Your personal data is not worth anywhere near what you think it's worth

I see a lot of Root Markets-like businesses. Companies creating a way for people to own their own data and profit from it rather than letting someone else profit from it. The idea is appealing: other people are selling your data, it's your data, why shouldn't you sell it yourself?

But most of the people I talk to don't have a good answer to the basic business question: can you sell your product or service for more than it costs you to buy or make it? In this case, can you sell personal data for more than it costs to garner it?

Well, can you?

The IAB says that in 2011 there was $31.74 billion in US interactive ad spend [pdf]. There were 245.2 million internet users in the US in 2011 according to Statista.com, using data from Nielsen and the ITU. That works out to slightly less than $130 in ad spend per internet user per year in the US.

Here is a breakdown of this per capita number, by channel, and a guess as to how much is potentially available for third party data sellers:

		$ per	Addressable
Channel		User	Market
Search	47%	$60.84	$0.00
Display / Banner	22%	$28.48	$7.12
Classifieds	8%	$10.36	$0.00
Digital Video	6%	$7.77	$1.55
Lead Generation	5%	$6.47	$3.24
Mobile	5%	$6.47	$1.29
Rich Media	4%	$5.18	$1.04
Sponsorship	4%	$5.18	$0.00
Email	1%	$1.29	$0.97
Total		$129.45	$15.21

The $130 needs to pay for several different functions. The $28 for display, for instance, pays for account management, creative, media planning, targeting, media buying, ad serving, analytics, verification, and--not least--the actual inventory the ad is placed in. I'm guessing that the maximum amount available to a company selling data to target display ads is 25% of the ad revenue*. The opportunity to use data to optimize lead gen is potentially larger, while the opportunity in sponsorship, classifieds and search is pretty much nil**.

If this is right, and given the fuzziness of the IAB numbers, it means that there is maybe $1.00 to $1.50 per person's data per month available to data sellers.

But keep in mind that Google does not need your data. Nor does Facebook. They are a large part of the market. Your data is competing with everyone else's data--first, second, and third-party data--for this $1 per month. And some of the data you are competing with is so closely tied to the awareness generating process that it can't be pried away and placed in a 'wallet' somewhere.

Take context. The context of an ad can account for somewhere between 50% and 90% of its effectiveness. Context correlates to demographics, purchase intent, state of mind, and behavior. If you are looking at a review of the new Mac Book Pro I don't need any personal information to make an educated guess that you are in the market for a new computer. I can confidently put a computer ad next to that article without any other data, and the only way someone else can intermediate my guess is by blocking the content or ad entirely. Same argument different data for Facebook, and for much mobile usage.

This means that of the $1 per month much less is actually available to you as a collector of the data.

The original Root business model was to allow users to own their data and rent it out to people who wanted to market to them. The problem: users think their data is worth far more than $1 per month. But $1 per month is all that is available, on average. To a single company, it's maybe $0.10 at best. And then there has to be a commission paid to the new intermediary--the Root-like company. The user ends up with maybe a dollar a year. Nobody cares about a dollar a year. There's no business model. I could even imagine a world where each user was worth $0.20 a month, but that price is still nowhere near where it has to be to have users take it seriously.

There is a business model for businesses that gather data very efficiently. There are several pretty large companies that do this. But they have figured out a way to gather the data for much less than $0.10 per person and to collect data on hundreds of millions of people. The Root model simply costs more per person than the data is worth.

I spent several years of my life trying to build a business that lets people take control of their own data while still leaving a way for marketers to find them. I believe in privacy. And I believe that marketers finding customers is key to economic efficiency. I would love to see someone square this circle, but the Root model is not the way to do it.

-----
* This takes into account the fact that I think the IAB/PwC revenue number is the amount paid to publishers, not the amount spent by marketers. The amount spent by marketers may be 50% to 100% more than that paid to publishers on average. Hard to know. This is an important point though: marketing is much, much more than advertising. The amount that companies spend on marketing in total is far higher than the amount that publishers make from selling ads. There are companies selling data that sell into this marketing market that are worth billions, they are not the focus of this post.
** The best businesses are the ones where everyone else thinks you're wrong. My saying there's no opportunity means that if you have a way to use data to optimize these channels, you may have an opportunity that no one else has seen. I like those.

That joke's not funny anymore

"[Y]ou have to assume that humans are capable of looking at facts, finding root causes and formulating solutions. On my planet there's not much evidence to support this assumption... If humans had the ability to look at facts and make good decisions, think about how different the world would be. There would be only six kinds of cars on the market and nobody would buy a car that was second best in its price range. There would be no such thing as jury selection since all jurors would reach the same conclusion after viewing the facts, and all elections would be decided unanimously. That's not the world we live in. Our brains are wired backwards. We make decisions first--based on irrational forces and personal motives--then we do the analysis. The facts get whittled until they fit into the right holes."

