‘Something is rotten in the state of Denmark:’ Why the Internet’s advertising business model is broken
Keywords:Facebook, Twitter, advertising business model, big data, platform economics
Large swaths of the Internet economy are based on an advertising business model. Many content platforms, social media sites and mobile applications provide a free service to users in exchange for personal data that, once collected, is sold to advertisers and data brokers to generate corporate revenue. Metcalfe’s Law predicts that corporate revenues should increase exponentially as a company’s number of connections goes up and that costs should increase linearly. The combination of exponentially increasing revenues and linearly increasing costs should generate large profits for ad-based Internet companies. However, the opposite tends to be the case. Many established Internet companies are deeply in the red and only an estimated 0.01 percent of mobile applications will ever earn a profit. This disjunction raises the question: why do so many ad-based Internet companies perform so badly?
The answer lies in the interaction of two factors. First, the costs faced by advertising-based Internet companies tend to increase faster than their core resource (i.e., users). Ad-based Internet companies, therefore, do not seem to benefit from economies of scale on the cost side of the equation. The implication is that such companies need a very large number of users in order to reach profitability. Secondly, profitability’s large user base requirement turns out to be extraordinarily rare in the Internet ecosystem because the network tends to structure itself into what are known as power law distributions, where most companies get only a few users (millions maybe) while some get literally billions. This suggests that the advertising model that underwrites so many Internet companies is broken. It works for a few, but not for most.
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