Online bubble is set to burst

Its been a turbulent month for traditional media stocks. Even a globally strong, market leader such as WPP has seen shares fall to a ten-year low (on the back of a leaked internal email claiming a hiring freeze), while unfashionable ITV shares are trading at less than 30p. And some of the stronger performing mid-cap groups, such as Future, YouGov and Chime, are being marked down despite strong trading results. Worst of all worlds, for sentiment, seems to be a music business just ask EMI, now being run by the somewhat ironically named Terra Firma.

Feature%203_120%20gifIt’s been a turbulent month for traditional media stocks. Even a globally strong, market leader such as WPP has seen shares fall to a ten-year low (on the back of a leaked internal email claiming a hiring freeze), while unfashionable ITV shares are trading at less than 30p. And some of the stronger performing mid-cap groups, such as Future, YouGov and Chime, are being marked down despite strong trading results. Worst of all worlds, for sentiment, seems to be a music business – just ask EMI, now being run by the somewhat ironically named Terra Firma.

The industry’s response over the past few weeks has been brutal. In TV, for example, ITV is to lay off 1,000 employees, and Channel 4 has announced plans to save £100m and drop its nascent radio business. In radio, GCap and Global Radio are to shed a further 80 staff in the merger of their sales teams; in newspapers, the Daily Mail & General Trust, News International and The Independent have all announced new sales structures, while the regional press – Johnston Press, Trinity Mirror and Midland News – all say they are planning organisational changes. Against this background, it’s no surprise that future-defining deals have either fallen through (like UBC Media Group’s sale of its commercial division) or are being pushed through shareholders on tough terms (like WPP’s acquisition of TNS).

According to the latest study by the IAB and its consultants PricewaterhouseCoopers, internet advertising is “propping up” traditional media. Thank goodness something is. “Overall, we believe online will perform better than other media during the downturn but expect to see differences in performance across the various online segments” said a PwC media director, before PwC and Enders Analysis both promptly dropped growth figures for 2008 online advertising revenues.

This to me is the real story that’s not yet been reported. What will happen online tomorrow threatens to be just as brutal as what is happening offline today.

Here’s why. On the surface it looks as if digital growth remains strong: online revenues are up 21% in the first half of 2008. But that masks two truths. First, the overall digital growth rate is in serious decline – indeed it’s about half the growth rate of a year ago. Of course, we’d all rather be growing (especially at 21%) than declining – but it’s also true that digital revenues are not immune to the downturn. If the growth rate halves again in the next few months (and all the marketing signals are that it could), then internet growth rates will struggle to make double digits.

Still, not a bad problem to have – until you unpick the sector a bit. Which leads to the second truth: more than half the overall digital market is in search and about 90% of that is Google – so one company accounts for half the total digital economy (which is growing at a faster rate than the other half). Put another way, all the other thousands of websites in the UK aggregate up to less than Google alone.

So, for Google, it’s probably just a bump in the road. Search remains the web’s killer application and while it’s arguable that a prolonged recession is bound to reduce consumer traffic and searching as purchases decline, it’s equally arguable that search – with its robust ROI – will hold up well. But, for all the other thousands of sites on the web, life’s about to get much tougher because if there is structural weakness in offline display revenues today (and there is), then the same will be true for online display revenues tomorrow.

Search has grown exponentially because it attaches ads to consumers with an intention to purchase; but display online (or anywhere else) attaches ads to content – a much less direct relationship. Put another way, search is part of the process of purchase rather than the initial persuasion to do so. Rightly or wrongly, many advertisers give undue credit to the former (because it’s much more measurable and translates directly to sales). In turn, advertisers fail to give sufficient credit to the latter because it starts rather than finishes the process.

Unfortunately, especially in a downturn, it will not be easy to nudge advertisers towards a greater respect for the contribution display makes to the initial customer persuasion – so the result will be a tough time for both the online and offline display market.

But, in the digital space, we know the number of content sites seeking advertising is growing fast (certainly at a rate many multiples higher than the current 16% revenue growth), because very few sites are cementing a subscription model. So, inventory is growing, not contracting, as it should in a downturn, meaning prices will tumble.

Too many sites chasing too little ad revenue. Haven’t we been here before? When sites that have users but no revenue next go to the bank for an extension of their funding, we’ll see a second digital bust. It’s not as if the banks have any money to lend to businesses without revenues.

But, this time around, one thing’s for sure: you’ll still be able to search on Google for an updated ranking of the winners and losers.

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