If anyone doubts that the online advertising world is currently undergoing a seismic shift, he or she need only look to one recent headline and two newly-released studies. The headline, “Top 100’s Ad-Spend Growth Grinds to a Halt,” appeared in the June 26 issue of Advertising Age and referred to an analysis of the 100 biggest advertisers in the U.S. market. The two studies, from research firm IDC, predict that U.S. Internet ad revenue will increase from $25.5 billion in 2007 to $51.1 billion in 2012 and that revenue for Internet video advertising will jump from $.05 billion in 2007 to $3.8 billion in 2012.

These figures have set off a flurry of activity at Microsoft, Google and Yahoo. Microsoft tried to buy first all, and then part of, Yahoo. Yahoo rejected the offers and moved ahead with its plan to form an ad-sharing agreement with Google, which will provide Yahoo with $250 million to $450 million in near-term cash flow and the potential to add $800 million to annual revenues. Google in turn recently acquired major online ad network provider Double-Click to maintain its role as the dominant player in the constantly evolving search universe. On July 21, Yahoo said it would give activist shareholder Carl Icahn, who had pushed a deal with Microsoft, a seat on its board and two seats for his allies. Earlier this month, under pressure from Icahn, Yahoo signaled it is still interested in striking a deal with Microsoft, which is seeking partners for a deal to buy and possibly divide the company.

Wharton marketing professor Peter S. Fader says he understands why Microsoft wants to beef up its presence in the fast-growing realm of online advertising, but doubts that pursuing Yahoo is an effective strategy. “I don’t see how this is going to get them anywhere close,” Fader says. “I don’t see any great synergies appearing out of this.”

“It’s all about Google,” adds Eric K. Clemons, Wharton professor of operations and information management. Owning a piece of Yahoo would give Microsoft the reputation and market share it needs to defeat Google, he suggests, noting that Microsoft is “terrified” of Google Apps, a free suite of productivity software that competes with Microsoft’s lucrative Office products. It would also raise Microsoft’s visibility as search provider. “Microsoft’s search is as good as Google’s, but nobody knows it or believes it,” says Clemons.

Yahoo CEO Jerry Yang sought earlier this month to soothe monopoly concerns over the agreement with Google, saying both firms were committed to an open online ad marketplace. The companies say they will voluntarily submit to a federal antitrust review before rolling out their combined technologies. The non-exclusive agreement with Google “will strengthen our competitive position in the convergence of search and display,” Yang stated in a conference call with investors. “We see this as a natural extension of efforts we have already made toward an open marketplace.”

No matter how the drama unfolds, advertising executives still might want to focus on getting more web savvy. The traditional, offline ad business is mired in a funk, as noted by the Advertising Age headline. Meanwhile, as the two IDC studies noted, all forms of online advertising revenue are expected to surge over the next several years. Indeed, part of Yahoo’s rationalization for the Google hookup was that it will more efficiently deliver display ads, or ads with an image element, when they perform searches for their favorite topics. The agreement with Google “will strengthen our competitive position in the convergence of search and display,” Yang said in a conference call with investors.

According to TNS Media Intelligence, traditional media ad spending rose a miniscule 0.6% overall in the first quarter of 2008, with anemic performances from television (1.7% increase), magazines (up 0.8%) and outdoor advertising (a 2.5% gain). Newspaper ad buys were down 5.2% and radio saw ad sales fall by 4.5%. Meanwhile, the Internet, for which TNS included only display ads, leaped ahead 8%, about $2 billion, for the quarter. John Swallen, a senior vice president for research firm TNS, chalked up the offline results to a dour U.S. economy and offered little hope of things looking up in the near future: “Early figures from the second quarter indicate little immediate or sustained improvement in the core ad economy,” he said in a statement accompanying the numbers.

So if the U.S. economy is in such bad shape, and print advertisers are hurting, why has the online market until very recently not shared in the pain? “What happens is that the current economic crisis puts pressure on advertisers to save money and find more effective marketing channels,” says Karsten Weide, IDC’s program director for digital marketplace and new media. “Effectively, the crisis accelerates the shift of advertising budgets from traditional media into new media.”

