How Does Online Advertising Work?

The Neeva Team on 04/14/21

Online ads are everywhere: They follow you around as you read the news, check social media, and search for information; and they can be eerily relevant, reminding you of things you’ve forgotten to buy, or services that seem tailor-made for you. Online advertising is a $398 billion industry, accounting for about half of all global ad spend, but most of us have little understanding of how exactly these ads work—and how they’ve gotten so good at blending into the digital landscape.

What is online advertising?

Online advertising, sometimes called digital advertising, is any type of paid communication or notice on the Internet. Since the appearance of the first banner ad in 1994 (more on that later), a large portion of the Internet operates on an ad-based business model, in which users are able to access information and services for free, in exchange for being shown ads.

Advantages of online advertising

From an advertiser’s perspective, online ad campaigns have many advantages, some of the most important being:

  • User targeting. The ability to target ads to specific sets of people is one of online advertising’s biggest draws. To serve targeted ads, websites collect information about users, such as purchase history, browsing habits (tracked using cookies), and location, and then show users ads that are relevant to them.
  • Retargeting. The ability to target people who have already interacted with a business with additional or different ads. If you’ve ever clicked on an ad and then seen a bunch of different ads from that same business in your social media feed, that’s retargeting.
  • Ability to accurately measure return on investment (ROI). Unlike print advertising or billboards, online ads have the potential to show advertisers useful information about the performance of an ad campaign almost immediately, such as how many users saw an ad, clicked on it, and took an action, such as signing up for a newsletter or making a purchase. This allows businesses to calculate exactly how much money it takes to acquire a customer.

All of these advantages allow advertisers to increase their spend massively on the things that work. Ever wonder why advertisers are showing you the same ad for that shoe two hundred times? That is because they know that it works and that they will wear you down!

How does online advertising work?

Advertisers, ad platforms, and consumers all play a role in online advertising.

  • Consumers use web services or consume information online for “free,” but they pay for it (knowingly or unknowingly) with their personal information and attention. Hence the famous saying: If you’re not paying for the product, "you are the product.”
  • Websites and ad networks collect users’ information and use it to create segments of people who can be targeted with ads. To keep their services free to users, these sites make money by selling ads.
  • Advertisers pay websites or ad networks to display their ads. They then bring in revenue when consumers click on their ads and buy their products or services.

Let’s look how these relationships work with paid search, the biggest sector in online advertising. These are the ads that appear at the top of the search engine results page (SERP), right above the organic results. Advertisers pay search engines, like Google, to display their ads at the top of the SERP for any number of search queries. So if you search “best rolling suitcase,” you might see an ad for Away. This doesn’t mean they are the best, it just means they paid top dollar to be the result you see first.

This system works out pretty well for advertisers: According to Google, advertisers make $8 for every $1 they spend on Google Ads. Google, too, benefits, as the majority of its $162 billion in annual revenue (as of 2019) comes from search advertising. But what about users? The presence of ads creates an inherent bias in search results, creating a demand for alternative search engines.

4 Types of online advertising

Gone are the days when “online ad” meant a banner or pop-up. Digital advertising has become more sophisticated, and the main types of ads are:

  • Display ads: When you think “online ads,” display ads might be what first comes to mind. These are visual ads, like banners or pop-ups, that appear on web pages. These are the kind of ads that an ad blocker will target. Both Google and Facebook have platforms for displaying visual ads on their own sites as well as other people's websites.
  • Paid search advertising: Free search engines like Google allow advertisers to place their content at the top of the search engine results page with Google Ads. Search advertising is the largest segment of online advertising.
  • Social media advertising: Social media platforms like Facebook, Twitter, and LinkedIn allow advertisers to target a specific audience, based on information the platform knows about its users, such as age, location, interests, and whether the user has interacted with the advertiser in the past. Many social media advertisements allow users to engage with the content by “liking” or commenting on paid posts. Some of the most common types of social media advertising include:
    • Right rail ads: Right rail ads are display ads that appear to the right of the content of your newsfeed on the desktop version of social media sites like Facebook and LinkedIn.
    • In-feed ads: These ads appear directly in your social media feed, and can be harder to distinguish from the posts of people and businesses that you actually “like” or “follow.” Businesses pay for these posts to appear in your feed, and then can include images, videos, slideshows, or carousels, which allow users to swipe or click through multiple images. One way to tell whether a post in your feed is an ad or not is that ads are often more colorful than organic content, and/or they have moving video.
    • Message ads: Social media sites that have a messaging platform, such as Facebook and LinkedIn, also have the option of allowing advertisers to show up in your inbox.
    • Story ads: For apps that have a “story” feature, like Snapchat, Instagram, Facebook, and TikTok, you may see an ad in the middle of a stream of videos from the people you follow, like a TV commercial, but clickable.
    • Sponsored posts: Instead of paying for ad space on social media, some advertisers pay a celebrity or influencer to use their product on social media.
  • Content marketing: Content marketing originated with the clickbait-y posts that appear at the bottom of many news sites under the heading “sponsored content,” led by the advertising platforms Outbrain and Taboola. Today, content marketers focus on creating high-quality content that tells a story or appears to provide useful information, including attractive promotional videos and search engine optimized (SEO) blog posts that are designed to rank highly on search engine results pages.

