Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
  • How do you encourage speedier adoption of your product or service?
  • How do you increase the value your product or service creates for your customers?
  • How do you extract more of the value created by your product or service for yourself?

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A copy of the full analysis can be downloaded by clicking on the link at the bottom of this blog entry.

 

In Part 1 of this analysis, I described recent trends in Internet advertising and Internet advertising pricing models. In Part 2, I introduced adblocking and described its use, together with the two major controversies surrounding the use of adblocking software. In Part 3 of the analysis, I described the players and their motivations in the Adblocking Game, and I also presented a model of the Adblocking Game. In this last part of the analysis, Part 4, I discuss some interesting aspects of the Game.

 

Discussion of the Adblocking Game

 

Ad-Based Models Create Misaligned Incentives

A big problem with ad-based business models is that they create incentive misalignments in the business process. More specifically, when a business relies on advertising revenues, it ends up putting the needs and/or interests of Advertisers and/or Users in front of the needs of the business. Ian McAllister explains this in “What's wrong with an ad-supported business model?”

From a user standpoint, the problem with business models where advertising is the primary source of revenue is because it forces you to make trade-offs to meet the goals of advertisers (i.e. your revenue stream) at the expense of your users.

For most online businesses, the end user would be better off if advertisements were replaced with other site content (or white space). Pick any website you please and ask yourself if you would be better or worse off if all the ads (including video pre-rolls) were removed. One exception to this might be Google, where some reasonable segment of users obviously get value from sponsored links.

The best sites look for areas of asymmetry where they can create maximum value for advertisers while taking away as little as possible from users. If your entire business is dependent on ad revenue the temptation will be to cut deeper into user value to generate more value for advertisers (i.e. bigger, flashier ads in more prominent locations).

Tom Foremski explains how catering to Advertisers through Users, by focusing on generating page hits instead of providing good reporting, affects the quality of journalism in “The rise of page view journalism…”

The New York Times motto is: "All the news that's fit to print." Today, many media organizations are following a motto that might be rephrased as: "All the news that's fit to drive views," because that's the pressure increasing numbers of journalists are facing. I get paid on the basis of page views by ZDNet, but I don't let that color what I will write about, I always choose subjects without regard to their potential popularity. That's not true for increasing numbers of journalists because they are under constant pressure to generate page views.



The dirty little secret of journalism's focus on page views is that the value of each page view is decreasing, because the value of online advertising is decreasing. This means it's a strategy that will likely lead to failure. Media organizations need to adopt a multi-revenue business model, or what I call a Heinz 57 model. Multi- revenues means incorporating lead generation, affiliate marketing, custom advertising packages, virtual currencies, and more.

 

The Online Ads Arms Race

As I described in the previous section, “The Online Adblocking Game: Advertisers,” Advertisers’ competition with other Advertisers and with website content has lead Advertisers to continually increase the intrusiveness of ads in an attempt to win the attention and interest of Potential Customers. It’s an ad arms race, and everyone is losing, except for a few scarce companies, like Google, who are actually making any money. An article from Kim Peterson, “Bells, whistles suit ads fine,” describes this phenomenon exactly, from way back in 2001, before ads even started becoming intrusive by today’s standards. Little did she know exactly how bad things would become. And ads don’t seem to work any better today than they did back then – the click rate is still the same one-half of one percent in 2014 as it was in 2001.

Had enough of Internet ads? Just wait.

They're getting bigger, flashier and more animated. They come with their own soundtracks. They're moving to the middle of Web sites or popping out into separate screens.

Anything to get your attention.

After struggling for years to attract the eye of computer users, Internet advertisers are finally admitting they went about everything the wrong way.

They say the banner ad -- the rectangular header that has become the de facto online advertising standard -- doesn't work.



Companies spend billions of dollars each year selling themselves on the Internet, even though there are no definitive studies that show online advertising is effective. People click on ads less than one-half of 1 percent of the time.

So after years of struggling to make banner ads work, Web publishers have adopted a new strategy. They're giving online advertising a complete overhaul.



The consensus: bigger and flashier is better. People preferred skyscrapers over banners and large ads over small ones. They liked animated and interactive ads more than static ones.

"Part of what we're getting at is novelty," said Sandra Marshall, chief executive and president of EyeTracking. "I think that people are so used to the banner ads they've learned to avoid them."

With that kind of research out there, marketers may be pushing constantly for more bells and whistles in online ads. But if people learned to avoid banner ads, they could certainly do the same with the new breed of ads.

"There will be this constant arms race around more interesting, more intrusive advertising and more sophisticated evolution of the brain to block out the advertising," said Nail, the Forrester Research analyst.

