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Where's the Internet Money Coming From?
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Other articles by Seth 

By Seth A. Maislin

  The uninitiated ask the same question: Where is all that Internet money coming from?

  The answer is easy: advertising, subscriptions, partnerships for reach and content, and online commerce. This article discusses each in detail -- plus some suggestions for milking the industry for everything its worth.

Web Advertising: Impressions

  If you've accessed the World Wide Web, you've seen the ads. Whether flashy or subtle, simple or sophisticated, web-based advertisements are broadly defined as marketing-oriented hyperlinks. Advertisers pay site owners for the space to display the ads; those in the know call this real estate, and the ads are sometimes called creatives. Advertisers produce the creatives, and site owners price the real estate. For many websites, advertising revenue is the sole generator of income, as it is for the entire media industry.

  There are three pricing models for online ads. The first, impressions, is a pay-per-view model. Every time an ad is displayed on a page -- "impressed" upon the page -- the page owner can collect money. In this model, it doesn't matter if a single person sees the ad 1000 times or if a single page is seen by 1000 people: it's still 1000 impressions. It doesn't matter if the ad is clicked on, read thoroughly, or even noticed. As long as it appeared on the screen, it counts.

  Rather ironically, impressions don't impress users. Usability studies demonstrate that users stop looking at them. Some users actually avoid viewing ads by using their hands, and ad-blocking software is readily available on the Internet. Ultimately, most ads are considered noisy distractions and completely fail to impact the user's consciousness. As a consequence, impressions are rather worthless these days -- and it's getting worse. A typical impression is worth one-thousandth of a cent. As the Web grows exponentially, real estate supply skyrockets, and its value plummets. Advertisers can't even build creatives fast enough, and many popular websites serve self-promotional "house ads" just to fill space -- vagrants living in new homes. For now, however, ad impressions is still the largest source of income for highly trafficked websites. For a website receiving ten million viewers per day, a single ad contract exceeds $30,000 per year; some websites serve four or more ads on a page.

  In general, the only simple way to increase advertising revenue is to increase audience size (or reach), but growing reach is extremely expensive, requiring ad campaigns and content acquisition. Fortunately for real estate owners, there is another way boost impression value: targeting. Consider an example: Which is more valuable, a billboard on a major highway or a sign on an obscure access road? If audience size is all that matters, clearly the highway billboard is more valuable because more drivers and passengers have the chance to read it. On the other hand, if the sign on the access road says, "Last Chance for Gasoline -- 50 Miles," I suspect this sign influences a higher percentage of drivers. Targeting is the process of intellectually connecting the products and services with the most likely (and lucrative) consumers.

  On the Web, targeting can be static or dynamic. Static targeting means that real estate is selected based on its current audience demographic. Thus a website about personal fitness is an excellent place for displaying ads for personal trainers and exercise equipment. Dynamic targeting is when ads are selected based on real-time determinations of audience demographic. Geographic targeting, for example, occurs when the geographical location of the user is considered before displaying web pages. Every user accesses the Internet from a relatively unique IP address, and these addresses are associated with geographic areas. Thus it would be possible to recognize users in Boston, Massachusetts, and as a result provide them with ads for Boston-based companies. IP addresses also contain some additional demographic information; users who access the Internet from educational domains can be shown products aimed at college students.

  Another form of demographic targeting is customization, which requires a user to be more clearly identified, often by registering at a site. A regular customer at an online bookstore, for example, can be characterized by past purchases; in response, advertisements can be targeted specifically to this customer based on that information. The bookstore might suggest books of a desirable genre, by a favorite author, or on a popular topic. The bookstore can even suppress ads for products already bought.

  Good targeting can seriously increase the value of the impression. Advertisements places on choice websites are worth at least 10 or 100 times more than untargeted ads. Further, geographical targeted can boost the impression's value an additional 100 or 1000 times. Suddenly impressions can be worth more that $1 each. On the other hand, good targeting earns the advertiser a smaller audience.

Web Advertising: Click-Through and Conversions

  Another advertising model measures click-through, which is the number of times an advertisement is clicked on. Some companies don't care about click-through; instead they are interested purely in market recognition, and getting the company name seen by people is the only important measure of success. Highway billboards, for example, rarely include phone numbers or website addresses, because the advertisers want to become household names. Good examples of these advertisers are politicians vying for election and organizations trying to implement social change.

  For many web-based advertisers, however, advertisements are a means to draw in customers and increase reach. As such, an advertisement that gets clicked on is more valuable -- worth 10 or 100 times more -- and thus real estate owners charge more for them. By paying additional money for click-through, the advertisers provide incentive for the website holders to give those ads prominence on the page. At the same time, website owners can charge extra for the premium real estate. Many companies charge fees calculated from both impression counts and click-through percentages.

