Advertising Economics

I hear a lot about the advertising business boom. Selling advertising on buses. On school buses. About FedEx sponsoring textbooks. Google and Yahoo selling ads. Recently, someone auctioned off the right to tattoo a section of his body. There's this vision of the future as a "Minority Report" scene where people receive personalized ads as they stroll about. There's moaning and worrying about us becoming overwhelmed with ads.

Lately I've been thinking about the economics behind this model. Here's my conclusion: This sort of future is only possible if advertising becomes very, very cheap.

Here's why: For a company, advertising is cost limited by profit per item. That is, advertising comes out of a company's profit. Long term, a business can not function if it cost more to sell the item than to buy it. (Yes, exceptions like the razor/razor blade model where one sells a cheap permanent item and an expensive replaceable item. But even then the net profit needs above zero.)

Now a company can shift where it advertises. Perhaps the internet is a better medium than newspapers. Perhaps advertising on textbooks is a better use of resources than magazines. Perhaps sponsoring college bowl games is better than radio. But companies are strictly limited their advertising budget based on their sales.

Likewise, credit cards not withstanding, there's a strict limit on the number of purchasing decisions a person makes during a year. Just because I see more advertising doesn't mean that my yearly buying power goes up. (Yes, there's suggestions that advertising does increase spending, which may lead to debt, which leads to interest, which in turn leads to less spending...or bankruptcy.)

So perhaps the question is really...what's the value to us of non-advertising filled space? What does an advertiser have to value a space at before we'll fill it with an ad? How good is a "FedEx" tattoo on my arm as an advertisement?

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