THE GROWING POPULARITY

of online advertising is hard to escape. Just ask any web surfer. A typical visit to the Internet is accompanied by an onslaught of flashing banner ads, animated pop-ups and ubiquitous "sponsored" search results.

The numbers bear out the shift to online marketing. While the total ad market is projected to have increased by less than 5% in 2005 final figures have yet to be announced online ads are expanding at a 25% annual clip. Granted, online ads made up just $12 billion of last year's estimated total ad market of $276 billion, but it's the rate of growth for Internet marketing that's turning heads on Madison Avenue. In 2002, online ads totaled $6 billion half of last year's tally.

"I can see if people were skeptical about a change from $1 billion to $2 billion," says Greg Stuart, chief executive of the Interactive Advertising Bureau, a New York-based trade association that tracks online advertising, "but it's doubled in such a short time. Six billion is a big number." Online ad spending was $9.6 billion in 2004.

Paid search, the hottest segment of online advertising in which links to advertisers' products appear next to keyword search results, generated nearly half of last year's online ad spending. The biggest beneficiaries of paid search, not surprisingly, were search engines Google and Yahoo, and portals AOL, owned by Time Warner, and MSN, a unit of Microsoft. Combined they collected between 80% and 90% of the $5.75 billion paid-search dollars shelled out by advertisers in 2005, according to the Search Engine Marketing Professional Organization, a Wakefield, Mass., trade group.

Recent trends indicate that advertisers should expect to spend even more on paid search this year, which would be a boon to the Internet heavyweights that dominate the market. The Search Engine Marketing Professional Organization found that most advertisers reported a 20% rise in prices for their most common keyword searches during 2005. Fathom Online, a San Francisco marketing company, said its Keyword Price Index showed overall rates flattening out in November and December, though certain advertising categories such as automotive, retail and telecommunications experienced rate jumps between 10% and 15% in the two-month period.

Not all advertisers have been able to keep up with the skyrocketing cost of paid search. FTD Group, the flower seller that relies heavily on web orders, was forced by climbing ad rates to cut back on online spending over the holidays. "During the Christmas season, certain online search engine costs increased significantly over the prior year, and as such we made the decision not to pursue the resulting high cost order volume," the company announced in a Dec. 29 press release. As a result, FTD said its holiday order volume fell 4% from year-earlier levels.

Out With the Old, in With the New
Despite the uptick in online advertising, traditional media companies aren't reaping the same rewards as their Internet counterparts. The big search engines and web portals have cornered the market on paid search, leaving old-line print publishers and broadcasters from Knight Ridder to News Corp. scrambling for a slice of the remaining online ad pie.

While data are hard to come by, media analysts generally believe about 5% of advertising revenues at major publishers comes from online ads. Sue Clark-Johnson, president of Gannett's newspaper division, last month told an industry conference that the company's online ad revenues would be up an estimated 52.6% for 2005. She didn't offer a dollar figure, however, or indicate whether the increase came from higher ad volumes or rate increases. Gannett's total sales for 2005 are estimated at $7.6 billion, which includes revenues from outdoor advertising, online properties and overseas newspapers, as well as 99 daily U.S. newspapers. Advertising accounted for about 75% of revenues in 2004.

One reason newspaper publishers, in particular, seem to be having trouble maximizing profits from the shift to online advertising is a deep-seated reluctance to embrace the Internet at the expense of print sales.

"[Online] advertising was just bundled in it was hidden initially, because newspapers didn't want to scare their advertisers," says Peter Zollman, founder of Classified Intelligence, a trade publisher and consulting firm in Altamonte Springs, Fla. "They didn't want to show them there was this additional product they were getting, because they wanted them to think in terms of advertising in the paper. The thought process was, 'Do nothing to hurt print.' At many newspapers that's still the thought process."

Another reason is the low rate base that traditional publishers are working from. A decade ago, when publishers started rolling out web editions, online ads were sold for little or even given away. That's no longer the case, but traditional publishers are still struggling to make up ground because their prices for online ads started out so low. Advertisers, as FTD demonstrated, have limits as to what percentage rate hikes they're willing to swallow.

"Many publishers bundled their online advertising with print, and that set value expectation early on," says Zollman. "The value perception used to be one where [an ad's effectiveness] was in print. Now that value perception is that it's online."

Career Builder, an online joint venture between Gannett, Knight Ridder and Tribune, offers a glimpse of the potential. The web site, which lists help-wanted ads, not long ago the exclusive purview of newspapers, saw revenues increase 78% year-over-year to $362 million during the first nine months of 2005.

"The audience shift is extremely obvious to anyone who's looking," says Zollman.

Political Correctness
2006 should be a big year for advertising, in general, and a pivotal year for traditional media companies trying to expand their reach to cyberspace. The total ad market is expected to hit $292 billion this year, according to a report issued last month by Robert Coen, a senior vice president at advertising agency Universal McCann. The Winter Olympics and congressional elections will be important drivers of growth.

Greg Sterling, an analyst with Kelsey Group, a market research firm in Princeton, N.J., says the ability to connect with specific audiences means political ads will be a much bigger factor in online advertising. This year's campaigns should feature an evolution of advertising across a mix of media, which should in turn help the bottom line throughout the industry. In the past, political advertising mostly benefited local broadcasters.

"In politics, you saw this last election more than prove the value of the Internet," Sterling says. "Now you have everybody talking about the substitution of the Internet for traditional media, but over time I think we're going to see a much more sophisticated mix and integration."

References to web sites in political ads are a good example of how traditional media may boost its interactive ad revenue volume, Sterling says. However, the growth process will be much slower than the growth exhibited by paid search.

"If you can drive people through traditional media to web sites, then you're not worried about Google or Yahoo," Sterling says. However, the pricing legacy of traditional publishers means the spending gap between old media and new media will continue at least for now.