Reversing the digital slide

The online media sector is in disarray. In the wake of failed revenue models and the Nasdaq crash, powerful incumbents such as Disney, Dow Jones and NBC have been struggling along with companies such as TheStreet.com and Salon.com to generate investment returns.

New investments are being curtailed, and the temptation to abandon the Internet is great.

The lesson to be drawn is that offline business models--founded mainly on interruption-based advertising and subscriptions--don?t work for incumbent media companies in the online world. Online audiences largely ignore advertising and rarely pay subscriptions because a free substitute is usually only a click away. So what are incumbents to do?

They should be patient. All new media models take time to achieve success. Meanwhile, they should look carefully at their properties and sustain, even reinvent, those that will respond best to promising new business models. Eventually--in a broadband world--traditional interruption-based advertising might bring better rewards.

More promising in the near term, though, is an emerging advertising model known as contextual advertising, which targets the consumer who plans to make a particular purchase and is thus more likely to be responsive. Not all media companies have the kind of specific content that lends itself to such advertising, however, and those that don?t must look to other marketing and cross-selling opportunities to increase their revenue.

Remember, too, that incumbents are in a better position than their pure-play competitors to absorb short-term losses in hopes of finding a long-term audience. Indeed, we expect 95 percent of pure-play online media companies to fail within the next two years.

The old model teeters
Advertisers know that interruption-based banner ads offer poor value; hence the media companies? low revenues online. The fact is that online and offline economics are different.

Uncompetitive pricing and a lack of innovation haven?t helped. Too quickly, banner advertisements became the standard online format, and click-through rates--the proportion of site visitors who click on an ad to reach an advertiser?s Web site--became the principal, though unsatisfactory, measurement. Even by that benchmark, banner ads have show to be ineffective. Click-through rates have dropped by more than half to less than 1 in 200, from more than 2 percent--and the decline continues.

The result is that under many pricing schedules, the cost to an advertiser of one online contact from a content site is greater than the cost of the offline alternatives.

Most big advertisers, then, largely ignore the Web. Last year, the top ten Fortune 500 companies accounted for only 2 percent of total advertising on it. About three-quarters of the almost $6 billion spent on Web advertising went to the ten sites that had the highest traffic, with a little more than half going to the top three portals: Yahoo, AOL and Microsoft's MSN.

Faced with such economics, even sites that deliver plenty of traffic can?t attract the revenue needed to cover their fixed costs. At current visitor rates, a typical pure-play content site makes $1 to $2 per user each month, compared with total costs of about $2 to $3 per user. Such a site would have to attract about ten million unique visitors a month to break even. Although incumbents can spread their costs among sites or across online and offline properties, the traffic volume they need is still higher than expected.

Get relevant
Offline, media companies create and package content, gather an audience around it, and then interrupt the audience with paid commercial messages. The advertising message isn?t necessarily related to the content--a car commercial during a televised football game, for example, or a cruise ad in a magazine--though some general demographic targeting is possible.

This model works because the content generally captures the readers? or viewers? interest and can?t be substituted immediately. Online, however, users take a more active role and are much less tolerant of interruptions. As a result, research shows, most Web users simply ignore ads.

It isn?t clear whether any kind of interruption advertising will work in the long term, though broadband technology will probably allow some media companies to deliver content that captures the attention of audiences for specific periods. Streaming video is the likeliest winner; examples could include live Webcasts of concerts, out-of-town sporting events, or exclusive fashion shows. Since these would be viewed in real time rather than downloaded for later viewing, the audience couldn?t click to a substitute, and since the content would be unique, there might be greater tolerance of advertisements shown before the Webcast or during breaks in the action. Like television commercials, such ads could also be more emotionally compelling to the audience.

The key to making advertising relevant lies in contextual marketing. This model works offline in trade and special-interest magazines, where reading the ads is part of the experience. Advertisements in a computer-gaming magazine, for instance, offer information that is related to the editorial content. Readers of such publications know the difference between the ads and the reviews, of course, but are more willing, in this context, to accept ads as relevant information, not just as interruptions. Advertisers therefore gain a more limited but also a more targeted audience.

Contextual advertising is particularly suited to Web sites. The Internet is an immensely rich contextual medium, awash with people searching for information to help them make immediate purchases. In this environment, advertising can be tailored to the context in which it is displayed.

However, media companies that choose contextual advertising--and those capable of doing so include the personal finance area of Yahoo and MSN?s CarPoint--must strike a delicate balance to succeed: They have to be seen as providing neutral advice accompanied by paid messages rather than as relentlessly pushing their advertisers? products.