on location, and viewer value depends on age among other factors.

The main technological difference between traditional media ads and online display advertising is that online, ads are served to targeted individual customers in real time, whereas in traditional media, targeting is done through broader categories such as demographic and socioeconomic groups. However, the degree of targeting among online advertisers as of now is still relatively modest, but targeting is becoming increasingly important.

Market Structure for Advertising on Publisher Websites

Publishers create content for their websites to attract viewers. They can then sell advertising inventory to advertisers. An intermediary acts between advertisers and publishers, called the advertising networks. Another player is the advertising software tool company, which supply software tools for both the advertisers and publishers, and aims to get good feedback from both.

During 2006, the top publishers for display advertising revenue include Yahoo, Time Warner/AOL and Microsoft Netowrk. Among advertising networks, Google tops the list, followed by and ValueClick. Among tool providers DoubleClick leads, followed by 24/7 Readl Media and Atlas. These rankings are only for the United States.

During 2007, most of the leading Advertising software tool companies were bought by huge platforms. For example, Google purchased DoubleClick and Microsoft bought aQuantive.

Prices and Costs for Online Display Advertising

Majority of display advertising inventory is sold using CPM, with prices varying from 1 dollar to more than a hundred dollars in 2007. Among advertising revenues, 15 to 20 percent is kept by the number one contextual network, Google.

Most large viewers view online display advertising as nothing more than traditional advertising but with the capability of customizing space for individual viewers. But one difference is the heteregoneity of online advertising space, which makes matching suppy and demand very challenging from a technical stand point. Therefore, transaction costs between advertiser and publisher in this case is 20 percent more than the sales price after taking into account publisher tools and ad networks, much higher than the costs of intermediation in other kinds of industries.

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