Analysis: Microsoft loss reflects Web display ad world's woes

By Alistair Barr and Poornima Gupta

SAN FRANCISCO (Reuters) - Microsoft Corp shelled out a record $6.3 billion for aQuantive in 2007 at the height of a race with Google Inc and Yahoo Inc to clinch the top spot in Internet display advertising, betting on what many thought was a red-hot business.

The writedown of almost all of that deal's value, announced this week, shows how misguided those expectations were, and how brutal the once-thriving business of selling banner ads on websites has become.

The main culprit is an explosion of advertising space offered by Facebook Inc and other websites that is outpacing steady demand. But automated online exchanges, smarter search advertising and a growing skepticism about the effectiveness of jamming ads in people's faces have also conspired to slash prices and suck profits out of the business.

"The inventory or amount of ad spots grew so fast, it outgrew demand," said Dave Morgan, an industry veteran and entrepreneur. "That brought pricing down massively. So a lot of display advertising really became a ghetto for bad direct-response advertising."

Morgan founded Tacoda, an online advertising firm that AOL acquired in 2007 for $275 million. He is now in TV advertising as the CEO of SimulMedia.

"That's where the big money and margins are," he said.

Microsoft's spectacular capitulation is the latest admission of failure on display advertising. Ad industry executives say the software leader might now join Yahoo in re-thinking its approach to Internet advertising, though there's no simple solution to the fundamental challenges they face.

Marketers today have more choices than ever, as Internet penetration swells in emerging markets and popular websites like Facebook multiply the amount of available online pages.