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Online advertising and gravity

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I have always loved new things and new ideas. I am the guy who must have every new gadget in the first week. On the downside, this has led to ownership of some remarkable but quickly obsolescent products. My favorite example is Sony's MiniDisc. (I thought this was such a good idea at the time.) On the upside, I have served for the past two years as a consultant to a small but vibrant venture capital group. My role there, advising on pricing issues and business models, feeds directly into my mania for newness, because, like so many other investors, this group has been focused on technology. The group now finds itself with more money than ideas and has started looking for places to invest. As the VC team weighs presentations about places to invest, it has seen many recent hopefuls who are bright young things with jolly good ideas and some proof of concept, but virtually no proof of revenue. Don't get me wrong. I am not ageist towards the young—some of my best friends are young—and, for what it's worth, I have run more businesses dealing with online and new media (whatever that means) over the past 15 years than “traditional” ones. However, the people offering new business plans all seem long on enthusiasm and theories but short on track records and business acumen. Many of these presentations have been centered on yet another way to amass huge traffic and snag ad revenue. However, I will share with you what I have shared with my VC colleagues: I am deeply worried about online advertising revenue models. I realize I am not alone in this concern. But most people are struggling to figure out why things are not working as they'd planned. They tend to plow on regardless, hoping they can keep increasing traffic while rates (usually CPMs) are heading down. They look like those performers spinning plates—and we all know the plates will eventually fall. So why am I concerned for the long run? The answer is pricing. In an unregulated market, price will always gravitate towards the marginal cost of distribution. To fully grasp this law and its implications, you have to understand the boundaries of a regulated market. TV, for example, is a regulated market in a traditional sense: The Federal Communications Commission decides who gets channels. Publishing is regulated by its marginal cost of distribution, i.e., the more copies you print and send, the more it costs you. The cost of doing business creates its own self-regulation: Any company will spend money to reach consumers as long as it makes sense. When many companies are offering the same product, everyone's costs will be pretty similar. And there will always be a limited, restricted market for goods because not everyone can provide the needed start-up costs and the money to maintain the business. Now think about the Web. Barriers to entry are virtually nonexistent; it is completely unrestrained, i.e., no FCC; and the marginal cost of distribution is nothing—it doesn't cost anything to add another 10, 20 or 2,000 people to access our online pages. So price will head toward the marginal cost of distribution, which, to remind you, is essentially zero. Backing a business model that is ad-based alone is OK—if you can be sure they will do it better long enough to allow you to exit. However, with time to exit getting longer, not shorter, this is a risky business. “Hurrah,” you may be thinking, “he managed to get through the article without once mentioning Variety.” Not so fast. This out-of-the-box thinking is driving our excitement for integrating ad spend across all platforms with one price. It is also driving the development of three new businesses: events and conferences, data sales and international licensing and syndication. All of them are working, which is a very good thing indeed—especially as we head into the sale process for Variety. (The new owners will be getting a very strong, profitable business with a well-thought-out business strategy.) From a business standpoint, continuing to rework Variety for the digital age is rewarding. And on a personal level, it still feeds into my quest for new things and new ideas. Neil Stiles is president of Variety. He can be reached at neil.stiles@variety.com.
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