The Online Advertising Quandry

Jason Calacanis, a good friend of ours, is doing the cartwheels over the third quarter (2006) online advertising data released by the Interactive Advertising Bureau. (I say cartwheels because, a few months ago, he was the most vocal critic of my story for Business 2.0, about the return of the Eyeballs.)

Why bring it up? Because online advertising is driven by eyeballs, which then leads to people acting on them as in the case of Google ads, or display-style advertising. The $4.2 billion is impressive — and not a surprise. Jason is proclaiming that this boom will continue for another 20 years, and it will keep going up and up. He says, the real story of Web 2.0 is advertising 2.0. He is right, and wrong.

He is right because as online video becomes more popular, the advertising dollars are going to shift to this nascent medium. Those dollars will qualify as Internet advertising, of course. He is wrong, because he is conveniently overlooking the fact that the sequential growth in advertising was essentially flat. “Online advertising will be a useful marketing tool, but no trend goes in a straight line for twenty years,” writes Carl Howe, in his excellent analysis.

Calacanis overlooks the fact that a disproportionate portion of the online advertising dollars is flying into the pockets of a handful of companies. A back of the envelope calculation shows that in the third quarter Yahoo and Google accounted for $2 billion (give or take a few million dollars) in total dollars spent on online advertising in the third quarter 2006. (This is after traffic acquisition costs, and factoring in their international contribution to their total revenues.)

Rest of the money – about $2.2 billion – is being shared by hundreds of web properties – everyone from big media owned properties to little tiny blogs like ours shared that pot of gold. Unless you are AOL, Facebook or MySpace, those advertising dollars don’t add up to all that much.

These big numbers are also creating a false sense of security for start-ups, and the venture capitalist community that is so willing to invest big money in utterly forgettable wiki sites.

Just for kicks, in the third quarter about $455 million was invested in Web 2.0 companies. That’s about $4.70 ad-dollars per VC dollar invested in these companies.