Fader warns, however, that such statistics don’t tell the whole story. “I’m always dismayed when people use overall spending as an indicator for measuring online or offline advertising,” he says. The dollar figures lack context for how effectively advertising is deployed in any given year. “It’s always a moving target.”

Wharton economics professor Devin G. Pope looked, not at spending, but at numbers of ads and effectiveness during his research into the impact of Craigslist, the online classified ads service. Pope and University of California Berkeley collaborator Kory Kroft found that the online classified ad site Craigslist, where it was available, reduced by nearly 10% the number of newspaper classified job listings between 2005 and 2007. “It not only crowds out those classifieds, it appears to be more efficient,” with significantly shorter listing periods for the Craigslist ads versus the newspaper classified ads, Pope says. For example, rental vacancies for Craigslist-listed apartments were shorter than those not advertised on Craigslist.

If online advertising can make such a big dent in the venerable newspaper classified, what might it do in other ad sectors? Here’s a look at the likely developments in online advertising’s biggest sectors:

Online Search

According to online market research firm eMarketer, search advertising raked in $8.6 billion in 2007, and the firm expects $11 billion to be spent on the category this year. The undisputed giant of search is Google, which gets an overwhelming majority of its revenue from search. Google owns 75% of the paid search business, with Yahoo trailing a distant second at 9%, by eMarketer’s count. Unlike display or banner ads, which feature pictures, animation or even embedded games, Google’s search-related ads are currently plain, unadorned text.

The power of search-related ads lies in the precision with which they can target online customers. Users looking for Hannah Montana web sites will find them — plus an array of ads for Hannah Montana tickets, toys, CDs and other official merchandise. But users probably won’t get ads for Harley-Davidson motorcycles — which might show up next to a Hannah Montana article in a print publication.

The model is simple: A company pays the search provider, such as Google or Yahoo, to have its name appear prominently among the listings whenever a person types in a related search term. The search engine owner makes money from the advertiser any time a sales prospect clicks on a paid search ad (which takes the user to the website of the advertiser or the product’s vendor).

Predictably, a cottage industry has sprung up to teach firms and would-be entrepreneurs how to take advantage of the model. Google AdWords for advertisers and AdSense for web site owners are the biggest and best-known in the category — an Amazon.com search for Google AdSense brings up two dozen titles on how to more effectively use Google’s ad services. For some, this Google gold rush means a suspension of the offline rules of engagement, including, “Thou shall not misrepresent oneself as one’s competitor.” Google has been feeling the heat from advertisers, including Marriott International, American Airlines and Northwest Airlines, over a practice called “piggybacking.” This occurs when small companies use the names of their bigger competitors in the text of their Google ads, so that the smaller companies’ ads will appear in search results by the bigger company. Some claim Google is slow to crack down on the practice, which violates its own user agreement. (Google says it does not allow customers to use trademarked terms in their ad text.)

Small Internet marketers, meanwhile, complain of getting arbitrarily “Google slapped” — financially penalized by the search engine’s word-auctioning algorithms. With Google’s AdWords service, advertisers place bids to appear in the text ads that Google displays in response to certain search terms or “keywords.” Google “slaps” the advertisers if it thinks the keywords are not relevant to what the advertiser actually has on his or her site. The slap might consist of a higher bidding price for the desired keywords, or a decision to disallow use of those keywords — effectively decimating that advertiser’s web traffic. Despite all the complaints — and many are out there — Mountain View, Calif.-based Google’s standing continues to rise. A recent Harris Interactive poll ranked Google as the most-respected U.S. corporate brand. Microsoft tumbled from the top spot, which it held last year, to number 10.

Meanwhile, the recently announced Google-Yahoo pairing signals what’s to come in the lucrative search realm — powerful and presumably appealing display ads that are served up based on a user’s search terms. 

Banner Ads

“Banners don’t work” was one of the Internet’s most commonly heard refrains throughout the dot.com era. Dull, often static and egregiously commercial to users, the online display ads initially had a hard time justifying themselves to advertisers or content publishers. Today, video capability enhanced with sophisticated analytics has this niche poised for dramatic growth. The market for banner ads this year will hit $5.9 billion, according to eMarketer, and could reach $8.1 billion by 2011.

