Online ad revenue — where does it go?

This year marks a milestone in the US digital advertising market — for the first time, digital ad spend will exceed traditional ad spend. We are expecting a 19% growth to $129.34 billion (or 54.2% of the total). Mobile continues to account for more than two thirds of all digital spending.

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These numbers suggest the ad model invented in the ’90s is not just alive and well, it is thriving. But in reality, things are working out only for the three largest ad platforms. The Google/Facebook duopoly has accounted for almost 60% of revenue for many years now, and Amazon has become a real threat during the past couple of years. The rest of the revenue is mostly divided amongst a few other big players.

Unlike traditional advertising, online ads have not, and will not, support creative content production. From large news publishers to bloggers, from music artists to video creators, they have all struggled in the new age of the internet.

In this article I will analyze the big players of the digital ad market and talk about their history. I will highlight what makes them so good at selling ads and show that content creators never stood a chance at capturing enough ad revenue away from the big platforms. Online content producers thus need to find a new model to supplement their revenue.

Google and the beginnings of the web

The first web browser was created back in 1990, but by 1995 less than 1% of the world population was connected to the internet. Nowadays, about half of the world’s population is online, following more than two decades of year-over-year double digit growth.

However, back in the mid ’90s, when the web started to grow, it was a very confusing place. Remembering domain names or just following links was a very poor way of finding information. So naturally, many ventured out to build a search engine, to help users navigate specific content related to queries.

The need for search was structural. However, only one company managed to come on top and dominate the market. Why did Google, of all the search engines, end up winning the search engine war?

There are several theories explaining Google’s success. Some of the most plausible reasons include:

• PageRank worked. Unlike all the other search engines, it provided users with the most relevant information in relation to their queries.
• The UX was simple and intuitive. All the other search engines were cluttered.
• Google ignored monetization in the beginning and focused on growth. The general consensus back in the day was “stickiness”, where you want to attract users to your page and keep them on for as long as you could, so you would pepper them with advertisements. Google did the opposite, trying to get users to their final destination as quickly as possible.

Finding a business model

It’s interesting to note that initially, the two Google founders opposed the idea of adopting advertising as the primary business model:

“The goals of the advertising business model do not always correspond to providing quality search to users. […] we expect that advertising funded search engines will be inherently biased towards the advertisers and away from the needs of the consumers. […] In general, it could be argued from the consumer point of view that the better the search engine is, the fewer advertisements will be needed for the consumer to find what they want.” — Sergey Brin and Larry Page, The Anatomy of a Large-Scale Hypertextual Web Search Engine

However, it wasn’t until Google embraced the ad model that their domination took shape. The initial piece of the puzzle, AdWords, was launched in the fall of 2000. Bill Gross, the founder of another search engine called GoTo (would later become Overture) was the one who first recognized the massive potential of advertising. But Google appropriated the model, and in 2002 managed to convince AOL, at that time a major portal, to switch over from using Overture. In 2003 Google launched the second piece of the puzzle, AdSense, following the acquisition of Applied Semantics, and it became an unstoppable advertising machinery.

Where does Google’s ad money go, 2018

In 2018, Google made 85% of its money from ads:

• 96.3 billion (70.4% of total revenue) from advertising on its own sites (known as Google Properties). Google.com search engine, but also Gmail, YouTube, Google Play are all counted here.
• And only 20 billion (14.6% of total revenue) from ads placed on other sites that Google does not own (also known as Google Network Members).

Google’s market share of online ad revenue in the US was 37.1%, making it the industry’s biggest player. However, Google employs a lot of people, builds a lot of products, and its margins are significantly lower than those of their biggest rival in the advertising space.

Facebook — another winner takes it all

The social networking market is much older than Facebook. Launched in 1997, SixDegrees.com was the first website to combine user profiles, friends and messages, making it the first attempt at what we consider today to be a social network. At its height, it reached 3.5 million users and was bought by YouthStream Media Networks in 1999, which shut it down a year later.

