Time to Admit What We Already Knew: Online Ads Stink

Every single major tech and business story this week was the same story: Even companies with 100 million, 700 million, and 900 million free users don't know what to do about Internet advertising.

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At first, they seem to be five separate stories ...

(1) An open discussion about what kind of company Yahoo! wants to be under Marissa Mayer.
(2) A debate about the future of Twitter.
(3) Facebook's predictably disappointing earnings pushing the stock to an all-time low.
(4) The observation, by Conor Sen, that LinkedIn now trades at a higher valuation ratio than Facebook.
(5) The fact that online news subscriptions are working better than online ads.

... and yet, they all ask the same question: Are online ads an utterly hopeless business strategy?

The short answer to the question is: Of course not. Google built an empire making more than 90 percent of its revenue with search ads (which is a categorically different business from display and other kinds of "targeted" ad buys). Yahoo!'s second-quarter earnings showed more than $530 million in display ads. Digital-first news organizations like Gawker have produced small but steady margins. Investors have plowed millions into online-ad-dependent businesses, and some firms like IAC have seen good returns.

But the businesses listed among the five news stories above don't aspire to be mere online lemonade stands. They're trying to build online empires. So the deeper question raised by these five disparate stories is: Can you really build a monster on the slender back of online ads?

Let's start at the top of the list. Yahoo! is a content behemoth, with 300 journalists and 700 million monthly visitors in 30 languages, and a business model that is broadly considered hopeless. "Yahoo has what all media companies want, which is a large audience," David Carr wrote for the New York Times. "The company just doesn't know what to do with it." Speaking of having a large audience without knowing precisely what to do with it, let's move down the list to Twitter, a bonafide attention hog with 140 million active users and $140 million in revenue in 2011. If revenue triples this year and Twitter doesn't add a single active user (both unlikely scenarios), the company will make $3 per active user, which would bring it in line with another company -- Facebook.

Facebook's quarter-over-quarter revenue growth going back a year and a half looks like this: 13%, 0%, 14%, negative-10%, 12%. As a result, the company has struggled to push ARPU (average revenue per user) beyond the $2.50-$3.50 band. How cheap is that? It means that if each Facebook user agreed to pay a quarter each month for the next three months, the company's quarterly revenue would nearly double to $2 billion. That is a remarkable statement of both Facebook's utter domination in the attention economy and how thinly that domination has paid off. Zuckerberg's invention is still a monster, and every start-up company in America would give various limbs to have the kind of "failure" Facebook is experiencing today. But the bloom is officially off the rose. "Before they were a public company, Facebook was judged by growth in users," Colin Sebastian, an analyst at Robert W. Baird & Company, told the Times yesterday. "Now that they are so well penetrated in most Western markets, growth has to translate into monetization."

LinkedIn is a different story, and a relatively successful story, in no small part because the core of its business is in premium subscriptions, paid job postings, and paid data-driven searches for hires -- not in online advertising. Almost all of the growth in LinkedIn's revenue has come outside of online advertising in the last three years. Meanwhile, in the lower-margin news business, we're learning the same lessons dawning on the tech industry: If the ads won't pay, find something that will. Paid subscriptions to theTimes' website continue to rise, and the paper now makes more money from circulation revenue than from ads, Dashiell Bennett reports. Meanwhile, at the Financial Times, more people than ever are paying for FT content, "with digital subscriptions exceeding daily print circulation for the first time," the company announced today.

To say that online ads "don't work" is plainly false. It is as silly as saying you can't buy anything for a dollar. Of course you can. Dollar-stores exist. And display ads cost something, and they can sustain a small enough operation. But, for the Silicon Valley empires-under-construction, a multi-thousand-person staff and an R&D budget and capital investments cost something, too, and the meekness of online ad revenue pales against the scale of these web companies' ambition.

We've sustained our optimism for web businesses with the hope that if these companies were smart enough to get our attention, they'd be smart enough to make money off it. This boils down to a faith that the smartest online companies would figure out how to make online ads pay big money. But it's hard to read this year's news closely and not see that this prediction requires a light editing, that the smartest online companies will figure out that online ads can't pay big money, and that they'll be smart enough to find something else, or someone else, who will.