Saturday, July 4, 2015

Allowing consumers into the advertising value chain

Online advertising market operates through a small number of service providers such as Google or Facebook which aggregate consumers' attention and offer it to advertisers via a B2B model based on CPC, CPM or similar indicators. Companies determine their total expenditure in advertising A as a fixed percentage of their revenues or with some other formula that takes into account the estimated increase in revenues that ads might bring in as a result of exposure of the company's products to their potential customers. In any case, we can consider that this figure is an increasing function of consumer spending C:
A = A(C).
In the United States, digital advertising spend amounted to $49.5B or 0.3% of the country's GDP, roughy $155 per person. Figures for Spain are more modest: €1.1B or €23 per person.
Consumers receive no direct payback from this business other than access to the free services online providers offer them. What would happen if users could actually charge online service providers for their share of attention? At first blush there seem to be no changes in terms of national economy as we are merely redistributing online revenues among a different set of players. On closer analysis, though, we can predict a multiplier effect that works as follows:
  • Online providers' net income I is reduced by some quantity Ic that is directly received by users themselves.
  • Consumer income Y is added Ic and detracted some unkown quantity L resulting from online provider's lower dividends (if any, as currently neither Google nor Facebook pay them), reduced market cap, adjustments in employees' salaries, etc. The key aspect is that, even if  Ic = L and so Y remains the same, this redistribution will benefit lower-income residents, with a net effect of higher overall consumption because these people pay proportionally less taxes T (so, the national disposable income Yd grows) and have higher marginal propensity to consume MPC.
  • Higher consumption increases demand and supply and produces a net gain in GDP (and online ad spending in its turn).
So, the entire cycle is summarized as
ΔA = (ΔAC) · ΔMPC · Δ(YT).
Of course this analysis is extremely simple and there are additional factors that complicate it:
  • Tax avoidance practices by big online providers basically take all their income out of some countries (Spain, for instance) to derive it to others where taxes are lower. For the losing countries, redistribution of ad revenues among their residents is a win-win as their national economies receive no input from online providers to begin with (that is, online income losses do not affect their GDP).
  • Global online advertising is currently a duopoly and challenges to the existing value chain can confront very aggressive opposition: no matter how big the multiplier effect ΔA/Ic, online providers can not compensate their loss with increased revenues in a bigger advertisement market, since ad spend is by definition a fraction of consumers' income. When French newspapers demanded sharing into Google News' business, a modest agreement was settled after harsh disputes, but the same situation in Spain ended much worse for everybody.
  • In fact, threatening the very source of revenues of online service providers could damage their business to the point of making it unviable. Current operating margins for this market go from  25% to 35%, though, which seems to indicate otherwise.
Now, if users were to enter into the ad value chain, they would need some proxy on their behalf who has the power to oppose online service providers (for a share of the pie, at any rate). Two potential players come to mind:
  • ISPs,
  • Internet browser companies.
As online ad spend per person is actually not that high, we are talking here of potential revenues for the end user of a few dollars a year at most. This would be best provided by the proxy in the form of virtual goods or, in the case of ISPs, discounts in their services.

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