So now we’re back where we started in 2001 with the same click rate, but with online ad spending having increased by 600% from $7.1B in 2001 to $49.5B in 2015 (Source: IAB/PwC).

The problem is that as all ads become more intrusive, no one Advertiser acting on his own has an incentive to make his ads less intrusive, because he would simply lose out to the competition. In other words, everyone displaying intrusive and obnoxious ads is a Nash Equilibrium.

So then perhaps adblocking is exactly what the industry needs to move away from the current equilibrium of intrusive ads, back to a more civilized equilibrium in which Advertisers use “acceptable ads”. The use of adblocking by Users provides a means of forcing all Advertisers together to scale back their advertising intrusiveness and adhere to new standards for less intrusive ads.

Advertisers may actually even end up better off under the new standards, because they will potentially achieve the same amount of sales with significantly less spending to design and post ads. In fact, Advertisers will be better off with less intrusive ads, even if they have to pay Adblock Plus to whitelist the ads, as long as the new lower costs of unintrusive, acceptable ads plus the payment to Adblock Plus is less than the costs of the current, intrusive ads:

Advertisers better off if

(Cost of Unintrusive Ads) + (Payment to Adblock Plus) < Cost of Intrusive Ads

Note also that if and when all the unacceptable ads have been removed and replaced by less expensive, less intrusive ads, Advertisers will end up spending less to pay Adblock Plus to enforce the standards.

 

Potential Adblocking Game Scenarios

As mentioned previously a small portion of Users (8%) account for the majority of ad clicks (85%). And only a small portion of Users who click on ads actually ends up buying anything (8.8%). So, while there are a ton of ad impressions on the Internet, only a very few of them lead to sales.  In other words, online advertising is an extremely inefficient way to for sellers to get sales.

As an aside, Samuel Scott, In “The Alleged $7.5 Billion Fraud in Online Advertising” cites a statistic that there is a humongous among of fraud in online advertising, and

“… only 8% of impressions that have the opportunity to be seen by a real person. Let me clarify: That does not mean that 8% of impressions are seen. That means only 8% have the chance to be seen.”

Now, the nature of ad clickers, together with the use of adblocking, leads to two potential scenarios: either (i) the Users who use adblocking software are not among the Users who click on Internet ads, or (ii) some of the Users who use adblocking software would have clicked on ads had they not been blocked.”

 

1.  Adblockers Are Not Clickers

Under this first scenario, none of the Users who choose to block ads are among Advertisers' customers. Alex Hern in “Adblock Plus: the Tiny Plugin Threatening the Internet's Business Model” cites Adblock Plus’ founder, who clearly shares this contention:

Adblock Plus developer Wladimir Palant responded that Adblock Plus users were unlikely to click on adverts anyway. “An ad that is displayed but ignored doesn’t provide value.”

In this case, total ad impressions will decrease (because adblockers don’t see the ads), but the total number of Users who click on ads does not decrease (because the Users who block ads wouldn’t have clicked on them even if they had seen the ads). So if clicks remain constant, while impressions drop, then click through rates (= clicks / impressions) will increase, but sales and conversion rates (= sales / clicks) will remain constant.

Under this scenario, ad-induced sales revenues for Advertisers will not change, so total revenues to Content Providers who host ads need not change. So then to the extent that current levels of ad-induced revenues have been sufficient to support the ad-based business models of Content Providers, then nothing need change, despite widespread use of adblocking.

 

2.  Some Adblockers Are Clickers

Under the second scenario, some of the people who choose to block ads are among Advertisers' potential customers. These Users are people who might click on unintrusive ads, but the increasing prevalence of intrusive ads drives them nuts and leads them to adopt adblocking software and block out all ads, both intrusive and unintrusive alike. The PageFair and Adobe Report suggests that this might, in fact, be the case:

The majority of adblock users do not object to advertising in principle. They are acting out against a number of ad formats that make it harder for them to access content. Many adblock users also cite practical or privacy reasons for adopting adblock. There is an opportunity to acknowledge all these concerns with advertising that respects the user’s privacy and hard-earned attention.

In this case, the use of adblocking will lead both clicks and sales to decrease, which might very well threaten the viability of Content Providers who rely on ad-based business models.

