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EDC 0124 Online Advertising 5 Jan14 Nexttofinalediteddraft
EDC 0124 Online Advertising 5 Jan14 Nexttofinalediteddraft
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Online Advertising
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Hairong Li
Michigan State University
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Abstract
This entry provides an overview of online advertising, focusing on its growth over a fairly short
period of time to become a major category for advertising spending, the various forms online
advertising takes, the measurement of online audiences, mechanisms for pricing online ad
inventory, and the new players that have emerged and the institutions that have developed to
serve the market for online ads.
Keywords
Introduction
Online advertising, or Internet advertising, is the practice of delivering marketing
messages to users through the Internet, either by email or via web-based services. Reflecting the
flexibility of the medium, online advertising takes a diversity of forms, varying from simple
display ads that have obvious offline counterparts to search advertising for which there is no
close analog in traditional media. Although the Internet was not fully opened to commercial
activity until 1995, spending on the various online advertising platforms already exceeds that for
any other medium in the United States, accounting for $36.6 billion, or 22.2 percent, of total U.S.
ad spending of $165 billion in 2012 (eMarketer 2013a). While North America is still the largest
regional market for online advertising, online ad sales have also grown rapidly elsewhere in the
world, most notably in the Asia-Pacific region and in Western Europe, as can be seen from Table
1.
This entry provides a brief overview of online advertising, the forms it takes, the
institutions and services that make the market for online ads work, factors that have contributed
to its remarkable growth and its impact on the advertising industry as a whole.
Types of Online Advertising and Their Growth Over Time
As the online advertising industry has developed, the number of ways in which online ads
might be used to promote advertisers’ products has grown. Online advertising services are
classified as belonging to one of six broad categories. The annual division of industry revenues
among the six formats from 1998 through 2012 is presented in Table 2. As the table shows, most
of the growth in online advertising sales has occurred since 2000 and different categories became
prominent at different times. For example, nearly all of the growth in mobile ad sales, which
currently are growing very rapidly, has occurred from 2010 onwards. Each of the six formats is
described below, roughly in the order in which they started to generate substantial revenues.
E-mail advertising is the delivery of advertising messages by email. Email ads may
accompany other messages in an email or may comprise the entirety of an email. Email
advertisements may also contain links to websites where further information and promotional
messages are provided. The very first online advertisements were emailed ads. The predecessors
of the Internet, ARPANET and NSFNet, had acceptable use policies that banned their use for
advertising. Nevertheless, the first emailed advertisement, which was used to promote computers,
was sent to American West Coast users through the APRANET in 1978.
Display advertising shows directly on the websites of web publishers of online services
that populate their sites with content designed to attract audiences. Among other things, text,
logos, animations, and videos may be employed to convey an advertiser’s message. Display
advertising started in the 1980s with Prodigy, a pre-commercial Internet subscription service
available only to its subscribers. Prodigy was owned jointly by IBM and Sears and displayed
advertisements for Sears on its home page. These ads were static images and not clickable. There
is some dispute regarding when and where the first clickable online advertisement appeared. The
founder of Global Network Navigator (GNN), Tim O'Reilly, claimed that the first clickable ad
appeared on his website in 1993, but Kaye and Medoff (2001) date the first clickable ad to 1994
when Hotwire sold its first banner advertisement. These early clickable advertisements could be
very effective. For example, AT&T’s first clickable ad had a 44 percent click-through rate
(Morrissey 2013).
The online advertising industry currently identifies two broad categorizes of display
advertising: “Run-of-site” and “Targeted”. “Run-of-site” advertisements are displayed to anyone
who visits a website. Advertisers who want to reach broad audiences often choose this kind of
advertisement. With targeted advertising, different visitors to a website may see different ads
because the ads delivered to each visitor are selected based on information the website’s owner
or a third party supplier has about the visitor. IP (Internet Protocol) addresses and Cookies are
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common mechanisms for collecting data about a user's characteristics and interests. IP addresses
convey geographic information about their users, while cookies can be used to track websites
visited and search behavior, both of which may convey information about a user’s product
interests.
Online classified advertising services provide lists of advertisements organized by
product and service categories. Private companies and other organizations trying to fill positions
with job postings and real estate brokers are major buyers of classified advertising, but
individuals may also pay for the opportunity to place ads as may be observed in the personals
sections of these services. Craigslist, which was founded in 1995, is probably the best-known
supplier of online classified advertising inventory.
Search advertising appears on search-results pages either to the right or above the listings
for organic search results that are called up when an individual using the search engine types in
one or more keywords or a more general search query. Paid ad slots above the organic listings
are more valuable than those to the right of organic listings, and advertisers pay more for ads
higher in the column of paid listings on the right side of the search screen. Advertisers bid for
positions with prices determined through a general second price auction that weights bids by
predictions for clicks the ads will generate and then assigns slots to bidders based on a ranking of
their clicks-weighted bids. Bidders assigned to each slot pay the price of next highest bidder.