-- Scott Adams*

[The first section of this post was previously published on AdExchanger, and there's an excellent comment thread there, so you should go read it. This is the rambling version.]

Jokes all start with one of a few stock set-ups. "A man walked into a bar." But the punchlines are all different. VC pitches are the opposite: the set-ups are all different, but the punchlines are all the same.

Stop me if you've heard this one before. "We enable the half of advertising that is not yet online: brand advertising!" Been hearing that one for more than ten years now. It permeates the hopes and dreams of every adtech entrepreneur and investor. And still no one has cracked the code.

My friend Tim Hanlon got together with Tim Chang a few weeks ago over on AdExchanger to offer some reasons why this might be. Worth your time, but here's the tl;dr**:

• No standards or consistent measures of “success” other than outdated or inadequate metrics like CPM and CTR;
• Limited real-time intelligence;
• Unsuitable display ad formats; and
• Lack of creativity in formats.

The prize is huge. As Tim and Tim point out, two-thirds of advertising spending is brand advertising, but online only one quarter is. In fact, if brand advertising dollars moved online in the same proportion that sales advertising has, it would almost exactly close the famous gap between time spent online and ad dollars spent online. The $50 billion gap that Mary Meeker mentions is exactly equal to the missing brand spend.

So I understand the urgent desire to figure out online brand advertising. If we did, we'd more than double the online advertising market. Online pubs would rejoice, online marketing pros would have more excuses to go out drinking with prospective clients, my portfolio value would quintuple overnight. Good things all. And I appreciate the optimism that Tim and Tim have, their willingness to keep suggesting solutions. But I think it's the triumph of hope over experience. Each of these things has been tried, and tried and tried. And still we believe that this time it's different, that this year an online branding play will work. Online video maybe, or Facebook, or Pinterest. Every new company is touted as the one that will make branding work online.

But what if we try all these things, like we've tried everything before, and they don't work? What if we eliminate all the possibilities and what remains is... nothing? I'm going to be branded a heretic for saying this, but what if online just doesn't work for branding?

I mean, not to be defeatist, but we understand branding pretty well. Marketers have been creating brands nigh on one hundred years now, it's not a black art. And the solutions I hear, even Tim and Tim's, are not untried. More, they are not what makes brand advertising effective in other media. I don't buy that these are the solutions. I think it's distinctly possible that there are no solutions.

Maybe the medium itself is antithetical to the way brands are built. Like direct mail, maybe the very fact of delivering your message in a low-budget, specifically targeted way can not in any way build a brand. Brands attempt to exist autonomously, they are objects of desire, they want to distinguish what otherwise is indistinguishable. The psychological processes of branding are inimical to the idea that the brand has been chosen for you. Brands do not choose you; you choose brands. Brands are aloof, they aspire to be the Platonic ideal, their competitors just shadows.

Perhaps. I mean, I could be wrong. It could be that even though we sell ourselves to clients as brand-building geniuses, we don't know what we're doing; that we're groping in the dark, throwing random darts and just haven't hit the bulls-eye yet. We could be a bunch of monkeys at typewriters and Shakespeare will just roll on out one day. Could be. But it seems unlikely.

What if I'm right? What if online branding is a mug's game? If it is, it won't be too much longer before marketers get wise and just stop listening to online branding pitches. Maybe they already have. Maybe they never did listen to them. What's the fallback plan? How do we go about getting the brand advertising dollars if online brand advertising doesn't work? What can we do that will cause brand advertisers to move their branding dollars out of advertising altogether into some other online channel? How do we disrupt branding?

*****

What is branding, really? Why does it work? For the marketer, branding is a way of wrapping all of a product's attributes in a neat package and giving it a handle so they can refer to it easily. For the consumer, brands are a shortcut: for products where the potential benefit of making a choice is smaller than the cost of choosing, a brand is a fallback. Brands are Scott Adams' whittled down facts, except that marketers have done the whittling for us so they can control the outcome to their advantage. The hole they fit into is your brain. And research shows people only have a few of these holes in their brain.

This can work in a couple of ways. A consumer confronted with a dozen pasta brands in the spaghetti aisle*** would have to expend some time and effort deciding which was best for them. The small potential benefit from finding a better quality pasta is less than the cost in time and effort to determine this, for most consumers. So even if De Cecco is a better pasta, it is a rational for someone familiar with Ronzoni to buy Ronzoni. The pastas are similar enough that someone who just wants a bowl of spaghetti should not expend any effort distinguishing them: just choose your brand and move on.

On the other end of the spectrum, some things are extremely costly to evaluate. Choosing a motorcycle, for instance. The variables that come into play include not just the motorcycle itself, but complementary goods like service quality and availability of third-party components (if the stock pipes are too tame, say.) There are also intangibles, like aesthetics, community, and how you will be perceived among your peers if you are riding a Honda instead of a Harley. A brand can ensure that, even when the objective technical qualities of the bike itself are the same or inferior, it has an advantage among certain consumers because the cost of objectively evaluating differences between bikes is, for most people, impossibly high.

