Monthly Archives: October 2012

How Do Companies Make Any Money in Digital?

(By Eric Picard, Originally Published in AdExchanger 10/25/12)

In 2007 I wrote a paper that analyzed the lack of investment from 2001 to 2006 in the basic infrastructure of ad technology.  The dot-com bubble burst had a chilling effect on investment in the ad tech space, and as an industry we focused for about six years on short term gains and short term arbitrage opportunities.

This period saw the rise of ad networks and was all about extracting any value possible out of existing infrastructure, systems, and inventory.  So all the “remnant” inventory in the space, the stuff the publisher’s in-house sales force couldn’t sell, got liquidated at cheap prices.  And those companies with the willingness to take risk and the smarts to invest in technology to increase the value of remnant got off the ground and succeeded in higher efficiency buying and selling, and lived off the margins they created.

But we lost an entire cycle of innovation that could have driven publisher revenue higher on premium inventory – which is required for digital to matter for media companies. There’s been lots of discussion about the drop from dollars to dimes (and more recently to pennies) for traditional media publishers. And while the Wall Street Journal and New York Times might be able to keep a pay-wall intact for digital subscriptions, very few other publications have managed it.

In 2006 the ad tech ecosystem needed a massive influx of investment in order for digital to flourish from a publisher perspective.  These were my observations and predictions at the time:

  • Fragmentation was driving power from the seller to the buyer. Like so:
  • A lack of automation meant cost of sales for publishers, and cost of media buying management for agencies, were vastly higher in digital (greater than 10x what those things cost for traditional on both the buy and sell side).
  • Prices were stagnated in the digital space because of an over-focus on direct response advertisers, and the inability of the space to attract offline brand dollars.
  • Market inefficiency had created a huge arbitrage opportunity for third parties to scrape away a large percentage of revenue from publishers. Where there is revenue, investment will follow.
  • There was a need for targeting and optimization that existing players were not investing in, because the infrastructure that would empower it to take off didn’t exist yet.
  • Significant investment would soon come from venture capital sources that would kick start new innovation in the space, starting with infrastructure and moving to optimization and data, to drive brand dollars online.

Six years later, this is where we are. I did predict pretty successfully what would happen, but what I didn’t predict was how long it would take – nor that the last item having to do with brand dollars would require six  years. This is mainly because I expected that new technology companies would step up to bat across the entirety of what I was describing.  Given that the most upside is on brand dollars, I expected entrepreneurs and investors to focus efforts there.  But that hasn’t been the case.

So what’s the most important thing that has happened in the last six years?

The entire infrastructure of the ad industry has been re-architected, and redeployed.  The critical change is that the infrastructure is now open across the entire “stack” of technologies, and pretty much every major platform is open and extensible. This means that new companies can innovate on specific problems without having to build out their own copy of the stack.  They can build the pieces they care about, the pieces that add specific value and utility for specific purposes – e.g. New Monetization Models for Publishers and Brand Advertisers, New Ad Formats, New Ad Inventory Types, New Impression Standards, New Innovation across Mobile, Video and Social, and so on.

So who will make money in this space, how will they make it, and how much will they make?

I’ve spent a huge portion of my career analyzing the flow of dollars through the ecosystem. Recently I updated an older slide that shows (it’s fairly complex) how dollars verses impressions flow.

The important thing to take away from this slide is that inventory owners are where the dollars pool, whether the inventory owner is a publisher or an inventory aggregator of some kind.  Agencies have traditionally been a pass-through for revenue, pulling off anywhere from 2 to 12% on the media side (the trend has been lower, not higher), and on average 8 to 10% on the creative side depending on scale of the project.  Media agencies are not missing the point here, and have begun to experiment with media aggregation models, which is really what the trading desks are – an adaptation of the ad network model to the new technology stack and from a media agency point of view.

The piece of this conversation that’s relevant to ad tech companies is that so far in the history of this industry, ad technology companies don’t take a large percentage of spend.  In traditional media, the grand-daddy is Donovan Data Systems (now part of Media Ocean), and historically they have taken less than 1% of media spend for offline media systems. In the online space, we’ve seen a greater percentage of spend accrue to ad tech – ad serving systems for instance take anywhere from 2 to 5% of media spend.

So how do ad tech companies make money today and going forward? It’s a key question for pure transactional systems or other pure technology like ad servers, yield management systems, analytics companies, billing platforms, workflow systems, targeting systems, data management platforms, content distribution networks, and content management systems.