Search advertising was the largest of the online advertising categories in 2013, but its
current prominence could not have been predicted from its early beginnings. The first search
engine, named Archie, which was introduced in 1990, was designed to help Internet searchers
find files with titles that contained keywords entered by the searcher on one of the small number
of computers connected to the pre-commercial Internet. Searchers could open such files remotely
and check their contents to see if they contained the information sought. Archie served the needs
of many of the techies using the Internet at the time, but it took over a decade of experimentation
with different mechanisms for organizing search results and pricing advertising inventory before
search advertising sales really took off. Search engines started to incorporate results ranking
systems starting around 1994 when Infoseek, AltaVista, Webcrawler and Yahoo! Directory were
launched. But search services did not settle on the now standard approach of ranking webpages
by the numbers of other sites that established links to them until after this ranking principle was
introduced by Google in 1996 (Battelle 2005). The generalized second price auction mechanism
now employed by all the major search engines was introduced by Google in 2002 (Edelman,
Ostrovsky, and Schwarz 2007).
Mobile advertising, which is the delivery of marketing messages through wireless mobile
devices, such as smart-phones and tablets, is a relatively new and fast growing advertising
category. According to the Walker Sands Quarterly Mobile Traffic Report, visits originating on
mobile devices accounted for 28 percent of total website traffic during the third quarter of 2013
(Walker Sands Digital 2013). The shift has been even greater for the email component of Internet
traffic. The marketing and analytics testing company, Litmus, reported that for the United States,
43 percent of emails were opened with mobile devices in December 2012 (Jordan 2013).
Although it is not Internet advertising, it is worth noting that mobile advertising may also be
delivered via Short Message Services and Multimedia Messaging.
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Lead generation refers to the efforts of third party services to identify attractive targets
for advertisers’ messages. Lead generators are typically paid by the lead. While lead generation
has been an established practice with traditional media for a long time, it now occurs online as
well. To generate leads, online lead generation services rely on a combination of information
volunteered by Internet users, as often is required when a user signs up for a new online service,
and information acquired by tracking users’ online activities.
Sources: Compiled from Interactive Advertising Bureau, Internet Advertising Revenue Reports,
1999 – 2013 inclusive, full year results, conducted by PricewaterhouseCoopers, at
http://www.iab.net/research/industry_data_and_landscape/adrevenuereport
Data collected in this manner is often combined with information Internet users voluntarily
supply when they sign up for online services or respond to online surveys to create profiles
reflective of users’ interests. These profiles are then used to select the recipients of specific ads.
Access to this data and real time connections to individual Internet users allow online publishers
to achieve more precise and sophisticated tracking and targeting than is possible with traditional
media.
A second advantage of having direct two-way connections to individual Internet users is
that it is possible to construct individual-level measures of audience members’ responses to ads
for which there are no close analogues in traditional media. This is possible because data is
generated on a server every time an Internet user opens a page containing an ad or clicks on an
ad. Actions for which advertisers may be charged include impressions, clicks, form submissions,
information requests, and purchases.
Setting Prices for Online Ads
As in markets for other goods and services, a variety of mechanisms may be employed to
determine the prices at which transactions take place. For online advertising, the four most
commonly employed mechanisms for pricing online advertising inventory are first price
negotiations, first price reservations, first price auctions, and second price auctions (Yuan,
Abidin, Sloan, and Wang 2012). First price negotiation refers to one-on-one negotiations
between an advertiser and a supplier of advertising inventory. Prices determined in this manner
are typically formalized in a sales contract. Publishers also sell some inventory on a first come-
first served basis at fixed pre-set prices, often to advertising networks (described in more detail
below). This process for setting prices is referred to as first price reservation.
With first price and second price auctions, advertisers bid for opportunities to advertise
with various types of online outlets. First price auctions and second price auctions differ in how
the prices paid by winning bidders are set. With first price auctions the bidder offering the
highest price wins the auction and pays the amount bid. The bidder offering the highest price
also wins a second price auction, but in this case the winner pays the price offered by the second
highest bidder. An important difference between first and second price auctions is that a bidder’s
best strategy is to bid her true valuation in a second price auction, while with first price auctions
there is an incentive to offer a bid less than an item’s value to the bidder on the chance that a less
than full valuation bid will still win. The search engine, Goto.com, was the first company to use
a first price auction in 1996. Google introduced the generalized second price auction in 2002 to
avoid the instability in bid prices created by advertisers’ attempts to strategically place less than
full valuation bids in first price auctions. The type of second price auction employed by search
engines is referred to a generalized second price auction because bids are used to determine the
assignment of multiple ad positions on the same search page by assigning the second highest
bidder the second most desirable placement, and so on for successively lower bids (Edelman et al
2007), while the simple second price auction describes the bidding process when only a single
item is up for bid. While the generalized second price auction has become standard for the sale of
virtually all search ads, first price auctions with real time bidding are still used to set prices for
display advertising. The search engines use per click bid prices weighted by the number of clicks
an ad is predicted to generate to rank bids because the revenue a search ad generates for a search
engine is its per click price multiplied by the number of times it is clicked.
