Investors began to cool toward such ad-supported Web sites when so many dot-coms closed shop this year, causing online ad spending to taper slightly after years of unprecedented growth. Even companies such as RealNetworks, which makes Internet media player software, are feeling the effects. Last week the company became the latest to warn of slower earnings and revenues growth.
But the slumping share prices are incongruous with the industry's positive growth over the last year. According to Jupiter Media Metrix, online ad spending in the United States will reach between $6 billion and $6.4 billion this year--up from previous estimates of $5.4 billion and nearly 40 percent more than last year's total.
So what went wrong?
Some say Internet advertising just doesn't work, but others say the industry is healthier than ever. Although the truth lies somewhere in between, the market remains under pressure on three fronts: continuing challenges in the technology sector, an overall slowdown in the advertising economy, and widespread skepticism about the effectiveness of online advertising.
Looking back, Internet companies dropped millions on online and offline advertising early in the year, as well as a smattering of "extreme" marketing promotions--a signature of dot-com style during the industry's salad days. But for so much capital with little or no return, once-generous investors soon turned sour toward dot-coms operating without a solid business or a quick path to profitability.
"It was 90 days of euphoria that led to nine months on the trash heap," said Lanny Baker, an online media research analyst at Salomon Smith Barney.
During those nine months, dot-coms died off or restrained ad spending. Start-ups Pets.com, Boo.com, Toysmart.com, Productopia.com and a laundry list of others shut their doors once the money ran out and funding was unavailable. The loss of ad dollars put the squeeze on content-related sites that rely on ad sales, including Women.com and NBCi, which have both been forced to restructure and cut staff.
Other dot-com advertisers began reevaluating their multiyear, multimillion-dollar portal deals when money got tight. Start-ups such as Drkoop.com, VitaminShoppe.com, CDNow and 1-800-Flowers.com are just a few of the companies that renegotiated their contracts this year with major Web companies.
Such factors contributed to worries about online ad sales for Internet stalwarts, including Yahoo. In the summer, Wall Street analysts began questioning whether the effect of the dot-com fallout would manifest itself in Yahoo's earnings statements.
"What made the trash heap stink more and more: As there was more dot-com wreckage, there was less pressure on traditional companies to spend to compete. The house was no longer on fire," said Baker, who covers such online media companies as AOL, Yahoo, CBS SportsLine, DoubleClick and CNET Networks, publisher of News.com.
These concerns dented Yahoo's steely image and sent its share price to a 52-week low by the end of the year. Despite this, Yahoo reported third-quarter profit and revenue that slightly exceeded analyst expectations in October.
Nevertheless, the concerns reverberated throughout the industry. Engage, DoubleClick and 24/7 Media, as well as other small online ad networks and agencies, underwent tidal shifts in the fall, cutting staff, juggling management, and playing defense while earnings missed their targets. Waning demand also hit companies that provide advertising and marketing services, including Lot21, iXL Enterprises and MarchFirst.
But some say this is merely a Chicken Little syndrome.
"Everyone wanted to blame the problem on click-throughs, banner ads, return on investment, privacy," said Baker, but people overlooked the obvious problems in the tech sector: closures and cutbacks on marketing budgets. "Many people want to talk about these theories--whether it works or it doesn't work--more than they wanted to look at the bigger picture."
Baker said the doubting attitude is reminiscent of the early days of cable. Before cable giant Ted Turner commissioned studies that supported the viability of cable advertising, it didn't take off.
"At the end of the day, what's most frustrating is the skepticism of the medium is not well-researched," Baker said.
Adjusted for inflation, Web ad sales have outpaced comparable growth for broadcast TV in its first five years, according to the Internet Advertising Bureau (IAB). They also surpassed outdoor ad sales in total dollars spent in 1999.
Researchers predict phenomenal growth for online advertising. Web ad sales are expected to grow to $16.5 billion in the next four years, making the Internet the fourth-largest ad medium behind television, radio and newspapers, according to Jupiter Media Metrix. Altogether, Net advertising will represent close to 8 percent of the total ad market in the United States by 2005.
In addition, marketers plan to increase ad spending online at a higher rate than on any other medium.
Although these figures are on a steep climb, industry watchers are relatively unimpressed by the levels of growth compared with previous years. Last year, for example, online advertising reached $1.7 billion during the fourth quarter, according to the IAB. In the fourth quarter of this year, spending is expected to reach $2.8 billion, or 65 percent year-over-year growth. By comparison, spending on Internet ads grew 160 percent during the fourth quarter of 1999, compared with the same period a year earlier, according to IAB figures.
Traditional advertisers are expected to pick up the slack and fill the gaps where dot-coms die off--but at a slower pace. Web sites are now trying to work more closely with advertisers to offer more results for the dollars.
For example, Yahoo partnered with Pepsico earlier this year for a campaign that didn't include banners. Instead, Yahoo built a Web site promoting Pepsi's age-old "under the cap" campaign, exchanging points for shopping bonuses.
There is "more emphasis on melding advertising, direct marketing and promotions to move people through the decision buying process," said Jim Nail, a senior advertising analyst at Forrester Research.
Because the click-through rate for ad banners has plunged, some of the largest Internet media companies have raced back to the drawing board for more effective formats. Microsoft's MSN, CMGI's AltaVista, eUniverse, RealNetworks, Walt Disney and CNET Networks--all freeways for heavy Internet traffic--are among those testing new ad formats beyond the banner. Formats in vogue include larger interactive ads, HTML emails and streamed pop-up ads.
In the second half of the year, dot-coms mostly dropped their big-budget, showy advertising campaigns, focusing instead on online and direct marketing to drive sales. The efforts were less about building awareness and more about building transactions.
Executives and analysts say fourth-quarter Internet ad sales won't be as frenzied as last year and will slow in the first quarter because of the usual sales slowdown after the holiday season in the United States.
"Nothing grows at 100 percent year over year forever," said Forrester's Nail. "The bubble we saw was unsustainable, and that's over. But the doomsayers are wrong. Online advertising is healthier than it's ever been.
"When I start seeing the Pepsis and Cokes start responding and competing with one another, then you know it's about to take of," added Nail, who projects growth next year will be between 30 percent and 40 percent.
In comparison, traditional advertising had a banner year in 2000 with 9 percent growth. But next year, analysts predict growth to slow by half, reaching only about 4.5 percent.
"The only thing that has changed in the world right now is that you don't have the wheelbarrows of cash going from Sandhill Road to Madison Avenue," Nail said.
News.com's Jim Hu contributed to this report.