(FORTUNE Magazine) – By most standards SportsLine USA is a new-media success story. It's the second most popular sports site on the Internet, behind ESPN. It benefits from a valuable alliance with CBS Sports. Its ad revenues keep climbing. And--you knew this was coming, didn't you?--its stock is up 600% since the company went public in 1997.

So why is SportsLine paying people to visit its site? It doesn't call it that, exactly, but SportsLine has created a "rewards" program that gives users points, similar to airline frequent-flier miles, for viewing pages and buying things. An avid sports fan (or anyone with nothing better to do) who visits frequently and clicks on enough pages can exchange points for T-shirts, movie passes, $5 and $10 restaurant certificates, hockey pucks, and baseballs, along with automatic entries in a $1 million sweepstakes. As you surf through all the freebies, it's easy to forget why you came in the first place--to check the scores.

SportsLine isn't alone. Other blue-chip sites like MSNBC and Yahoo are trying to spike traffic with incentives and giveaways. It's the latest evidence that challenging times lie ahead for media companies on the Internet, where competition for viewers and advertisers is cutthroat. To generate traffic, Internet publishers are spending more money than ever on marketing and promotion. But advertisers have countless choices online, so the rates that publishers can charge for ads are coming down. In essence, many new-media companies are buying eyeballs at high prices and selling them at low prices--not a good thing, even in the Through the Looking Glass world of Internet economics.

Particularly worrisome are the declines in advertising rates, since most Internet media companies are counting on a rising tide of ad revenues to lift them to profitability. Sure, overall ad revenues are still growing rapidly as new users come online and e-commerce sites spend lavishly to attract customers; Internet ad spending will probably top $2 billion for 1998, more than double the previous year. But CPMs--the cost to advertisers of showing an ad 1,000 times--dropped by some 5% during the year, to about $35, according to Adknowledge, a Palo Alto company that helps clients buy ads. Ad buyers who are just seeking mass impressions can buy them for $5 per 1,000 or less from aggregators like Flycast, a San Francisco firm that gathers unsold inventory on Websites and sells it to sponsors at bargain prices.

"Rates are plummeting," says Greg Smith, director of strategic planning at Darwin Digital, a unit of advertising giant Saatchi & Saatchi. "For some of the most successful sites, their models are in jeopardy.... If the Internet follows the life cycle of traditional media, there will be a shakeout."

No one should be terribly surprised by this. Since the beginnings of the World Wide Web, publishers have celebrated their ability to deliver more information than any other medium because they have unlimited space. The trouble is, the same goes for ad space, creating an oversupply. Fueling the glut is the fact that barriers to entry on the Internet are low, particularly when compared with other media businesses like radio and TV, which operate with finite spectrum and airtime. One reason sponsors paid $1.6 million for a 30-second spot on the Super Bowl--that translates into a $20 CPM, by the way--was that Fox had only a few dozen spots to sell. By contrast, Super Bowl sites on the Web were plentiful.

"There's an unlimited supply of banner real estate out there, and that can only drive the prices down," says Chase Franklin, CEO of Qpass. His company, a Seattle startup, helps publishers that can't survive on advertising alone charge small fees for digital content. "We're firing a shot across the bow at the absurd notion that all information on the Internet ought to be free," he says.

With CPMs dropping and IPOs looming, it's no wonder some new-media outfits are spending more money on marketing than they're bringing in (see chart). Says SportsLine CEO Mike Levy: "We've got to make sure that all the new people coming on the Internet know who we are." He has given up 18% of SportsLine's equity plus warrants to CBS and another $23 million in cash, stock, and warrants to America Online, all in exchange for promotion. (Even so, SportsLine's traffic slipped last fall.) MSNBC, the NBC-Microsoft joint venture that gets nonstop exposure on TV and cable, nevertheless launched a "Return Rewards" contest that gives frequent-flier miles to regular users. Like radio station contests and cut-rate magazine subscriptions, such gimmicks have become widespread. Besides pumping up traffic, they help publishers get valuable demographic information from users.

While paying people to view content is unorthodox, new-media companies are hell-bent for market share. Internet publishing is evolving into a Darwinian world of haves and have-nots, with the top ten publishers capturing 70% of all ad revenues, according to the Internet Advertising Bureau. Although they may appear desperate, SportsLine and MSNBC are among the Web-advertising leaders.

The big will only get bigger. In the biggest interactive-marketing deal ever, AOL recently announced a five-year, $500 million agreement with First USA to make the Bank One unit the exclusive marketer of credit cards on AOL. Big portals like Yahoo and Excite have the scale to invest tens of millions of dollars on technology that will enable them to target ads; they can measure an advertiser's return on investment with a sophistication that old media can't match. "We can direct an ad to a West Coast audience that is predominantly male and between the ages of 18 and 25," says Yahoo's Jerry Yang. Says Excite founder Joe Kraus: "The ultimate promise of the Internet is the ability to generate TV-sized audiences and to target a single individual."

Publishers serving salable niche audiences will also thrive. The Wall Street Journal's interactive edition, whose readers register and pay subscription fees, commands an average CPM of $65 from advertisers seeking upscale decision-makers. Technology site CNET turned profitable last year because it reaches buyers of computers and software with news and product reviews; it also offers them a database of 125,000 products and 1.5 million prices at its shoppers.com site. "If you stand between buyers and sellers, your chance of turning traffic into revenue is much higher," says Halsey Minor, CNET's CEO.

As for the rest--the hundreds, if not thousands, of news, sports, women's, health, entertainment, and community sites--only the best will become real businesses. Those allied with TV and cable networks have an edge; they get promotion and access to video, which will become important with the spread of broadband. "Being a stand-alone is dangerous in any field of media today, and the Internet is no exception," says Larry Goodman, president of sales and marketing at CNN, which like FORTUNE is a unit of Time Warner.

But even the strongest companies face perils. Fewer users are clicking on banners. New technology enables consumers to block ads. And there's the "Where's the beef?" factor--no Internet banner ever coined a catch phrase or caused a user to laugh out loud or hum a jingle. And no one has ever argued about who had the best commercials on SuperBowl.com.

REPORTER ASSOCIATE Jane Hodges

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