Wednesday, June 25, 2008

Advertising Value Chain 201: Why Google Dominates and Why Facebook and MySpace Need Applications to Monetize

So, I ran across an interesting post that covers the basics of the Advertising Industry Value Chain by Ian Thomas at Microsoft (thanks to another post by Mike Nolet). Its a good advertising 101 summary of the players involved. I thought I'd expand a bit on the Advertising Value Chain 101 bit to illustrate how I think about value chain analysis which will then (hopefully) help illustrate why Google dominates, why agencies will continue to play a part in the ad value chain, and why Facebook and MySpace absolutely need applications to monetize better.

Here's what I will be trying to show in this post:
  1. For publishers - advertising captures value, but does not create it
  2. For advertisers (or marketers) - advertising creates value, but does not capture it

My supposition is that knowing where you are in a value chain is critical to understanding (or in some cases discovering) your business model.

(One side note - I'll use advertisers and marketers somewhat interchangeably in this post but in my mind they are slightly different. An advertiser is anyone who buys advertising. A marketer is someone that uses advertising to create demand for a product or service.)

The Publisher Value Chain

Let's start by looking at an extremely simplified value chain for the publisher and focus on where value is created and where value is captured.

A publisher of any sort (online, radio, TV, magazines) creates value by aggregating a specific type of audience that is attractive to a set of advertisers. Each publisher's audience has an inherent maximum theoretical value based upon that specific audience's willingness to engage in commerce-enabling activities. Some portion of this theoretical value is reflected within the publisher's CPM value (for a breakdown of things that affect CPM and theoretical value - check out Andrew Chen's blog here). However, while a publisher can capture some of that value through a direct sales force, they typically need help in finding and servicing other advertisers that help them monetize their theoretical value.

Between the advertiser and the publisher there are a bunch of potential folks that assist publishers in capturing some of the value they have created by facilitating the transaction. In exchange, they keep some of the value created for themselves. Facilitators include ad-technology players like Tacoda and Revenue Science and ad networks like (I don't include agencies in this list for reasons I will go into later)

Finally, a marketer is willing to pay to reach some of the audience which helps transform some of the theoretical value that a publisher has accumulated into real dollars.

Some take-aways:
  • Publisher Value is Set by the Audience (Not by Technology)
If you run "Guns N Ammo" magazine, no amount of technology is going to enable you to attract advertisers from "New Republic" magazine. Your audience is what it is - you can choose to change your audience by publishing different content but their value is fixed.
  • Realization of Value Comes from Being Able to Reach the Right Advertisers.
Your theoretical value is set by your audience's maximum "Willingness to Pay" for a set of products and services. "Willingness to Pay" is a product of both your audience and the context of the audience (whether they are in interest or intent mode - Andrew Chen talks about some of this here). Realization of that value comes from being able to match your audience with the advertisers that can extract the most "Willingness to Pay".
  • The Broader, More Fragmented Your Audience is the Harder it is to Reach the Right Marketer
If you run "Guns N Ammo" chances are your best advertisers are those folks that sell guns and ammunition. If you are MySpace and are working with billions of impressions per month then you have a tougher problem. You can use technology to find and isolate high value audience segments (cherry picking) but that still leaves the majority of your billions of impressions unsegmented. As nice as it is to have a billion impressions there are very few marketers in the world willing to pay top dollar for a billion broad impressions (I'm not going to get into the pageviews / unique problem as that has been covered far better than I could by Mike). Again, if the majority of your audience has a low "Willingness to Pay" then the only way you can change that is by changing your audience or the context of the audience.

The Marketer Value Chain

Mike Nolet had a post that talked about the value chain and how folks in advertising will typically put the advertiser first and show how money flows out of that spend. Although I am on the business side, I tend to start with the publisher myself. Publishers create value and a bunch of other folks help them realize that value. However, I do think that there are multiple points of value creation and value capture within any industry. In the case of advertising, I think it might be more useful to think of it as two different value chains that are connected. The Publisher Value Chain shown above, and the Marketer Value Chain shown below.

The reason why I like to separate the two value chains is that any one company can be both a publisher and a marketer and seeing those strung along together in one chain gets too confusing. It makes sense though because any good publisher still needs to build brand and awareness of its product in order to continue to aggregate the strongest most desirable audience (just think about how much money ESPN spends on building its brand). Successful marketing creates value by developing Demand for products and services above and beyond what those products and services could garner on their own.