If this is, in fact, what the situation is, is there any way to save the ad-based business model? Perhaps there is. Adblockers are still currently in the minority (about 28% of Users). Advertisers and Content Providers might be able to stem further adoption of adblocking software by Users, by removing currently intrusive ads and returning to the use of unintrusive ads. In this case, Adblock Plus might actually end up saving the day by helping Content Providers support and enforce a new Nash Equilibrium at low levels of ad intrusiveness. And this is precisely what Adblock Plus hopes to accomplish. From Alex Hern:

Adblock Plus’s spokesperson says: “It’s likely a long way off, but the logical outcome of Acceptable Ads is a day with only marginal adblocking use – because advertisers would have finally realized that they do not need to annoy users. So in that sense you could say that if our initiative is successful it will lessen the desirability of using ABP or other adblockers – that’s part of the reason that we want to develop additional products with [parent company] Eyeo. As we say, purging bad ads is just a start to a better internet.”

Robert L. Mitchell (cited earlier in the section on About Adblocking: How Adblocking Works) sums up the situation well:

Everything turns on what consumers do next.

Existing users of ad blocking software may be a lost cause. Once consumers decide to block ads and experience the cleaner Web pages and faster load times that ad blocking delivers as it filters out bandwidth-hungry animations, video and other advertising content, they're less likely to want to give it up.

But will mainstream consumers in the U.S. turn to ad blockers in a big way? "The numbers have not reached the point where publishers are panicked … But if those products were on 80% of computers, we'd be having a very different conversation."

 

Another Potential Outcome of the Game

There’s an alternative to the two potential outcomes of the Online Adblocking Game that I just described in the previous section: The increasing prevalence of adblocking by Users wakes up the industry to the fact that ad-based business models don’t work.

My sense is that right now, not a lot of people are actually making much money on online advertisements (except, of course, for Google). However, a lot of people are trying to sell/use the ad-based business model because they want it to work (it's the easiest business model out there). In his presentation that I cited earlier, Maciej Cegłowski indicates

Investor storytime [convincing an investor to invest in your ad-backed online business] only works if you can argue that advertising in the future is going to be effective and lucrative in ways it just isn't today. If the investors stop believing this, the money will dry up.

Matt Assay expresses a similar thought in “Funding The Web With Ads: This Outdated Model Has To Go”

Some (like 37signal's David Heinemeier Hansson) argue that ad-based business models, often focused more on generating eyeballs than cash, can't sustain a real business. Responding to an article that bemoaned social platform company Ning's inability to match sustainable business with traffic growth, DHH ridicules the notion:

“    Are you kidding me? The company has blown through $120MM of VC funding over six years, built up massive traffic, yet just had to slash and burn, and you’re saying that ‘traffic growth is no longer good enough’. How the hell was it ever good enough? Ning’s problem is not a lack of eyeballs but its inability to turn them into cash money to pay the bills. Getting more of something that’s a net-negative is not going to make up for it.”

But the bigger issue may actually dovetail with financial success. While Google's intent-based search meshes well with advertising, most business models don't.

Theoretically, as long as most of the clicking minority does not block ads, then the ultimate amount of lost sales from adblocking should actually be small. However, what I think may happen is that the adblocking phenomenon will wake up the industry to the fact that most ad-based businesses models just don’t work. In this case, I think you're going to see a lot of ad-backed content dropping of the web and more content backed by alternative business models appear.

This would be a shame, because advertising supports some extremely worthwhile content that wouldn’t be provided otherwise. Ethan Zuckerman makes this point in “The Internet's Original Sin”:

The great benefit of an ad supported web is that it’s a web open to everyone. It supports free riders well, which has been key in opening the web to young people and those in the developing world. Ad support makes it very easy for users to “try before they buy,” eliminating the hard parts of the sales cycle, and allowing services like Twitter, Facebook, and Weibo to scale to hundreds of millions of users at an unprecedented rate. This, in turn has powerful network effects: Once all your high school classmates are on Facebook, there’s a strong temptation to join, even if you don’t like the terms of service, as it’s an efficient way to keep in touch with that social circle.

On the other hand, advertising also supports a lot of content that doesn’t actually have a lot of real value to Users and content whose Providers couldn’t come up with a more “productive” way, so-to-speak, of monetizing their content. As one commenter (an adblocker) on an Adblock Plus blog entry noted, “It’s not my fault your business model sucks.”

 

Alternatives to Ad-Based Models

So then what are some alternatives to ad-based business models that we might start to see?

Robin Good posted a fantastic graphic at MindMeister that presents alternatives to ad-based models. I provide a copy of the graphic as it appears on the Internet in Figure 17A. However, since you can’t see the detail, I also present the graphic in two separate pieces that are more readable (Figures 17B and 17C). Robin Good presents similar information in tablular form, which I provide in Figures 18A and 18B.

Figure 17A

Figure 17B

Figure 17C

Figure 18A

Figure 18B


 

 

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