June 3rd, 2008
Technology Doesn’t Work
For a technologist like myself, one of the more frustrating aspects of online advertising is that most technology companies don’t succeed. There are countless tech-focused startups, each of which has a new “technology solution” that will revolutionize social media, online branding, contextual classification or user categorization. Countless teams of great engineers who know build great products. Sadly, most make little or no money.
But it’s ONLINE advertising you say — isn’t the whole industry based on technology? If a bunch of bright entrepreneurs come up with some new technology shouldn’t they be able to make lots of money? Well here’s the problem: the whole industry is based on weak technical underpinnings — browser-side redirects and cookies — that make it incredibly difficult to integrate services across providers. The end result is that the online advertising market is controlled by media companies.
Media Makes Money
At the end of the day, everybody is trying to get a slice of the media dollar as it moves from the brand to the actual publisher. Whether it is vertical ad-networks who aggregate publishers to help make finding inventory easier, behavioral ad-networks who enrich user-data to help brands reach the right users or technology providers who ease the whole process — each is simply looking to take a cut of that dollar.
As a new company you have two options — start an ad-network and inject yourself directly into the money stream or selling your technology to one of the existing players in the food-chain. Realistically — most agencies and publishers aren’t very tech savvy, so as a cutting edge technology player you are primarily limited to selling to ad-networks. Here’s the problem — although running an ad-network can be a highly lucrative business — selling technology to one is not. Three reasons:
First and foremost there is the issue that the integration of your technology with a network will be a total pain. If anything needs to be installed directly (eg code level) with a serving system you might as well forget it. For the sake of this post — let’s assume that you can overcome that hurdle.
Valuations in the industry are largely driven by technology platforms & solutions. A plain tech-free network will sell for 5x revenue whereas a tech platform can easily hit a 40x multiplier. This is why you see more and more networks popping up around “platforms” as they are hoping it will net them the big Yahoo or Google acquisition. When selling a technology solution to the network the natural response will often be — “We can’t outsource this”, or “We need to own this IP”.
Pricing is Hard
Once you have proven some ‘value’ it’s time to price your technology solution. Now Ad-networks make a business out of squeezing out margins. They buy inventory from some party, sell it back to another and take a certain percentage cut which ranges from 20-50%. Any fee, whether CPM or revenue-share, will directly impact the bottom line of the network — this means a low apetite for expensive software. Let’s walk through a pricing example:
A (purely hypothetical) example
Travelocity.com and is buying inventory from Advertising.com. Ad.com is short of direct travel based publishers and buys additional inventory from the vertical ad-network “Travel Ad Network” who ends up displaying the Travelocity ad on a website ilovetravel.com.
Travelocity pays Advertising.com $1.00 CPM for the inventory. Ad.com takes a 30% margin and pays Travel Ad-Network $0.70 CPM. TAN takes an additional 30% cut and pays the publisher $0.49 CPM. So in this scenario we see the following revenue:
So now here you are — you think you have a new way of optimizing travel-focused media by customizing the creative message per user and want to start your company. Let’s imagine that your new technology can improve the efficiency of travel ads by 50% and hence increases the value of impressions by 50% You have two choices, one is to go off and build some technology and try to sell it to Ad.com. The other is to start an advertiser-facing travel based network and get the deal directly from Travelocity. You cannot sell the technology directly to Travelocity since they do not have the technology or knowhow to implement your solution and you cannot sell to Travel Ad Network because they don’t have direct access to the creative.
For the sake of argument, let’s suspend disbelief and assume that there aren’t any integration challenges and there is a magic way in which you can seamlessly plugin your technology. Your technology increases Ad.com’s revenue by $0.15 CPM so let us assume that your sales team can negotiate a 50% revenue share, or a $0.075 CPM fee for your technology. In this case the revenue flow looks as follows:
Now if you became an ad-network and contacted Travelocity’s directly and offer to optimize their ad-campaign for them. On their behalf you will approach publishers, vertical ad-networks and other sources of inventory and use your “secret sauce” to increase their efficient by 50%. You get the deal and start buying ad-inventory from travel publisher, and of course, Travel Ad Network as well. Because your technology increases effectiveness by 50% you now spend $1.50 CPM on this ad-campaign, which means you take in your 30% ($0.45 CPM), and pay off the rest ($1.05 CPM) to Travel Ad-Network. In this scenario you see the revenue as follows:
See the difference? Selling pure tech gets you $0.075 CPM whereas starting the network gets you $0.045!! You make six times more money as a network and the worst part is this — it’s probably easier.
So the arguments above are obviously not very scientific — but I stand by the basic premise. This is why more and more we are seeing tech companies rebrand themselves as or launch new ad-networks. They are finding that the margins are much higher selling the inventory themselves. This in itself causes a whole new problem — hundreds and hundreds of new ad-networks. In essence, although each company individually is solving a specific problem with their technology it is causing a whole new problem of fragmentation.
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