  Click-through percentages for untargeted ads are small, often less than 1%. This means that more than 100 impressions are necessary before a single user responds to an ad. Measuring click-through is an excellent way to measure promotional efficacy: good products with catchy advertisements have the highest click-through values. Click-through fees for highly targeted ads, on the other hand, earn website owners the most, imaginably as much as $10 or $50 each. This is the Internet equivalent to rewarding client referrers.

  Of course, just because somebody clicks on the ad doesn't mean that user spends money (or time) at the advertised site. Awarding $50 to a referrer is a lot of money, especially because the referred customer might be a complete dud. Thus a third advertisement model exists: conversions. Conversions are defined as the number of fully completed sales that occur as a direct consequence of advertisement-based referrals.

  The conversion model supersedes both the impression and click-through models, in that impressions and click-through percentages are wholly ignored. Money changes hands only when sales are made -- when visitors are "converted" into customers. In fact, the payment of conversion funds is frequently delayed beyond deadlines for returns and payment checks, in case the transaction is annulled.

  These referral-conversion relationships are a type of affiliate program, which usually pay the referrers a percentage of the complete sale value. For example, if a referred individual spends $400 at a shopping site, the referrer might receive 5% of that value, or $20. Giving away a percentage of gross sales is expensive, but it's much cheaper than the average advertising budget. Further, affiliate programs have greater click-through values because the referrers, or affiliates, are generally supportive of the companies for which they advertise. Word of mouth is much more effective than impressions.

  For the affiliates, since they earn money only when a sale is completed, driving a user to complete a transaction is the important goal. Thus the affiliate works very hard to complete the sale before the ad is actually followed. In this way, the responsibility for good targeting rests on the affiliate.

  I have one important warning to advertisers: develop good creatives, but make websites better. If you are going to pay someone every time an Internet user clicks on your advertisement, be certain you can earn money from that user once he arrives. If you want affiliates to continue promoting you, make sure their referrals actually lead to completed transactions. I have seen too many companies with brilliant ads and horrible websites; they seem to comprise a majority of online companies. A great ad for a horrible product is twice a waste of money.

Subscriptions

  Advertisements, while popular with those earning it, is quite unpopular to users. Remember, some users actually hold their hands over the monitors to avoid seeing them. So why subject users to the discomfort? Instead, charge your users for the pleasure of having no advertisements! This is a subscription, money paid by users for exclusive access to content or services. The subscription fees themselves depend on the quality of what's provided: high quality begets high rates.

  Subscription payment plans can be periodic, pay-as-you-go, or part of an exchange agreement. Periodic fees are the most common, where the user pays some amount after a regular time period (e.g., monthly). For example, some Internet service providers charge approximately $20 every month to users wanting Internet access. Similarly, some news content providers (like online newspapers) charge an annual fee for access to a library of news archives. Unwillingness to pay subscription fees means missing out on this service and content possibilities.

  Pay-as-you-go subscriptions are much like e-commerce itself, described below. Users pay a small amount of money for continued access, like quarters into an arcade game. Effective models include how users pay $1 for a file download, a five-cent fee for a financial transaction, or $15 for a stock brokerage transaction. Users might be prompted to pre-purchase a number of transactions, depositing money into an account and then spending that money a little at a time. Pay-as-you-go subscriptions are different from commercial fees because membership, although free, is required. Only subscribers can complete the transactions, and as such transaction fees are charged only to members.

  Exchange agreements are subscriptions in which no money changes hands. Between two companies, these are strategic deals that are better explained in the next section, "Partnership and Reach." Exchange agreements between companies and individuals are non-monetary transactions in which subscription is granted to any user who provides a service. For example, a newsletter subscription might be awarded free to any author to submits an article.

  In today's environment, many users expect Web-based content and Internet services to be free. At the same time, users dislike the preponderance of advertising. Companies hoping to earn money via the Web have no choice but to choose the lesser of these two evils.

Partnerships and Reach

  Building an advertising network is only half of the equation. Without audience, advertisements and subscriptions are useless. And audience is very expensive.

  How expensive? Consider Blue Mountain Arts (http://www.bluemountain.com), which in late 1999 was purchased for $750 million. At the time, Blue Mountain Arts was a website that offered a free service, required no registration, and served no advertisements. In other words, this site had a gross income of zero. Nevertheless, the Excite/Go Network purchased the site for three-quarters of a billion dollars! Why? Because one million unique people visited the website every day, and that's a lot of people. (The industry refers to viewers as "eyeballs," so increasing one's reach is called "finding eyeballs.") If we compare the numbers, the market value for a unique daily visitor is $750. So if you visit a website every day -- to check email, the news, or a stock portfolio -- you're worth $750 to that company. If you visit a website only one a week, then you're worth one-seventh of that amount, or about $109. It's improper to use Blue Mountain Arts as the final metric for calculating the price on eyeballs, but anecdotally it illustrates the difference between people and ads. On that takeover date in 1998, a single daily visitor was equivalent to 750,000 untargeted ad impressions.

