Where's the signal?

Philosopher Thomas Wells, in an essay for the Australian Broadcasting Corporation, makes the case that advertising is an example of market failure.

The advertising industry consists of the buying and selling of your attention between third parties without your consent. That means that the cost of producing the good - access to your attention - doesn't reflect its full social cost.

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Since advertisers pay less to access your attention than your attention is worth to you, an excessive (inefficient) amount of advertising is produced.

Wells makes some good points that apply to some problematic forms of advertising. But much advertising does have value. And for those of us who work on the web, the medium is new enough that we can still make web advertising into a net positive, if we fix a few things.

The main reason we have advertising in the first place is help deal with an information asymmetry problem. Nobel Prize-winning economist George Akerlof wrote, Dishonest dealings tend to drive honest dealings out of the market. In a market where low-quality and high-quality sellers compete, and sellers know their products better than buyers do, high-quality sellers have trouble staying in business. When the buyer can't tell a low-quality car, a lemon, from a high-quality car, no buyer can justify paying more than a lemon's value for any car, so the high-quality seller can't compete.

Many institutions, norms, laws, and habits have popped up over thousands of years to deal with Akerlof's market for lemons problem. Licensing and regulation of sellers, product reviews, and protecting trademark rights, are all ways to give some advantage to high reputation sellers.

Advertising is another piece of the solution. Tom Goodwin compares advertising expenditure to impressive stone buildings for banks, and writes,

Old world advertising used to be the same, the very act of investing in TV, buying a premium billboard, taking an ad in Vogue, became brand building element because of the cost, not despite. The general public doesn't know rate cards, but there was a tacit, enduring, innate feeling that companies that advertised were companies of quality.

Perceived advertising costs do matter to users. In The Waste in Advertising Is the Part That Works, Tim Ambler and E. Ann Hollier describe a signaling test based on showing "expensive" and "degraded" versions of the same TV commercials to experimental subjects. The audience's estimation of advertising expense had an effect on brand preferences.

[P]erceived expense rarely is an important direct predictor of brand choice. However, there is a very consistent, though largely indirect link between the two because perceived expense influences perceptions of brand quality, which in turn is the most critical predictor of a participant's inclination to purchase a brand.

Ambler and Hollier split out the effects of familiarity, information, and persuasion from signaling. "[H]owever much attention, recall, and persuasion an advertisement may garner, the effectiveness of the advertisement, and thus brand performance, will depend on the perceived advertising expenditure."

Wells, however, argues that signaling is a waste. He writes,

Like banks housed in grand marbled buildings, companies which pour vast amounts of money into advertising campaigns must be supremely confident about the quality of their products and its long-term sales. Otherwise they couldn't afford to burn so much money on ridiculous Super Bowl ads. This argument rather reminds me of John Maynard Keynes's suggestion that in a recession caused by a collapse of aggregate demand one could solve the problem by burying bottles filled with bank notes and then leaving it to private enterprise to dig them up again.

The missing part in that argument, though, is that signaling by advertising isn't just based on the production values of the ad. Ambler and Hollier tested ads in isolation, but in the real world, ads appear attached to content. The signal is proportional to the value of the content, not just the ad itself. Although Wells suggests that cultural works do not require advertising, and can be paid for by other funding mechanisms such as subscriptions and patronage, some cultural works that would not exist otherwise are still funded by advertising.

When those works go on to other uses, whether it's in a book of William Gibson stories originally paid for by Omni advertisers in the 1980s, or a boxed DVD set of Star Trek DVDs paid for by TV advertisers in the 1960s, then advertising doesn't just pay its way, but creates positive externalities.

An ad pays for content, of course, but it also pays for the user attention is consumes by sending an economic signal about the advertiser's intent in the marketplace. The more obviously expensive the content, the stronger the signal. Users tolerate ads in signal-carrying media such as magazines, and a positive feedback loop can emerge. Valuable signal-carrying ads make more money available to fund content, whose quality and perceived cost increases signaling power and therefore ad rates, and so on. All of this makes a signal-carrying medium a great business to be in once the feedback gets going.

But when advertisers try to "efficiently" target some users and not others, though, signaling breaks down. Targeting turns an ad into the digital version of a cold call. With all the information on the seller's side, the cold call is of no value to the recipient. The same users who willingly look at magazine ads choose to block email spam.

As web ads get more and more targeted, they're steadily moving away from magazine-style, with signaling value, toward spam-style, with no signaling value. Targeted ads tend to "burn out" the medium in which they appear, through a Peak Advertising effect. While magazine ads continue to plug away, pulling in CPMs that would be headline news in any digital medium, each new targetable medium falls in value and popularity as users figure it out, filter it, or get their governments to restrict it. Remember junk faxes?

Even when a web ad appears on expensive content, it fails to carry the signal that it would convey in a less targetable medium. Users are aware that ads "follow them around," so instead of viewing an ad as part of an expensive, signal-carrying ad buy, even a well-designed ad on high-quality content could be an example of cheap targeting. (Are they really still supporting that product, or am I the one poor loser who they're targeting with the last obsolete machine in the warehouse?) The better that users understand how targeted ads find them, the less well those ads work.

Solutions

Two extremes dominate the conversation about what do to about online ads. The first is to deploy general-purpose ad blockers everywhere and eliminate ad-supported content in favor of other business models. This is clearly suboptimal. The existence of magazines that people voluntarily subscribe to is proof that there is some level of advertising that can works.

The other extreme is to advocate that users run in a completely unprotected and targetable state. This doesn't work, not just because of the ongoing data leakage, ad fraud and malvertising problems, which make some protection a necessity, but because of signaling failure. No positive feedback from signaling, no cheddar for publishers.

A third way is needed. Fortunately, new tracking protection tools are able to block the low-value, cold-call-like targeted ads while permitting signal-carrying ads, the ones that respect users' choices not to be tracked. Tracking protection gets web sites out of the peak advertising cycle and into the signaling business.

Instead of waiting for more and more users to give up on advertising and go get an ad blocker, publishers can help and encourage users to run tracking protection tools instead. There are lots of low-impact, easy ways to get started. But if sites fail to turn the web into a signal-carrying medium, web ads could slide into a no-win struggle like email spam/anti-spam, and anti-advertising philosophy could turn out to be right after all.