Dude, Where’s My Ad?

Last week, after ignoring the world’s financial problems for almost a year, Silicon Valley woke up to find itself caught in the death grip of the credit crunch. Declining stock markets only added to the overall gloom. And when one of its own — Sequoia Capital, among the smartest and most rational investors in the world — told its portfolio companies to cinch their belts tighter than ever, all hell broke loose.

Those of us in the Valley are now reassessing our bullishness and trying to quickly figure out which sectors are going to get hit the hardest. The consensus that is fast emerging? Advertising.

And yes, that does include online advertising — even if it is likely to recover first. Regardless of the timeline involved, the destruction that will follow is going to be on a massive scale, as it will take down any number of poorly funded startups whose fortunes depend on those ad dollars.

In a sobering and harsh analysis sent to his clients, UBS analyst Ben Schachter said online advertising network ValueClick (s vclk) would be among those negatively affected. Using that as a proxy for the “advertising network” business, it’s safe to assume that dozens of advertising networks that have cropped up over the past two years will be impacted.

The economic problems are much wider and deeper than most people realize. The sub-prime mortgage industry lit a fire not only under the housing market but under consumer spending as well. All that spending led to big-time advertising on the part of consumer companies and, as those revenues worked their way across the entire technology food chain, healthy ad spending spread to even decidedly non-consumer areas.

The boom was particularly evident on the web, where it helped to spawn a whole slew of ad-supported ventures such as social networks, video sites and other web services. Now, however, we are moving in the opposite direction. Consumer spending is starting to fall, and the long-term prognosis isn’t pretty.

As Schachter wrote, “[W]e see no business model based on advertising or consumer spending that will be immune to a downturn. Specifically for the advertising names, as corporate profit forecasts come down, we expect planned advertising spending will be delayed and/or cut.”

The problem isn’t limited to smaller players. Yahoo, for example, which is heavily dependent on display advertising from the financial and automobile sectors, is very vulnerable and might soon face a day of reckoning. Viacom slashed its full-year earnings forecast Friday afternoon, citing the softening ad market. The only ad-related company that looks like something of a safe place amidst this chaos is Google, thanks largely to its performance-based advertising system, which allows advertisers to only pay for what brings them returns.

For the rest of us, the era of sleepless nights has begun.

This article also appeared on Businessweek.com.