Economics

By the Project for Excellence in Journalism

Largely fueled by a red-hot ad market, 2005 appeared to be a year of strong economic growth for online news. Significantly, the growth came at a time when many other media sectors such as print and local TV were suffering.

What’s more, increasing revenue has created vast opportunities for further investment and technological development, though not always in traditional newsgathering operations. Many questions remain; probably the key one is whether the dominant online economic model can produce quality journalism.

Online Advertising Revenue

Growth in 2005

In 2004, the headline was the online ad industry’s rapid recovery from the boom and bust of 2000. Preliminary data for 2005 suggest that the online ad market is still growing very rapidly.

According to data from the Interactive Advertising Bureau and Pricewaterhouse Coopers, online ad sales were expected to surpass $12.5 billion for all of 2005. This number represents a 30% increase over the $9.6 billion recorded in 2004.^{1 2}

And many of the country’s largest advertisers moved more of their ad dollars online. For example, the Ford Motor Company reportedly shifted 15% of its billion-dollar ad budget to the Web. As Greg Stuart, CEO of the Internet Advertising Bureau, said, “At a certain point, the Internet isn’t just a rational business decision [for brands]. It’s part of a big advertising idea.”³

Explaining Online Ad Growth

What accounts for such strong growth, besides the obvious increases in online audience numbers?

From the start, online advertisers have been lured by the ability to track their ads with greater detail and accountability than they can in any other medium. While advertisers in platforms like television and print could only estimate how many eyeballs were exposed to their ads, the Internet allows them to make a more precise measurement. Of course, counting the number of clicks is the most basic way to assess online advertising strategies, but advertisers also use such metrics as average frequency of exposures, ad exposure time, ad interaction rate, and view-through rate.⁴

In 2005, the Internet continued to uphold its claim as one of the most accountable advertising platforms with the emergence of some new marketing programs. Akamai, a technology company headquartered in Cambridge, Mass. developed new software that allows advertisers to look at audience spikes during certain big news events. Akamai’s chief executive, Paul Sagan, hopes that the service “can be used to help reveal geographic and sociological trends in public spectacles,” adding that “data generated by the index can be used by advertisers and investors to map social patterns and make buying decisions.”⁵

And in November, Google began offering Google Analytics as free software that allows customers to track how often Internet users click on ads that appear after a search is conducted.⁶

Looking Ahead

Beyond 2005, the evidence suggests online advertising should continue to grow. The rate of growth may slow, however, according to at least one research organization. Emarketer, a New York-based market research firm, is now projecting that from 2006 to 2009, online ad spending will decline each year: by 21.2%, 14.1%, 13.5%, and 10.4%, respectively.⁷

“No medium before the Internet had more than 32% increases (the growth for 2004) after it had been around for a few years,” the EMarketer analyst David Hallerman said. “Runaway growth isn’t all that good, since it could end up like the early years of the Internet — hype.”⁸

Even more modest growth, however, would outpace what is occurring today for many other media platforms. Veronis Suhler Stevenson, a private equity investment firm that publishes an annual “Communications Industry Forecast,” projected the compounded advertising spending growth for 12 different media and communications segments for the years 2004 to 2009. Advertising spending on consumer Internet, which includes advertising on television, newspaper and radio Web sites, was projected to grow 24% between 2004 and 2009, second only to videogame advertising (46%).⁹

Growth of Advertising Spending
By media platform

Source: Veronis Suhler Stevenson, Communications Industry Forecast 2005-2009, Nineteenth Edition, 2005
Out-of-home advertising includes traditional roadside billboards, as well as non-traditional forms of out-of-home media, such as bus stations and street furniture.

Total ad revenue online is still a fraction of that coming into other media platforms. Online ad spending accounted for less than 4% of all ad spending in 2004 compared with 24% for newspapers, 6% for magazines, 10% for radio, and over 30% for television.¹⁰ Yet clearly those percentages are shifting.

Online Newspapers

Revenue in 2005

One way to illustrate the economics of online advertising is to talk about one sector. Newspapers are the biggest recipients of online advertising, and in 2005, it appears spending on them continued to surge.

