Why Behavioral Targeting is not a Publisher-driven Technology

A colleague recently pinged me to get my thoughts on behavioral targeting companies and the new influx of a number of different companies. Basically, I argued that if you are focused solely on trying to sell behavioral targeting to publishers your company will fail. This dovetails a bit with a post Mike Nolet recently did on the Plight of the Ad-Technology startup where he points out three reasons why its hard to make money as an ad company: 1. Integration sucks, 2. IP Ownership, and 3. Pricing is Hard. While all those points are true, my argument basically comes down to the fact that no amount of technology can change the core audience of a publisher (see my value chain analysis of the ad industry for more detail).

The basic problem of behavioral targeting technology is:

• The sites with good data / good audience don't need you
• The sites that need you don't have good data or a good audience

This is the fundamental reason why companies like Revenue Science and Tacoda had to create their own ad networks (early on RSI tried to sell BT as a product to publishers). They needed some way to transfer value between their publisher partners. The only way to get your BT technology to work is to buy the data/audience from the sites that have it in order to sell it to the sites that don't. (Hence the recent rise of ad exchanges to help facilitate this further)

Unfortunately, if you are publisher-focused, there is an upper bound to how much money you can make. Here's why:

1. The valuable audience you have identified is fixed (if you can target all WSJ members on Facebook, you're still limited to just targeting those WSJ members)

2. If you decide to expand that audience with inferred behavior (e.g. "People like you also liked") you still can't reach the rest of the population and your CPM values will drop

3. Each individual has an upper limit to how many advertisements they will respond to, so you can only target these valuable segments a limited number of times in a given period before they burn out

4. The more niche the audience segment the harder it is to pull together enough volume to be valuable

5. After the initial obvious verticals are gone (finance, autos, electronics, real estate), new valuable verticals are harder and more costly to identify

If you are strictly focused on trying to sell BT technology to publishers, you are not going to make a heck of a lot of money based on the dynamics above. However, there are two other ways to make money if you have invested in good BT technology:

1. Start an ad network and become a facilitator of buying and trading audience between publishers

or

2. Align with Marketers and Agencies to improve the effectiveness of a Marketer's ad buy.

The real value in BT is actually not in raising the average CPM of a publisher site (which is a fallacy in itself), but in improving the effectiveness of a Marketer's ad buy by identifying those individuals most likely to respond to the Marketer's offer. The best way to take advantage of that value is by aligning with the Marketers rather than the Publishers.

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 Ad.com. (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!

3 Ways to Scale an Advertising Business

I thought I’d try to tackle the “how to obtain scale in advertising” from more of a product development / product strategy standpoint. This is pretty basic though, so probably more geared for folks that haven’t spent a whole lot of time in advertising.

How to Get Scale

This is (perhaps) obvious, but I think there are three basic ways to get scale:

1. Build it
2. Buy it
3. Borrow it

Although not mutually exclusive, companies need to choose one of the three to focus on in terms of competitive differentiation. Each direction requires a slightly different mix of products and has a slightly different customer base.

Build – Focus on attracting your own audience. (e.g. build a media business like CNN, WSJ)
Buy – Aggregate or acquire audience by buying on the market either directly or through rev share (e.g. Ad Networks)
Borrow – Aggregate audience by “borrowing” or trading for traffic with sites that already have audience through building features or providing technology. (e.g. Build Facebook Apps, or provide search technology to Yahoo and AOL a la Google and Overture)

The "correct" answer on how you should attack the scale problem will depend on a host of factors including the evolution of the advertising ecosystem in your industry (i.e. dynamics are different if you are in mobile vs. internet vs. tv), your competitive advantage, and the relative strength of the other players in the space (in typical 5 forces fashion). Your decision should impact how your product development team prioritizes its product queue.

Building your own audience is probably the riskiest route but potentially gives you the most option value. Owning an audience lets you expand into “Buy” or “Borrow”, but the reverse is not as easy. If this is your focus, you should be heavily weighted towards consumer-centric features and products.

Buying audience requires a large existing market and a pre-existing network of buyers and sellers (doesn’t quite exist on mobile yet for example). It also requires a larger budget, but if your analytics are good enough the risk isn’t actually that bad (there are a surprising number of ways to arbitrage ads). If this is your focus you should be heavily weighted towards metrics, analytics, and integration with multiple parties in order to find and exploit market inefficiencies quickly.