This cost/benefit analysis masks another obvious aspect of branding: risk-mitigation. I have, driving down the highway with my kids, chosen McDonalds though this would be at other times not on the list of possible dinner spots. But I know exactly what I'm getting, how long it will take, and how much it will cost. Because there's a fixed cost of investigating new options, even if for one-time use, the risk/reward curve is not linear.

The answer seems obvious. If branding is a needed compensation for something our brains are just not good at, a low quality way to reduce search costs, an easy alternative to remembering tons of facts, then the answer is to provide a better, more efficient way to sort alternatives. The internet, in its ability to instantly connect you to huge data sources and extremely fast algorithms no matter where you are and what random question you're asking, seems to be the perfect answer.

This is what computers are good at. Lots and lots of data, changing prices, personal utility curves. Right now I might walk into the supermarket looking for a relatively healthy breakfast cereal that my kids will eat. Given the huge number of choices, I might settle on Frosted Cheerios (even though they're probably about as healthy as a glazed donut) because Cheerios has pounded the idea that they are healthy into my brain. I can imagine, instead, walking into the supermarket, scanning the Lucky Charms with my smartphone and asking it to rank healthier alternatives for me. I can imagine a world where I tell an application what I like and dislike about my current pair of sneakers and it recommends a pair that would be better for me. I can imagine a world where I enter the specs and spec tradeoffs for any good imaginable--skis, cars, laundry detergent--and my computer finds me the best match.

But I'm not leading you down a garden path here. I don't do Socratic dialogue. I do not know the answer to the question I'm asking. I do not think these ideas will work because nobody will pay for them.

*****

Generally, and certainly with advertised goods, the seller is the one paying to find buyers and not vice-versa. This has resulted in all sorts of market distortions. Sellers are motivated to sell, and not necessarily only if the product is right for the buyer. That the seller is paying to find buyers--any buyers--instead of the buyer paying to find the perfect seller is a bit of an historic accident. The media was once solely a broadcast mechanism, a mass-reach vehicle. Before the internet, seller-financed advertising was cost efficient while buyer-financed search was cost prohibitive. Even though that is no longer necessarily true, advertising is stuck in a local maximum.

It would certainly be more systemically efficient today if consumers decided what they wanted and then went out and searched for their best match themselves. Then advertising would be less effective so there would be a lot less of it. If sellers did not need to advertise, they could lower the cost of the product and this lower cost would--I'm guessing--more than compensate buyers for the time needed to find the right product. The buyer would end up even on cost (lower product cost ~= higher search costs) but with a more appropriate product. That's the ideal world, but it requires massive behavior change from both sides of the market at once. There's no way to achieve that kind of coordination.

As long as advertising continues to be cost-effective, sellers will advertise. As long as they advertise, they will not lower prices. And as long as they don't lower prices, buyers would have to pay twice if they decide to do the search themselves: once for the advertising and once for the search. This is a long way of saying that no one except the sellers themselves will pay for anything to do with informing consumers about products and services. We are stuck with what we have, efficient or no.

Want to quibble? We now have some seventeen years of evidence that, even if it's a better way of doing things, consumers will not pay for search in any way other than by looking at ads. This is, if you think about it, probably the most bizarre thing about internet marketing. People pay for media that compares and analyzes products, but in a way that undermines the value of these comparisons. Yelp, Google (like Car & Driver magazine offline) critique the very industries that finance them. Their interests are in question. Marketers are attempting to influence people right as they are trying to make uninfluenced choices. Search for a product on Google and you are inundated with ads. Odder, many are clicked. People are searching for someone to convince them, they are going through the motions of choosing and then avoiding making choices. The media soothes the cognitive dissonance with a pleasing veneer of objectivity, but the objectivity is--has to be--a sham. Follow the money.

The non-profit Consumer Reports has overcome this criticism by refusing to accept advertising. But they may be the exception that proves the rule: despite almost certainly being worth the subscription price for anyone who buys even one thing in any category they cover, they only have some seven million monthly subscribers. Consumers will not pay to inform themselves. That's why we're stuck with marketing.

*****

Some other, possibly spurious, correlations to note:

	TV	Print	Online Display
Measurability	Low	Medium	High
Involvement	Absorbed	Absorbing	Engaged
Audience	Mass	Select	Targeted
Branding	Yes	Sure	Not so much
CPMs	High	OK	Low

Many intelligent observers, when contemplating low CPMs or recalcitrant brand advertisers say we just need more measurement, more engagement, or more specific targeting. But these things seem to go the wrong way. On the other hand, there are some exceptions: the trade press is more targeted and has higher CPMs; search is more engaging and has higher (effective) CPMs; etc. So the point here is not that we're doomed, but that the easy answers will not do--we're probably analyzing success along the wrong dimensions.

