Advertising bubble to burst or a new tax: take your pick

The dot-com bubble burst

I fully expected the dot-com bubble to burst.  The entire premise driving all the enormous bank loans, the promise of huge returns from the newly discovered worldwide market, was mistaken.  Obviously.  It’s old news now, so it won’t impress you for me to recite it as I understood it before it happened, but indulge me while I recite the reasoning, because I predict it will happen again.

The premise behind the dot-com boom was that a small upstart company could reach the ends of the earth with their marketing and sell an unprecedented amount of their products and services.  What they failed to account for was the finite quantity of expendable income in each household and business.  Just because everyone can suddenly sell their wares to virtually everyone on the earth, that does not mean that everyone on the earth can suddenly afford to buy everyone’s wares that are suddenly available to them.  Consider: these web sites were built to make money by collecting that money from people.  For that to be successful, these new customers would have to reallocate their money to this web site from something else they would have spent their money on. 

It’s so basic, but somehow people missed the repercussion of this: overall, the web couldn’t generate the enormous amount of money it was supposedly destined to.  Take Frank, who used to buy their diapers at the grocery store.  Now Diapers.com wants Frank to buy diapers from them instead.  Frank decides to go with the online diapers, and spends less at the grocery store.  The grocery store now makes less money.  Money wasn’t created out of thin air here, it was just spent in a new place.  Now consider that many web sites were selling diapers.  There is a fixed number of people in the world even interested in diapers, and grocery stores were happy to supply them.  Add a few dozen web sites that want to sell them, and a few people might switch, especially with online discounts, but in the end no new money was generated.  And each web site would only collect a small number of people. 

Now instead of diapers (hey, I just had a baby a few months ago), just substitute in each product or service that was available.  With a finite number of people with a finite budget, you don’t get the orders of magnitude growth people were predicting.  When this realization spread around, we had the enormous implosion we know as the dot-com bubble burst.

This didn’t come out as clearly as I had hoped, and as clearly as I think I have it in my head.  I hope it makes sense to you.

An advertising bubble that’s getting thin

Now consider the overall feeling people have for the web: if it’s not free, it’s worthless.  Ironic, but very true.  No one wants to pay for online email, storage, search or backup.  There are plenty of free services on the Internet right now offering these, sponsored by advertising.  Why pay when you can get it free, right?

Well, why do those advertisers sponsor your free storage and email?  Because they hope you’ll click on their ads and spend your money on their wares.  But wait… we just agreed that people don’t like paying for stuff on the Internet.  If it’s digital products or services (highly profitable because it can be produced for virtually nothing) people will expect it to be free.  How do you make a business out of that?  We just covered that as well: advertising.  You can make anything free by sponsoring it with advertising. 

So what we have is a self-supporting circle.  A perpetual motion machine.  An outlet that provides power from a plug that plugs into… itself.  If nearly everyone gets onto the advertising bandwagon in order to provide free services, no one can make money and the system will collapse.

Except for one market: tangible, retail goods.  People will expect to pay for their diapers for a long time yet.  If a diaper manufacturer chooses to advertise on a web site and a person clicks their ad, that person is likely to be willing to pay money for the product.  This is where the new Internet tax will come into play.

Those products that actually can make money in and of themselves (like diapers) will effectively be sponsoring the entire free Internet.  Since we’ve seen how advertising cannot pay for itself in an endless circle, those who actually make money by selling material goods will end up supporting the whole infrastructure.  Where will they get the money to pay for all these free services on the Internet?  Why from all of us, of course, through the diapers they sell.  With every product you buy, whether on the street or on the Internet, a huge chunk of what you’ll be paying will go toward advertising expenses.  And thus everyone who buys real goods (which is everyone) will be paying for the "free" services on the Internet. 

When everyone is paying for everything that is supposedly free, doesn’t that sound a bit like communism?  Capitalism suggests that if people pay for the services they use (as opposed to all services regardless of use through taxes), that competition will bring the best innovation and products to market and the invisible hand gets to work.

The middle ground

But people won’t pay that much for diapers.  Competition will come in and those who don’t advertise as much will offer significantly lower prices on diapers than those who do and people will figure that out and buy the cheaper ones.  The advertising revolution that makes everything free will not have the funding it requires.  Advertisers won’t make the money they thought they would, and will cut back on their advertising budgets.  Web sites that were once free will have to charge something either for all their services or for some premium offering.  And the whole advertising industry that supposed to boom on the Internet in the coming years will be much smaller than the experts seem to anticipate.

I believe we’re at least halfway to the end result now.  I don’t actually expect for us to reach the extremes I described here in the process of reaching the end.  Both the factors that went into my dramatic extremes will work to keep us somewhat in balance along the way to realizing that just like the dot-com burst, the advertising arena isn’t a magical bullet to an enormously huge economy.