Worldwide: The Economics Of The Online Advertising Industry

Online advertising has grown rapidly in the last decade. It now accounts for almost a seventh of all advertising spending and contributes to the preponderance of revenues for most websites. It is projected to increase sharply as more consumers spend time online on their personal computers and as additional devices such as mobile phones and televisions are connected to the web. This article describes the market structure of the online advertising industry and several complex economic aspects of it. Using the lens of the new economics of multi-sided platforms it examines search-based advertising platforms, as well as platforms that facilitate the buying and selling of advertising space on websites. The unique features of online advertising include the use of Internet-based technologies and data collection mechanisms to target and track specific individuals, and to automate the buying and selling of advertising inventory. Like modern finance, online advertising relies heavily on advanced economic and statistical methods.

I. INTRODUCTION

Online advertising began in 1994 when HotWire sold the first banner ads to several advertisers.¹ Revenue in the United States grew to an estimated $7.1 billion in 2001 or about 3.1 percent of overall advertising spending. The dot-com bust destroyed or weakened many of the early online advertising industry players and reduced the demand for online advertising and related services.

The industry regained momentum by 2004 as the business model for "Web 2.0" came together.² A number of businesses emerged that facilitated the buying and selling of advertising space on web pages.³ Entities that operated web portals settled on the traditional "free-tv" model: generate traffic by giving away the content and sell that traffic to advertisers. Most web sites, with the exception of transaction ones such as eBay, generate the preponderance of their revenues from the sale of advertising inventory—the eyeballs that view space allocated for promotions—to advertisers.⁴ In the first half of 2007 alone, advertisers in the US spent more than $10 billion advertising on websites.⁵ That was about 14 percent of all advertising spending.

The portion of advertising that is done online will increase significantly over time as more devices such as mobile telephones and televisions are connected to the Internet and people spend more time on these devices. The valuations that the capital markets are placing on businesses related to online advertising are consistent with this prediction. Google has had a seven-fold increase in its market value from August 2004 when it was valued at $29 billion to $215 billion in December 2007. During 2007 several companies in the online advertising market were purchased at multiples of 10-15 times annual revenues.⁶

The online advertising industry burst into the public eye in 2007. Google's sky-rocketing stock price and its forays into industries such as word processing software, online payments, and mobile telephones drew significant attention. More than 500 articles on Google appeared in the New York Times, Wall St. Journal and the Financial Times during the year. The U.S. Federal Trade Commission and the European Commission launched in-depth antitrust investigations into Google's acquisition of DoubleClick, which provides software technology and services to online advertisers and publishers.⁷ Privacy concerns also came to the fore in 2007 as consumers, government agencies and the media started focusing on the massive amount of personal data that online advertising companies were storing and using.⁸

This article describes how the online advertising industry works, focusing on several complex economic aspects of this business.⁹ Although the online advertising industry has revolutionized many aspects of an age-old business, it is important to understand, as we present in Section 2, that the new industry has much in common with the old. The unique features of online advertising include the use of Internet-based technologies and data collection mechanisms to target and track specific individuals and to automate the buying and selling of advertising inventory. Like modern finance, online advertising relies heavily on advanced economic and statistical methods. These topics are discussed in Section 3, which focuses on searchbased advertising- the most well developed part of online advertising business to date- and Section 4, which examines non-search based advertising, a rapidly evolving part of the business. The online advertising industry is highly complex, undergoing a series of rapid changes, and could well result in a high degree of concentration, if not monopoly, in the intermediation of advertising inventory and the control of personal data. Section 5, presents concluding remarks, and explains why the online advertising industry will remain at the center of public policy debate for many years to come.

David Evans is Vice Chairman of LECG Europe and Managing Director of LECG's global competition practice. He is currently Executive Director of the Jevons Institute on Competition Law and Economics at the University College London, where he is also a Visiting Professor. He is also a Lecturer at University of Chicago Law School and is Chairman of the editorial board of Competition Policy International.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.