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by individual online ads. Like the advertising networks and publishers that generate various
measures of their own audiences, audience measurement services use cookies to track Internet
users, but they may also use panels of users who have given their explicit permission to have
certain of their online activities tracked for more extended periods of time to gather additional
information about internet audiences.
Agencies draw on in-house expertise to advise advertisers on the design of advertising
campaigns and the creation of advertising content. Advertising agencies have always provided
these services, but they have been forced to develop new expertise to advise clients on the design
of Internet campaigns, the creating of content for Internet ads, and the integration of Internet
options with traditional media to better serve advertiser objectives. While there are advertising
agencies that specialize in Internet advertising, the major advertising agencies have all added
online components to the services they offer clients. This is one of the ways the advertising
industry has adjusted to the emergence of online advertising options.
The Impact of Online Advertising on the Advertising Industry as a Whole
The most obvious effect of online advertising on the advertising industry is the
emergence of a whole new category of advertising that, starting from virtually nothing 20 years
ago, is now one of the largest advertising categories worldwide and the largest category in North
America. The financial dimensions of this growth were reported at the beginning of this entry.
Not surprisingly, this development was accompanied by the entry of new players and substantial
changes in the institutions and practices that coordinate relationships among industry players. It
is also clear that this process of change is far from over, partly because the industry is still
figuring out how the various types of online advertising might be used in conjunction with ad
campaigns in traditional media.
There are still only a few studies examining the budgeting decisions that advertisers
must make in determining how much to spend on online media and how to allocate an
advertising budget between online and offline channels (Silk, Klein, and Berndt 2002). Most
economic studies (e.g., Bergemann and Bonatti 2011) treat online and offline media as
substitutes for each other in the sense that they are alternative ways to deliver messages to
potential customers. However, there are marketing studies that suggest that online and offline ads
may be complementary because each can reinforce the effects on audience generated by the other
(e.g., Naik and Peters 2009). Empirical studies have found evidence for both substitutability
(e.g., Goldfarb and Tucker 2011) and complementarity (e.g., Zigmond and Stipp 2010).
More obvious are changes in industry practices, institutions, and the mix of players.
Driven by advancing information and communication technologies and technological
innovations within the industry, the shape of online advertising has been in constant evolution,
from banners, search ads and rich media to sponsorships, promoted posts and native advertising.
To maintain order in the highly competitive digital advertising marketplace and increase the
efficiency with which online ads are bought and sold, a new body of knowledge has emerged
which has informed the development of online advertising standards, guidelines, and best
practices. A key institution has been the Interactive Advertising Bureau, which, since its
establishment in 1996, has worked with member firms to develop and publish guidelines and
standards covering matters varying from the units in which interactive ads are sold, ad
verification and digital video definitions to social media advertising, real-time bidding and
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SEE ALSO: Data Mining and Marketing; Electronic Commerce Recommender Systems;
Monitoring Online Behavior and Marketing; Online Consumer Behavior
The Search Engine Marketing Professional Organization. 2011. "State of Search Marketing
Report 2011," accessed November 15, 2013,
http://c.ymcdn.com/sites/www.sempo.org/resource/resmgr/members_only/sem_sos-res_11.pdf
Walker Sands Digital. 2013. "Walker Sands Mobile Traffic Report Q3 2013. Study: Percentage
of Mobile Traffic Websites Visits Up Year over Year, iPad Market Share on the Decline,"
accessed November 15, 2013, http://www.walkersandsdigital.com/Walker-Sands-Mobile-
Traffic-Report-Q3-2013
Yuan, Shuai., Ahmad Zainal Abidin, Marc Sloan, and Wang, Jun. "Internet Advertising: An
Interplay Among Advertisers, Online Publishers, Ad Exchanges and Web Users." Cornell
University Library, 2012.
Zigmond, Dan, and Horst Stipp. 2010. "Assessing a New Advertising Effect: Measurement of
the Impact of Television Commercials on Internet Search Queries," Journal of Advertising
Research, 50: 162–168.
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