Nick Denton, the owner of the blog “empireGawker Media, has some advice for ad-supported online businesses: prepare for the market to get much, much worse.

Telling “conglomerates” and “internet ventures” alike that they’re “sleepwalking into economic extinction,” Denton lays out an admittedly gloomy argument that executives at ad-supported online businesses “should be planning now on a decline of up to 40% in advertising spending during this cycle.

While all but the naive now accept that the online ad market is not going to be untouched in the world’s severest economic challenge since 1929, there are still many who believe that online will hold up decently.

Denton disagrees. He argues:

  • The forecasters haven’t anticipated a deep recession. He points out Morgan Stanley analyst Mary Meeker’s observation that for every 1% decline GDP output growth, advertising growth declines by 3%.
    Yet Denton notes that Meeker’s presentation at the recent Web 2.0 Summit contained the International Monetary Fund’s forecast for a flat 2009 in the US economy.

    As Denton states, “we should be so lucky.”

  • The banking crisis points to further deterioration. He looks at “the path of other countries that have suffered a credit crunch in the last two decades” and the results aren’t pretty.

    Plugging past economic downturns experienced by Japan, Sweden and Indonesia into Meeker’s formula, Denton concludes that the US ad market could see spending decline anywhere from 9% to 43%, far more than most anticipate.

  • Online advertising isn’t immune. Many argue that the internet ad market is less susceptible to cutbacks because the market is more mature today and internet ads are more “measurable” than other forms of media.

    Denton, however, points out that maturity is a double-edged sword. Now that the online ad market has matured, “underlying growth is more sluggish” than it was in the downturn of 2001.

    And when it comes to “measurability,” Denton observes that “it’s still only television advertising that can demonstrate a correlation between spending and a boost to a marketer’s sales.

While the possibility of a significant decline in the online ad market that Denton lays out is gloomy to say the least, unfortunately the logic behind his argument isn’t exactly unreasonable.

And Denton is putting his money where his mouth is. He’s merging his Silicon Valley gossip blog, Valleywag, with Gawker and has already shut down some of Gawker Media’s underperformers. And he’s looking to sell off some of his properties, including the popular Consumerist.

Denton’s logic makes sense: if he’s right about the online ad market decline and doesn’t act now, it will already be too late for his business by mid-2009. If he’s wrong about the magnitude of the decline, Gawker Media will come out of the downturn with lots of cash on hand to invest.

So what advice does Denton have for other ad-supported online businesses?

  • Get out of markets that marketers are adverse to. He lists politics as an obvious market that is vulnerable.
  • Renegotiate with vendors. With vendors more eager than ever to go the extra mile to retain business, why not use the situation to obtain the best deals possible?
  • Consolidate. Denton recognizes something that many in “new media” surprisingly still don’t recognize: scale is everything.

    Having a network of properties that don’t “register” with services like comScore and Nielsen means major advertisers and agencies probably aren’t going to give you the time of day. So focusing on your top properties and consolidating where appropriate makes sense.

    So too does ditching underperforming properties.

  • Offshore. As he’s based in the US, Denton observes that the recent strengthening of the US dollar makes sending projects offshore even more appealing to US firms, even though costs are declining (albeit more slowly) at home.
  • Use variable compensation. By investing executives and important employees in the business through profit-sharing pools, the company conserves cash and executives/employees get to share in the wealth if/when things get better.
  • Focus on value. Denton argues something that I’ve argued for some time - online publishers need to do more for advertisers.

    As Denton correctly notes, “Internet publishers have forced marketers into a straightjacket of standard ad units too small for brands to breathe. If the sector is to capture a larger share of brand advertising from magazines and television, the creative needs to have more impact.

All in all, while nobody likes doom and gloom scenarios (even Drama 2.0), Denton’s post should serve as a wake up call to those who have buried their heads in the sand.

Nobody knows the extent to which the global economy will continue to decline and the impact it will have on the online ad market. Right now, all appearances are that we’re not out of the woods yet and that there’s a decent chance the worst might be yet to come.

Yet the positive takeaway from Denton’s look at his own business is this – companies that take action now and plan for the worst may come out looking the best.