Another major website that turned out to be a disappointment was Friendster. Launched in 2002, it reached 115 million users, but was sold in 2009 and then shut down in 2015. A great beneficiary of Friendster’s failure was MySpace, which was launched just a year later, in 2003. MySpace had an early lead in the social networking space: it had already reached a million users by the time Facebook launched in 2004. Even more, in 2006 it surpassed Google as the most visited website in the US.

But something went terribly wrong, and after being acquired by News Corp in 2005, MySpace failed to dominate the social networking space. That achievement went to Facebook, who finally surpassed MySpace in terms of US unique visitors in May 2009. Ever since, there has been no competitor for Facebook. Instagram and WhatsApp were acquired, while Snapchat’s main innovation, Snapchat Stories, were bluntly copied.

The need for a social network has always been around, from the beginning of the web. By its very nature, the social network space benefits from great network effects. Once Facebook reached a critical mass in terms of adoption, it was impossible to stop it from becoming a monopoly.

The business model

However, in order to become a great company, user count alone is not enough. Great revenue is also needed.

Probably there’s no other institution in the world that knows so much information about so many people. Naturally, this makes Facebook one of the best tools for selling ads. Information about users is served to advertisers in custom demographic buckets. Region, income group, sexual orientation, religion or political affiliation are all used for the branding goals of different advertisers.

Facebook has one of the greatest business models in the world:

• Users and companies provide the content, so there is no cost for the goods sold.
• They don’t need any marketing, everybody’s on the platform already. They never actually needed marketing, word of mouth and virality played that role.
• They built self-serve tools to allow advertisers to target audiences, so they don’t need a large sales department.

Will Facebook change its business model?

In 2018, Mark Zuckerberg testified before Congress. By most accounts, the hearing was a success, reflected in the company’s $34 billion market cap increase. The congressional representatives tried to attack Facebook, looked outraged and, at times, out of touch with technology. Mark’s answers were well rehearsed and he managed to come out on top of a difficult situation.

However, we were also able to get a glimpse into Mark Zuckerberg’s deepest thoughts. Whenever he was pressed about Facebook’s business model, he stalled, played dumb or avoided giving a straight answer.

When Anna Eshoo asked “Are you willing to change your business model in the interest of protecting individual privacy?”, Zuckerberg’s answer was “Congresswoman, we have made and are continuing to make changes to reduce the amount of data…”. After Eshoo stopped him and repeated the question, Mark replied “Congresswoman, I’m not sure what that means”.

The real answer is no, Facebook is not willing to change its business model — there’s no way users would be willing to pay for an ad-free experience the same amount of money advertisers are willing to pay for targeted ads.

Facebook’s ad revenue in 2018

The proof that Facebook will never change its business model willingly lies in the company’s financial data. Facebook’s revenue increased 38% to $55 billion from 2017, more than 7 million advertisers use Facebook’s family of services. The annualized revenue per user (ARPU) was $24.96 worldwide and a whopping $111.97 in North America, with 92% of revenue coming from mobile.

This shows Facebook would have to charge more than $100 for each user in North America to make up for a potential loss in advertising revenue — how many people would be willing to pay that much for their services?

Facebook’s market share of online ad revenue in the US was 20.6%, a well consolidated second spot. Even in the face of multiple scandals regarding misinformation, privacy leaks and censorship, advertisers continue to spend more and more on Facebook ads.

However, Facebook’s (and Google’s) dominance might be threatened by a third big player in the space.

Amazon

It might sound a bit surprising, but Amazon is now the third digital ad platform in the US. Its growth is so spectacular that 2019 is estimated to be the first year when Google and Facebook’s duopoly will shrink (as a percentage of total online ad revenue).

To be fair, Amazon’s online ads business rate of growth was artificially boosted last year by an accounting change that took place in 2018, resulting in 4 consecutive quarters with triple digits year-over-year growth rates. However, even adjusting the rates still results in amazing numbers (38%-73% y-o-y growth in 2018). In Q1 2019, Amazon’s ad business growth decelerated to only 36%, but it’s still going strong.

Amazon’s core business had traditionally been e-commerce, but the company also leads the cloud computing industry and the smart speaker category, amongst many others. Amazon has promoted products for a long time on its site, but they have increasingly focused more on the advertising segment over the past few quarters.

