The Rationalist Conspiracy

Two of the most famous companies this decade – Google and Facebook – made their money with online advertising. Because of that, a lot of people think that online ads are a great way to get rich, like Larry Page and Mark Zuckerberg did. Just build something popular, anything you like, and stick a few banners or Google ads on it.

Certainly, many people have gotten rich through ads. It’s definitely an option to consider. However, consider that, in 2011, online ad spending was just $32 billion, about 0.2% of the US economy. That’s a tiny fraction, especially in a year when Man of the Year Zuckerberg made his billions with online ads. It wouldn’t surprise me if fully half of Silicon Valley companies planned to make money with advertising.

What’s going on there? For a reasonable comparison, take the American movie industry. Everyone knows about Hollywood, and zillions of kids dream about becoming actors or directors and living the high life. Yet, all of Hollywood is only an $11 billion industry, less than 0.1% of GDP. So why do so many dream of getting rich, in such a limited space?

I think the main answer is what one might call time-to-money ratio. The amount of time people spend sitting in movies, talking about movies, and watching trailers is pretty big – a feature film takes about two hours, not including all the time spent discussing and analyzing it. Yet, the amount of money spent is very small; even for a low-skill worker, it takes less than an hour of work to earn the $8 for a movie ticket. Many movies are pirated, shown on TV, watched at home, or bought on Netflix, further increasing “time” without increasing “money”. As a result, the amount of noise the movie industry makes is really big, even though the industry itself is fairly small. Hollywood has one of the highest time-to-money ratios out there. For every dollar made, people pay lots and lots of attention.

Online advertising is the same, albeit not quite as bad as Hollywood. The cost of purchasing, say, a banner ad is tiny. Ad prices are commonly quoted in CPM, or cost per mille – the price per thousand people who look at the ad. An average CPM might be $2. That means that, for the price of a decent burger, you can get four thousand people to look at almost anything you please. Even though most of them won’t pay any real attention, that’s an awful lot of man-hours for very little money. Hence, everyone who makes serious money in online ads will generate lots of noise, though not as much as movie stars. A standard example is the social news site Reddit, which had to essentially ask for donations (as a for-profit business) when they couldn’t make money, even with three hundred million pageviews a month.

Because of its high time-to-money ratio, a company based on ads will almost always generate more attention than another company of comparable size. Hence, the ad industry will seem a lot bigger – and a much better opportunity – than it really is. Where there’s muck, there’s brass.

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