AOL and Yahoo! have been struggling since the first quarter of last year with sustaining their ad-based business.



NEW YORK (TheStreet) -- Jim Cramer made an interesting observation about Web ads on CNBC last week -- they stink.

Cramer made the point that Web companies that are dependent on basic banner ads and other display ads are seeing their business just evaporate.

AOL(:AOL) and Yahoo!(:YHOO) are two companies that have been struggling since the first quarter of last year with sustaining their ad-based business.

Although AOL has seen some marginal increase in its display ad business in the last quarter, it has been under enormous pressure in the last year to sustain that business. It launched its ambitious Project Devil initiative last spring in order to try and face this problem head on.



The problem is that there appears to be an infinite inventory of ads on the Web. Not many consumers are interested in clicking on them. The laws of basic supply and demand suggest that prices in that environment will drop and they have.

The aim of Project Devil was intended to combat that problem by creating new kinds of ads that would appeal to publishers and seem unique to users. The ads were much larger and more interactive than basic ads. They take a lot more time to create but the early indications were that consumers had a higher click-through rate for these ads compared to the run-of-the-mill ones.

Yet, AOL hasn't spoken much about Project Devil since the summer. One of the challenges is the time needed to build these ads and therefore the ability to get them out there on scale. Another issue that has come up is how such ads take up the entire web page. People wonder if that lowers AOL's overall display ads because they have to give up some relied on revenues today for the hope of greater Project Devil revenues in the future. For whatever reason, we haven't heard much on Project Devil recently.

Yahoo! has also seen its display business challenged since the second quarter -- and that's been the greatest strength for the whole company. Its response to date has been to try and be more efficient at matching ads to the right viewers and cutting out the middle men handling their Class 2 inventory. With new CEO Scott Thompson and his background in data at PayPal, he will certainly maximize whatever value is there that's not being captured.

Some analysts have suggested that perhaps Yahoo!'s problems are due to lost business to Facebook. TBG Digital recently released some data on Facebook that showed its CPMs were up 23% in Q4 vs. Q1. It's the multi-billion dollar question on whether Facebook is the disruptor that is causing the problems experienced by AOL, Yahoo! and others, or if it's subject to the very same forces.

Cramer was asked why Google(:GOOG) seems to be bucking this trend. Their business has grown in the last year. Jim's response was that Web ads are a winner-takes-all business. Google is winning and everyone else is losing. I agree with him in the sense that no one in the last 10 years has come up with a better business model tied to more relevant intentional results than AdSense. The ROI is clear for advertisers.

However, even Google is feeling the pressure of maximum market share and slow growth in their core index share business, which is why they've been so aggressive in moving into other growth areas such as mobile, travel (Kayak), and now want to return to China -- where, even today, they are bringing in $600 million a year in ad revenue and they're no longer "in" the country.

I watched an interview between Flipboard CEO Mike McCue and entrepreneur Chris Dixon where they were discussing the origins of Flipboard. One of the comments Mike made was, in discussing the story of how he came up with the idea for the company, how some off-line, old magazines have done a great example of making money from ads. He cited how Vogue has only a million offline subscribers but was able to sell $300 million of advertising against it last year. Mike created Flipboard with the idea that it would be a beautiful form factor (which it is) that users would want to interact with and advertisers would want to appear in (which it is still too early to judge).

But Mike is right and he points to a simple fact -- which Cramer would agree with -- Web ads, in their first iteration, have hit the saturation point.

The next leaders in Web ads are going to be the people who think about Web ads in a fundamentally different way than has been done in the past.

It will be interesting to see what Apple(:AAPL) does with its nascent iAd mobile ad business. Will it try to innovate something completely new that's much more exciting for advertisers?