A Brief History of Online Advertising

Online advertising has evolved immensely since the first display ads appeared in the early ’90s.

  • 1994: HotWired (the online version of Wired magazine) launched the first banner ad for AT&T. With a click-through rate of 44 percent, the ad was a huge success, suggesting that publications may be able to fund online content with ads and provide it to readers for free.
  • 1996: DoubleClick launched its Dynamic Advertising Reporting and Targeting (DART) service, which tracked the way users interacted with ads. It also replaced the flat-fee business model of online advertising with a cost per impression model (CPM), meaning that the more times the ad appeared on a web page, the higher the cost—bringing the pricing of online ads in line with that of offline media.
  • 1998: The search engine GoTo.com launched with a pay-per-click model, auctioning off space at the top of its search engine results page (SERP) to the highest bidder. Whoever won the auction would pay the winning bid for each click it received. So a $1 bid for an ad that reached 1,000 people would cost $1,000: The more people who click on your ad (and visit your website), the more the ad costs. A version of this model is still dominant today.
  • 2000: Google AdWords followed, serving its SERP ads based on keywords in users’ search queries, and adding the option for a pay-per-click model in 2002.
  • 2003: Google expanded its reach, selling ads not only on its website, but to the rest of the Internet, with Google AdSense. AdSense placed ads on websites in its network by matching advertisers’ keywords with relevant websites. These ads, initially text and over time, display ads, could appear anywhere on the web.ll the advertiser would have to do is let AdSense know that they were selling premium dog food, and Google would display their ad on every dog-related website in their network: breed clubs, rescue organizations, and training blogs, who got paid to host the ad.
  • 2006: Social media added a new dimension to targeted advertising when Facebook partnered with Microsoft to serve its first targeted ads: graphic banners and sponsored text links based on users’ demographics and interests. Outbrain, which bills itself as “the number one native advertising platform,” launched.
  • 2007: Facebook launched Facebook Ads, selling space on the right rail (to the right of the News Feed) to advertisers.
  • 2009: Google AdSense began “behavioral targeting,” which served ads based on users’ browsing history, rather than just the keywords associated with a website. To serve more precisely targeted ads, Google used cookies, which logged information every time a user visited one of the hundreds of thousands of websites in the AdSense network. Although Google was not the first to use this technique, its status as the biggest online advertiser had far-reaching consequences, paving the way for retargeting on a large scale.
  • 2011: Twitter pioneered a new type of social media advertising with the emergence of sponsored Tweets. This was the first time advertisers could pay celebrities and influencers to advertise their product on social media.
  • 2013: Facebook introduced Sponsored Stories, a much-reviled feature that would surface businesses a user “liked” to their followers, as if that user were endorsing the business. The feature resulted in a class-action lawsuit and was shut down within the year. Meanwhile, Facebook’s new acquisition, Instagram, launched its first ads, sponsored posts that can show up in your feed regardless of whether you follow the sponsored account.
  • 2016: “Spon con” reached its peak, with 82 percent of the 50 largest news sites featuring sponsored content from Outbrain and Taboola. Soon after, reputable sources like the New Yorker began to cut ties with the spon-con giants, as consumers increasingly deployed ad blockers and mocked clickbait.
  • 2018: The European Union implemented its General Data Protection Regulation, which limited the way websites could collect users’ data.
  • 2021: Apple announced privacy changes that require mobile apps to get users’ permission before collecting information about users’ activity. Facebook claims this update will severely impact its business, by limiting its ability to both serve targeted ads and measure advertisers’ ROI.

Challenges of online advertising

As a consumer, it’s easy to see the drawbacks of online ads: They can get in the way of the information you’re actually trying to find, and as advertising becomes more sophisticated it can be hard to tell the difference between paid advertising and organic content. Sometimes it feels like you’re being hounded by a product or service.

Internet advertising has drawbacks for businesses, too. Some of the biggest challenges are:

  • A few platforms dominate the online advertising landscape. Google accounts for 29.4 percent of the U.S. digital ad market, with Facebook close behind (22.7 percent). This huge reach means that most online advertisers are forced to work with Google and Facebook, whether or not they want to. Some states have even sued Google over what they call an unfair monopoly on online advertising.
  • It’s difficult to measure effectiveness across platforms. Because two platforms dominate the online advertising landscape, it is almost impossible to measure the effectiveness of online advertising uniformly. Facebook and Google measure ad effectiveness in different ways, and there is very little incentive for them to create a uniform system of measurement.

Moving beyond the ad-based model

Facebook and Google’s dominance over the online advertising landscape has compelled many businesses to look elsewhere for their revenue. Major news sites, which used to provide their content for free, are finding that ads both fail to pay the bills and create an irreconcilable conflict of interest on their platforms. They’re now moving towards a subscription-based model, in which their content is behind a paywall.

While consumers may be resistant at first to paying for information and services they’re used to getting for free, the fact is that we’ve always been paying for digital content—just in different currency. Nominal-fee subscriptions allow for a more transparent value exchange. Sridhar Ramaswamy, co-founder of Neeva, explains: “We pay for the water that comes through our tap, and we don’t mind that. It’s clean, it’s inexpensive. There’s no assumption that water is free.”



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