*****

Regardless, I believe in the power of the internet. I think that we can achieve a better product-consumer match by using personalization, community, data and machine learning. In fact, this seems almost too obvious to say. The internet has the power to create a much better branding mechanism: one that works better for brands and for consumers.

I also believe that brands can be valuable. They are proprietary marks, so can guarantee implicit promises and ensure repeat business. They allow trust, and trust is a necessary lubricant for commerce. If there were no newspaper brands, no one would read newspapers, because they would not be able to judge the quality of the news they were reading. If there were no retail brands, every purchase would be like walking into a generic electronics storefront in Times Square: buyer beware.

My objections are not to the internet or to branding. My objections are to the way we are approaching disrupting**** branding. I do not believe the success of online brand advertising is about waiting a bit longer, or measuring better, or creating more engagement. We've waited long enough, we measure better than any other medium, and we are as interactive a medium as they come. If you are espousing those ideas, then you have to also explain why you are right now when you would have been wrong all these long internet years. Things do change, but sudden change is either because of a compounding effect or a catalyst. It does not look like to me that online brand advertising is increasing in an exponential way. Nor do I recognize a catalyst*****.

Or, and I think this is a more promising path, we need to accept that branding may not change to accomodate us, we may have to change to accomodate branding. No more complaining that brand marketers just don't get it. No more waiting on incremental change in measurement or attribution technology. Find a way to allow brands to hone and prove their promises, while giving them a much larger payoff for doing so. Don't think about how to service Procter & Gamble or Coca-Cola--disruption starts off by creating new markets, not servicing old ones--think about how you could help a quality product or service build a brand from the ground up for far, far less than a TV branding campaign would cost. If you do that you will have the big brands' attention, and an amazing business.

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* Quoted in Bruce Tremper's Staying Alive in Avalanche Terrain, a must read if you like the backcountry in Winter.
** Seriously? What are you doing here?
*** I was in a supermarket in a hispanic part of Pennsylvania recently where pasta was in an aisle labeled 'Ethnic' while the Goya black beans were in an aisle labelled 'Beans.' Where I live in Hoboken, the exact opposite is true. I wonder if there's a place where the ethnic aisle stocks Oscar Meyer and Easy Cheese.
**** I wrote a typically long blog post on disruption and what it means in this context here.
***** A catalyst has to be a new technology or an entirely new way of utilizing it. The internet itself, say, or social media, or collective intelligence, or online video, or data-driven matching. These could all have been catalysts but, as it turned out, they were not.

You can't manage what you can't measure. Not at scale, anyway.

A year ago I wrote, re investing in social marketing, "The social loop will share superficial characteristics with the display loop, but it's really completely different... the area with the most near-term leverage will be tools that help communicators understand the impact of how they are communicating and then help them make better decisions." This has turned out to be completely true.

I've been thinking about social marketing for five years. It has seemed obvious that major advances in marketing technique will occur through the social channel, but it was never clear to me exactly what those would be. I looked at and worked with a couple dozen social media marketing companies before throwing up my hands and declaring non-prescience.

My rule of thumb is that when the evolution of the landscape seems unknowable it is usually because the technology that will underpin the advance is still in flux. The obvious solution is dropping a level deeper in the stack and looking for investments there. In mobile, that meant Flurry four years ago and Media Armor a year ago. In social, it meant Awe.sm.

The smartest guy I ever knew in the ad business (like being the tallest dwarf, I know...) said, of managing people, "Whatever chart you put on the wall goes up."

-- Clay Shirky

That was me, the tallest dwarf, from back when I knew Clay, when he was just another guy.

I worked at IBM during the heyday of the Six Sigma movement. I was a design engineer, trying to optimize a very small piece of the central processor of what became the System 390 series of mainframes. As a design engineer there were several layers of abstraction between me and the silicon: the design language was a visual one--I wrote a flowchart which was compiled into a set of logic gates which were then mapped onto silicon. Aside from tweaking the logic gate-level design to try to get better performance, I spent my time at the flowchart level, as did most of the engineers.

Six Sigma methodology has you measure processes, find causes of errors and remedy them. The idea is to improve processes until there are fewer than 3.4 defects per million. IBM had a company-wide mandate to implement Six Sigma. I was subject to this mandate.

I asked my manager how I was supposed to measure my 'defects' and why would I even want to if I had to define them in such a way that I essentially never, ever made that type of mistake. He said "How are you going to improve if you aren't noticing your mistakes and figuring out how to stop making them?" "I already do that," I said, "I'm just not marking them down on some stupid piece of graph paper thats been pre-printed with a normal curve." He said "But then how can we manage it?"

Ah, Bach.

You can't manage what you can't measure. Stupid as managing designers on the binary idea of defect/not-defect and on such a stringent scale, constantly knowing how well you are doing so that you can constantly improve is extremely powerful. This idea, probably more than any other, drives my investment strategy: things that are not being measured are being managed poorly; creating new ways to measure creates ways of doing things immensely better, it creates entirely new businesses.