There’s only so much money that publishers and advertisers will allow to be skimmed off by companies supplying technology to the ecosystem. In traditional media, publishers have kept their vendors weak – driving them way down in price and percentage of spend they can pull off. This is clearly the case in the television space, where ad management systems are a tiny fraction of spend – much less than 1%.

In the online space, this has been less the case, where a technology vendor can drive significantly more value than in the offline space. But still it’s unlikely that any more than 10% of total media spend will be accepted by the marketplace, for pure technology licensing.

This means that for pure-play ad tech companies with a straightforward technology license model – whether it’s a fixed fee, volume-based pricing, or a  percentage of spend – the only way to get big is to touch a large piece of the overall spend. That means scaled business models that reach a large percentage of ad impressions.  It also means that ultimately there will only be a few winners in the space.

But that’s not bad news. It’s just reality.  And it’s not the only game in town. Many technology companies have both a pure-technology model, and some kind of marketplace model where they participate in the ecosystem as an inventory owner. And it’s here that lots of revenue can be brought into a technology company’s wheelhouse. But its important to be very clear about the difference between top-line media spend verses ‘real’ revenue. Most hybrid companies – think Google for AdSense, or other ad networks – report media spend for their marketplaces as revenue, rather than the revenue they keep. This is an acceptable accounting practice, but isn’t a very good way to value or understand the value of the companies in question. So ‘real revenue’ is always the important number for investors to keep in mind when evaluating companies in this space.

Many ad technology companies will unlock unique value that they will be the first to understand. These technology companies can capitalize on this knowledge by hybridizing into an inventory owner role as well as pure technology – and these are the companies that will break loose bigger opportunities. Google is a great example of a company that runs across the ecosystem – as are Yahoo, Microsoft and AOL.  But some of the next generation companies also play these hybrid roles, and the newest generation will create even greater opportunities.

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Why publishers’ ad experiences need to be more flexible

(By Eric Picard, Originally Published in iMediaConnection.com October 11, 2012)

In 2004, I was recruited to Microsoft, where among other things I was put in charge of coming up with a new plan for the overall advertising experience for MSN and, soon after, Windows Live. I spent about eight months digging into the advertising experience as it then existed and tried to rationalize how advertising should work on a major site like MSN and across a variety of user experiences.

In an early meeting with a group of folks from the sales team, Gayle Troberman made a fateful suggestion: “You really need some kind of framework for assessing what kind of ad fits in what kind of experience.” This was a key suggestion because it forced me to assemble a cross-disciplinary team and create a shared language that drove numerous long-term decisions.

The first-order considerations were driven by “user modality,” which is defined as the behavior and related mindset that a user is engaged in during specific activities. We needed to determine which advertising experiences were acceptable in each type of modality that existed across the myriad experiences on our properties. By carefully considering modality, we were able to create a set of guidelines for what advertising should be enabled in each type of environment.

To illustrate the point, let me give a few key examples of what we put together:

  • Users who are reading email are open to advertising experiences that are relevant and non-invasive, but that are not explicitly targeted to that user based on the content of the mail — which just is creepy.
  • Users who are writing email are not open to advertising experiences.
  • Users who have sent email are open to a broader ad experience with a larger format ad.
  • Users who are reviewing a home page or section front are open to a large format ad.
  • Users who are reading an article are open to non-invasive ads that can be large format as long as they don’t encroach on the reading experience.

The guidelines I created with that team quickly became the overall framework used by Microsoft to drive advertising experiences across all content experiences across MSN, Windows Live, and even in a variety of emerging media experiences. My “day job” at the time was managing product planning for emerging media, which at that time included video, over-the-top television, mobile, video games, software applications, and new device formats (e-readers, tablets and other device prototypes, Zune, etc.).

Some key principles that I came up with include the following:

  • Ensure that ad clutter is kept to a minimum. It’s better to have one very large-format ad on a page than five small-format ads.
  • Ensure that ads have enough white space around them.
  • Give the user the ability to give feedback about ads (both positive and negative) — such as rating ads.
  • Be transparent about behavioral targeting of ads, including how an ad was targeted to them and what profile information we stored about users. Enable users to correct and enhance their targeting profiles. (This was the most controversial of my recommendations and was discussed at length.)
  • Enable every ad unit to become “rich media enabled” with specific templatized enhancements, such as a store locator, a pop-up video unit, RFI, and others.

Like many efforts I’ve been engaged in over the years, this one met with a mixture of success and failure. It took almost five years before we enacted most of the privacy and targeting features I recommended. And none of the rich media templates ever saw the real world. But the user modality guidelines were a huge hit — maybe in a sense these were too successful. Sometimes the creation of a set of clearly defined “rules” empowers folks who are embedded more deeply in an organization to say “no” to next efforts very quickly. This is often the case with any standards effort, whether at the industry level or within a specific organization.

