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The End of Digital Advertising as We Know It

Facebook has said that “ad load,” or the relative volume of advertising versus content on its pages, isn’t going to be able to fuel revenue growth as much as it has to date. The disclosure indicates that the display-ad business model – which has largely been the industry standard for monetizing content on the internet — may be tapped out.

When Facebook reported its third quarter earnings, CFO Dave Wehner outlined how ad load is going to be less effective in the very near future. “We continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the past two years we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth,” explained Wehner on a November 2 conference call. “With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.”

Facebook officials’ comments recognize that advertising has its limits online and may have peaked. The popularity of ad blockers highlights how consumers are turning their backs on internet advertising as it becomes ever more plentiful — and intrusive. Research firm eMarketer estimates that 68.9 million Americans will use software to block advertisements in 2016, a 34.4% increase over 2015 and a number expected to rise to 86.6 million people in 2017.

“Long-term, the ad landscape we know today is so archaic. It’s a legacy to an old world where ads were the only way to pay for media,” says Peter Fader, a marketing professor at Wharton. “There’s no good aspect to them, and anything they are doing now is hurting the user experience and the value of brands.”

Wharton management professor David Hsu says the balance between usability and advertising has been lost. “If you use an ad blocker you know how many ads are blocked. It’s ridiculous,” says Hsu. “These companies [ad-based publishers] have gorged and it’s slowing down the infrastructure. Some of these experiences are really terrible.”

“Long-term, the ad landscape we know today is so archaic. It’s a legacy to an old world where ads were the only way to pay for media.” — Peter Fader

Wharton experts give Facebook credit for noting that filling its news feed with ads is a bad long-term strategy. They also applaud efforts like Facebook’s Instant Articles, which run natively on Facebook for faster mobile viewing, and Google’s Accelerated Mobile Pages (AMP) project, which also limits ad formats in exchange for speed. But publishers have reportedly been complaining about AMP monetization – multiple publishers told The Wall Street Journal that AMP pageviews currently generate about half as much advertising revenue as a pageview on their full mobile sites.

Wharton legal studies and business ethics professor Kevin Werbach says that Google and Facebook can take steps to curb advertising because those companies have a massive user base and the scale to forgo revenue. “It’s not written in stone that advertising has to be the dominant monetization model for online and mobile services,” says Werbach. “Google and Facebook figured out how to generate huge advertising revenues based on massive user numbers and sophisticated targeting, but that doesn’t mean the model is viable for everyone.”

The Interactive Advertising Bureau (IAB) said November 1 that digital ad revenue grew 19% in the first half of 2016 to $32.7 billion. But the IAB also said that 74% of ad revenue in the first half of the year was concentrated with the top 10 ad selling companies. Pivotal Research Group analyst Brian Wieser said in a research note November 1 that Google and Facebook captured 68% of digital ad spending in the second quarter, up from 61% a year ago.

The Conundrum for Publishers

The dominance of Facebook and Google may present a conundrum for other publishers that rely on advertising and can’t shift to a new business model easily. Fader says that advertising is likely to give way to the more direct marketing approach used by Google. To shift away from advertising, a company would need more customer data. Companies such as Facebook and Google have amassed extensive data on users’ characteristics and behaviors.

“A lot of media will simply go away,” says Fader. “Google will be fine due to sponsored search. Facebook also has the clout to charge for a premium version.”

In other words, advertising will be dominated by two giant companies and possibly a few others. “The data-centric model of online advertising also trends toward concentration, because those with the most data can provide the best service for advertisers,” says Werbach. “Hence Facebook and Google’s dominant share of advertising revenues online.”

Werbach says the likely outcome is that internet publishers will have to band together to offer bundles that can justify subscriptions. He sees the cable TV model as a potential option for content sites.

“Google and Facebook figured out how to generate huge advertising revenues based on massive user numbers and sophisticated targeting, but that doesn’t mean the model is viable for everyone.” –Kevin Werbach

“If you look at the way television has evolved, for a long time it was predominantly advertising-supported through over-the-air broadcasting,” Werbach notes. “Eventually, though, cable TV came along with a subscription model. It’s ultimately better to have the opportunity to generate revenues from both sides of the market: users and businesses who want to reach those users.”