The fact is, you do get what you measure, whatever graph you put on the wall will go up. But the moral of that pithy aphorism was meant to be: be careful what you wish for.

If what you are measuring in social marketing is Likes or Follows, that is what you will get. But how closely aligned are these measures with what a business really wants: happy and loyal customers, higher sales? You don't know. No one knows. This particular loop hasn't been closed. Because the social gesture cause and business result can't be tied together in a measurable way, it can't be managed and it can't be improved.

I invested in Awe.sm's seed round because they provide core social measurement functionality, the ability to tie social actions into their actual results, to close the loop. I re-upped into their Series A because they're now doing something even more interesting: they're providing this functionality to other developers via API. Instead of being just an analytics player, they're now enabling the creation of an entire social marketing infrastructure that can use measurement to provide a ever-improving feedback loop.

I may have gravitated to marketing in part because dealing directly with people is too messy to ever even approach Six Sigma, but the engineer in me still believes that by measuring you can improve, and by linking measurement and algorithms you can create a feedback loop that allows you to improve adaptively and in real-time. This idea has revolutionized online advertising over the past few years. It's going to revolutionize social marketing over the next few.

Disruptive innovation, buy vs. build, the most pernicious lie in business, and how to know if you're fooling yourself

If a man has good corn or wood, or boards, or pigs, to sell, or can make better chairs or knives, crucibles or church organs, than anybody else, you will find a broad hard-beaten road to his house, though it be in the woods. 

—Ralph Waldo Emerson, big fat liar

No matter what the dictionary says, you can't describe a company as disruptive without giving weight to Christensen's description of innovation. It's perhaps overly simplistic to divide innovation into two categories--disruptive and sustaining--but the strikingly different characteristics of companies pursuing these strategies makes the partition a natural one.

Sustaining innovation means finding ways to do things better. Lowering the cost of manufacturing a widget by 10%, making a widget 20% more durable while only spending 10% more, reorganizing a department so ten people can do the work of twelve, creating an integrated supply chain to deliver goods to your stores in smaller quantities and less time. That sort of thing. Sustaining innovation often results in products that exceed customer needs at a given price point. The proliferating options in Microsoft Office show a sustaining innovation cycle that has exceeded most of the market's need.

Disruptive innovation means creating a product or service that is radically cheaper but much less functional (and this needs to appeal to a customer set that was previously underserved, so disruptive innovation often creates entirely new markets) and then using sustaining innovation to improve it until it meets mainstream customer needs (but is still radically cheaper.)

Before Google, there was targeted advertising. Very targeted. Hog Farmers Digest (now National Hog Farmer) was aimed at hog farmers. If you were a hog farmer, you read it; if you weren't, you didn't. It was a pretty effective buy: not a lot of wasted impressions. But creating an entire magazine for a very specific market is a difficult business proposition. The fixed cost of putting a book together limits how small its audience can be and so how targeted its ads can be.

Google's disruptive innovation was being able to create content for next to nothing. They can create a page that addresses a market segment as small as a single person for nominal marginal cost. Even though the content was lower quality than that it was competing with--the lack of human writers and editors means that any specific page is much less useful than a well-written and thought-out page would be--it turned out it was good enough. And because advertisers could be so specific in their buy, they could spend much less money. This opened up an entirely new market: advertisers that don't have multi-million dollar budgets.

Existing publishers could not compete: they could not lower their cost per page to anywhere near Google's. If they tried, they would lose quality and the loss of quality would mean losing their existing customers. This is the beauty of disruptive innovation: it is almost impossible for incumbents to respond. Disruptive innovations are disruptive because business logic precludes old-line companies from shrinking their business to address the disruptors.

It's incredibly difficult and expensive to challenge incumbents with nothing but a better product. Sustaining innovations are easy to copy and well-managed incumbents are always on the lookout for challengers and willing to learn from them. But when a disruptor comes along, they are trapped.

*****

What kind of innovation are we peddling in adtech? Article after article calls our companies disruptive, but do we really fit the Christensen mold? A disruption scenario would look like this:

• the existing industry would supply a product of higher quality/functionality than the majority of potential customers actually needs and at a very high price;
• the disruptive companies would find a way to bring in a product of lower quality/functionality at a much lower price;
• customers that did not need and could not afford the old product would emerge as customers of the disruptive product, allowing the new companies the wherewithal to quickly mature their technology until it was competitive in the old product's market.

Does this sound like ad tech to you? It doesn't to me. The current ad-world is not supplying services at a higher quality than its customers need and there seems to be advertising inventory at every price point. If you can't supply advertising at a radically lower price point to customers who were previously underserved at a quality level that the incumbents are not interested in touching, you aren't really in a position to be disruptive. Almost all of adtech now is sustaining innovation: building a better mousetrap.