“It’s heading way up,” says Jason Tafler, CEO of PointRoll, a Pennsylvania firm that designs and delivers web “rich media” advertisements that include snappy graphics and even video. PointRoll has grown to 260 employees, up from 50 three years ago. Ad servers such as PointRoll and its top competitor, Google-owned DoubleClick, act as advertising air traffic controllers for the web sites that are their clients. The ad server automatically generates advertisements and serves them to the customer’s web site, where they are viewed by site visitors. The ad server can have 100 or more ways to measure any given ad’s effectiveness — how many times users click on it, how long a user’s mouse hovers over it, what times of day it’s most effective, etc. The demand for rich media ads on the web is expanding right along with the shift away from traditional outlets. “Two years ago, 20% of our ads had some video component to them. Now it’s more like 50%,” Tafler says.

As online consumers have become savvier, advertisers have been pressured to make their pitches more targeted, more creative and more relevant. And because web users don’t want to interrupt their online browsing to be whisked away to an advertiser’s site, PointRoll has designed for its clients “mini-sites” that unfurl, play video and allow potential customers to interact without leaving the page where they found the ad. “If you can have a mini web site within an ad … it’s a lot more powerful than having the user clicking off,” Tafler says. Because of web browser “cookies” and other tracking tools, online advertisers have the ability to target and customize come-ons with accuracy unattainable through traditional media.

Social Network Advertising

Social networks, such as Facebook and MySpace, provide an environment in which marketers hope to instigate word-of-mouth advertising for their products. The idea is that a product or service gains credibility through validation by someone the user either knows personally or who belongs to a community that the user trusts. Research firm eMarketer estimates advertisers will spend $1.4 billion in 2008 to place ads on social networking sites, with that number predicted to rise to $2.6 billion by 2012.

Advertisers are still feeling their way on this one, but observers say it’s an important and growing part of the online ad mix. As many commentators have noted, there’s a fine line between matching customers with products they desire, and coming off as calculating and exploitative.

 In a recent address to the Association of National Advertisers Integrated Marketing Conference, Joseph Jaffe, founder of marketing firm Crayon (which says its main office is in the virtual world of Second life, but which also has real regional offices in the United States and Britain), outlined five deadly sins advertisers routinely commit in dealing with their online audiences: “faking” candidness by company officials; “manipulating” through the use of blogs that falsely appear to have a grassroots foundation; “controlling” the conversation through the heavy-handed use of lawyers; “dominating;” overwhelming with their brand until consumers begin to regard it as clutter; and lastly, “avoiding” — ignoring customers who complain, especially if they are small and seemingly insignificant (an even bigger mistake if that customer has a blog). To illustrate “faking,” Jaffe cited a Sprint campaign in which new CEO Dan Hesse invited customers to e-mail him with ideas about the long-suffering cell phone provider’s “revolution” in the making. Those who took Hesse up on his offer got a boilerplate customer-service e-mail response.

Other Online Advertising

Affiliate marketing, popularized by Amazon.com, allows web publishers of all sizes to get a cut of revenues when their visitors buy via the publisher’s affiliate link. The method has proven particularly popular with bloggers, small web entrepreneurs and product review sites.

E-mail marketing remains a highly effective way to reach consumers. It’s also a favorite delivery vehicle for Nigerian money fraud hustles, shadowy sales of “enhancement” products and “phishing” — obtaining consumers’ account information by masquerading as a trusted business. Congress cracked down with the CAN-SPAM Act of 2003, a legislative attempt to deter such abuses. In May, perhaps the most infamous unsolicited bulk e-mailer of all time, Sanford Wallace, was ordered by the Los Angeles district court to pay News Corp.’s MySpace more than $230 million for massive spamming and “phishing” of MySpace users.

With Google reporting first-quarter revenues this year of $5.2 billion — a 42% increase — and traditional ad spending clearly migrating to the more targetable online consumer, it’s difficult not to see opportunity in the sector. But Wharton’s Fader offers this advice to any company that uses advertising to generate business: Stop thinking in terms of online vs. offline ad spending and break down any walls that may exist between online and traditional media advertising departments. “Anyone who has the capability to do only one thing or the other is in trouble,” he says.