Digital – It Shrinks The Pie
In 1996, when many of us were lauding and forecasting the impending digital transformation of media, one observation we made was the great margin enhancement likely to result from analog media turning digital. We saw the disappearance of physical goods as a reason to expect margins to expand. No more trucks to distribute newspapers, no more physical COGS for plastic shiny discs, no more giant warehouse and inventory costs tying up valuable capital.
But two things are happening to undermine that: First, markets are efficient. As the lower digital cost structures appeared, margins naturally compressed to take advantage of that. Second, as advertising for the first time because highly measured, CPMs plummeted based on the (newly discovered) efficacy of online marketing. Where TV CPMs can be $80, video ads online fetch $25 CPMs. Many people argue that this is because TV is “more valuable” a medium. I contend it is simply because we can actually track who is watching online, and it’s far fewer people than we expected to find. If we knew the truth about TV ads, advertisers would not pay $80 CPMs.
Jeff Zucker, in one of the few comments of his with which I agree, said…
“Our challenge with all these [new-media] ventures is to effectively monetize them so that we do not end up trading analog dollars for digital pennies.”
Well, that is exactly what is happening, and it cannot be stopped. The “new” super-blog newspapers and magazines like Huffington Post, and Silicon Alley Insider will continue to be fantastically successful delivering a product highly appropriate for this medium. But they will do so with vastly reduced cost structures more appropriate for the modesty of their business size. They will fetch $10 – $20 CPMs (maybe a bit more when highly targeted) and deliver revenues of $10M – $40M at maturity. Those are interesting numbers when their cost basis includes 10 employees and some space on Amazon S3 and EC2. But these new web businesses do not support housing your employees in a landmark building at 43rd & 8th or the CondeNast building at 4 Times Square. And Hulu and Veoh won’t support the compensation structures and elaborate media exec pay packages at NBC.
Indeed, we now know that digital shrinks the pie. Something like for every $1 of ad revenue that goes to Politico.com or YouTube probably takes $5 away from a traditional media company. The new businesses are taking audience away, selling advertising for less, and doing it all for a fraction of the cost. The good news is that this is disruptive and new value is created elsewhere. The flip side is that the new businesses will have tighter margins as a result of the great efficiency available online. Hey, at least there are no trucks and warehouses.
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While disruption will create value elsewhere it does not necessarily translate into lower margins.
The web’s infinite supply of content is outstripping available attention. Successful web business models adapt to attention scarcity by converting attention value into fungible value. Google’s search is a great example; they convert attention value by creating attention inventory, identifying it, differentiating it, and selling it. They do this at scale with good margins. Yahoo’s biz model is not as efficient at converting attention value. iTunes even less so.
Media properties are huge draws for attention. The companies that efficiently, scalably, and legally convert this attention to currency will reap very nice margins.
as Einstein said, business models are neither created nor destroyed, they are merely transformed…
when rent goes away (no physical store-like presence), ad expenses go up. when prices are lower, advertising converts better. and magically, we all wind up at 10-15% EBITDA, irrespective of the gross margin. any higher and we’re undergrowing, any lower and we’re not-having-much-reason-to-be-in-businessing.
that’s why (at least i THINK that’s why) the phenomenon you describe exists most everywhere that’s not Google.
[...] NBC, who licenses thousands of shows to Hulu, in their wisdom, is getting scared. They are hearing about all these 20-somethings who are cutting their cable bill and foregoing the $80 a month to instead watch their faviorite shows online. They aren’t stealing the shows through torrent sites, mind you, they are watching them legally through the means that NBC is providing. The problem is that NBC makes an overwhelming amount of their profits through subscriber fees paid to them by the MSOs. The ad revenue they get from putting ads in Hulu are the digital pennies I refer to here. [...]