We clearly have a better solution than what existed, no argument. But the big lie of business, the pernicious fallacy that has deluded countless entrepreneurs, is that if you build a better mousetrap the world will beat a path to your door. It doesn't work that way.

*****

What is going on in adtech right now is clearly innovative. But because it's not disruptive in the Christensen sense, it means we're going to have to earn our money. We need to move fast to build scale.

There have been scores of M&A discussions in adtech this Summer and only a few have resulted in deals. One of the things I heard as an excuse over and over (from buyers, from sellers, from bankers, from founders, after a few drinks) is that the buyer said "we don't need to pay up for this, we could build it internally."

Build versus buy is an interesting discussion to have before you buy anything, especially something with the revenue multiple adtech VCs are looking for. Cold hard fact is, there's almost nothing out there in adtech that someone else couldn't build from scratch. The CTO would certainly tell the CEO that building would be cheaper than buying a company, and be right.

And yet, and yet. And yet the companies that are prowling for bargains still can't get advertising right. They clearly have a ton of tech talent in their core businesses, and the ability to hire more. They have the money to hire and manage and build adtech solutions. But they don't. Why not?

When I was at Omnicom, back in the 90s, investing in the early interactive agencies--clearly not disruptive businesses--the old-guard ad agencies that then made up the bulk of Omnicom's business talked big about building their own interactive units. But they never could. They also refused to pay the valuations the i-agencies commanded. They were on the sidelines while their clients hired hotshot young startups to build their websites, and some of the startups got pretty big in the process.

There were several reasons for this. Primarily, the old guard couldn't hire good people: no one who understood the web back then would go work for an agency whose primary business was making 30 second films for TV. Why would anyone who was any good go be a second-class citizen at a firm that was paying nothing but a salary and had no career path in interactive? Why wouldn't they go instead to Razorfish and get stock options and be a hero to their management everyday? They would, of course, and they did. And almost all the true stars of that era spent time in one of the independent agencies.

As then as now. Why would any competent adtech engineer go work for AOL or Yahoo or Twitter or any of the other big old companies where stock options issued today will in all probability never be worth anything? There are plenty of good jobs at exciting startups where there's the possibility of making actual money*. More importantly, why go to one of those big companies and be a second-class citizen, the "ad guy," when at a startup you're essential to their product?**

Companies can do very well at their core mission. But when their core mission is media or software or infrastructure or professional services, it's going to be really hard for them to get a foothold in the quickly changing adtech world. This never seems to be taken into account in build versus buy analyses: they can't build, and even if they could, they won't. And if they do, it will suck. Trust me, I've been there. And if you don't trust me, just take a look around.

But remember that the era of the independent i-agencies only lasted some six or seven years. At some point the number of people that could do the work more than competently was enough that even old-line agencies could hire them. At that point the i-agencies were like every other agency: they competed head-to-head with the old guard. Many of the biggest remained independent until acquired for great prices. But these were the ones who earned it. Unlike a disruptive business where nothing but guts, an innovative spirit and a huge dose of luck are necessary, competing head-to-head means competing: blood, sweat and tears.

We need to keep building, ignore the distractions and focus on winning clients, not just raising money, so that when it comes time to compete head-to-head, we will win. That's as it should be, of course, and I think many of our industry leaders have what it takes. But if you're starting an adtech company and you want to win, you have to know that you're in it for the long-term. It's a marathon, not a sprint, the cliche goes, and it's true.

*****

Meh, you say. I'm disruptive, I am going to go viral, achieve imminent world domination and sell to Google for $5 billion in two years. Neumann's an idiot.

Maybe. But disruptive businesses have certain characteristics. Ask yourself these questions.

1. Am I creating a new market, bringing in a set of customers for whom there was previously no value proposition?

Disruptive businesses bring out a product or service that is so far off the industry price/quality line that customers who would never have used the industry's products start to. This gives the disruptor the foothold it needs to start improving quality until it threatens the incumbents. Google AdWords is an excellent example of this.

Who are the unserved markets in advertising? Are there any? I think there are, and I think that if you don't see any, you need to think about what advertising is more broadly.

2. What is price in my market?

If you're in ad-tech, what does price even mean to your end-customers (the advertisers***)? Is it just lower CPMs? There have always been low CPMs out there. Is it higher ROI? That's probably closer to the mark. The best answer I have heard is that it is lower risk: the ability to more accurately predict ROI.

You have to credibly answer this question and then be radically better along this dimension if you are disruptive. I think there are many answers here, and your answer will depend on your answer to question one, above.

3. What is quality in my market?

In disk drives (Christensen's first case study), this is an easy question: quality is how much data can be stored. The disruptors built lower-quality disk drives at lower prices, then used the march of progress to threaten the old-line disk makers. The old-line disk makers' customers wanted more storage, not less, so they did not see this market and could not address it with the existing customer bases. But key to the disruptors long-term value was the ability to improve quality quickly. If they could not, they would not have been able to displace the old guard.