I experienced this one day when I was trying to roll out a new set of ad formats for software applications. I sat down with the product manager in charge of the effort, and when I started walking him through the prototypes, he quickly stopped me with a clear set of concerns: “Uhm… look — these ad formats clearly don’t fit the ad experience framework we use here. So I’m just going to have to say ‘no.'”

Of course, once he learned that I had written those guidelines, the conversation was reopened. But this is an important lesson. Core principles always need to be flexible enough to allow testing the edges and borders of experiences. Once a new content experience is rolled out, an ad experience needs to be tried out with it. Sometimes that new experience doesn’t fit in the guidelines you’ve created.

Entering the Fourth Wave of Ad Technology

By Eric Picard (Originally published on AdExchanger.com, 9/18/2012)

Ad tech is a fascinating and constantly evolving space.  We’ve seen several ‘waves’ of evolution in ad tech over the years, and I believe we’re just about to enter another.  The cycles of investment and innovation are clearly linked, and we can trace this all back to the late 90’s when the first companies entered the advertising technology space.

Wave 1

The early days were about the basics – we needed ways to function as a scalable industry, ways to reach users more effectively, systems to sell ads at scale, systems to buy ads at scale, analytics systems, targeting systems, and rich media advertising technology.

There was lots of investment and hard work in building out these 1.0 version systems in the space. Then the dot-com bubble imploded in 2001, and a lot of companies went out of business.  Investment in the core infrastructure ground to a halt for years. The price of inventory dropped so far and so fast that it took several years before investment in infrastructure could be justified.

We saw this wave last from 1996 through 2001 or 2002 – and during that dot-com meltdown, we saw massive consolidation of companies who were all competing for a piece of a pie that dramatically shrank.  But this consolidation was inevitable, since venture firms generally invest on a five to ten year cycle of return – meaning that they want companies to exit within an ideally 8 year window (or less).

Wave 2

The second wave was really about two things: Paid Search and what I think of as the “rise of the ad networks.”  Paid search is a phenomenon most of us understand pretty well, but the ad network phase of the market – really from 2001 to 2007 was really about arbitrage and remnant ad monetization.  Someone realized that since we had electronic access to all this inventory, we could create a ‘waterfall’ of inventory from the primary sales source to secondary sources, and eventually a ‘daisy-chain’ of sources that created massive new problems of its own.  But the genie was out of the bottle, and this massive supply of inventory that isn’t sold in any other industry was loosed.

It’s actually a little sad to me, because as an industry we flooded the market with super cheap remnant inventory that has caused many problems. But that massive over-supply of inventory did allow the third wave of ad tech innovation to get catalyzed.

Wave 3

Most people believe that the third wave was around ad exchanges, real-time buying and selling, data companies, and what I like to call programmatic buying and selling systems. But those were really just side effects. The third wave was really about building out the next generation infrastructure of advertising. Platforms like AppNexus and Right Media are not just exchanges; they’re fundamentally the next generation infrastructure for the industry.  Even the legacy infrastructure of the space got dramatic architectural overhauls in this period – culminated by the most critical system in our space (DoubleClick for Publishers) getting a massive Google-sponsored overhaul that among other thing opened up the system via extensive APIs so that other technology companies could plug in.

Across the board, this new infrastructure has allowed the myriad ad tech companies to have something to plug into.  This current world of data and real-time transactions is now pretty mature, and it’s extending across media types.  Significant financial investments have been made in the third wave – and most of the money spent in the space has been used to duplicate functionality – rather than innovate significantly on top of what’s been built.  Some call these “Me too” investments in companies that are following earlier startups and refining the model recursively.  That makes a lot of sense, because generally it’s the first group of companies and the third group of companies in a ‘wave’ that get traction. But it leads to a lot of redundancy in the market that is bound to be corrected.

This wave lasted from about 2005 to 2011, when new investments began to be centered on the precepts that happened in Wave 3 – which really was a transition toward ad exchanges (then RTB) and big data.

That’s the same pattern we’ve seen over and over, so I’m confident of where the industry stands today and that we’re starting to enter a new phase. This third major ad tech wave was faster than the first, but a lot of that’s because the pace of technology adoption has sped up significantly with web services and APIs becoming a standard way of operating.

