Is it just Yahoo or is there an ad glut?

by Mathew on October 19, 2006

This is a column I wrote that ran in the Technology section of the Globe on Thursday, and on globetechnology.com

The exclamation mark in their company’s name must really bug people at Yahoo! sometimes — like when the CEO announces that Yahoo’s profit fell almost 40 per cent in the most recent quarter, as he did Tuesday. That’s not exactly something to get excited about (unless you sold the stock short six months ago, of course, in which case you’d have every reason to celebrate).

Why is Yahoo doing so poorly? The company says on-line advertising growth is slowing, and that profit margins on those ads are also slipping. That isn’t just bad news for Yahoo and its shareholders, it’s potentially bad news for all sorts of people, including those who work at other on-line advertising-dependent companies (such as Google and MSN), and those who own shares in such companies.

Just a few years ago, people were debating whether on-line advertising would ever take off and become a real force in the market. Take off it did, thanks in large part to Google. Unfortunately, however, it became such a hot property that everyone jumped into it with both feet, counting on continued growth in on-line ad spending to provide them with a business model.

There are signs emerging — and Yahoo’s announcement is one of them — that this may have caused an on-line ad glut, exacerbated by a slowdown in spending on the part of financially strapped car makers and other prominent ad buyers. That in turn has had a fairly predictable effect on prices. All of which is great if you’re buying ads, but not so great if you’re selling them.

MySpace, the social-networking site owned by News Corp., and video-sharing site YouTube — which Google recently bought for $1.6-billion (U.S.) — are only two of the most prominent examples of companies whose entire business model relies on on-line ads. AOL recently dropped its membership fees and made all its content free, supported by advertising.

Yahoo CEO Terry Semel blamed this glut of ads for increased price competition and thinner margins. And the story could be getting worse: A report from Blackfriars Communications estimates that on-line ad spending by U.S. businesses will come in at 7 per cent of overall corporate spending this year, down from initial estimates of 10 per cent.

Is Yahoo’s weak performance a sign of a broad decline in on-line ad profits and revenues, or just a case of Yahoo losing ground to competitors like Google? Many analysts will be poring over Google’s quarterly results Thursday, looking for an answer to that question. There is little doubt that Google continues to take market share: A recent report from consulting group eMarketer said Google could wind up with as much as 25 per cent of the entire on-line ad market this year. Last year, Both Google and Yahoo each had market shares of about 20 per cent.

According to the report, Google’s on-line ad revenue is expected to hit $4-billion for 2006, up by 65 per cent from 2005. Yahoo, by contrast, is expected to see only 17.5-per-cent growth and revenue of $2.9-billion. Last year, ad revenue at the two companies was almost neck-and-neck at $2.4-billion.

The consulting firm says on-line ad spending continues to grow at fairly impressive rates, but that those rates are likely to slow over the next couple of years, from 30 per cent last year to about 26 per cent this year, and as low as 15 per cent in 2007. Major advertisers are expected to continue to move their ad spending on-line, but not as rapidly as they have been over the past year or so.

The amount that companies are having to spend is also declining in part because oversupply is pushing prices down, and that means advertisers can get a lot more on-line bang for their buck. MySpace, for example, reportedly has a CPM (cost per thousand) as low as 10 cents, compared with anywhere from $4 to as much as $50 for a major property like Yahoo.

Sites such as MySpace, YouTube and Facebook are also growing much faster than Yahoo — by some estimates, the number of visitors to MySpace is actually larger than the number that visit Yahoo properties. That gives Yahoo even less leverage to raise prices for on-line ads, or keep from having to cut them. And there are a host of smaller Internet companies that are just as willing to undercut the big Web players on price.

The bottom line is that while on-line advertising is growing, so is the number of players offering websites and web pages to host those ads. When the latter outstrips the former, it’s not just companies like Yahoo that get hurt, but any company that relies on ads for a major proportion of its revenue — and that includes Google, which still gets about 90 per cent of its income from on-line advertising.

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