What is quality in adtech? Conversion? Click-through? Pinpoint targeting? And if you know what quality is to your market, can you then improve quickly along that metric so you serve not only the new market you've created, but the giant market that already exists?

Quality. I've been thinking about this question for ten years and don't have a definitive answer. Do you?

If you do, if you think you really have a disruptive business model, call me, I'm looking to back people like you.

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* If this is you, email me.
** Soldiers don't get promoted if they haven't seen battle. If you want a career path, always take the job in the middle of the action, even if it pays worse.
*** And are the advertisers really your customers? Why aren't the 'consumers'?

The new adtech is disruptive, and that's a good thing

I was at Luma Partners' Digital Media Summit today. Great event, saw lots of familiar faces. I watched the adtech panel. Of the people I didn't get a chance to invest in, these are four of the smartest: Brian O'Kelley, Joe Apprendi, Michael Barrett, and Mike Leo.

Mike Leo said something that struck me as wrong. He said, roughly, "30% of the media spend is getting spent on the pipes"--by which I think he meant the other panelists' companies--"and that's eating into the creative and the content, where it should be spent."

This is exactly the wrong way to look at it.

The entire process between the maker of a product or service and the user of that product or service--what we call marketing--is friction. This includes the pipes, the ads themselves, and even the content created to wrap the ads. Friction, all of it.

I agree that we should reduce the friction, make things more efficient. But if we give credit to Wanamaker's 50% waste in advertising spend, then the 30% that's now being spent on the "pipes" is a 40% improvement. A 40% improvement over five years is pretty spectacular. But disruptive technologies do that.

Leo is looking at the wrong place--he's complaining about the one area of the marketing process that has actually shown efficiency gains, while giving a pass to creative and content, the areas that have fallen behind.

The client does not care if you are intellectually stimulated, Kendall, they just want the goddamned sales curve to start moving up

Every revolution has its reactionaries. I was going to respond to Kendall Allen's article The Math State, but didn't, for a few reasons: it wasn't convincing enough to need a response, I've stated my answer to the objection elsewhere, and Joe Zawadzki is a better writer than I am.

I want to note, though, that when I accepted an offer to work at Omnicom, some 15 years ago, I was handed a copy of Peppers and Rogers.  This was the future, I was told, One to One Marketing. Some six years later the Economist wrote that "the marketing department is the last part of the modern corporation to resist automation." It's interesting that after so many years of wishing for it, the industry starts to object as soon as it becomes plausible.

This new math state is not new. It is a stage in a journey that some of us have been taking for more than a decade and one that will take another decade to reach its apotheosis. For those who don't like it, I'll trundle out the old Rosser Reeves quote that everyone in the agency world says they believe but that few really do:

What do you want out of me? Fine writing? Do you want masterpieces? Do you want glowing things that can be framed by copywriters? Or do you want to see the goddamned sales curve stop moving down and start moving up? 

- Reality in Advertising, R. Reeves, 1961.

Almost a license to print money

Advertising, in time, proved almost a license to print money, and the effects on broadcasting of the revenue model it introduced can scarcely be overstated. It gave AT&T, and later the rest of the industry, an irresistible incentive not just to broadcast more but to control and centralize the medium. To see why, compare the older model: When revenues came from the sale of radio sets, it was desirable to have as many people broadcasting as possible--nonprofits, churches, and other noncommercial entities. The more broadcasters, the more inducement for the consumer to buy a radio, and the more income for the industry. But once advertisements were introduced, radio became a zero-sum game for the attention of its listeners. Each station wanted the largest possible audience listening to its programming and its advertisements. In this way advertising made rivals of onetime friends, commercial and nonprofit radio.

This is Tim Wu in The Master Switch*, describing the beginnings of commercial radio broadcasting.  When AT&T (who was competing with RCA to dominate radio broadcasting) started using its 'long lines' to carry programs to transmitters across the country, they discovered that advertising to a mass audience was far more profitable--and could support professionally produced, higher quality content--than any other business model available to them. This, in turn, lead the industry to successfully lobby the government to allow only a few, high-power 'clear channel' broadcasters (instead of allowing many lower-power ones.)

It's interesting to see how advertising, because it pays for attention, a resource too easily divisible, caused media to agglomerate. The media industry, in protecting itself from competition, has to limit the number and variety of voices that are heard.  Mass media is, by its nature, homogeneous media.

Two things:

1. Mass media, as it is today, is not the only way things can, or should, be. There was a vibrant radio culture before it became a mass medium, with a more democratic voice.

2. Our adtech allows advertisers to reach small audiences. The advertiser no longer needs mass media. Mass media will, however, fight to maintain their current market position. In almost all of the other media this book chronicles, the government was eventually enlisted to regulate out weaker players. The fight over net neutrality was one of these efforts, but certainly not the last.