According to research by Borrell Associates, online revenue for daily and weekly newspapers owned by publicly traded companies grew by 47% in 2004, from $811 million in 2003 to $1.19 billion. For 2005, Borrell projected revenues would climb another 28%, to $1.52 billion. ¹¹

And the partial-year data suggest the projections were on target. For the first two quarters of 2005, online ad spending on newspapers grew 29%, according to estimates released by the Newspaper Association of America. By comparison, total spending on print advertising in the period had grown just 2%.¹²

At the New York Times Company, to take one case, online advertising revenues were up approximately 30% while overall advertising, for both digital and print operations, grew only 0.9%.¹³

Indeed, many newspaper companies have turned to their online ad growth as a remedy for their rather anemic print ad revenue. In May of 2005, Merrill Lynch estimated that half of first-quarter ad revenue growth for public newspaper companies came from their online operations. And in the second quarter, a Bank of America report indicated that more than 100% of the growth for some of the biggest companies — Dow Jones, Journal Register, Knight Ridder, and Tribune — was credited to online. Percentages were lower at other newspaper companies, but the median for all companies researched was nearly 80%.^{14 15}

Despite their importance as a growth sector, however, online ads still contribute only a small percentage to their companies’ overall revenue — between 1% and 7% of total newspaper advertising revenue. Newspapers currently can charge only a fraction for online ads of what they charge for ads in their print editions. The reason for that was a much-discussed topic at Forecast 2006, the latest in an annual conference on the future of media: the question of engagement. Namely, how much is an online ad worth if the viewer is not as engaged with the ad as he or she is with advertising placed in other media, particularly print media? The answer, at this point, is that no one really knows.

Newspapers in the Future

Looking ahead, at least one market research firm, Emarketer, projects that online newspapers will contribute as much as 8% to total revenue by 2009 (compared to 4% and 5% now).¹⁶ Yet even if strong growth occurs, there is reason to believe that online ad revenue won’t be able to compensate for many years of struggling print revenue . Rick Edmonds of the Poynter Institute, a collaborator on this annual report, has estimated that if online revenue grew annually by a third, and newspapers ’ print ad revenue grew by just 3%, online revenue wouldn’t surpass print revenue until the year 2018. Yet as the discussion here makes clear, sustaining annual 33% growth rates online is probably unlikely, and may only get harder, especially if competitors like Google, Yahoo and craigslist remain growing players. ¹⁷

Online Revenue vs. Newspaper Revenue
Revenue in millions

Source: Rick Edmonds,"An Online Rescue for Newspapers?", January 27, 2005, Poynter Institute
Projected revenue growth through 2018 is based on 2004 growth numbers of 4% for newspapers and 33.3% for online.

This is one of the critical questions for newspapers: will revenue from online advertising, even as it grows, be enough to bolster the struggling newspaper industry, which has long prided itself on its ability to do difficult investigative work that costs a lot of money? (For a closer look at newspaper economics, click here). If not, will anything else take up the slack? Could quality journalism become a philanthropic exercise? Could local interests begin to invest in journalism, and invest more, because they expected smaller returns than Wall Street and publicly traded media companies have typically demanded? As noted in past years, this is the probably the most fundamental issue underlying any discussion of media economics today. (See overview.)

Rich Media

Defining “rich media” may be as difficult as agreeing on one definition for blogs. It may include video, graphics, text, animation or audio. Still, there are certain characteristics of almost all rich media, most notably that they are digital and interactive.

While spending on rich media has increased in the last few years, it has not yet increased its share of the online advertising market. After the first six months in 2005, rich media accounted for an 8% market share of all online advertising, as reported by IAB, the same as in the first half of 2004.²⁶ In 2004, total spending on rich media grew 32%, increasing to $963 million from $727 million.²⁷

Video, of course, is a large component of rich media. Many extol the new technology as a gateway to economic viability on the Web. As the New York Times described it, “new Internet video programming is a way to cash in on the demands of advertisers who want to put their commercials on computer screens, where new viewers are watching. And for many Web sites, viewers can’t skip the video commercials, the way they can when using TIVO and other video recorders.” ²⁸

There was considerable discussion in late 2004 that 2005 might be a breakout year for online video. Based on audience and preliminary economic figures, online video use is widespread, although regular use appears to be relatively small. But based on the increasing number of video clips that have become available on the Web, particularly on news sites, higher levels of both use and revenue from advertising seem likely in 2006.

