October 18, 2010 – It’s Not Just Advertising … It’s New and Improved Advertising!

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Advertising is a $200B+ market in the US.  On-line accounts for less than 10% of total ad spend today, but the migration of video onto the internet and the proliferation of tablets and smartphones will make the $60B of annual ad spending currently directed to channelized TV, the $47B captured by print publishers, and the $50B+ direct marketing market addressable by web-based platforms.  While traditional media has taken solace in the modest progress of the shift of advertising to the internet to date, we believe that a confluence of innovations – e.g. portable platforms, wireless broadband, social networking, media streaming, content delivery networks (CDN), etc. – will accelerate the adoption of on-line advertising over the next few years

Spending on internet advertising has been growing at a 10% CAGR over the past four years, but it remains a third the size of television advertising and less than half the size of print.  However, a lackluster 2009, particularly relative to TV which performed nearly as well, has fueled concerns that the pace of transition will be measured.  While the limits of current generation Internet advertising models – e.g. traditional paid search, sponsorship and on-line classified – may be conceivable, new models are emerging – e.g. mobile search, digital video, location specific advertising, etc. – that will be the impetus for the next phase of growth

At the same time, emerging technology is radically improving the ability to target and reach consumers on-line.  Smartphones and tablets greatly expand the number of opportunities to reach consumers, with the added benefit of knowing their precise location.  Upgraded 3G and 4G networks can deliver much richer media to these platforms, while content delivery networks accelerate response time and enhance the performance of streaming media.  Social networking expands on the superior “targetability” of on-line ads, and the potential of raising impact through trusted recommendations.  CDNs are enabling big improvements in the experience of streaming video just as Internet signal is starting to reach living room TVs.  These technology transitions are still in their early stages and their effect on advertising is largely still in the future

The rise of Internet advertising has been largely at the expense of print.  Newspaper advertising has plummeted, declining at a 21.6% CAGR since 2006, with classified ads the biggest casualty of the Internet assault.  Magazine advertising has also suffered disproportionately, down 18% in 2009, vs. the 12.7% drop in overall measured ad spending.  Looking at historical cost per million impressions for both suggests that advertising is reactive, lagging rather than anticipating industry change .  As such, the rise of tablets and smartphones as e-readers portends further cannibalization of print advertising in the future

In contrast, television advertising has been more robust, dropping just 7.5% yoy in 2009, with cable networks holding almost steady despite the weak economy.  Total television viewing has been trending upward for several years, likely driven by the penetration of DVRs and the increasing numbers of TVs in the average household, which could also yield an increase in “ambient” TV usage.  This growth, undeterred by simultaneous increases in on-line video viewing, has yielded the robust ad spending and skepticism by many observers as to the longer term threat of Internet TV

However, to date, Internet video has been limited to PCs, inconvenient, small screen alternatives to cable TV on the living room wide screen.  This is changing.  New TVs are offering direct WiFi connections, a panoply of internet connected TV peripherals – e.g. game consoles, Apple and Google TV, etc. – are coming to market, and proposed FCC regulations could require cable operators to open the set-top-box market in a meaningful way.  Tablets are also emerging as viable personal viewing platforms.  At the same time, the quality and quantity of programming available on the web has been expanding dramatically.  We believe that this an exodus of eyeballs from channelized entertainment to on-line video has begun, and that advertisers will surely follow, enticed by the growing audience, interactivity, far more precise targeting, and opt-in viewer choice.  Thus, a virtuous cycle accelerates, attracting more content, more viewers, and more advertisers in turn

We believe that Internet TV, mobile search, location-based advertising, social network driven ads, interactive/rich media advertising, and other new approaches will eventually draw the majority of the 90% of the advertising market that remains off-line.  The shift continues to lag the internet’s share of daily consumer activity, even considering Google’s strong recent results, but should accelerate with the rapid adoption of new, disruptive innovations.  This multi-fold increase in the market addressable by web-based advertising will accrue enormous benefit to companies able to establish leadership in these new approaches.  We believe the companies best positioned to do this are Google, Apple and Amazon, although several others – such as Microsoft, Yahoo!, Netflix, etc. – have credible plays at leadership as well.  While all of the traditional media companies – e.g. Disney, News Corp, Time Warner, Viacom, Comcast, etc. – will vie to transition leadership into the new domain, we believe their incumbency makes them fundamentally disadvantaged in managing the transition

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