Is The Online Ad Industry Partying Like It's 1999?

Online advertising spending is healthy, and most people in the industry seem to believe that the industry faces nothing more challenging than a few speed bumps on its way to inevitable dominance of advertising as a whole. The success equation, in the words of Microsoft CEO Steve Ballmer, is stunningly simple: "Over time, all ad money will go through a digital ad platform... as all media goes digital; all advertising goes digital."

Ballmer's optimism is understandable, because Microsoft stands to gain a lot from the increasing flow of ad money through its digital platforms, which now include desktop, gaming and wireless devices. But there's increasing evidence that the road to digital ad dominance will be a lot rougher, with a lot more road kill, than the optimists would have you believe. Why? Because the current online ad industry has many characteristics of a classic speculative bubble.

What Makes a Bubble?
If you're too young to remember the Internet advertising shakeout/meltdown/implosion of 2000-01, the "bubble" was what happened when irrational exuberance intersected with fast-talking technology optimists, half-baked business plans, immature technology, credulous analysts, and too much stupid speculative money. The result was trillions of dollars worth of lost equity, the near-complete destruction of an entire generation of pioneering companies, and legions of 20-something former masters of the universe moving back to live with Mom and Dad.

Today, of course, nobody seriously believes that the online ad industry is on the verge of melting down the way it did in 2000-01. After all, all those crazy Web 1.0 business plans are history now, investors are much wiser, Google is making tons of profit and the industry is ruled by good old-fashioned concepts of profitability and business best practices, right? Well, maybe. Sure, Google is insanely profitable and the other search engines are making money. Microsoft's profits have never been higher, and the entire hardware and software infrastructure of the Net has been massively upgraded in the past seven years.

Speculation Didn't End in 2000-01
But while the online ad industry and the infrastructure it rides upon has matured, speculative fever hasn't gone away: it just relocated itself from Wall Street into the boardrooms of public companies, including Google, Microsoft, Yahoo, IAC and others. As each vies for dominance in online advertising, acquisitions are considered not for their asset value but for whether such acquisitions can be denied to rivals. The result is that valuations are no longer rational, which is a critically important leading indicator that a bubble may in fact already be upon us.

Last week, Microsoft's Steve Ballmer came very close to uttering the "B-word" when he called Facebook and other social networks "fads." EBay's executives certainly had the B-Word on their minds last week when they admitted that Skype, a company acquired in 2005 for $2.6 billion, was a bad acquisition, and that it doesn't matter how many millions of subscribers you have if they're not paying you a dime.

Is Google the Ultimate Bubble?
And then there's Google, the poster child for online ad profitability, whose stock price is the bellwether for the overall health of the online ad industry. While it's been phenomenally successful in monetizing paid search, it has completely failed to derive any material revenue from any of its post-search projects. Google's stock price (currently at $581) is as high as it is because investors seem to believe that it can keep growing at the same healthy rate as it has since its 2004 IPO. And yet every non-search product it's launched, including, the Google Print Ads Program, Google Audio Ads, Google Video, Google TV Ads, Google Checkout and YouTube have failed to generate any material revenue. How can Google's stock price possibly be sustainable if all its efforts to grow beyond search are miserable failures?

The Doomsday Scenario
If you remember the day the online ad bubble burst in 2001, you'll recall that it all began with an article in Barron's that calmly warned investors that many prominent dotcoms would begin running out of money within a few months. This article was the catalyst for a chain reaction that could not be reversed.

Today, the "doomsday scenario" goes as follows: sometime in the near future, Google misses badly on its quarterly earnings. The result is panic selling of Google, which casts a pall over the entire online ad business, restoring some measure of rationality to stock valuations. Keyword prices crash, as marketers, responding to a new wave of investigative articles about the effectiveness of search advertising, reign in their budgets. With search spend weakened, overall online ad industry spend weakens, severely depressing CPMs. On the cover of Fortune Mmgazine, a solemn Eric Schmidt is portrayed beneath the headline, "Web 2.0 Wipeout: How Could It Have Happened?"

This doomsday scenario isn't inevitable, but the chances of dramatic corrections in the online ad sector are, in my view, high. As the overall economy begins to enter a slowdown, and consumer behavior changes, it's certain that the online ad industry will undergo changes, and they will not all be positive. My hope is that these changes will not be catastrophic, but if history is any guide, there will be plenty of road kill on the online ad superhighway in the next several years



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