Research from Comscore shows that nearly 60% of the online population consumes online digital media (streams and downloads) every month.²⁹

Regular online video consumption, however, is small. As of 2004, just 5% of online users said they watched video over the Internet daily.³⁰

There is some evidence that online video may surge during very large news events, particularly those that provide dramatic news footage. For example, online video traffic performed extremely well during the aftermath of Hurricane Katrina. Media coverage of the storm’s aftermath generated 10 million video downloads on CNN.com on August 29; MSNBC.com generated 10 million video downloads by mid-afternoon on that same day.³¹

Meanwhile, survey research shows that news clips are the most commonly watched type of online video, even surpassing movie trailers. Fully two thirds (66%) of online video watchers say they watch news or current-event videos on the Web, compared to movie clips and trailers (49%), music videos (29%), and sports highlights (27%), according to the Online Publishers Association.^{32 33}

It seems marketers have so far remained cautious toward investing in online video advertising. According to Jupiter Research, just $121 million of the $9.5 billion spent by advertisers in 2004 was spent on online video. Two research firms, Jupiter and eMarketer, however, project that video will grow exponentially over the next several years, with Emarketer projecting $1.5 billion by the end of the decade.³⁴

Several technological developments were made in 2005 that could lead to both higher penetration and more ad spending on online video in the immediate future. Google and Yahoo added links to video search engines on their home pages. Those two are, of course, the world’s largest search engines.

Other media companies have also made moves to showcase their growing online video inventory. In September, the New York Times reported that Time Warner and Viacom were beginning to post some of their video on the Web that could ultimately be indexed in online search engines.³⁵

What’s more, the former Internet titan Lycos announced in October that it had launched technology to take video publishing to the small-scale content operations — even the one-man show. Its technology, said the company’s CEO, Brian Kalinowski, will allow users to self-publish their own videos. Users would have to post the video on the Lycos Web site, but they would maintain ownership of the content.

And as further evidence that online video is now being taken more seriously, the Internet Advertising Bureau announced in late November it had issued new guidelines for online video advertising and had formed a Broadband Committee to develop the standards for tracking commercial figures.

Though spending on rich media should grow, are there obstacles to overcome? Challenges may be “a dearth of inventory, with publishers unable to create content fast enough; technological obstacles to transferring high-quality video online and to broadband penetration; and consumer resistance.” ³⁶Also, a lack of standardization among online video players is a critical concern, and some consumers may not want to take the time to download the players from the Web. ³⁷

In addition, production costs may still be too high for many marketers. Right now, an Internet commercial costs about $15 to $20 for each 1,000 viewers, nearly as much as broadcast networks charge. The price may be high because there is much more demand from advertisers than there is Internet video programming available — though that might change as software companies make it simpler and cheaper to upload video on the Web. For example, the Cambridge , Mass.-based company Brightcove allows amateur videographers to post their work on the Web and even make money through advertising.

Survey research among business leaders also seems to suggest cost may be an issue: 78% of executives reported that impressions on home pages, vertical channels, and rich media cost more in the second quarter of 2005 than in the first quarter.³⁸

Local Online Advertising

Spending on local advertising should continue to grow in 2006 and beyond as a mix of so-called old media and Internet companies compete for an increasingly lucrative market.

Local online advertising generally includes automotive, real estate and employments ads. It accounts for approximately 30% of all online spending. In 2005, spending on local advertising was projected to reach somewhere between $3.2 and $4.1 billion, up from $2.7 billion in 2004.³⁹

The predictions seemed to be holding up in 2005. Media buyers and planners reported that they spent 18% of their clients’ ad budgets on online local media in the third quarter, up from 13% in the first two quarters.⁴⁰

When we look closer at how local online advertising is shared across the different types of Web sites, we see that newspaper companies and non-traditional media companies, such as Google and Monster.com, continue to perform well. Newspapers grabbed 44% of the local online advertising marketplace while companies like Monster.com and Google, among other non-traditional companies, absorbed 40%.

