This is because the model is not mature and there is significant subsidy built into the system. Subsidies don’t last for ever. At some point NYT and WSJ will charge for content production when they cannot monetize using their own captive distribution mechanisms.

The ground rules of economics of hyperlinks will evolve and the costs of GigaOM type aggregators will eventually increase , increasing the net-distribution costs also(i.e if you view GigaOM as a distribution channel)

Look at it from the perspective of the sites offering a supply of space to the advertisers…as price goes down, demand goes up!

Because there is a limited supply of desirable websites with a limited number of ‘premium’ advertising spots. If you are a car company and want to advertise to potential buyers, you will pay to have your ad inserted into a site that fits your target demographic. Websites that fit this bill only have so much advertising space (especially premium space) – so you pay up to advertise on these sites.

It is the same reason that you would pay a lot of money for an adsense ad targetting ‘New York Dentist’ if you were a new york dentist and you have a number of competitors bidding for those keywords as well – you want the face time with the potential clients instead of others.

I am talking about premium advertising, the cost for non-premium non-targeted advertising might decrease as the number of websites will continually increase, creating a never ending supply of space.

No matter the sprawl of the web, there will always be more demand than supply for targeted advertising that reaches the right people. In fact, as ways to link ad views with RL purchases improves, CPM and CPA rates will increase even further.

Great article btw.

Dramatic improvements in measuring the efficacy of brand advertising are certainly possible. In a sense, improvements are already happening through behavioral targeting and the like. But the real breakthrough will likely come from some brilliant [human] insight that has yet to be made. That’s a problem worth solving….

As I noted in the post, there are objectives other than immediate purchase that have real value (delayed purchase, increased willingness to pay, etc). The issue is that until these are measurable, it’s very difficult to understand the true ROI of brand marketing. And until that happens, direct the way to go.

Great article Mike! Although I don’t really understand economics in depth, do you think that the above will happen anytime soon. In fact, is the above even possible from a freakonomic point of view. Won’t the people in marketing try to stay away from doing this kind of research. In which case, the impact of online advertising will always be somewhat fuzzy, and the prices will remain adhoc or driven by a few.

First of all, on your graph, the supply curve goes down. That means the slope is negative, per definition.

Second, you say they will end up lowering their CPMs until it’s 0, but really you’re ignoring the value that the ad brings. I mean, this value may be hard to measure, but it’s still very real. It’s definitely above 0. This means that the equilibrium in perfect competition will not be 0, but above that.

Perfect competition theory says that you cannot make profits in the long run. Marginal benefit=marginal costs. But this does not have to mean that it ends up being zero! It merely means that you will be paying exactly what you will get in return. You will be paying an amount above 0, because the value of the ad is more than 0..

Thanks for the responses…you started a great conversation even if we’re all focusing on the details rather than the big picture. :)

I actually did read that Wiki and if you notice, it talks about the change in FC and VC over the change in quantity. Fixed costs by their very definition are not going to change from unit to unit so you’re talking about the change in variable costs per unit which would be the variable cost of the unit. Splitting hairs because I know you can argue that “variable cost” is usually rolled up over the entire production but still.

Back to the main gist of your post, again, I might be splitting hairs but like I said before, you’re never going to NOT have a variable or marginal cost that is greater than absolute zero. Sure, it’ll end up being 0.0001% of a penny at some point but it’s still a cost due to electricity and bandwidth costs.

Electricity isn’t getting cheaper and though Intel and other technology companies have sort of veered towards low heat/more energy efficient products there will always need to be an electrical source pumping electrons into that equipment.

Bandwidth has been getting a bit cheaper but we still run into roadblocks (whether it’s dark fiber or the geographical disparities of Internet reach). Again, like electricity, newer technologies that are expanding our ability to connect to the net from wherever, including GigaOm favorites like LTE and WiFi-Max. However, these still will have to run the gamut of Moore’s law-like efficiencies to bring costs down so that they are negligible.

And, while you want to ignore marketing and production costs (I understand, we’re talking about consumer Web production which is really “free” but I’ll get to that), you can’t really. At least not completely. The reason Facebook and Twitter are whether they are (on everyone’s radar and “producing” so much content is because of the network effects that have finally reached a critical mass. If you looked at either three or four years ago, people were barely using them. How do you value that? You can argue fixed costs there which is why I’m not saying you HAVE to include any sort of marketing/sales budgets or whatnot into your calculations.

I feel, though, you still have to either find a cost that makes sense or at least asterisk the line item because outside of determining the advertising price/rate for an existing business, this sort of analysis would be what you’d need for a business looking to dip their toe into social applications like Facebook or Twitter (or to quote Dennis Leary: “Facyspacies and your TweetyPages”). The cost of a new business trying to achieve that critical mass in a shorter time frame than the existing players did would add (potentially) to the variable and marginal costs.

Again, splitting hairs. Overall, you’re on the right track when it comes to the low cost of content acquisition for an existing enterprise and I am surprised that advertising costs haven’t become a commodity in the Websphere. Obviously, there’s still some perceived value in the sites that have the most eyeballs that is in complete opposition to what you’d expect in the “real world” model of supply and demand. I don’t know if you can really escape that when it comes to virtual commerce.

Look at virtual goods (I’m talking microtransaction virtual goods, not gold farming and other labor intensive virtual goods). They have the same thing going for them. Outside of bandwidth to download and electricity to run the sites where you download them (or transfer them), their production costs are fixed (you build the item once and distribute many). Still, they can be priced pretty high considering the negligible cost to manufature them.

Always great to participate in a stimulating conversation. :)

kn

Since we’re talking about marginal cost of the entire industry the thing that would drive “marginal” costs up would be scarcity of some asset. If there is no scarcity, then the curve is basically horizontal. Or, if we overlay time as well and marginal cost decreases with respect to time, then the curve might even decrease.

So, it’s clear to me that over *time*, the marginal cost of production of online content and services is going down. This is a result of Moore’s law in CPU and storage, open source software, cumulative knowledge in the engineering community about how to build these services, off-shoring, and so on.

The question is on the scarcity bit — my basic argument implies (1) that we’re far away from having to steal time from one service in order to grow a new service, and (2) that buying content or eyeballs to achieve #1 isn’t a viable strategy.

Many folks here are arguing against both of the scarcity assumptions. I’ll think about it some more and appreciate your comment.

To summarize the criticisms and my responses here, before I power down:

+ My argument assumes that there are good substitutes. If there aren’t good substitutes and people really want the content, you can charge for it. But that’s rarely the case — if it were, everyone would be paying for content.

+ My argument ignores the growing marginal cost of content production. I think this criticism is rooted in old line media thinking. Twitter’s content grows as its content grows. How do their costs of content acquisition grow over time? Google’s? Facebook’s? This is true for mainline media if you are paying reporters — even there, bloggers are keeping a cap on the cost of production…

+ My argument ignores the growing marginal cost of marketing. Same fundamental argument as above. What are Twitter’s marketing costs? Facebook’s? Eventually there is truth to thus, but to be safe I included ALL fixed costs in my analysis (marketing, content, G&A).

+ My argument assumes that we are far away from having to trade attention between online services. This is the fundamental macro flaw in the argument, according to Professor Eisenmann — that’s a fair argument. I will think about that one some more. It’s clear that the delta between this for consumers and advertisers is so far apart that it’s not an issue yet, but I can certainly see how looking at the long-term that this is a fundamental limitation…

Thanks for all the great feedback.