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Summary:

The news coming out of advertising-focused companies is not good. And that means Silicon Valley is in for a long-overdue reality check, one that should worry one and all. Continue Reading

Updated at the bottom: We have short memories in Silicon Valley, which is both a blessing and a curse. We forget the bad times as quickly as we forget the good times.

At the turn of the century, everything went to hell with the dot-com bust. Then the pendulum started to swing the other way; the pessimism that once reigned supreme was being replaced by wild-eyed optimism. Now Silicon Valley is in for a long-overdue reality check, one that should worry one and all. Why? Because the news coming out of advertising-focused companies is not good.

Yesterday ValueClick, a display advertising network, said it now expects its second-quarter revenues to range from $162 million to $164 million, lower than the previously forecasted $170 million. The company also cut its full-year 2008 sales guidance by about 10 percent, to between $655 million and $675 million. It blamed weakness in its display and comparison advertising business, and flatness even in its lead-generation business.

Time Warner’s Platform-A advertising division isn’t doing so well either, according to some of my sources. The company is instituting wide-scale belt-tightening measures, including freezing travel budgets. Pali Capital in a blog post today forecast, “AOL’s display advertising revenues down about 8% in Q2 (Q1 ‘08 was down about 10% organically), with the back-half down mid-single digits.”

Microsoft, in its fourth-quarter 2008 earnings call today, also admitted that online advertising was tough. “The one proviso to that is in the online advertising space…it was weak in the fourth quarter. There is a direct impact and we’re not immune in the online space, ” Microsoft CFO Chris Liddel said in a conference call with analysts. “The online advertising area is part of the business that we think is most challenging…the online advertising area is very difficult at the moment.”

And if that wasn’t enough, Google just announced spectacular growth in its second-quarter revenues — about 39 percent over the same period lat year — but fell short of Wall Street’s profit expectations. Between The Lines blog notes that Google CEO Eric Schmidt, in his company’s conference call with investors, said they would survive the downturn because there will be a flight to quality, and that they will provide a better return on investment. Maybe! Larry Dignan hit the nail on the head when he wrote:

“Color me skeptical. Anyone that lived through the dot-com bust has heard these lines before and no company is immune if there’s a recession.”

Like him, the skeptical me went straight to the traffic acquisition costs (TAC), which is where I think the real story lies. If you look at the image below you’ll see that Google’s traffic acquisition costs have declined rapidly while its revenues have ballooned. TAC in general and AdSense specifically are like a black box – no one quite knows how much Google gives out. Sometimes it feels like Google can use this “black box” to come up with pretty much any numbers it wants to.

We’ll get a better sense of the overall health of the market when Yahoo reports its latest numbers, but the way I see it, things are sort of troubling. We wrote about this nagging problem back in May. I think that as we go forward things are only going to get worse — and even Silicon Valley can’t ignore what’s been going on in the overall economy.

The housing crisis is being replaced by a much scarier problem: the personal credit crunch. In a recent report, American Express noted that it has started to see a sharp increase in late card payments. Now folks, this is American Express, whose customers skew towards the affluent, especially compared to those of its competitors. The company has boosted loss provisions for its U.S. card business, profits have declined, and defaults are up.

Will these problems escalate? Probably. Consumers struggling with the housing crisis and rising fuel costs — and thus higher basic living expenses — will be forced to cut back on other spending, which will lead to slower sales and in turn, less money for advertising.

We know the housing and financial sector-related ads have already declined drastically, now we’re going to start to see other sectors cut back on advertising, too — and that is going to have a negative impact on everyone from large social networks to ad networks to Yahoo and Google to small startups, including weblogs like ours. I guess Provigil sales are going to take a nosedive in the Valley as we stay up all night worrying about everything.

Update: And there’s more bad news today. The Wall Street Journal reports that General Motors is going to sharply cut back on advertising. GM is one of the big spenders in U.S. — last year the company spent about 32 percent of its $2.3 billion dollar ad budget on newspapers and 11 percent on television networks — but it looks like those expenditures are going to get hacked. It’s not clear from the report how this move will impact Internet advertising.

Photo courtesy of ZDNet

  1. Given that the web is becoming more and more social everyday, and not a single social network is profitable from advertising – this added news of TAC increase, and ad spend reduction is definitely looking a major correction to me.

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  2. Silicon Valley revenues will definitely be affected by the recession…its pretty much guaranteed. However, we have to be careful not to equate this to the dot-com bust as this is apples and oranges. In 2000 you had a massive slate-cleaning as the market “revalued” a whole slew of companies. Nowadays, there is more maturity in the sector but it will be interesting to see how it handles the recession. I doubt there will be many sites that prove to be “immune”…even Google. After all, when consumers are not in “commerce mode”, they don’t click on the ads!
    Let’s break it down:

    Commerce Sites (Amazon,etc.): guaranteed drop as consumers shop less plus rising shipping costs will affect value proposition.

    Search Engines : less clicking on ads since consumers are not in “commerce mode”

    Social Networks: they’re not terribly profitable even now. CPM rates will drop as advertisers see lower click-thru-rates on display ads. This will offset rises in page views

    Subscription services (salesforce, etc.): may see less volatility than advertiser-driven models but certainly won’t grow…they just may not drop as hard.

    The one exception are sites that benefit from recessions and penny-pinching consumers. Sites like fatwallet.com and others come to mind. Sadly, I suspect there will be some scam sites that flourish in these unfortunate times.

    Hopefully, this will be a brief recession but with the number of market forces at play right now, I won’t be making any bets one way or another.

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  3. [...] could not get historical data, but ZDNet took care of that, and Om Malik was kind enough to point it [...]

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  4. SV shouldn’t be any more worried than the rest of the country/world. Sad to say, that’s pretty worried.

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  5. I’m actually looking forward to a cleaning of Silicon Alley & Valley. I think it’s healthy.

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  6. [...] Malik posted on Why Silicon Valley Should be Worried which you should certainly check out.  Upon Google’s Q2 announcement today, the stock [...]

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  7. [...] Gigaom Share and Enjoy: These icons link to social bookmarking sites where readers can share and [...]

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  8. Good post Om, though the right online Ad platforms should win in a downturn, as advertisers will look to move their ad spend to more efficient places. In theory the web should take more of the ad slice in a downturn, even as the overall pie gets smaller.

    The Goog result is just expectations being set too high. If we reset to normal mode things would be good.

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  9. Oh and IBM and MSFT kicked ass today, despite the economy

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  10. [...] Om Malik says its a sign Silicon Valley should be worried.  Indeed, an awful lot of the Valley’s economy is associated with ad revenue in some form or fashion.  But there are vital other areas.  SaaS businesses, for example, seem to be doing pretty well from what I gather asking around.  They’re raising money quite successfully and the smaller SaaS players are growing like weeds. [...]

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