Meanwhile, Yellow pages and television and radio sites are still receiving a relatively small piece of the pie , though growing . In 2004, TV stations increased their local online ad revenue nearly 59% to $119 million , while radio stations’ revenues nearly doubled, reaching $34 million. ⁴¹

Looking ahead, newspapers may find themselves facing even more competition from the non-traditional, Internet-based companies for local ad dollars. Research from the Kelsey group estimates that Internet companies’ search engines will generate $3.4 billion in local ad sales by 2009.⁴² In San Francisco, some analysts believe that if Google is successful in its bid to provide the city with free, universal WiFi, local newspapers — estimated to have lost between $50 million and $65 million in employment advertising revenue to craigslist — could see their share of local ad revenue further reduced.⁴³

In addition to businesses and marketers becoming increasingly comfortable with and knowledgeable about the Web, perhaps another reason for higher growth at the local level is new developments in technology. Not surprisingly, Google jumped into the game with the 2005 launch of a product that combines its online maps with local search features that include links to local businesses.⁴⁴

Market analysts generally agree that there will be strong growth in local advertising, but differ over how strong and how it will get there. According to Jupiter Research, local online spending will reach $5.3 billion in 2010. Borrell Associates anticipates that the market will grow to $8.6 billion over the next five years. The reason for such a gap is that Jupiter Research analysts believe that the market will remain heavy on classified ads rather than moving toward a more lucrative, search-based market that currently exists at the national level. According to David Card, vice president and senior analyst at Jupiter Research, local businesses still lack a sense of comfort and familiarity with local online advertising:

“[Local advertisers] are going to have to go through the whole education process that multinational advertisers went through. It’s many years behind where current online advertising is.”

Borrell Associates, on the other hand, believes local advertisers will be able to adapt more quickly to a search-based market, and thus projects higher growth for the rest of the decade.⁴⁵

Like the industry over all, the local online advertising industry is still maturing. Currently, around 2% of all local advertising is spent online, though it is projected to reach 6% of all local spending over the next five years.⁴⁶ For online advertising to continue to grow at the local level, it will have to reduce its “dependence on bundling print or broadcast advertising with online advertising” and continue to “reach out to that large segment of advertisers that don’t currently do business with them,” according to Borrell Associates.

The Success of Other News Sites

Surging revenues from online advertising ha ve not been limited to traditional newspaper companies. In 2005, non-traditional news sites like Google and Yahoo continued to generate headlines for their astonishing economic performances.

Google

Google became a public company in the summer of 2004 and quickly became the world’s biggest media company, at least in stock value . Deloitte Touche has named Google the fastest-growing company ever with its five-year revenue growth at over 400,000%.⁴⁷ In 2004, Google’s revenues were $3.1 billion, a huge increase over the $1.5 billion in 2003 and just $440 million in 2002.⁴⁸

Of course, almost all of Google’s revenue comes from search advertising . In 2004, 99% of Google’s total revenues were from advertising, according to the company’s SEC filing.⁴⁹ And Google made a significant move in late 2005 to preserve its position atop the online search industry. In late December, it was announced that Google and AOL had agreed to a sale that would give Google a 5% stake in AOL. Th e agreement was generally seen as further consolidation in the online search industry and a setback for Microsoft , which had hoped to increase its revenue from online search advertising and increase its chances to compete with Google and Yahoo .

As of October 2005, Google was worth $80 billion in stock market capitalization , ahead of Time Warner, which was valued at $78 billion . Google’s annual revenues , though, are comparatively just a drop in the bucket —  slightly over $3 billion in 2005 compared to $42 billion for Time Warner.⁵⁰ The Silicon Valley-based company’s ad sales for 2005 were projected to put them fourth among all American media companies.⁵¹ At the end of 2005 there was discussion of whether Google’s stock valuation needed to be realigned. In late November, the stock fell from nearly $20 a share to $403.54.⁵²

How has the company managed such success? In some ways, Google’s business strategy has been compared to the one adopted by ABC, CBS and NBC in the first days of network television. Google first allows people to conduct searches on almost any conceivable topic free, just as the networks distributed free programming. Then both Google and the television networks use advertising to produce revenue. And finally Google links together smaller Web sites with national advertisers, in much the same way that networks placed national advertising on local TV stations.

