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Reversing the digital slide

The traditional models of the incumbent media companies failed them online. Success will require innovative models managed with familiar techniques--such as a focus on efficiency and financial returns.

The online media sector is in disarray. In the wake of failed revenue models and the Nasdaq crash, powerful incumbents such as Disney, Dow Jones and NBC have been struggling along with companies such as TheStreet.com and Salon.com to generate investment returns.

New investments are being curtailed, and the temptation to abandon the Internet is great.

The lesson to be drawn is that offline business models--founded mainly on interruption-based advertising and subscriptions--don?t work for incumbent media companies in the online world. Online audiences largely ignore advertising and rarely pay subscriptions because a free substitute is usually only a click away. So what are incumbents to do?

They should be patient. All new media models take time to achieve success. Meanwhile, they should look carefully at their properties and sustain, even reinvent, those that will respond best to promising new business models. Eventually--in a broadband world--traditional interruption-based advertising might bring better rewards.

More promising in the near term, though, is an emerging advertising model known as contextual advertising, which targets the consumer who plans to make a particular purchase and is thus more likely to be responsive. Not all media companies have the kind of specific content that lends itself to such advertising, however, and those that don?t must look to other marketing and cross-selling opportunities to increase their revenue.

Remember, too, that incumbents are in a better position than their pure-play competitors to absorb short-term losses in hopes of finding a long-term audience. Indeed, we expect 95 percent of pure-play online media companies to fail within the next two years.

The old model teeters
Advertisers know that interruption-based banner ads offer poor value; hence the media companies? low revenues online. The fact is that online and offline economics are different.

Uncompetitive pricing and a lack of innovation haven?t helped. Too quickly, banner advertisements became the standard online format, and click-through rates--the proportion of site visitors who click on an ad to reach an advertiser?s Web site--became the principal, though unsatisfactory, measurement. Even by that benchmark, banner ads have show to be ineffective. Click-through rates have dropped by more than half to less than 1 in 200, from more than 2 percent--and the decline continues.

The result is that under many pricing schedules, the cost to an advertiser of one online contact from a content site is greater than the cost of the offline alternatives.

Most big advertisers, then, largely ignore the Web. Last year, the top ten Fortune 500 companies accounted for only 2 percent of total advertising on it. About three-quarters of the almost $6 billion spent on Web advertising went to the ten sites that had the highest traffic, with a little more than half going to the top three portals: Yahoo, AOL and Microsoft's MSN.

Faced with such economics, even sites that deliver plenty of traffic can?t attract the revenue needed to cover their fixed costs. At current visitor rates, a typical pure-play content site makes $1 to $2 per user each month, compared with total costs of about $2 to $3 per user. Such a site would have to attract about ten million unique visitors a month to break even. Although incumbents can spread their costs among sites or across online and offline properties, the traffic volume they need is still higher than expected.

Get relevant
Offline, media companies create and package content, gather an audience around it, and then interrupt the audience with paid commercial messages. The advertising message isn?t necessarily related to the content--a car commercial during a televised football game, for example, or a cruise ad in a magazine--though some general demographic targeting is possible.

This model works because the content generally captures the readers? or viewers? interest and can?t be substituted immediately. Online, however, users take a more active role and are much less tolerant of interruptions. As a result, research shows, most Web users simply ignore ads.

It isn?t clear whether any kind of interruption advertising will work in the long term, though broadband technology will probably allow some media companies to deliver content that captures the attention of audiences for specific periods. Streaming video is the likeliest winner; examples could include live Webcasts of concerts, out-of-town sporting events, or exclusive fashion shows. Since these would be viewed in real time rather than downloaded for later viewing, the audience couldn?t click to a substitute, and since the content would be unique, there might be greater tolerance of advertisements shown before the Webcast or during breaks in the action. Like television commercials, such ads could also be more emotionally compelling to the audience.

The key to making advertising relevant lies in contextual marketing. This model works offline in trade and special-interest magazines, where reading the ads is part of the experience. Advertisements in a computer-gaming magazine, for instance, offer information that is related to the editorial content. Readers of such publications know the difference between the ads and the reviews, of course, but are more willing, in this context, to accept ads as relevant information, not just as interruptions. Advertisers therefore gain a more limited but also a more targeted audience.

Contextual advertising is particularly suited to Web sites. The Internet is an immensely rich contextual medium, awash with people searching for information to help them make immediate purchases. In this environment, advertising can be tailored to the context in which it is displayed.