Wave 4

This new wave of innovation we’re entering is really about taking advantage of the changes that have now propagated across the industry. For the first time you can build an ad tech company without having to create every component in the ‘stack’ yourself. Startups can make use of all the other systems out there, access them via APIs, truly execute in the cloud, and build a real company without massive  infrastructure costs.  That’s an amazing thing to participate in, and it wasn’t feasible even 3 years ago.

So we’ll continue to see more of what’s happened in the third wave – with infrastructure investments for those companies that got traction, but that’s really just a continuation of those third wave tech investments, which go through a defined lifecycle of seed, early, then growth stage investments.  Increasingly we’ll see new tech companies sit across the now established wave 3 infrastructure and really take advantage of it.

Another part of what happened in Wave 3 was beyond infrastructure – it involved the scaled investment in big data.  There have been massive investments in big data, which will continue as those investments move into the growth phase. But what’s then needed is companies that focus on what to do with all that data – how to leverage the results that the data miners have exposed.

Wave 4 will really change the economics of advertising significantly – it won’t just be about increasing yield on remnant from $0.20 to $0.50. We’ll see new ad formats that take advantage of multi-modal use (cross device, cross scenario, dynamic creatives that inject richer experiences as well as information), and we’ll see new definitions of ad inventory, including new ad products, packages and bundles.

So I see the next five years as a period where a new herd of ad tech companies will step in and supercharge the space. All this infrastructure investment has been necessary, because the original ad tech platforms were built the wrong way to take advantage of modern programming methodologies.  Now with modern platforms available pretty ubiquitously, we can start focusing on how to change the economics by taking advantage of that investment.

I also think we’re going to see massive consolidation of the third wave companies. Most of the redundancies in the market will be cleaned up.  Today we have many competitors fighting over pieces of the space that can’t support the number of companies in competition – and this is clearly obvious to anyone studying the Lumascape charts.

Unfortunately some of the earlier players who now have customer traction are finding that their technology investments are functionally flawed – they were too early and built out architectures that don’t take advantage of the newer ways of developing software. So we’ll see some of these early players with revenue acquiring smaller newer players to take advantage of their newer more efficient and effective architectures.

Companies doing due diligence on acquisitions need to be really aware of this – that buying the leader in a specific space that’s been around since 2008 may mean that to really grow that business they’ll need to buy a smaller competitor too – and transition customers to the newer platform.

For the investment community it’s also very important to understand that while Wave 3 companies that survive the oncoming consolidation will be very big companies with very high revenues, it is by nature that these infrastructure heavy investments will have lower margins and high volume (low) pricing to hit their high revenues. They still will operate on technology/software revenue margins – over 80% gross margins are the standard that tech companies run after. But the Wave 3 companies have seen their gross revenue numbers be a bit lower than we’d like as an industry.  This is because they are the equivalent of (very technically complex) plumbing for the industry.  There are plenty of places where they invest in intelligence, but the vast majority of their costs and their value deal with massive scale that they can handle, while being open to all the players in the ecosystem to plug in and add value.

Being a Wave 4 company implicitly means that you are able to leverage the existing sunk cost of these companies’ investment.  Thomas Friedman talks about this in “The World is Flat” – one of his core concepts is that every time an industry has seen (what he called) over-investment in enabling infrastructure, a massive economic benefit followed that had broad repercussions.  He cites the example of railroad investment that enabled cheap travel and shipping that led to a massive explosion of growth in the United States.  He cites the investment in data infrastructure globally that led to outsourcing of services to India and other third world countries on a massive scale.  And frequently those leveraging the sunk cost of these infrastructure plays make much more money from their own investments than those who created the opportunity.

So what should investors be watching for as we enter this fourth wave of ad tech innovation?

  1. Companies that are built on light cloud-based architectures that can easily and quickly plug into many other systems, and that don’t need to invest in large infrastructure to grow
  2. Companies that take advantage of the significant investments in big data, but in ways that synthesize or add value to the big data analysis with their own algorithms and optimizations
  3. Companies that can focus the majority of technical resources on innovative and disruptive new technologies – especially those that either synthesize data, optimize the actions of other systems, or fundamentally change the way that money is made in the advertising ecosystem
  4. Companies that are able to achieve scale quickly because they can leverage the existing large open architectures of other systems from Wave 3, but that are fundamentally doing something different than the Wave 3 companies
  5. Companies that take advantage of multiple ecosystems or marketplaces (effectively) are both risky but will have extremely high rewards when they take off

This is an exciting time to be in this space – and I predict that we’ll see significant growth in revenue and capabilities as Wave 4 gets off the ground that vastly eclipse what we’ve seen in any of the other waves.