Based on more than 1,000 hours of research into advertising spending across 12 sectors, a recent study by FTI Consulting forecasts a 13% decline in advertising spending in 2009 and another 1% decline in 2010. This follows decreases of 2% and 5% in 2007 and 2008 respectively. While the report predicts a small upturn in 2011, real advertising spending will not climb back to 2008 levels of $284 billion until late 2014.

Looking at the trend in spending patterns, traditional print media (particularly newspapers) will continue to bear the brunt of the spending decline, and will regain prior years’ market shares only in rare cases. Internet substitution has permanently changed print media’s market share. Over the coming years, the Internet’s share of advertising spending is expected to grow at a steady pace, rising from current levels of roughly 9% of total advertising spending to 15% in 2015. Exacerbating the problem for traditional media companies is that one dollar of advertising spending on traditional media is replaced by just 33 cents on Internet sources. Thus, the fastest-growing segment of advertising spending substitutes digital cents for each previous dollar spent.

The Impact of Online Advertising on Traditional Media

Our forecast research considered historical advertising spending patterns by medium to estimate the rate of growth of the Internet over the next five years, determined what percentage share will represent a steady state for the Internet and assessed its impact on traditional media.

The research indicated that television was the best analogy to the Internet in terms of its impact as a disruptive technology. The relationship between household penetration and advertising market share of TV is very similar to that of the Internet. After its introduction in 1949, television experienced rapid household penetration, reaching 50% of homes in four years and 90% in only 13 years. It captured about 15% of the advertising market during that time period, 20% after 25 years and eventually settled, 40 years later, at its current level of about 25%. Television put dramatic pressure on newspapers, which accounted for 37% of advertising spending in 1949 but only 29% of advertising spend by 1962. Radio’s share of advertising spending contracted by 50% over this time period.

The Internet also took approximately four years to reach 50% household penetration. In comparison to TV’s 15% ad share in 13 years, Internet ad-spending share is expected to reach 10% by the end of 2009. This is 15 years after Internet usage debuted in the home and 11 years after broadband connections were introduced. FTI’s research suggests that the Internet will eventually peak and settle at approximately a 25% advertising market share. This forecast is based on a dynamic advertising-spend regression model, which uses the historical relationship between five variables to predict future ad spending: consumer spending, private investment, the unemployment rate, online market share and the incremental impact of either a U.S. presidential election or the Olympics.

Until 2000, real GDP growth and real advertising spending correlated quite directly. Advertising spending represented about 2% of GDP. When the economy grew, advertising spending grew and when GDP contracted, advertising spending contracted disproportionately. Since GDP is comprised of roughly 70% consumer spending, 10% private investment spending and 20% government spending, FTI found a stronger relationship between advertising spending and consumer outlays and private investment.

But spending and investment alone did not predict the trends experienced since 2000 quite as well. Therefore, to improve the accuracy of the model, particularly as GDP contracted, we also factored into our analysis three other variables.

First was the impact on consumer spending of employment, which we captured with changes in the unemployment rate. And, because of the effect of online price performance on total advertising spending and the resulting pricing pressures on traditional advertising media, we added a variable to reflect the change in online advertising market share. Finally, we captured the average boost in advertising spend during a U.S. presidential election and Olympic Games years.

The result of these additional factors was significant. The historical correlation from using our five factors was high, and the post-2000 correlation held even better.

As part of economic stimulus legislation passed earlier this year, the U.S. Federal Communications Commission is charged with developing a national broadband strategy “to ensure that all people of the United States have access to broadband capability.” Indeed, even though broadband adoption has incre
ased more than sixfold since 2001, some 43% of U.S. households have yet to adopt high-speed access in their homes. The Compass Lexecon findings underline the potential benefits of accelerating broadband adoption.

Size of the Prize

In a survey of American consumers in April, the Pew Research Center found that around one third of respondents considered high-speed Internet a necessity. And broadband was one of the few items to grow in importance in surveys over the past three years.

But just because something is desirable doesn’t necessarily make it useful. Thus, the researchers at Compass Lexecon sought to quantify the benefits of household broadband for consumers, deploying an array of econometric tools in the process. The goal was to identify the ‘consumer surplus’ associated with broadband access – that is, the value of the service to subscribers above what they actually paid for it. If the actual value of a service is less than its price, nobody will buy it. On the other hand, if the value surpasses its price, buyers receive benefits from the service that are not captured simply by how much is spent on a particular service. 

To determine the actual surplus from broadband Internet access, Compass Lexecon’s researchers analyzed a sample of broadband purchasing data for 30,000 households from the largest 100 metropolitan areas in the U.S. between 2005 and 2008, and then extrapolated up their findings to the U.S. population. Based on pricing and adoption rates in the sample, the researchers could estimate consumers’ willingness to pay for broadband under a variety of conditions.

A 10% rise in the price of broadband would have led to a 15% decline in demand in 2005 whereas, in 2009, a 10% rise in price would result in only a 7% decrease. Thus, growth in the value of broadband to consumers increasingly outstrips a rise in its price, implying that the size of the total consumer surplus is growing. At current prices, the net consumer surplus for broadband is $31.9 billion per year, Compass Lexecon estimates, up from $20.1 billion in 2005.

Onwards and Upwards

There are strong reasons to believe that the true value of broadband is significantly larger than these estimates. The research looked only at fixed-line broadband use at home and estimated the aggregate consumer surplus. Outside of the scope of the study were mobile wireless broadband, consumer gains as the productivity gains from business users are passed on, and the producer surplus enjoyed by broadband providers, as well as firms whose services become more economical or feasible as the speed of Internet access increases.

Finally, broadband access can also be considered an ‘experiential good’ – once consumers experience high-speed Internet access, they tend to value it more highly than if they had not experienced it before. The size of the consumer surplus would therefore grow if the current share of households with dial-up or no Internet access were to try broadband for the first time.

For companies, the case for greater broadband adoption is compelling. Compass Lexecon researchers found that 22% of workers with broadband regularly access their employer’s network from home versus only 8% of employees with dial-up access. Given the well-established benefits to employee productivity and retention that stem from flexible working practices, anything that can be done to make working away from the office easier should be encouraged. Broadband also allows firms to open new sales channels, develop new product markets and expand customer-service possibilities.

The steady expansion of Internet access over the past 15 years has revolutionized the workplace, not to mention the world. The next step is expanding access and affordability to broadband, which promises to deliver billions of new opportunities across all segments of American society.