Borrowing audience requires some technology advantage or asset on your part to exchange with the large players that have audience (like the carriers). Working with large players also requires longer sales cycles so you may be looking at a deeper and longer “J-curve” than for other routes. If this is your focus, you should be heavily weighted towards building technologies that integrate easily with the top players.

Again, these three paths aren’t mutually exclusive, but if you look at your development resources and they are split evenly between all three, you are most likely unfocused and spread too thin. In addition, the investment criteria and early success metrics tend to be different depending on which way you attack the scale problem. My preference is to choose one direction and try to knock it out of the park, although its certainly possible to do two (like Google). In those cases, though, their “Borrowing” technology is usually an easy offshoot of their consumer “Build” site.

A big part of your decision will be around the type of audience you want to try and aggregate. As Andrew Chen has noted, CPM values will vary a lot based on who is using your site, where they are located, and whether or not it’s a niche focus. The minimum scale you need in terms of pageviews is inversely-related to your CPM, so for modeling purposes spend the time to get a realistic CPM value for your audience. Once you have a realistic CPM, you can figure out the minimum scale you need with some simple math:

Just take your monthly target burn rate (let's say $1M) divide it by your expected CPM and multiply by 1,000

So let's assume your burn is $1M
Let's assume you figure out your CPM is going to be around $5

$1,000,000 / $5 CPM * 1,000 = 200 M Impressions / Month

Then your minimum scale for becoming an "ad-supported" business is around 200M impressions per month.

There are a couple of things to think about when you calculate your minimum scale and start thinking about your likely advertisers:

1. The more unstable your source of impressions the more unlikely you are going to get the big budgets. Advertisers (whether they are direct response or not) still need to plan their spend, which means if they allocate $30k to you they want to make sure you use it at the ROI they expect.
2. The smaller the average budget the more automation you will need (and your development costs might go up increasing your burn, and consequently raising your minimum scale number)
3. There is generally such a thing as a minimum budget for advertisers. For most companies spending less than $5k / month on your site may not be worth their time - unless you happen to be aggregating a very unique audience.
   

I'm skipping over a few things, but at the very least at the end of this exercise you have a better idea of what "scale" actually means relative to your idea, your company, and your industry. [As a total aside, I believe that most folks understand that advertising needs scale, but most don't really grasp the magnitude. It’s sort of like the fact that there are more stars in the universe than individual grains of sand on the earth (some math on this here) or the fact that life on earth has been evolving for potentially 3-4 billion years. One can hear the number, but the entire concept of a “billion” anything is a hard one to get one’s head around. It’s a similar thing when someone says, “Google served 5.9 billion queries in February”. The scale is so massive its almost incomprehensible and meaningless - especially if you are just a small startup trying to make $1, let alone $1,000,000,000. Jeremy Liew covers some of the math here and Mike Speiser correctly points out "The legions of entrepreneurs out there should appreciate just how MASSIVE you need to come in order to build a big advertising-based business.”]

One thing to watch out for: when you are doing your modeling don’t make the mistake of thinking that your ad technology can change the inherent value of the audience. I have yet to see any ad technology alchemy that can make online lead (broad social networking) into online gold (search) (although there is technology that lets you find the gold among the lead). So, if you have assumptions in your model that say "the social networking avg. CPM is $0.30, but my average will be $0.60 because of technology" - well, I would be wary of that. (More to come on this topic later)

A lot of how you decide to split your resources depends upon where you think your competitive advantage will lay. For example, if your company DNA is that of math PhDs then I would seriously think about focusing more on building fancy ad targeting and analytics and taking a "Buy" strategy. However, if your company DNA is of folks from consumer products then it would probably be a mistake to invest a lot of resources in building your own ad serving / ad targeting technology and better for you just to double down on building audience. Again, this seems obvious, but I think really smart people sometimes have a tendency to make simple things more complex than they really are. It's sometimes surprisingly hard to keep things simple.

Once you have picked the audience you are trying to aggregate and have an idea of the advertiser base that would buy that audience a lot of the tactical questions start becoming more obvious. Your target audience becomes more clear, your product prioritization becomes more clear, and most importantly your value proposition becomes more clear (both to your audience and to your advertisers). You know exactly who you have to reach (either customers, publishers, or partners) and therefore you can figure out what they need. As you develop your product to meet those needs, you’ll be well on your way to achieving scale.