A Paradoxal Business Model Called Online Advertising

Yesterday I gave some excellent tips on how (not) to pitch your startup, good stuff! One of my points was it’s better to say that you haven’t quite figured out your business model instead of saying advertising is your business model. Internet addict Okto, better known as @labanux, asked me why. Why is online advertising as a sole business model so bad? Google, Facebook, Twitter, Kaskus, Detik and many many others run on online advertising so is it really that bad a business model?

Ever been to a restaurant where one waiter welcomes you and another waiter tells you the neighbors have great Japanese food? Ever been to a boutique where, before you bought anything, the sales person tells you two blocks down you can get 20% discount on an iPad? Well, chances are slim that this happened to you in a brick and mortar store but it happens online. Entrepreneurs on one hand do their utmost best to get more people to visit their site or use their app to then show them the way out with a banner or ad. Though this is a black and white interpretation of something that has more shades, it’s basically the paradox of using online advertising as your business model.

For Google this is not a problem at all, this is actually exactly what Google is build for, pointing out where people can find what they look for. Getting paid for exactly that is great and as long as ads are relevant users don’t mind as well. So search engines in general are perfect for integrating online advertising as long as it connects to what the visitor is looking for. Obviously Google has after years perfected this model and is the undisputed king in online advertising.

Twitter I think is a bad example. I see promoted tweets, promoted accounts and promoted trends totally different from the usual advertising. With these promotional services people stay on-site and basically they get paid for connecting people or read tweets. Pretty much perfect but it still has to be proven to be a sustainable profitable business model.

For sites where one of the goals is to let visitors engage in the service showing ads accomplishes exactly the opposite. Now if your a media portal like Yahoo or Detik things are slightly more nuanced. Both offer news or any other kind of content to attract visitors which they then aim to monetize through showing ads and banners. There’s not much of an engagement requested from users, same goes for sites like Flickr, Youtube and other content sharing sites.

Surely one can make some money on advertising but to make advertising your business model you will need a critical mass. You need a true shitload of visitors to be able to make some serious money which is enough to build a profitable company. You will even need much more when you’re operating in an emerging market where CPM/CPC’s and fill rates are mostly much lower.

A quick calculation which is pretty accurate for the Indonesian market where the website is only in the Indonesian language:

CTR: 0.1% (average click-through-rate)
RPC: $ 0.03 (revenues per click)

These KPI’s show you need 1000 pageviews to make a mind blowing $0.03 so in order to make $100.000 you need more than 3 BILLION pageviews. And let’s be honost, if you have 3 billion for sure you’re operating cost will be much higher than a measly $100.000.

So how do they do it? Why do companies like Yahoo and Detik make lots of money on advertising? Well, once you have a critical mass and you’re in the top of the hierarchy the advertising game changes. If you play your cards right, like Detik certainly did, you will attract A-brands who are willing to pay much more. Your ad space becomes prestigious, recognized and wanted by many marketing managers who want to make sure their over-seas Japanese CEO sees how good a job he’s doing.

So in effect, instead of earning $0.03 per click, companies like Yahoo and Detik earn $0.75-$1 per click. I’m using the words “in effect” because these companies mostly use a CPM or sometimes even time based price models which makes them more independent of the quality of the message and product their advertisers offer.

Facebook is now “re-wrapping” and pimping their market place ads giving it a golden shine and trying to sell it for 8-times the price you pay on the market place. However, in my opinion Facebook has made the mistake of basically let everyone advertise any kind of product. Result is that it’s not an “exclusive” destination for the A-brands advertisers who are willing to pay the big bucks. So these A-brands seem to shy away from Facebook and prefer portals like Yahoo or f.i. the reputable online newspapers where it’s just more sexy and exclusive to advertise.

Though every entrepreneur will be extremely optimistic about the growth projection of their startup, some realism would be in place too. Chances of your site becoming the next Yahoo or Kaskus are pretty slim and why should it? I see some companies in Indonesia no one in the “scene” talks about because they’re not big in terms of visits and don’t care about the attention. But I can share they make a truly impressive amount of money because they’re actually selling products and services and are successful at it.

And then there’s the issue of “over-monetizing”. Don’t get me wrong, I love Detik and the team. But let’s be honest, in my opinion the number of banners on their sites is just over the top to a point where it starts to become a serious annoyance for their visitors. Unfortunately for Detik they don’t have a monopoly so companies like Vivanews and Inilah are catching up because they offer a more clean site and more pleasant user experience. So even if you have the critical mass needed you need to be extremely careful and find the right modus and balance.

So Okto is right in a way that there are plenty of companies who are making money solely based on an advertising business model. But investors shy away from it mostly because of the reasons as described above. Nothing wrong with earning some extra money from advertising. However, if you’re app or service is that good you should be able to monetize it in another way which will be much more profitable and sustainable without showing your users the way out.

UPDATE: Read @treespotter’s post on Dailysocial about this topic.