Are VCs wasting money on online ad models? Photo via Images of Money

Over the last ten years, more than $43 billion was invested in 7,200+ Internet-related companies, according to the PWC MoneyTree report. Fifty percent of those companies will disappear within the first three years of operations, and the average venture capital fund will fail to even return back the capital plus management fees as per the Kauffman foundation report.

But blaming the venture capital model is just scratching the surface of the real problem. The root cause of these poor returns is the lack of sustainable and user-friendly monetization mechanism beyond the unprofitable display advertising business model. Ad-funded Internet models are a more than $40 billion money drain.

During the past five years, worldwide Internet user base doubled, yet online advertising grew less than 70 percent. Between 2012 and 2016 online ad spending is projected to grow 14 percent CAGR, but this growth does not factor in the erosion in display advertising revenues that will come as a result of the rapid migration to mobile and the most likely scenario is a contraction of the total display ad category.

Mobile is extremely hard to monetize using traditional display and search advertising as discussed in previous posts (Making web 2.0 profitable beyond display ads). This means the gap between user growth and profitability will continue to increase, creating pressure on the leading portals, digital media companies, social and business networking sites and forcing them to explore new avenues to monetize their audiences.

Paid content revenue dominates the mobile web. Only 5 percent of the global mobile Internet revenues come from advertising while 73 percent comes from eCommerce and 22 percent from paid services. Fifty four percent is paid digital content: apps, ringtones, music, video, etc., according to Morgan Stanley.

The role of micro transactions is key in the mobile web, which will be also known as “the paid web.”

While Apple is leading the path on monetizing audiences through micro-transactions, effectively reinventing themselves as the largest eMarketplace (Apple reinvented: the profitable web) and increasing the average revenue per transaction 100 percent over the past five years (47 percent of apps are paid with an average price of $1.99). Facebook, Linkedin, Yahoo!, MSN, AOL, and a long line of Internet companies backed by venture capital are struggling to monetize their audiences.

These companies suffer from their audience migration to mobile devices and to apps in the smaller screen form factor, the continuous erosion in CPM rates, and the end-user apathy towards online display ads, coupons and paid search results.

As an executive advisor to large and emerging tech firms and advisor to venture investment firms, one of my focus areas for the past five years has been in monetization technologies for profitable Internet companies and I have actually delivered on Internet companies’ turnaround by implementing profitable models.

These days, I am highly skeptical of advertising as a valid monetization mechanism as I think it is a macroeconomic nihilism. There are always better ways to monetize audiences, as long as one is delivering value in return for engagement.

Leading companies in terms of engaged audiences, such as Google, LinkedIn, Yahoo!, and Facebook, are starting to test new monetization in the form of “application” stores, e-commerce, eWallets and payment mechanisms, paid digital content, and by selling their “audience” as a qualified “panel” to serve the need of the online market research industry.

Luis Salazar

Market research is a good and overlooked example of an adjacent monetization mechanism for large audiences. It is a more than $31 billion industry, according to ESOMAR, and more than 70 percent of that money is spent offline using outdated tools. Online market research makes up more than $9 billion of that and is monetized through micro-transactions in a B2B model, where the average price per completed survey is around 2x to 4x the average revenue per user per year reported by most successful social networks and Internet portals. Hence, online market research constitutes a valid monetization mechanism for those large audiences.

The same algorithms used to serve targeted and relevant advertising based demographics and observed behavior can be used to create virtual samples of survey respondents in real time. This opens up the large audiences built during the Web 2.0 boom to an adjacent form of monetization, where users continue receiving the benefits of the free-Web by paying with time responding to surveys, in addition to the time they spend looking at ads.

While this introduces new opportunities and potentially doubles the total addressable opportunity for online audience monetization, it is still not enough to bring balance to the macro equation of social networks, Internet software companies and digital media companies.

The only reason to think that Facebook is worth $70 billion is if one believes they will be able to monetize their audiences via ecommerce, transactions and other yet-to-be-revealed monetization mechanisms. With 50 percent of their users migrating to mobile and 25 percent of those users accessing Facebook via third party apps that are not exposed to ads, the current revenue trends are just not sustainable in the short term.

Hybrid mechanisms, such as Apple or Android stores where users pay for premium digital content or digital goods through micro-transactions and are also exposed to some sort of transactional-advertising, are a more sustainable model.

There is simply not enough online advertising money or minutes spent online to pay for the billions invested thus far in Internet-related deals by venture capital and corporate venture capital over the past ten years.

