For a year, we've listened to analysts passionately explain how online ad spending will power through any broader economic and advertising weakness. Eyeballs are moving online, this story went (goes), ad dollars will follow. Online advertising is accountable. Online advertising is the future. Blah, blah, blah.

It's time we woke up and faced reality. Online display-ad spending will fall in 2009, probably sharply. It will probably fall again in 2010. Hundreds of startups counting on advertising as a business model will be flattened. Yahoo, CNET, AOL, and other big display-ad properties will get hammered. Legions of me-too video sites will croak. Ad networks, the "hey, let's just start an Internet company!" flavor of this second dotcom boom, will get decimated.

This is why Nick Denton, the CEO of the highly profitable Gawker Media, just blew out so much of his staff. Nick's no fool, and his only concern at this point is that he didn't go far enough. This is why Yahoo will almost certainly fire too few employees when it announces its mass layoffs this week. This is why the value of AOL, MSN, and other second-tier properties will continue to atrophy.

How do we know online display ad spending will fall? Because by Q2 of this year it had already slowed sharply--to mid-single digit growth--and that was before things even began to get bad.

According to IAB, the growth of non-search online ad spending (display, classifieds, lead-gen) was 14% in Q1 and 5% in Q2. 5%! That's before the horrific fall-off in consumer spending in September. We'll be lucky if non-search spending is up year-over-year in Q3. By Q4, it will almost certainly be negative.

How much has online display ad growth already deteriorated? Take a look at this chart from PriceWaterhouse. For the last three years, Q1 spending has been higher than Q4 of the prior year and Q2 was higher than Q1. This year, both numbers are down (see the two righthand columns). Again--that's before things really got bad. (And this is total spending, which includes the still-growing search).

Now, look at how Q2 revenue has behaved over the years. See that 25% dip from 2000-2002? The coming drop probably won't be that bad, but it will be bad. And it will last at least two years. (These numbers, by the way, are all online advertising, not just display.)

How bad will the online display ad market fare over the next couple of years? At this point, we would estimate at least a 10% drop next year and probably more. (20% is not inconceivable). Again, the overall market fell 25% from 2000-2002. There are many reasons why this falloff should not be be so extreme--namely, that half of online ad customers won't go bankrupt this time. On the other hand, there are many reasons why this falloff could be worse: The general economy is going to get clobbered in this recession--something that didn't happen last time.

So, what's the smart amount of spending decline to plan for? We think about 10% next year and slightly more in 2010, with the possibility that things could get a lot worse. We would also plan on the decline lasting at least two years. The country isn't going to dig itself out of this economic hole quickly.

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