A couple of years ago, I was chatting with an executive at Fox and told him, “MySpace killed the online ad business,” adding that the social networking giant’s ballooning inventory of display ads depressed ad rates.  He didn’t seem to disagree, which made sense since we were talking about how the only solution to falling ad rates in display advertising was video content, inventory and ads.  He added that all sites tend to sell out the premium real estate on their properties — and without video inventory, they really cannot find ways of generating more revenue from ad sales.

We now know what happened to MySpace: Facebook ate its launch.  But what has remained constant is the challenge of growing ad rates in an environment where there is more inventory than ever before.  In fact, fast-forward a couple of years. ComScore announced that Q1 saw over 1 trillion display ad impressions generated, with Facebook accounting for 16%.  Yahoo was second, with 12%.

To indicate how much the optimization of inventory is a problem for the largest properties, consider that Yahoo paid nearly $800 million for Right Media, operator of an online auction system for display ads.  Following Facebook and Yahoo is Microsoft — which has lost money from its online operations forever — and Fox properties, which includes MySpace and IGN.

Speaking of IGN, when it bought my last company in 2005, executives mentioned that one of the largest drivers of ad inventory on their property were the message boards, and that inventory wasn’t worth “a bucket of warm spit” — as an explanation of why, despite its having hundreds of millions of pageviews, they were going to buy the company where I ran ad sales.

That was then, this is now, and everywhere you look, the forecasts for online advertising are turning increasingly bullish, as reported in the trade press:

“Double-digit growth is set to return to the online ad market this year, according to IDC. The market research firm says it expects online ad spending to jump 12.6 percent to $29.7 billion in the U.S. By contrast, spending dropped 2.4 percent in 2009.

According The Interactive Advertising Bureau and Pricewaterhouse Coopers, “Internet ad spending jumped 7.5 percent during the first quarter to $5.9 billion-marking the ‘highest first-quarter revenue level ever for the industry.'”

“Revenue from online video advertising networks — typically the lowest-priced digital content for marketers — is due to grow 41% in 2010 over last year to $377 million.”

Indeed, while the macro-level picture for online advertising remains very rosy, on the front lines, online media professionals understand that there will remain a pricing pressure on ad inventory, which is ultimately what drives revenue for their properties.

Without a doubt, over the next year, the difference between the $70 billion television ad market and the $30 billion Internet advertising market will shrink. However, ad rates will face enormous pressure as long as consumers continue to turn to the web to consume media and social media (including user-generated content), catapulting ad inventories to increasingly higher levels.

It’s basic economic theory that when supply of one thing increases, prices will have difficulties rising if demand stays somewhat constant or grows moderately.  This, in turn will affect price-to-earnings and price-to-revenue multiples for publicly traded companies and valuations for private ones.

To understand the video opportunity, consider the following two sets of data:

–       comScore: “U.S. Online Video Market Continues Ascent as Americans Watch 33 Billion Videos per Month.”

–       Nielsen: “More than 9 Billion Video Streams Viewed in the U.S. per Month.”

Initially, I wondered about that 24-billion discrepancy, but I reached out to Andrew Lipsman, senior director of industry analysis at comScore, who explained to me that: “One source of difference is that comScore data includes video ads,” whereas — one can presume — Nielsen only looks at content views.

If that is the case, then roughly 24 billion video ads were seen each month, over a quarter — that is 72 billion video ad impressions.  Now consider that with the 1 trillion display ad impressions over Q1. 

In other words, whereas just over 20 billion video ads are seen each month, there are 333 billion display ads per month (dividing the 1 trillion in Q1 by 3).  Of course, with video ads being worth ten times more than display, this is comparing apples to oranges, but ultimately this creates an interesting opportunity for sites to start replacing at the real estate they now use to sell static or flash display ads with in-banner video ads — which not only garner a higher CPM, but are far more effective.

To be very clear: in no way am I recommending that Web properties insert video ads in display spots and pass them off (or price them similarly) to the video pre-roll ad you see before an actual piece of video content.  What I am outlining is that many advertisers will welcome paying more (relative to display banner ads) for video ads in spots historically reserved for display ads — and would welcome seeing more inventory for video ads that don’t garner the nosebleed rates that pre-roll inventory fetches (due to its limited inventory and availability).

Of course, we should be careful what we ask for. If all of the inventory that now runs display ads gets used to run video ads, then we will also see a rise in supply. Still, sometimes the devil you don’t know is better than the one you do.