Yahoo

In 2004, Yahoo ’s revenue increased from $1.6 billion to $3.6 billion — a 125% increase.⁵³ That was even higher than the 113% increase at Google. In the third quarter of 2005, 87% of Yahoo ’s revenue came from advertising. The other 13% came mainly from subscription-based services, like broadband access fees and Musicmatch.⁵⁴ While Google’s appeal to advertisers is mainly built around the incomparable popularity of its search engine technology, Yahoo attracts advertisers for additional reasons.

First, it has registered over 190 million users , which means it can provide marketers with a wealth of personalized information they can use to customize ads. Google, on the other hand, has just started to collect personal information through its Gmail and blogging software.

Second, Yahoo users, who are exposed to a diverse range of features on the site such as sports, financial, health and entertainment information, personal and real estate ads, music downloads, e-mail, an instant message service, and a link for booking flight and hotel reservations, prove more engaged than users on other sites. For example, Yahoo generated 178 million page views in May 2005 compare d to 96 million for MSN, 68 million for Google, and 39 million for AOL, according to Comscore Media Metrix.⁵⁵ For many marketers, the number of page views is a key indicator of the level of consumer engagement with the ads.⁵⁶ (For a fuller discussion on how Yahoo and Google invest in their news operations, see the news investment section of this report.)

AOL: Don’t Call It a Comeback

Another big economic story from 2005 is the quiet — at least initially — resurgence of AOL. As Randall Stross of the New York Times pointed out, AOL has long been the online world’s “dead man walking,” but has rebounded time and time again.⁵⁷

Soon after AOL acquired Time Warner in January 2000, broadband service began to take over the lucrative dial-up system on which access to AOL was based. As a result, AOL saw its subscriber base dwindle from 26.5 million in 2002 to 21.2 million in January 2005.⁵⁸

In December 2004, AOL announced it was becoming a largely free portal basing much of its revenue from advertising, much like Yahoo, Google and MSN, although it said it would charge for several features its research showed were most appealing to subscribers, including special features for children with access control for their parents, Spanish-language pages, protection against viruses and spam, and e-mail addresses at AOL.com.⁵⁹ In the fall of 2005, AOL began an estimated $50 million campaign to promote the site as a free portal.⁶⁰

The shift to a more advertising-dependent site has helped soften the blow of its losses in subscription revenue. In the second quarter of 2005, that revenue decreased 9%, or $168 million, but advertising revenue surged 45% over the year before to reach $99 million for the quarter. Combined with the increase in advertising revenue has been a reduction in expenses that has resulted in a 33% increase in operating income, from $276 million in the second quarter 2004 to $368 million in 2005.⁶¹

In addition to opening up many of its features to non-subscribers, AOL is also hoping to increase traffic through use of its free accessories, including Netscape and the AOL Instant Messenger chat system. Combined, those services are used by more than 50 million people a month who are not AOL members.⁶²

AOL has also looked to video as way to increase its overall audience figures and appeal to more advertisers. Video coverage of the Live 8 concert drew 5 million viewers the day of the performance and tens of millions more who logged on later, according to Jim Bankoff, executive vice president of AOL.⁶³

While some analysts speculate that AOL’s best days are behind it because it is already too far behind the other free, advertising-based portals, others say that AOL’s previous history with many former AOL subscribers and the belief that broadband is only in its early days could help AOL over the long run.⁶⁴

Moreover, the AOL brand is still considered an “awfully powerful brand,” an important reputation not only for advertisers but for an audience that seeks reliable, trustworthy, and virus-free content.⁶⁵

Profitability

Until recently, it would have been a major event for an online news site to report a profit. Over the last two years, that has changed. There is still a fair amount of unneveness, and some sites have a long way to go. But the trajectory is increasingly clear.

Last year we discussed the difficulty of reporting profit figures for online news, including the fact that different companies handle the accounting for their online operations differently. Still, there are indicators that offer an overall picture.

