Tuesday, November 26, 2013

Social Advertising Economics

YoY ad pricing from Yahoo!'s 3Q2013 presentation
Like Facebook before them, new "social" web properties eventually have to monetize to and generate revenue. As properties seek to monetize their user base through the use of display or per-click ads, the amount of ad space being sold will increase. In economics parlance, what we would be seeing as mature high-traffic web properties seek to monetize with advertising is the advertising supply curve shift right, increasing the quantity supplied at a lower price point (ceteris paribus). Of course, one tiny website can't really move the curve, but when Facebook,  Yelp, Twitter, Tumblr, and now Instagram, are all pushing to monetize their traffic--large sites with lots of traffic and lots of growth--it matters.

What this means, in simpler terms, is that as long as the change in web/mobile traffic * the change in density of ads (ads displayed per user/visit/pageview, whatever) increases (S right) faster than the natural growth of advertising budgets * the change in share that web commands vs traditional (D right), the price of ads will fall. Judging by the double digit pageview growth rates and double digit revenue growth targets in most of these names, as well as addition of new entrants as more maturing services start monetizing, it looks a lot to me like advertising space, especially display ads, will see increasing price pressures down and, in my opinion, the market will segment into highly-targeted ads to a small sliver of the users that will command a high but shrinking premium, and the rest, which will be a margin-destroying race to the bottom. If you don't believe me, look at Yahoo!'s YoY change in ads price and ads sold and see if you can pinpoint when Facebook went public. Their price trends have deteriorated while their volume was improved, or rather their volume has improved because their prices have declined.

I think it's very likely that in the next 12 months we will find out what the price elasticity of demand for web advertising is and--particularly for display ads--I think it will be a lot more likely to surprise to the downside.

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