Advertising is a dead, decaying disease. Usage-fees are positive-sum games. So why are usage-fees generally unsuccessful and advertising everywhere?

Like so much in today’s society, we can find the answer at the Federal Reserve.

Advertising

Fundamentally, TV exists in order to help Dove and Budweiser convince people to pay more for soap, shampoo and beer. Companies pay based on NBC’s perceived ability to persuade. Hey Busweiser, why not just lower the price?

I suspect that the vast majority of the 20th century’s advertising bonanza depends on cheap debt subsidized by the Federal Reserve.

Coca-cola borrows money at a fixed cost subsidized by the Fed. The money spent today convinces customers to spend more tomorrow. The extra revenue services the subsidized debt and adds a little to KO’s bottom line.

This only works on account of the Federal Reserve and US Treasury’s policy of permanent inflation. Tomorrow’s supply of money is always greater than today’s. This growing money supply makes it easier to stimulate someone into spending nominally more on sugar water tomorrow. In addition, Coca-cola can repay their nominally-fixed debts with a dollar that is increasingly less valuable per unit.

Honest money would make profitable advertising far more difficult: Coca-cola would have to borrow money at higher interest rates today; they would have to repay their creditors with equally valuable money tomorrow. We would have far less advertising in such a world.

Eric Clemons, Professor of Operations and Information Management at The Wharton School of the University of Pennsylvania, gives a dim forecast for advertising’s future:

Advertising will fail for three reasons:
There are three problems with advertising in any form, whether broadcast or online:

• Consumers do not trust advertising. Dan Ariely has demonstrated that messages attributed to a commercial source have much lower credibility and much lower impact on the perception of product quality than the same message attributed to a rating service.Forrester Research has completed studies that show that advertising and company sponsored blogs are the least-trusted source of information on products and services, while recommendations from friends and online reviews from customers are the highest.
• Consumers do not want to view advertising. Think of watching network TV news and remember that the commercials on all the major networks are as closely synchronized as possible. Why? If network executives believed we all wanted to see the ads they would be staggered, so that users could channel surf to view the ads; ads are synchronized so that users cannot channel surf to avoid the ads.
• And mostly consumers do not need advertising. My own research suggests that consumers behave as if they get much of their information about product offerings from the internet, through independent professional rating sites like dpreview.com or community content rating services like Ratebeer.com or TripAdvisor

So why is advertising is everywhere? I only expect to see the end of most advertising after the collapse of either pure-paper currency systems and/or legal tender laws.

For example, Clemons seems to think Google’s business model will be an eventual loser:

Misdirection, or sending customers to web locations other than the ones for which they are searching. This is Google’s business model. Monetization of misdirection frequently takes the form of charging companies for keywords and threatening to divert their customers to a competitor if they fail to pay adequately for keywords that the customer is likely to use in searches for the companies’ products; that is, misdirection works best when it is threatened rather than actually imposed, and when companies actually do pay the fees demanded for their keywords. Misdirection most frequently takes the form of diverting customers to companies that they do not wish to find, simply because the customer’s preferred company underbid. Misdirection also includes misinformation, such as telling a customer that a hotel is sold out when, indeed it is still available, if the hotel has chosen not to pay a promotional fee, and then allowing the guest to choose an alternative property. Misdirection is, regrettably, still a popular business model on the net, although for reasons I explored in an earlier TechCrunch post on Google it seems ultimately to be unsustainable. More significantly from the perspective of this post, it is not scalable; it is not possible for every website to earn its revenue from sponsored search and ultimately at least some of them will need to find an alternative revenue model.

Google still makes money today, but I consider Clemons’ pessimism all too valid in world using sound money. So how will companies make money?

Usage-Fees

People want access for information. Public demand for information access is the primary reason Verizon, Comcast, etc. earn revenue each month. It makes logical sense for me to pay Qwest more as I access more information. After all, this is how things work on my water, electrical and gas bill.

Yet this is not my arrangement with my internet service provider. I seem to pay the same amount regardless of whether I check my email once a day or use BitTorrent to download every episode of every tv show ever made each month.

In other words, Verizon and Comcast’s business model resembles a fitness gym. They make money based on their ability to convince people to buy more than they need or are willing/able to use. The ideal gym customer is the overweight engineer-economist who resolves to finally get in shape and signs up but is too lazy to actually do any physical labor (like me). The ideal Comcast customer is the person who signs up expecting to download movies and music, video-chat and play exciting video games but never actually figures out how to do anything (like far too many people).

The typical gym has too few lockers for everyone to work out as much as they intend. Show me an internet service provider that has enough bandwidth for everyone to video chat with each other at the same time: I will almost certainly show you a calculation error.

So in effect, I subsidize the cost of the fitness enthusiasts’ equipment usage. And grandmas subsidize the cost of their children’s pornographic downloads. While this often benefits the subsidized users, the model often misaligns a company’s financial interests with the demands of their customers.