Amazon is winning the product search market

Reports by the market researcher Survata show that 49% of shoppers looking for specific products start their search on Amazon, as opposed to a general search query on Google. Other reports turn out even better for Amazon, placing the number even higher at 54%. We might not know the exact value, but the trend here is clear: a growing number of people start their search for a product on Amazon.

This creates a huge competitive advantage, because advertisers can exploit a captive audience within its targeted demographic. On Amazon, advertised products appear first when a customer searches for something, and then they’re only one click away from a purchase.

It seems that Amazon’s rise has affected Google the most. WPP PLC, the world’s largest ad buyer, reported that 75% of their spending on Amazon came at the expense of Google. In 2018, WPP PLC reportedly spent $300 million on Amazon ads, up 100% from 2017. It’s still a small number compared to the $3 billion the agency spent on Google, but it confirms the general trend.

Amazon’s online ads financials in 2018

Following a stellar year, Amazon’s online ad revenue topped $10 billion. About 35% of that revenue came from mobile; no surprise, considering Amazon saw the percentage of shoppers using its mobile app climb from about 50% to over 70% during the holiday season. With mobile video advertising being one of the fastest-growing segments of digital advertising, there is plenty of room for Amazon to grow their business in the future.

What makes the big three so successful

Ads have been around for thousands of years, ever since Egyptians carved public notices in stele. The first Western print ad was created in England in 1472 announcing a prayer book for sale, and the first official TV commercial ran in 1941 for Bulova clocks and watches. Historically, ads took many shapes, and with the shift brought by the internet, their diversity exploded.

However, advertisers have always been interested in a few things that remained constant throughout the years, including:

1. the size of the addressable audience;
2. the ability to target their ads.

The three giants all share traits that make them excellent at providing advertisers with the infrastructure they need:

1. Everybody is using Google/Facebook/Amazon. Users that don’t use any of these services can be treated as a negligible amount. By comparison, even the top newspapers in the US have only a few million subscribers (the most popular newspapers have an audience close to a hundred million, but the amount of time they spend reading is limited, often by paywalls).
2. Google knows what you are searching for, Facebook is familiar with your most intimate interests, and Amazon knows your purchasing history. All three have a lot of information about their users to allow advertisers to target their ads pretty precise. A generic TV commercial simply cannot compete with the internet giants.

Advertising is not (only) about selling the product anymore

In the pre-internet days, most of the advertising was carried out on radio, TV, newspapers and billboards and it was mostly about selling a product. Take for example the Marlboro Man, one of the most iconic characters of last century’s advertising. His role was to convince the audience that filtered cigarettes are not exclusively for women, but rugged cowboys smoke them too. In the end, it was all about selling those cigarettes.

Today, we often see advertising campaigns where the product is no longer the centerpiece. Instead, they are focused on community building and/or brand awareness. As audiences are refusing to sit through traditional commercials, it’s become crucial for brands to build a loyal base of users, that can do the advertising for them.

The internet is the ideal place for this kind of new age marketing. It provides a place for users to share their problems, post reviews and build communities. Blogs and social media present more trustworthy sources of information for the younger generations. And in this environment, Google and Facebook are overseeing our online activity, like Orwellian overlords ready to sell whatever interests us.

Content creators are not in the business of creating content

What makes these companies so successful is their ability to dominate the online ads market. But the growth of online ads has come at the expense of traditional advertising; and those relying on traditional advertising are now suffering.

We watch TV stations and read newspapers because we enjoy the content. But we don’t really pay for it (or at least, not enough). These businesses have traditionally relied on advertising to supplement their revenue — the better the content, the more viewers/readers, the more interest from advertisers.

However, with the rise of the internet, better content doesn’t necessarily translate into more advertising revenue; the internet giants are better suited to place ads. Ultimately, content creators know best how to create content — which makes it extremely challenging to compete in an essentially different field, the business of selling ads.

And the money that used to go in traditional advertising continues to bleed into the pockets of Google, Facebook and Amazon…