95% Of Pure-Play Online Companies Will Fail, Says McKinsey

An active audience Offline, advertising is primarily interruption-based; online, interruptive ads do more harm than good and other ads are largely ignored by users who approach the internet in a much more active way than viewers relate to television, for example.

The effects that these differing audience dynamics may have on the future of television, as it moves towards greater ‘interactivity’, are discussed in recent Insight Analysis: Should Advertisers Fear Digital Video Recorders?.

Whilst interruption-based advertising may become more appropriate as broadband content develops, not all media companies have content that lends itself to such advertising. Those that don’t, says McKinsey, must look to other marketing and cross-selling opportunities to increase their revenue.

Major incumbents – such as Disney, NBC and Dow Jones – have the financial resources to absorb short-term losses in the search for long-term audiences, but pure online companies do not. As a result, McKinsey predicts that 95% of pure-play internet companies will have failed in under two years.

Shifting economics The economics of the offline and online worlds are not the same, the report notes.

The basic economics of media require a greater demand than supply. Offline this is the case: the high costs of entering print or television mean that there are relatively few players. This creates demand from advertisers and larger audiences from the public.

Conversely, in the online world, there are a vast number of media ‘outlets’, being served by a limited and finite pool of advertising money and being used by an extremely fragmented and ‘active’ audience (which largely wants to ignore the ads anyway). This, says McKinsey, is unsustainable, as the table shows.

Banner ads have proven ineffective, says the report, with click-through rates falling ever lower. Most big advertisers ignore the web completely; the top ten Fortune 500 companies accounted for just 2% of advertising on the Net in 2000.

“Faced with such economics, even sites that deliver plenty of traffic can’t attract the revenue needed to cover their fixed costs,” says McKinsey Quarterly. This is illustrated here.

Contextual advertising, consolidation and cost-cutting McKinsey says that the only sites that are showing any healthy revenues from advertising are those which provide genuinely contextual ads, preferably delivered at the point at which the user is researching a purchase.

Some online media companies have content which is focused enough to allow contextual advertising to work, particularly those which sell specific products. Some, like magazine or news sites, do not. In the latter case, advertisers still prefer ad-based offline media, says McKinsey.

The report also points to the benefits of consolidating online businesses together, or with offline companies, in order to reduce costs.

Riches don’t come overnight Media companies must be patient with their online investments, advises the report. “The fast riches of the internet boom may have led many people, media executives included, to develop false expectations about online investments.”

McKinsey says that advertisers are very slow to move their spending from one medium to another and as a result acceptance and profits from online investments will take time to develop. Even then, only a small number of companies will succeed.