These Internet companies and large audiences never delivered on the promised monetization, but the audiences were built. As corporate and venture capital learn the macroeconomic realities of ad-funded models, the time is ripe for innovation on profitable consumer Internet companies.

Traditional online advertising is looking like a $40 billion money drain.

Luis J. Salazar serves as an investing and executive adviser to technology and digital media companies. You can follow his blog at NakedCMO and on Twitter @NakedCMO.

Comments

  • Paul_Owen

    Nice article. Two comments:
    1. No mention of AMZN. They lag in hardware but lead in credit cards on file. Raise your hand if you have purchased something from AMZN. Is the same true for Google?
    2. Secondly, when does Luis predict the return to quality? Are Netizens still content w free “news” from FB and Google? When will consumers tire of the digital equivalent of “The Little Nickel” and start paying for content?

    • nakedcmo

      Yes, AMZN is the obvious gorilla in the marketplaces segment, alongside eBay and other groups in Asia, and they are all a mix of digital goods and finished goods, but Apple with 400 million credit cards on file is a dominant player in the digital goods arena and shows a potential path to monetization beyond display ads. Convincing people to pay $0.99 for something that was “free” was a huge step of infinite growth. On the “paying for content” I think we all do so in one way or another when we buy a song for $0.99 or pay for Spotify monthly subscription or Netflix, we are all paying for “quality” content, regardless of the source. In most cases this micro-transaction ecosystem brings the best as it allows the long tail to get paid for their good work. The average paid app, even at $0.99 will generate more revenue for that developer than the average “ad based” app… unless Facebook comes and pays you $1B as a developer for an app with lots of traffic and zero revenue and “guest” comment suggested.

  • guest

    Timely article. I was recently reading a bunch of comments along the lines of “congrats to Yammer on a successful exit” and wondering why that has become the model to emulate? Sure, it’s financially attractive for those founders and that provides *one* very strong motivation to start something. But the likes of IBM, GE, MS, Apple, etc, didn’t get built on people saying “awesome, let’s convince a bunch of customers to commit to our technology and then just as they start doing so, let’s bail for big $ and leave them to the mercy of whoever acquired us, knowing they’re likely to lose focus within twelve months and dump the product entirely within three years, leaving those customers to start all over.

    • nakedcmo

      Good point. I made a similar reference here: http://www.thenakedcmo.com/2012/04/making-web-3-profitable-beyond-display.html celebrating Instagram is just the wrong signal to the entrepreneurship system as we all celebrate the $1B exit but forget the many corpses around as venture capital invested +$430b since 1995 in internet deals and most companies disappeared. “Build large audiences” cannot be the only metric of success and the ecosystem of entrepreneurs, angels, VC and PE should probably dig a bit deeper beyond that key metric.

  • ruchitgarg

    Typical tech entrepreneur now-a-days do not have shopkeeper’s mentality which is essential for building a successful business (think AMZN, MSFT, APPL) Unless you have cash inflow (from customer not investor) , operating margin and recurring customers you do not have a sustainable business.

    Its surprising to find that so many startups are getting funded because they may have lot of users in future, without focus and/or understanding on how they will generate money. They might be able to flip it, but if not they will tank multi-million dollar investor;s money.

    I would highly encourage entrepreneurs to watch this video, to learn basic blocks of building business http://www.ram-charan.com/videos/ram_charan_covey1.wmv

    • ruchitgarg

      Sorry for duplicate comments, seems like there is some issue in the comment system here..

  • http://www.9slides.com Ruchit Garg

    Typical tech entrepreneur now-a-days do not have shopkeeper’s mentality which is essential for building a successful business (think AMZN, MSFT, APPL) Unless you have cash inflow (from customer not investor) , operating margin and recurring customers you do not have a sustainable business.

    Its surprising to find that so many startups are getting funded because they may have lot of users in future, without focus and/or understanding on how they will generate money. They might be able to flip it, but if not they will tank multi-million dollar investor;s money.

    I would highly encourage entrepreneurs to watch this video, to learn basic blocks of building business http://www.ram-charan.com/videos/ram_charan_covey1.wmv

  • Tanja Danker

    The average, non-Apple consumer is broke, overloaded with student loan and credit card debt. Internet companies will never be able to charge enough microtransactions to cover their overhead. Yammer/MSFT new model of charging corporations to integrate with federated Active Directory to filter out non-FTE’s might work however.

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