Marketing is so central to economic life that if you suggested otherwise to anyone who’s ever run a business, they’d think you were having a bad hair day. But someone forgot to tell economists. I did two economics degrees and it was barely mentioned (OK, that was a fair few years ago). Even nowadays, the extensive literature on advertising is a more or less self-contained area of economics. And, though entire universities are devoted to marketing, that discipline is mainly about how to do it, not what it does to the general economy.
GAF rules the world
So the economists’ toolbox didn’t help me much when I started trying to understand how Google affects the macro economy, which it must do, because it’s so vast. Google’s business model was founded on advertising revenues (even though parent Alphabet has since diversified), with Facebook and Amazon following.
A Faustian Bargain: You make more profits, We take them away
The impact of these online giants is often seen in terms of taking ad revenue away from old-fashioned media like newspapers, as well as privacy issues. But their effect is far wider, on almost every business in the whole economy, in a kind of Faustian bargain.
Onine adverts have revolutionised marketing, with vastly improved targeting, immediacy and feedback. That tends to boost profits and business efficiency throughout the economy. But the other side of the bargain is that those ads are priced by online auctions at a level that identifies those extra profits and transfers most of them away from the businesses actually selling stuff, and into the bottom line of the GAF.
The Prices of Online Ads
To understand this, look at how (some) online ads can be priced. Let’s say you are an insurance company, and you want people who type “car insurance” into a search engine to go to your website. “Car insurance” is an example of an ad-search “keyword”, which could be almost anything, such as “muesli” or “flight to New York”. You want your ad displayed prominently in the search results, so you place a bid in an online auction.
The system can then work as follows. Your website is checked and deemed relevant, and you are the highest bidder, so your ad is displayed in the most prominent place in the results. Every time someone clicks on it, you pay the amount bid by the second-highest bidder. Suppose you bid $45 per click, and the next highest bid is $40. Then, for the next 24 hours (or other agreed period), if 1,000 people click on your ad, you pay $40,000.
Studies suggest this hypothetical $40, though it may intuitively seem high, is the right ball-park for some of the most sought-after keywords in areas like insurance and autos. How do these prices come about? Of course, online search is dominated by one big player, Google. Advertisers who go to other search engines, like Microsoft’s Bing, reach only a tiny fraction of consumers. When there is one dominant seller, theory suggests that it can charge a monopoly price (or close to it), which will be higher than the competitive price, perhaps much higher.
$40 a Click?
But, why would anyone want to pay $40 for a click? Suppose that 5% of those 1,000 clicks (ie 50) lead to someone taking out an insurance policy, which they renew several times, and let’s say the total expected future profits are $1000 per policy. That’s a total of $50,000, which is $10,000 more than was paid for the clicks. So the insurance company is happy, sort of, since they made some money. Their marketing campaign got a shot of accurately targeted adrenaline.
But from a more macro view, things don’t look quite so rosy. The search engine got four-fifths of the profit from those insurance policies, the insurer kept one-fifth. OK, this is a made-up example, but it captures the essence of an auction: the value (monetary or emotional) that the winner gets from the thing they buy can be next-to-nothing, once the price paid is deducted. Auctions where the price is set at the second-highest bid, like this example, ensure that some value is always left for the winner, though it still may not be much.
Why the Tech Boom Happened
The results of all this, of course, have driven a multi-year trend in stock markets. The GAF have dominated more and more, alongside a handful of other tech giants their share prices have outperformed almost everything else as they take a larger and larger share of total profits in the economy. The Covid lockdown gave this long-term process another big push forward (though the prices stumbled in early September).
Monopoly Good, Monopoly Bad
It’s been a great run for investors. But it’s difficult to see that this is good for the overall economy. And, capitalism has a way of eventually squeezing out things that get in its way.
Of course, monopoly profits, for a while, are an essential and healthy part of the capitalist process, to reward innovative companies for their risk-taking and investment. But it becomes unhealthy when those profits persist long after that reward has been paid, and especially when their impact is felt not just in one narrow sector of the economy, but across the whole of it. This example feels especially unhealthy because it affects marketing, which is itself such a core part of capitalism.
Governments don’t look set to address this anytime soon. Even the countries that have started to regulate the tech giants, notably the European Union, India and Australia, have not focused on advertising. So, will the capitalist system itself start to erode the monopoly profits, via increased competition?
Competition: A Slow Start, but it’s Coming….
Fifteen or so years ago, online advertising more or less meant Google. As Facebook developed ads on its social media channels and then Amazon expanded its marketing offering, and as a plethora of smaller online choices emerged, a form of competition has developed, moderating Google’s earlier exponential growth in ad revenue.
But this competition is still limited. One reason is that the three big channels are complementary rather than alternatives: a search engine does not compete directly with social media. The other reason is that the GAF control many of the brokers that give access to “independent” channels such as banner ads or in-game ads.
Nor have China’s own tech giants provided head-to-head competition, with Baidu’s search engine focussed on China and Alibaba focussed on wholesaling. The one exception is TikTok’s video-sharing platform, which has seen rapid growth in the US and elsewhere with online ads that offer clear competition to Facebook. Far from welcoming this competition, the Trump Administration has challenged TikTok’s US operations, so it has started discussions for a possible sale, with the leading (joint) bidders being Microsoft and Walmart; Beijing is not pleased.
Walmart in 2020: Three’s Company, Four’s a Crowd
Meanwhile, Walmart’s promotion of third-party ads on its US website has seen it emerge as a significant challenger to the big three (especially Amazon). This challenge would be given an enormous boost if it were able to buy TikTok’s US operations, potentially leapfrogging this fourth platform to a serious position of strength. And, when measuring market power, to paraphrase a well-known saying: three’s company, four’s a crowd.
This acquisition may or may not happen, but that’s not really the point. The Walmart strategy, with or without TikTok, demonstrates what ought by now to be blindingly obvious to any company with a reasonable online presence: why stop at selling your own products?
I’m based in the UK and when I go on a website like John Lewis, it seems crazy that this venerable but struggling department store is not selling space on its site for third-party products that complement its own offerings. Same for Galleries Lafayette in France, Co-op in Switzerland or whatever. Some sites, notably some airlines (remember those?) are doing this, but overall the eyeballs visiting many sites are a grossly under-monetised resource.
In the aftermath of Covid, with online traffic so greatly increased, all this may change rather rapidly. Many companies with a strong eyeball count can start to offer ad space and cross-sell products. This won’t change the big picture much, if they sell ad space through brokers controlled by the big three. But as they grow, and deal directly with advertisers, or use independent brokers, they will start to make the online ad market much more competitive.
A Whole Family of Amazons
In effect, the web can start to look like a whole family of Amazons, each with their own ads and cross-sales, and their own internal search engines. As the choice of targeted ad channels widens, prices for those ads will come down. Walmart is moving along this road; watch for European retailers going the same way.
Google, Amazon, Facebook: End of the Ad-Boom
Ad profits are big for the GAF, even with their other large revenues like cloud services and logistics. So, the accelerated shift to online business during Covid may turn out a double-edged sword for them: great for their profits in the short-term, but so profound that it will shock older players into changing business models faster than otherwise, bringing new competition to the online ad world. As ad rates come down, it’s difficult to see the GAF’s incredible share price run continuing.
And, some of the profits that they have been earning from those ads can flow back to the companies that generated them in the first place.