Misaligned interests cause aggressive, unfriendly behavior towards customers: the fitness center that refuses to cancel my subscription until I appear in person (and turn down the gorgeous woman insisting to know how she can make my membership more valuable). Time pushing buttons on my touch tone phone, waiting on hold for a customer service agent and finally receiving terrible technical support.

Imagine a restaurant that optimized their menu according to what their most frequent patrons like least and told waiters to antagonize these customers. It sounds absurd but this is exactly what service providers do: spend resources to throttle their most active customers.

Luckily the dining reality is that the guy who goes to the same restaurant seven days a week is a favored, profitable customer. The restaurant goes out of their way to assist this person. They are likely to make his desired dish, even if it is not on the official menu.

Internet usages fees would create the same type of customer relationship. New services like BitTorrent or video chat will periodically appear, dramatically increasing bandwidth demand for a subset of users. The increased usage revenue signals a profit opportunity for Verizon. Since Verizon’s financial interests are aligned with what their customers value, they will seek ways to make it easier for as many users to discover and benefit from as many services as possible.

The benefits to usage fees are clear.

So ask yourself: what is preventing service providers from successfully adopting this model?

David Beckworth outlines the case for benign deflation:

an increase in the growth rate of productivity or the labor supply should raise the natural rate of interest and create deflationary pressures. If, however, monetary authorities attempt to offset the deflationary pressures by lowering the policy interest rate, they may force the real interest rate below the natural rate and create an unsustainable credit boom. The resulting macroeconomic disequilibrium will be manifested in unwarranted capital accumulation, excessive leverage, speculative investments,and inordinate asset prices

Every year we make more cars than we destroy. We make more homes than we destroy. This increases the supply of goods. Increased supply lowers prices. So the price of these goods should fall.

The Federal Reserve is afraid of deflation. They are not limited to changing interest rates. The Fed might print money. Who gets the money first? Bankers.

Bankers spend this new money, increasing demand. Increased demand raises prices. This lowers the value of our income and savings. So the gap between rich and poor increases.

The Federal Reserve and inflation help some, but hurt many more. Celebrate falling prices. End the Federal Reserve.

Eric Knight argues for a deflationary default of HSBC’s sub-prime debt:

Knight Vinke, the activist investor, told The Times last night that HSBC should refuse to pay the bondholders that fund Household’s business, which it estimated would save the bank an estimated $35 billion. (£23.6 billion).

Eric Knight, Knight Vinke’s chief executive, said: “Why should HSBC’s shareholders take all the pain when these [Household] bondholders are unsecured?” To do this, HSBC would have to threaten to allow Household to take Chapter 11 bankruptcy protection.

So far shareholders have taken almost all of the losses. Why spare bondholders? Defaulting on debt is deflationary.

Will bailing out Ford, GM and Chrysler help increase your income? Eugene Fama finds this unlikely:

Bailouts of auto firms will be financed with government debt. The government deficit gets larger; that is, government savings, GS, become more negative. If private and other corporate savers do not save more in response to additional government debt, the auto bailout displaces productive investments elsewhere. If private and other corporate savers do save more in response to additional government debt, private consumption must go down by the same amount. This lost consumption and investment, and the incomes they would create, are the big costs of a bailout.

Other stimulus programs are no different:

Like the auto bailout, government infrastructure investments must be financed — more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount.

The government can allocate resources to auto-workers. These resources are unavailable to electric-car manufacturers. The same thing is true for teachers.

Is allocating resources away from electric-car manufacturers a good idea? Is it better to allocate them to teachers or Ford? These are hard problems.

Government tends to screw things up. Misallocated resources reduces your standard of living.

Will Obama’s deficit spending plan keep unemployment below 8% in 2009? Gary Becker does not think so:

with unemployment at 7% to 8% of the labor force, it is impossible to target effective spending programs that primarily utilize unemployed workers, or underemployed capital. Spending on infrastructure, and especially on health, energy, and education, will mainly attract employed persons from other activities to the activities stimulated by the government spending. The net job creation from these and related spending is likely to be rather small. In addition, if the private activities crowded out are more valuable than the activities hastily stimulated by this plan, the value of the increase in employment and GDP could be very small, even negative.

Maybe the government decides to borrow more money. Maybe the money is spent building a bridge. Were the bridge-builders unemployed? Keynesian economists assume they are. Good engineers may already have a job. Hiring them does not help employment. Other people are still out of a job. They might be poor engineers.

What if no one wants the bridge? Bridges to nowhere do not help the economy. Building a bridge creates debt. Repaying debt prevents other activity.

Job creation does not fix things unless the jobs are productive. Ron Paul:

The goal of a healthy economy is productivity. Jobs are a positive outcome of that. A “job” could be to dig a hole one day, and fill it back up the next, or perhaps the equivalent at a desk. This does no one any good. But the value in that paycheck ultimately has to come from taxing someone productive.

Imagine someone wants a well. Digging a hole for the well has value. Imagine another person dug a hole in someone’s driveway. The effort it the same. The hole is less valuable. It may have negative value. The effort was not productive.

Effort is orthogonal to value and productivity.