Dec 13, 2012 · 5 minutes

I’ve written before about how well Silicon Valley VC’s understand advertising — which is to say, they don’t understand it very well at all. So it was a relief when a New York VC decided to cover this meaty topic, and it was a special bonus when that VC was Fred Wilson. He made several good points, but his overall thesis is one to which I take exception:

I will conclude by saying that an advertising model is a viable revenue model option if you are building a service that has a lot of scale. But if you don't have millions of users a month, you should think hard before going in this direction. There is a limited amount of ad dollars out there (except CPA budgets which are in theory infinite) and more and more services trying to tap into them every day which is why advertising rates on the Internet seem to be in permanent and systemic decline.
This passage contains precisely the three fallacies that investors seem to always employ when discussing consumer-advertising models — especially display advertising. I will now discuss all three fallacies.

Fallacy No. 1 -- “There’s so much inventory out there...”

It’s true that there is a lot of crap inventory out there, and that more and more crap gets put onto the Internet each day. But that has absolutely nothing to do with the stuff that isn’t crap. Fred Wilson describes the stuff that isn’t crap as “niche,” and maybe it is the minority of inventory in cyberspace, but for an entrepreneur who has a vision for a great product, that is exactly what he/she is aspiring to build.

Do you think that a great site like ESPN is watching its CPM’s collapse? Nope. How about a new media site like Refinery29, Huffington Post, PopSugar, BuzzFeed, Business Insider, IGN, The Verge, Bleacher Report, or any of the other properties who have "brandable" content? Who's ever heard of a multi-million dollar video game launch that didn’t buy out the front page of IGN and Gamespot? Or a new Ford truck that didn’t roll out on ESPN?

In short, it doesn’t matter if you smother the Internet with a trillion more Tumblr pageviews that contain some combination of porn and animated GIFs… That will not impact the CPMs of good digital destinations.

And there is a lot more pie to steal from the likes of Newsweek, USA Today, Vogue, GQ, USMagazine, and the countless other "old media" dinosaurs that have brought no innovation to their businesses in decades, and deserve to be disrupted. I look forward to stealing lots of said pie in the coming decade.

In short, the average CPM across the Web is an inconsequential metric, and when a VC talks about it, that is an immediate red flag.

Fallacy No. 2 — “But you have to get so big to succeed…”

This fallacy is so common that it has turned into something of an anti-advertising mantra, which is frightening because it makes zero sense when a VC utters it. Fred Wilson states it more or less verbatim in his article:

If you have a unique and valuable audience, you might be able to get a $5 to $10 CPM. So you will need 100 million impressions per month instead of 1bn impressions. That's still a lot of super valuable users engaging a lot.
Yes, Fred, we get it… you have to be successful in order to succeed. If you launch a news site like Huffington Post or Business Insider, then it has to succeed in order to make money for the founders and investors. And how exactly does that same concept not apply to the near-infinite iPhone apps that get funding every single day? How does it not apply to the innumerable music products that are doomed to fail before they even launch?

For some reason, investors just assume that an advertising model is doomed to fail in its goal of attracting a few million unique visitors, and that every single music, social, and AirBnB clone that is founded by an engineer is deserving of a $750,000 roll of the dice.

Most angel investments will fail – but the number of advertising-based businesses with nine-figure exits will continue to grow.

Fallacy No. 3 — “Advertising isn’t exciting compared to all those other consumer business models…” 

Yes, all “those” other consumer business models on the Web besides advertising and ecommerce — the duo of business models that have existed for almost two decades. It’s like when my mom tells me that I should eat some fish or vegetables, because “they” are saying that it is healthy. After the implosion of Groupon and Zynga, teamed with the blatant over-valuation of momentum plays like Foursquare, maybe it’s time for some good old reliable business models that actually exist.

Let’s keep in mind that the three mediums preceding the Internet — newspapers, radio, and television — all depend heavily or entirely on advertising. Two years ago, I had the opportunity to pitch one of the most successful venture capitalists on the planet, at a time when Bleacher Report was doing very well. It was a compelling investment at that point, based on user and revenue growth.

The VC asked us politely whether we would consider adopting the “two new and exciting revenue streams” of the day: social gaming and daily deals. We said no, and he ultimately passed. Today, of course, we realize that the Zynga and Groupon models were flawed and unsustainable, and provided speculative wealth and ruin to countless people, in much the same way as tulip bulbs did to 17th century Dutchmen.

And even AirBnB has its issues that may or may not eat into its viability as a business in the long run. Time will tell.

But advertising has existed for thousands of years. It’s not going away, it will continue to grow at a healthy pace, and digital will take disproportionate share. And while it’s true that Google currently has the most compelling advertising product, that will eventually change and those ad dollars will start to be shared more equitably. On that point, even Fred Wilson is in agreement.

[Illustration by Hallie Bateman]