The Economics Of The Online Advertising Industry

Online advertising has grown rapidly in the last decade. It now accounts for almost a seventh of all advertising spending and contributes to the preponderance of revenues for most websites. It is projected to increase sharply as more consumers spend time online on their personal computers and as additional devices such as mobile phones and televisions are connected to the web. This article describes the market structure of the online advertising industry and several complex economic aspects of it. Using the lens of the new economics of multi-sided platforms it examines search-based advertising platforms, as well as platforms that facilitate the buying and selling of advertising space on websites. The unique features of online advertising include the use of Internet-based technologies and data collection mechanisms to target and track specific individuals, and to automate the buying and selling of advertising inventory. Like modern finance, online advertising relies heavily on advanced economic and statistical methods.

1. INTRODUCTION

Online advertising began in 1994 when HotWire sold the first banner ads to several advertisers.1 Revenue in the United States grew to an estimated $7.1 billion in 2001 or about 3.1 percent of overall advertising spending. The dot-com bust destroyed or weakened many of the early online advertising industry players and reduced the demand for online advertising and related services.

The industry regained momentum by 2004 as the business model for "Web 2.0" came together.2 A number of businesses emerged that facilitated the buying and selling of advertising space on web pages.3 Entities that operated web portals settled on the traditional "free-tv" model: generate traffic by giving away the content and sell that traffic to advertisers. Most web sites, with the exception of transaction ones such as eBay, generate the preponderance of their revenues from the sale of advertising inventorythe eyeballs that view space allocated for promotionsto advertisers.4 In the first half of 2007 alone, advertisers in the US spent more than $10 billion advertising on websites.5 That was about 14 percent of all advertising spending.

The portion of advertising that is done online will increase significantly over time as more devices such as mobile telephones and televisions are connected to the Internet and people spend more time on these devices. The valuations that the capital markets are placing on businesses related to online...