For online newspaper sites, survey research from Borrell Associates Inc. suggests that large spikes in ad revenue have helped push profits upward. According to a survey of 719 daily and weekly newspapers across the country, the average online profit margin was nearly 70% — an increase of nearly 10 percentage points over 2003. Moreover, 90% reported they were making some profit, up seven percentage points from the previous year.

It also appears that there is a direct relationship between a newspaper’s circulation and its online profitability. Generally, with a few exceptions, the sites with the largest audience figures tend to be the most profitable.⁶⁶

At least one online news division appeared to be collecting more profit than its print counterpart. In the second quarter of 2005, the Dow Jones print publishing division, publisher of the Wall Street Journal, reported an operating income of $7.2 million, a decrease of nearly 60% from the same period in 2004. The electronic publishing division of Dow Jones, however, which includes WSJ.com as well as Market Watch, reported an operating income of $29 million, an increase of 28% from the year before.⁶⁷

Only two public media companies were still reporting online losses in 2004, according to Borrell: Belo had a loss of $4.7 million on revenues of $31.1 million from its digital operations, while Media General Interactive reported a loss of $6.3 million on revenues of $13.9 million.⁶⁸

Local television Web sites, meanwhile, are still struggling to earn a profit. More than three quarters (75.8%) of TV stations were unprofitable in 2004, although that was better than 2003 (85.2%).

The Online Economic Model

The flip side of profitability online, of course, is that some of the gains are coming at the expense of the traditional print media, which supply the online news sites not only with the content but with investment dollars as well. In other words, the Web sites might be eating the lunch of the old media they are so dependent on, and this is perhaps nowhere more evident than in the alarming number of layoffs at newspapers across the country.

Up to this point, the economic model of traditional media online has been largely dependent on advertising and support from the parent company, with the content offered free as consumers have seemed to resist paying.⁶⁹

In 2005, there was finally some evidence that the efforts of online newspaper sites to diversify their revenue stream by charging for content might be making headway — at least a little. Indeed, roughly 40% of online newspaper editors and managers expect to charge a subscription fee in the future. In late September 2005, the New York Times started charging readers access to its opinion columns, frequently the most popular features on its site. In mid-November, the Times reported that it had registered 270,000 for the TimesSelect; approximately half of those were new, online-only subscribers. Heading into 2006, though, of the nation’s 1,456 daily newspapers, only one national newspaper, the Wall Street Journal, and approximately 40 small dailies charged their online readers.⁷⁰

The question of paying for content is critical for several reasons. If online advertising revenue is not likely to catch up to print anytime soon — or at all — the profitability of online journalism, and the resources of the newsrooms that produce it, may depend heavily on whether a second revenue stream can be developed.

And since newspapers on average generate 20% of their revenue from circulation, if the Internet cannot begin to charge, that would represent a major blow to revenues as well. As Colby Atwood, vice president of Borrell Associates Inc. told the New York Times in March, 2005:

“A big part of the motivation for newspapers to charge for their online content is not the revenue it will generate, but the revenue it will save, by slowing the erosion of their print subscriptions.”⁷¹

Conclusion

There was much talk in late 2005 of another economic bubble like the one that devastated the online industry at the turn of this century. But most signs point to much healthier, stable economic conditions in 2006 and beyond.

As John Battelle and Chris Anderson have written, there are several key reasons not to expect a repeat of 2000. First, as suggested earlier, broadband penetration has increased rapidly since the online world began to emerge from the ruins of 2001 and 2002. And broadband access is the engine for much of the industry’s growth.

Second, the technological infrastructure to run online sites is much cheaper now, which helps keep down operating costs. That is particularly true for servers that are needed to host both existing and new sites. Moreover, less expensive hardware means less of a risk in launching a new site and thus encourages more entrepreneurship.

Finally, there is considerably less venture capital circulating in Silicon Valley. According to Chris Anderson, venture capitalists are now investing “less than a fifth” of their 2000 level.⁷² Less venture capital has meant many fewer public offerings. Rather, hot new companies are being woven into more secure, corporate media structures like the News Corporation or the New York Times Company.

Click here to view footnotes for this section.