A new age of advertising nirvana is too optimistic

The total market value of a basket of a dozen firms that depend on ad revenue, or are devising their strategies around a growing online ad market which has risen by 126% to $2.1trn over the past five years. The part of the economy that is ad-centric has become systemically important, with a market value that is larger than the banking industry.

Data suggests that stock prices that advertising revenues will rise from 1% of GDP today, to as much as 1.8% of GDP by 2027—a massive jump.  But this isn’t realistic.

There are two logical limits why projections are way off base.

First, the irritation factor, or how much consumers can absorb without being put off. In the analogue era the rule of thumb was that ads could comprise no more than 33-50% of TV or radio programming, or of a magazine’s pages, says Rishad Tobaccowala, of Publicis, an advertising firm. [inlinetweet prefix=”” tweeter=”” suffix=””]The digital world is already showing signs of saturation[/inlinetweet]

More people are using ad-blocking software. Tech brands that eschew bombarding customers with ads, such as Apple and Netflix, are wildly popular. The drive to lift user “engagement” on social-media platforms by showing sensational content, in turn boosting the number of ads that can be sold, has prompted a backlash. [inlinetweet prefix=”” tweeter=”” suffix=””]Time spent online by the typical American is growing at about 10% a year, less than the 15-20% ad- sales growth that many digital firms expect.[/inlinetweet]

The second limit on the size of the advertising market is how much cash all other firms, in aggregate, have at their disposal to spend on ads. In theory they could spend more and more until their overall returns on capital drop below the cost of capital, compromising their financial viability. Remarkably, expectations for ad revenues are now so bullish that they imply that this boundary will indeed be tested.

Imagine if advertising spending really did rise to 1.8% of GDP in America by 2027. Most firms’ costs would have to rise, cutting total corporate profits (excluding those of ad platforms) from about 6.5% to 5.7% of GDP, the kind of drop normally associated with a recession. Alternatively, imagine if the firms in the S&P 500 index (excluding ad platforms) bore all the additional cost of the advertising boom. Their combined return on capital would drop from the present 10% to 8%, at or just below their cost of capital.

That does not seem realistic. More probably, hopes for a new age of advertising nirvana are too optimistic. Perhaps the ad sales of conventional media firms (which are about half of the total, with TV dominating) will drop fast rather than merely stagnate. Or perhaps digital firms will struggle to increase ad sales at compound annual rates of 15-20% or a decade, as their valuations imply. Expectations for both groups are surely too high. In the advertising world, and on Wall Street, something does not add up.

Source: The Economist

About richmeyer

Rich is a passionate marketer who is able to quickly understand what turns a prospect into a customer. He challenges the status quo and always asks "what can we do better"? He knows how to take analytics and turn them into opportunities and he is a great communicator.

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