Successful marketing is a big reason for why Coca-cola is able to charge a premium for carbonated sugar water and why Starbucks is able to charge $4 for a coffee. It enables these companies to create value beyond the inherent product or service and hence, allows them to ultimately capture more value from an audience segment than the price they paid to reach the audience. Here's how I see the value chain (which is a bit different from how other folks would show it)

Within this value chain, the value is created by the marketer through the products and services themselves coupled with the marketing campaign. Those products and services have an inherent margin that represents the utmost theoretical value of that combined bundle of products, services, and marketing. Marketers try to increase that theoretical value by targeting the right audiences, increasing the perception of value (and the willingness to pay of consumers), and (of course) by delivering a product or service with real value.

In order to find the right audience and deliver the right message to audiences, marketers will hire agencies to help them create, manage, and track campaigns to reach audiences. Some agencies help marketers create value by developing the actual strategies and ad campaigns needed to drive demand. For their services, these agencies (which include large agencies, and SEMs) extract a bit of the value they help marketers create or capture.

Once the audience has been reached there are usually another set of Facilitators that help the products and services get distributed to the audience members who decide to consume the product or service.

Combining the Two Value Chains

So, if you know where and how other folks are getting paid then you
understand where the risks and gaps are in your business model.
  • Marketers Create Value Through Advertising but Capture it Elsewhere
While Marketers help publishers realize value they only do so because they believe they can create and/or capture more value down the road. Marketing is not meant to be a "Get out of Jail Free" card for the publisher to enable them to monetize the value they have created, unless we are talking about bad marketing (let's not forget the dotcom boom and crash and all the bad marketing that went with that).
  • Publishers Can Be Marketers Too
There isn't a set sequence to these two value chains. You can very easily have a publishing company like ESPN that creates tremendous brand value through marketing first and then captures it through publishing later.
  • Companies Aren't Restricted To a Single Point on the Value Chain
You can also have a publishing company like Google create tremendous value through a search audience and then capture even more value by being a market facilitator (through Google AdSense) between long-tail publisher and advertisers.
  • Creating the Most Value Doesn't Mean You Capture the Most Value
Even though publishers can create a tremendous amount of value, it doesn't necessarily mean that they are best equipped to capture that value. To continue the previous point, this is the beauty of Google's AdSense program. Google can aggregate a ton of high-value niche sites that don't have the scale themselves to attract the right advertiser. Those sites are creating a ton of value by aggregating a high-value niche, but they aren't able to capture that value because they don't have the scale or the sales force to reach the marketers with deep pockets.

Competitive Strategy

Understanding where your company falls in the value chain is a core component of understanding your competitive position relative to the other players in the industry.

Once you understand where power is created and how it is captured some of the industry dynamics become a bit easier to understand.

This value chain analysis gives you a bit of insight into the questions I mentioned in the title:

1. Why Google is so powerful: If all value is dependent upon the initial quality of the publisher then the company with largest, highest quality audience will have tremendous power.

Search is by far one of the highest quality sources of audience and Google dominates search. This gives them tremendous negotiating leverage when working with facilitators in the value chain. In fact, it gives Google so much leverage that they can move down the value chain taking over more and more of the "facilitation" role (thus capturing more of the value they create) without losing business (because the facilitators have no leverage, and marketers are willing to keep paying).

2. Why the Top Ad Agencies are so powerful: The top agencies can aggregate the largest amounts of marketing dollars because they are helping the marketers to create value through advertising. The best agencies are those that control some aspect of the marketing value creation process.

3. Why Facebook's and MySpace's investment in Applications makes sense: Both Facebook and MySpace need to inherently change there Audience profile. Investing in applications does a few things to help:
  • It changes the context in which members interact the site - allowing for more intent driven applications (Where is the Facebook Shopping App?)
  • It helps audience members self-identify their interest in more natural and measurable ways (Getting usage data on "I like movies" Application signifies more interest than just seeing "I like movies" in a profile)
  • It changes the audience mix - new applications attract new users (that are hopefully more valuable)
My personal feeling is that Facebook is inherently more appealing to a more valuable audience segment and so has an advantage over MySpace. (Total aside: since LinkedIn supposedly has a $70 CPM, if they aren't already doing it, Facebook should sell a campaign that targets LinkedIn users on their site - I see a bunch of LinkedIn applications on Facebook already)

In any case, hope this was useful. Comments welcome!