  If this purchase is indicative of the industry, then paying for advertising is clearly misguided. Instead of trying to discover new customers by advertising to them, perhaps companies should just buy consumers. Consolidation is an important element to generating income.

  Of course, few companies can afford to buy billion-dollar companies. So instead, companies can elect to "borrow" the eyeballs from companies that have them. Put another way, companies can subscribe to the audience holders. These are partnerships, in which a company pays for access to another companies audience. A company with content but no audience agrees to pay another company with audience but no content. Those who offer audience and accept content are known as content aggregators.

  The challenge in the marketplace, however, is to determine which is more important: content or audience. We know daily visitors are worth at least several hundred dollars per daily visitor, but how much is content worth? Without good content, there are no visitors. And without visitors, content is effectively valueless. The challenge for most websites is to find an acceptable balance between the two: content that is good enough to keep users, but not so expensive that the website loses money.

  So the money exchange between partnered companies can move in either direction. Some content aggregators buy high-quality content, hoping to draw in a larger audience; some content producers buy space at high-trafficked aggregator sites, hoping to find consumers. It doesn't matter in which direction the money travels: the spending company is looking for eyeballs.

  In the print world, only one of these models appears: companies paying for content. Authors of magazine and newspaper articles get paid by the word, book authors receive royalties, and television and radio programs are purchased by networks. However, the other model appears in different scenarios. In bookstores, for example, a publisher might provide an end-of-aisle display, tee shirts, speakers, and other funds to ensure that a particular author or book is prominently displayed. End-of-aisle displays and public book readings get eyeballs, and publishers know that by partnering with bookstores they can earn greater recognition by consumers. Similarly, companies with similar audiences can agree to promote each other, such as a recent arrangement between Internet company WebMD (http://www.webmd.com) and drugstore chain CVS. By associating CVS's large market share in consumable health and pharmaceuticals, as well as its many physical stores, with WebMD's wealth of medical content, the two companies share content, audience, and other commercial possibilities. I don't know the specifics of the WebMD-CVS arrangement, but either WebMD is paying CVS for its audience, or CVS is paying WebMD for its content, hoping to build market share.

  In other words, it doesn't matter if audience is being bought outright, or if content is being bought in the hopes of earning audience later. Partnerships are about eyeballs. And if a company has a huge reach, they can also command more money for advertisements.

Targeted Reach

  Conversely, advertisements that have no viewers might as well not exist. In fact, money is wasted on advertisements that fail to reach the right viewers. Subscriptions also are valueless unless customers are willing to buy them. Regardless of a company's ability to reach consumers, its products and services still need to meet consumers' needs.

  This may sound obvious, but advertising departments sometimes forget this, overwhelmed by the astounding numbers of perceived customers. The Internet is analogized to an orchard overburdened with fruit, but this is completely untrue. The Internet is simply an access tool. Reach is no longer limited geographically, but consumer demographics aren't changing. A company's market share-the percentage of potential clients who complete transactions with that company-doesn't increase when its reach increases. If a certain brand is bought by 8% of men between the ages of 25 and 35, increasing the number of men doesn't matter.

  Considering the Blue Mountain Arts purchase again, we determined that a single daily viewer is worth 750,000 untargeted ad impressions. We also know that properly targeted ads are worth more than untargeted ads, so we could imagine extending this equation to equate a daily viewer with just 75 ads, provided those ads are targeted brilliantly. But how brilliantly can Excite target an ad when it just bought an unregistered audience of one million people a day?

  Consider an imaginary company called Maislin Shipping. This company provides custom luxury shipping solutions to only 100 customers. For example, an art gallery in New York City might use Maislin Shipping to ship multimillion-dollar antiques to a sister gallery in Paris, France. Irreplaceable items such as famous artwork must be properly insured, and insurance arrangements for expensive artworks are significantly specialized. This presents a targeted opportunity for Kushner Insurance Company. If Kushner Insurance wants to increase its reach within this select market, they should consider partnering with Maislin Shipping. Kushner may find only 100 more clients, but it would all but guarantee income from each of them. Kushner could buy 100% market share in Maislin's clients. In fact, Maislin's loyal customers could be more valuable to Kushner Insurance than the millions of unknown Blue Mountain's users are to Excite.

  Once again, we're talking about targeting. Targeted partnerships are clearly more valuable than untargeted partnerships. The more you know about an audience, the more value it has. The demographics of Maislin Shipping's audience is extremely specific: not-for-profit institutions of marketers and lovers of artistic masterworks, supported by government grants and private funding.