However, media companies that choose contextual advertising--and those capable of doing so include the personal finance area of Yahoo and MSN?s CarPoint--must strike a delicate balance to succeed: They have to be seen as providing neutral advice accompanied by paid messages rather than as relentlessly pushing their advertisers? products.

Market consolidation
The economics of some media sites might improve if they were combined with others and with offline properties. Consolidating the infrastructure of a company?s sites might help cut costs, as could partnerships or the purchase of external sites with potential overlapping strengths in editorial, sales, marketing, and back-office operations. In a consolidating industry, strong incumbents should be able to negotiate favorable deals.

Restructuring could also clarify the role of Web sites that offered benefits other than revenue. Such sites might be necessary for magazines, let us say, to satisfy readers who wanted to experience them in both online and offline versions or to meet the demands of advertisers that wanted to run integrated media campaigns across several channels.

These sites should be maintained at minimal cost and regarded as a supplement to offline operations and, perhaps, as an additional channel for subscription sales. Trying to change such a site so that it offers an exhaustive range of information will almost certainly lead to losses.

Keep innovating
Whatever the benefits of contextual advertising, consolidation and cost cutting, they are unlikely to help most media Web sites make a profit. In this case, the only alternative to more losses is more innovation.

For large media businesses such as Yahoo and AOL Time Warner, innovation means using interactive platforms to help companies reduce the inefficiencies inherent in all of their interactions with consumers--interactions through such means as promotions, brochures, coupons, physical locations like bank branches and car dealerships, and consumer-service call centers.

In addition to the advertising dollars that online media sites aren?t capturing, companies such as Coca-Cola, Pepsico and Procter & Gamble spend a large part of their overall budgets on marketing, sales and service expenses with well-known inefficiencies and with returns that are often hard to quantify.

Media companies can improve their value proposition to marketers by emphasizing the Web?s low-cost, high-touch qualities to raise the efficiency of these investments.

AOL, for example, recently teamed up with Coca-Cola, and Yahoo with Pepsi, to shift bottle-cap promotions to the Web--a departure from the era when some bottle caps could be redeemed for prizes only at stores; buyers can now enter the redemption codes from their bottle caps online to find out if they have won a prize. Both Coca-Cola and Pepsico say that in this way they have saved money and time.

Media businesses could capture nonadvertising marketing expenditures and position themselves to boost their advertising revenues in other ways as well. First, they could help marketers test the effectiveness of planned national offline advertising campaigns by providing targeted online audiences. They could also use information gathered online to identify the most valuable customer groups and to help advertisers plan and execute more finely targeted offline strategies.

One media company increased a food manufacturer?s sales by identifying office workers in its audience and sending them targeted online ads for spaghetti sauce at the end of the workday, when they might be thinking of buying food on the way home. This approach substantially refines targeted advertising, but, unlike contextual ads, it relies on a timely message to a specific demographic group rather than on a message linked to a site?s content.

Large media companies could even host marketers? Web sites, which, after all, are essentially media platforms; media companies such as AOL Time Warner have the scale and skills to manage them more efficiently than does, say, a consumer products company. In addition to managing operating costs--everything from network connections to content management--AOL could help such a company place ad banners effectively within AOL?s broad media site. Thanks to the breadth of AOL Time Warner's offline media products, it could also offer the company an integrated, cross-media marketing program.

Learn new skills
To host sites and offer bundled marketing services, media businesses need to have skills in three key areas. First, they must be able to define--and clearly--the new value proposition being offered, by showing how the value of a consolidated service might outweigh that of a campaign mounted by a consumer products company on its own, buying piecemeal.

Media businesses will also need to have sales forces that really understand the new services, as well as how to communicate their value to potential customers and to negotiate contracts for them.

Media businesses will, as well, have to transform the sales process, for in the beginning the media buyers at advertising agencies--whose job it is to purchase ad pages in magazines and ad time on television for their clients, the marketing companies--will not be expected to negotiate these complex deals and have no genuine incentive to do so. As a result, AOL, for example, negotiated the bottle-cap promotion program directly with high-ranking executives at Coca-Cola.

Create tiers of value
Finally, incumbent media companies must capture a kind of value that has largely eluded them: the sale of tiered value bundles, similar to the Green, Gold, and Platinum offerings from American Express. For traditional publishing companies, as well as for companies such as CNN and MTV, this opportunity is far more valuable than chasing online advertising dollars. We would go so far as to say that the creation of tiered value propositions for consumers may be the biggest opportunity that media brands have missed so far.

For more insight, go to the McKinsey Quarterly Web site.

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