We May Be Overestimating the Digital Advertising Opportunity

Time spent on mobile isn't worth as much as time spent watching television. Image: Facebook.

Mobile is eating television. Americans spend 24% of their time consuming media on mobile devices, according to KPCB analyst Mary Meeker. And while they still spend more time consuming television (37%), those numbers are trending in opposite directions.

The ad spend on mobile, however, has yet to catch up, considering 41% of ad budgets still go toward television, while just 8% goes toward mobile.Meeker believes that the gap between time spent on mobile and its share of ad dollars represents a $25 billion opportunity. But while the biggest growth driver for companies such as Facebook and Alphabet may be the shift in ad dollars from television to mobile, it's unlikely that those companies will win ad spending from television at a 1-to-1 ratio with time spent on each platform.

In other words, for each ad dollar shifted from television because people are now consuming media on the Internet, Facebook and Google will only see something like $0.90 of it. The advertiser will retain the other $0.10, or it will be spent elsewhere.

Getting more for lessWhen an advertiser shifts money from television to digital, a couple of things happen. First, it decreases the total demand for television advertising inventory. That reduces the price per ad on television shows -- a trend we've seen for several quarters now.

Second, that advertiser will look to produce similar results to what it got from TV advertising. It can often do so for less money than it pulled from TV, considering the amount of time spent on digital and mobile continues to rise, increasing ad inventory, and advanced targeting makes digital advertising extremely cost effective, reducing demand for inventory. Consider that a television show could have multiple bidders targeting different audiences. That doesn't happen often on digital.

While businesses want to maximize their ad dollars to produce the most customers, there comes a point where marginal ad dollars spent on digital are no longer worth the money. If a company is already targeting everyone who fits into its target market, expanding targeting wouldn't produce good results. At that point, continuing to shift ad dollars to digital, regardless of how much time is spent on the Internet, is no longer an effective use of ad money.

Considering this dynamic, the amount spent on advertising will decline over time.

But ad spend is still growingHowever, that scenario assumes that the number of advertisers remains constant. Of course, we live in a capitalistic society where new businesses and products are being created every day. As a result, the total number of advertisers is growing, offsetting the decrease in ad inventory demand created by the effectiveness of digital advertising.

For an advertising company to succeed, it must attract business to its platform at a rate that offsets the increase in ad inventory from more time spent on its platform.

Facebook has done an excellent job of doing so over the last several years. Facebook now counts 2.5 million businesses as advertisers and has 45 million businesses on its platform. Over the past 18 months, active advertisers have grown 67% compared with user growth of 17%. As a result, average ad prices have increased substantially despite constant improvements to its ad efficacy.

Google, meanwhile, has seen its total users grow and its advertisers remain relatively steady over the past few years. More importantly, it has seen usage increase dramatically because of the rise of mobile devices. As a result of this increased usage, Google has seen its average ad prices decline as inventory outstripped demand. (The effectiveness of mobile ads compared with desktop also played a role.) Offsetting that decline in ad prices has been a huge spike in total ad impressions afforded by the increased usage.

Television, meanwhile, is stuck with a shrinking audience while total potential advertisers remain relatively steady. As a result, ad prices are down and total ad spend is down. Some networks have tried increasing the number of ads they show to offset price declines, but many are backing away from that tactic because of the negative impact it has on viewership.

What should investors make of it?Television networks are surely in trouble as more people cut the cord. For networks to succeed, they need to innovate by developing new forms of more effective advertising, or figuring out how to insert more advertising into a time slot without negatively affecting viewership. The other option is to improve other forms of monetization.

Meanwhile, Google and Facebook investors expecting digital advertising to eventually monetize their audiences at the same rate as television ought to reassess that assumption. It's unlikely that an hour of browsing Facebook is worth the same as an hour of watching TV because of the cost effectiveness digital advertising offers. Still, the strong growth in time spent on mobile and the Internet in general means that both companies will continue to see strong revenue growth for the foreseeable future. It just won't be in line with the ad revenue contraction from the television industry.

The article We May Be Overestimating the Digital Advertising Opportunity originally appeared on Fool.com.

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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