  Targeting works in the opposite direction as well through exclusivity arrangements. Once a partnership is formed, one or both of the partners could agree to not establish additional partnerships with competitors. For example, Maislin Shipping might select Kushner Insurance as the exclusive insurance provider for all Maislin contracts. This is similar to a product declaring itself the "official product of the 2000 Sydney Olympics": the company is paying for the worldwide Olympics audience, and in return it gets advertising and placement exclusivity.

  In conclusion, the best partnerships are those involving targeting and exclusivity. The more a company knows about its reach demographics, the more valuable those eyeballs, and the more money it can command in advertising deals and partnership arrangements.

  There is an interesting side-effect to subscriptions and partnerships: the value of customer lists. Companies that record information about their customers can sell that information for money. If Blue Mountain Arts had required all million daily visitors to identify themselves, Blue Mountain could have then sold that information to clients interested in large numbers of undifferentiated Internet users. Similarly, Maislin Shipping could avoid partnership by instead sending a list of its 100 clients to specialized insurance companies around the world. As before, reach is a valuable commodity, and targeted reach is even more valuable.

The Money's Coming From Somewhere

  So where is all this money coming from? One company pays for a targeted audience, and then they sell targeted advertising space. But where does the company buying the advertising space get its money? Often they are selling advertising space themselves. In other words, the money moves from one company to another company in a giant industry circle, with Company A advertising with Company B, who advertises with Company C, who advertises on Company A. Partnerships are a fancier way of passing funds between companies, and exclusivity is a great way to shut other companies out of advertising possibilities, but still there is no source of new money.

  Subscriptions do bring in fresh funds -- but those funds are spend on the services and content themselves. A company that sells Internet access subscription uses those subscriptions to pay for the infrastructure. In an industry where users are less and less likely to pay for anything, however, subscriptions are often insufficient to keep a company afloat. Thus they find a partner, entering into the circle of the money exchanges.

  The largest source of new funds is venture capital. When a company first goes into business, venture capitalists (VCs) invest money into that business. That money is immediately spent on infrastructure, content, and marketing. In other words, VC money gets added into the circle. The companies who invest first get the audience first, and so when the newer companies (with fresher VC money) enter the fray, they give money to the older companies. Thus the new VCs are paying off the debts of the old VCs. Thus system doesn't work, however, and Internet companies are disappearing rapidly, going out of business more often than succeeding. Making money on the Internet is extremely challenging. In fact, employees who leave failed companies actually are considered more valuable than employees who leave successful companies, because startups crave people who learned from mistakes.

  So the only other source for money is online commerce, or e-commerce. This is the process of buying something over the Internet. E-commerce is not anything special or spectacular; it's an ordinary financial transaction without an ordinary cash register. The rules for physical commerce still apply, although the dynamics feel quite different. Companies still need good products and services, consumers need to learn about their availability, and the price must be appropriate. Rules for targeted e-commerce are the same as for ordinary commerce.

  In e-commerce, money is earned by three types of people. The most obvious are the people who make and market the products and services themselves, for a profit. The next group of people are the middlemen, who build the e-commerce software or enable the transactions to take place. Just as superstores and supermarkets provide access to multiple products from numerous companies, so do online auction sites and B2B companies enable buying and selling services between others. Third are the affiliates again, who receive referrals kickbacks when a transaction is completed. In all cases, money enters the system from the buyer and is distributed to everyone involved: the referrer makes 5%, for example, the middleman takes 25%, and the seller takes the remaining 70% to cover overhead and profit. Again, just because this takes place over the Internet doesn't mean the process is new.

  There is no new money in the Internet. Money is just moving from the physical world into the virtual world -- except that the "virtual world" is just the real world on telephone lines. People communicate and negotiate as before, buy and sell in the same ways, and continue to transfer money between bank accounts.

And the Big Winners Are...

  So there are two ways to fill your bank account faster than everyone else fills there. One of them is targeting. If you can target your advertisements, you can charge more for them. If you can target your subscription offers, you'll get more subscribers. And if you can partner with companies with well-defined audiences, you can gain exclusive control over your more promising customers.

  The second way is infrastructure. The unsung heroes of the Internet world are the companies who build the tools on which the Internet runs. Perhaps it's rather unglamorous compared to the sexiness of websites and e-commerce and billion-dollar buyouts, but as long as money is going to change hands, the tools builders earn a cut. Advertisements can't be displayed with good network connections, subscriptions can't be tracked without good encryption techniques, and e-commerce transactions won't happen without solid database solutions.

  We have two choices, then. We can build machines in our garages, or we can focus on precisely what we want and reach for that. If we can connect exactly the right content with exactly the right audience, we are much more likely to succeed.

  Unfortunately for the true Internet buffs, the focusing part requires human involvement.

Other articles by Seth 

 

Copyright 2000 Seth A. Maislin
(Available for re-publication. Written October 2000.)

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