Digital Advertising Industry and its Correlation to Economic Growth

Author: Aditya Raghunath

Estimated read time: 7 minutes

Publication date: 6th Aug 2020 12:27 GMT+1


The emergence of the internet in the 90s laid the foundation for the digital advertising industry in 1996. The digital ad industry offered solutions that no other medium (TV, print, radio) offered. Digital ads offered flexibility, cost-effectiveness, targeted audience, global reach, and tracking of advertising effectiveness. This cost-effective approach creates a level playing field.

A young entrepreneur can compete with the big boys by creating a targeted ad campaign and acquire customers by minimizing marketing costs. Digital ad spends and effectiveness can be tracked in real-time. This helps a company gauge the usefulness of an ad campaign or the changes required to make them successful over a period of time.

Such unique solutions drove the industry’s revenue from just $130 million in Q1 1997 to $29.9 billion in Q2 2019, according to IAB's Internet Advertising Revenue Report.

Digital or online advertising allows companies to leverage their online presence and internet technologies. Enterprises can now deliver targeted and promotional ads to potential customers via a range of tools and platforms.

The digital ad space expanded from display ads to search ads to social ads and created some of the world's biggest companies Google (NASDAQ: GOOG, NASDAQ: GOOGL), Facebook (NASDAQ: FB), and Amazon (NASDAQ: AMZN).

With the number of internet users exploding in the past decade, companies are increasingly reliant on digital ads to reach consumers. In the U.S., digital ad spend will outpace traditional ad spend for the first time in 2020. According to a report from Digital Media Solutions, while the total ad spend will rise 6.5% in the U.S. this year, digital ad spending will increase by 12.4% and account for 53% of total ad-spend.

In the above chart, we can also see how spending on digital advertising is estimated to reach $517.5 billion by the end of 2023.

However, the ongoing COVID-19 pandemic might negatively impact enterprise spending this year. Ad spending is directly proportional to economic conditions. In an economic boom, businesses spend more on advertising to boost revenue. The opposite is true in an economic downturn.

The Great Recession of 2008-2009 was the only time when the U.S, digital ad spending fell by single digits, according to eMarketer.  The total media ad-spend grew swiftly in 2010 as the economy started to stabilize. After 12 years, history is repeating itself.  

 

COVID-19 pandemic slows ad spending

As the world grapples through the COVID-19 pandemic and people stay-at-home, they are spending more time on digital platforms. But this increased traffic is not translating into higher ad revenue for digital advertisers. This is because operations of the biggest ad spenders have paused.

Revenues of airlines, automotive, travel, hospitality, and non-retail companies have nose-dived, and they are struggling to stay afloat. With no revenue growth in the vicinity, they have adjusted or paused their ad spend. According to the IAB survey, digital ad spend is down 33% for March to June period.

A glimpse of the COVID-19 impact was visible in the first-quarter earnings of Google and Facebook, which together account a significant portion of the U.S. digital ad market. But the impact will be more prevalent in the second quarter as ad spend will decline throughout the quarter. The two companies have refused to give earnings guidance due to the uncertainty around the duration and impact of the pandemic.

 

Google – the biggest digital advertiser

Google is the world's largest digital advertiser and earns over 80% of its revenue from advertising. In 2019, the company earned $135 billion in advertising revenue. It offers advertisers the most comprehensive platform where they can reach out to a broad audience, real-time. Their ads appear on Google search engine and other platforms like Gmail, YouTube, Google Maps, Google Play, and network members' properties.

Google earns revenue by charging for every paid click. Hence, its advertising revenue is a product of paid clicks and cost per clicks. Paid clicks revenue is subject to an increase in online traffic and cost per click revenue is dependent on the number of advertisers and their ad-spend. The COVID-19 pandemic increased its paid clicks but decreased its cost per click as many clients reduced their ad-spend.

In the second quarter, Google's revenue fell 2% YoY (year-over-year) to $38.3 billion and the stock fell 5% on the back of this decline. In the 2008 crisis, Google’s stock fell 57% as its ad revenue was hit by the downturn.  However, the stock recovered and grew nine-fold between 2009 and 2019.

Google stock has returned 10.7% year-to-date and while it has underperformed the NASDAQ (up 21.7%), it managed to beat the S&P 500 that has gained 2.2%.

 

Facebook and Amazon

Facebook is a better platform for video ads that are displayed on major social platforms like Instagram and Facebook. These platforms generate more qualified leads with its curated communities and targeted ad space. Unlike Google which has more diverse revenue streams, Facebook earns 98% of its revenue from advertising. In 2019, its ad revenue stood at $69.6 billion. 

Facebook's revenue was stable in the first three weeks of April. However, the company had warned that its business would be significantly impacted by the COVID pandemic and the resulting economic downturn and currency fluctuations. Hence, it did not provide any earnings guidance. 

This is the first economic downturn for Facebook. It will survive this downturn with $60 billion in cash reserve.

Amazon is largely known for its e-commerce business but it earns about 6% of its revenue from the advertising business, which comprises of search, display, custom ads, and demand-side platform. In 2019, its advertising revenue stood at $14 billion, making it the third-largest digital advertiser. 

Amazon’s major advertising revenue comes from product search ads on its e-commerce platform, which helps brands to connect with customers directly. The company is gradually taking some share of the search ad spending from Google. The e-commerce giant is expanding its ad business to over-the-top video ads.

Even Amazon saw a pullback in ad-spending amidst the lockdown, which was offset by strong traffic on its e-commerce site. Amazon stock has been making new highs at the height of the pandemic as its e-commerce and cloud businesses were the biggest beneficiaries of the lockdown. 

 

What next for the digital ad space

The world is currently at the height of the pandemic, and major economies have imposed a lockdown. By the time the global economy reopens, many companies would be out of cash, most people would be unemployed, and consumer spending would be low. Any economic recovery would only begin after mid-2021, said Kristalina Georgieva, managing director of The International Monetary Fund.

The economic weakness will reflect in digital ad revenue. According to FT Alphaville, MoffettNathanson expects Google's and Facebook's digital ad growth to decelerate in the coming two quarters and not normalize before the second quarter of 2021. According to the IAB survey, 74% of respondents believe that the COVID-19 crisis would be worse than the 2008 crisis in terms of U.S. ad spend. 

Facebook, Google, and Amazon are tech behemoths and accounted for 22.1% and 37.2% and 8.8% of the US digital ad market. While ad sales might fall in the first nine months of 2020, these companies have enough reserves to tide over the downturn.

The digital advertising revenue has been growing double-digit in the last decade. Even though the COVID crisis is hampering growth in the near-term, the industry has a bright future in the long-term as global businesses restart ad-spending. 


Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.com. The observations he makes are his own and are not intended as investment or trading advice.