Werbach argues that in the end, large sites will have power as aggregators. These aggregators, such as Facebook and Google, will be able to bundle ad-free content from publishers similar to the way cable TV does. “A fair number of users might be willing to pay for ad-free content on high-quality sites like newspapers, but they don’t want to pay each of them individually,” says Werbach. “The natural solution is a bundling model like cable TV, where the user pays one fee to an aggregator who then signs up and pays the content providers. This is where Facebook’s Instant Articles and similar services could go. The big challenge there is what we’ve seen in the communications market: It gives enormous power to the aggregators.”

Fader agrees that subscription based models will emerge. For instance, Facebook could charge for a premium ad-free experience similar to Spotify. “Facebook Premium could charge $6 a month, have an ad-free experience and offer more control. Facebook could make so much more money,” says Fader.

What remains to be seen is whether consumers will go for an à la carte subscription approach where every company has relationships based on data. “Look at the over-the-top [direct internet-delivered content] companies like Netflix, Hulu and Amazon. They’ve managed to go it alone,” says Fader.

Hsu says whatever models emerge, they aren’t likely to be developed by existing players. “We’re going to see new models, but it’s quite a challenge,” says Hsu. “The only opportunity is really for the next era of companies. There’s a limit on ads, but it’s unclear people will pay for the alternatives. None of the current companies want to try a new model because you can’t spring it on consumers midcourse. If you start with a non-ad experience, that is easier than starting free and then trying to charge.”

Some publishers such as The New York Times have made the transition to digital subscriptions. New York Times CEO Mark Thompson said November 2 that digital news subscription revenue was up 15% in the third quarter, but also noted there was pressure on the traditional print business. The digital gains were helped by the presidential election in the U.S., but Thompson also said that the company has improved its targeting and marketing to gain more subscriptions.

Nevertheless, the company’s digital-only subscription revenue was $58.5 million in the third quarter, while total revenue was $363.5 million.

“We’re continuing to optimize our consumer marketing and the configuration of our pay model. Our investment in international is translating into more subscriptions. We are reducing churn. We’re putting more focus into corporate and education subscriptions,” said Thompson. “Our market research and our practical experience on the ground makes us more bullish about the future growth of this model than we were even a year ago.”

“The only opportunity is really for the next era of companies. There’s a limit on ads, but it’s unclear people will pay for the alternatives.” –David Hsu

According to Hsu, a business model similar to that of software company Zenefits may also make sense. Zenefits gives its human resources software away, but makes money by being a health care insurer of record and generating commissions. “We are living in an era where there are more touch points and there are more revenue models,” says Hsu. “If we’re compiling all of this data, what are we going to use it for?”

Novel models that revolve around using data and customer relationships may give internet publishers more control over their destinies. “The risk is that Google and Facebook have all the data,” says Hsu. “Can you live in that ecosystem?”

Is Advertising Doomed?

Meanwhile, online advertising may decline over time. “Advertising still has some room, but Facebook’s comments illustrate that it is reaching the saturation point,” says Hsu. Forrester Research analyst Brigitte Majewski said in a November 3 blog post that the end is near for advertising. Forrester found that one third of U.S. online adults use an ad blocker and 48% actively avoid ads on web sites.

Werbach adds that the biggest issue with advertising is that there are “divergent incentives between users and advertisers.” “We’ve clearly reached the point where many users feel the proliferation of ads has gone too far,” says Werbach. “Right now we’re seeing a technological arms race behind the scenes between the advertising-dependent sites and the ad blockers. That’s not a healthy or stable situation.”

The tug of war will be between publishers and users who employ ad blocking technology or forgo advertising sites completely. Werbach says large sites like Facebook will continue to do well, but smaller players will suffer.

One option is to use data to better target ads. “Marketers will choose quality over quantity advertising. This doesn’t mean no advertising — just better advertising,” said Forrester Research’s Majewski. Marketers will have to adapt to lower ad consumption, she added.

The new era of post-peak advertising will mean that publishers and marketers will have to adapt or die, says Fader. “Companies will have to run experiments beyond where to put an ad or the right size,” says Fader. “That approach would just prolong the agony. Some of these experiments will go under. Some will go right.”

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