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* Required reading. This is the first book in twenty years that, as soon as I finished it, I started reading again. A history of the rise, consolidation and disruption of the telephone, radio, motion picture, and television industries, it elucidates the history that can inform scenarios of the possible future of our industry better than any other analysis. It's a good read, too, with wonderful descriptions of the people behind the inventions and companies and how the culture of their times influenced them.

Advertising, the Fallacy of Perfectibility, and the Best Minds of My Generation

Between men and brutes, there is another very specific quality which distinguishes them, and which will admit of no dispute. This is the faculty of self-improvement... perfectibility... It would be melancholy, were we forced to admit that this distinctive and almost unlimited faculty is the source of all human misfortunes; that it is this which, in time, draws man out of his original state, in which he would have spent his days insensibly in peace and innocence; that it is this faculty, which, successively producing in different ages his discoveries and his errors, his vices and his virtues, makes him at length a tyrant both over himself and over nature. 

- The Social Contract and Discourses, Jean-Jacques Rousseau

An entrepreneur I'm working with on an adtech company asked me recently "does any of this make any difference?" It's a good question.

Here's something you probably didn't know about me: when I ran venture capital for the world's largest advertising agency holding company back in the '90s, I refused to invest in internet advertising companies*. I did not think banner advertising was useful. I have not come so very far from that view.

* * * * *

There is a sometimes infuriating disdain of advertising among those who wear Northface and Converse, drink Starbucks and Horizon Organic milk, and find out about the farmers' market from drop cards in the local organic grocery store. But that they can hate advertising while being avid consumers of it isn't irrational, because advertising has two faces.

Before World War I in America, a belief in perfectibility was widespread.  Not just human perfectibility, but technological. Businessmen created and grew businesses based on a belief in perfectibility. All success required was creating the best product at a fair price, driving competitors out of business and cementing a permanent monopoly, all for the betterment of society. Competition, to people like Henry Ford and Theodore Vail, was a waste of resources. Creative destruction would have seemed like madness.

In this no-nonsense model, advertising was product news, an attitude typified by the Bates agency in New York in 1904, who viewed anything more as "bad copy--too literary and too general, lacking prices and good information." John E. Kennedy, the head copywriter for Lord & Thomas in those years thought that "instead of general claims, pretty pictures, or jingles... an ad should offer a concrete reason why the product is worth buying."  One of the students of this method said this method of copywriting "aimed at an appeal to reason and intelligence rather than the time-honored assumption that the public was a mass of dumb, driven sheep, who could be swayed with mere picture-and-catch words."**

This approach, though it was itself a reaction to an earlier character-and-jingles driven approach (Aunt Jemima, the Uneeda slicker boy and the Arrow Shirt man were all products of this earlier approach) finds its intellectual rationalization in the Chicago School. George Stigler described it: advertising provides information to buyers, allowing them to make better choices.  Because the Chicago school believed that economic actors were rational, and that economic activity must have some underlying sense, this was the only coherent explanation... even if the facts on the ground at the time did not bear it out (Stigler published his seminal Economics of Information [pdf] in 1961.)

By that time, advertising had changed. Many times. The War to End All Wars itself may have been the catalyst. At the beginning of the conflict, fact-based ads played well to a righteous population. But later, when war-weariness had taken hold, patriotic advertising showed that appealing to the emotions may be even more powerful, especially when the facts aren't all that pretty. Advertising can persuade. Posters of Uncle Sam pointing his finger and saying "I Want YOU for U.S. Army" worked.

But the creator of that image, James Montgomery Flagg, had misgivings: "A number of us who were too old or too scared to fight prostituted our talents by making posters inciting a large mob of young men who had never done anything to us, to hop over and get shot at... We sold the war to youth."***  These are the poles advertising swings between: providing information so people can make better decisions about which products to buy, and persuading people to do things they might otherwise not have done. This is why people can hate advertising while listening to it closely, both of these approaches are at work, sometimes in the same ad.

The carnage of WWI had another effect: the idea of perfectibility itself fell out of favor. There was no one after that war that could still believe that those in power were infallible or even that doing the right things leads to the right outcomes. A belief in the universal power of reason now had a powerful enemy in American culture: pluralism. I'd argue that the battle between openness and control that we see happening to the internet now (cf. Google v. Apple) is a battle between perfectibility and pluralism, between one person knowing what is best and the belief that progress proceeds from chaos.

* * * * *

Productivity growth has made our lives enormously better. And it is one of the keys to making the lives of our offspring better than ours. If there is one guiding principle in my work, it is trying to help nurture innovations that create productivity growth.

Productivity is not just doing more with ourselves, it's also preventing waste, and guiding resources to their best use. This last is what Hayek called "the economic problem." Hayek said that the solution was the price system, the "invisible hand" that put resources where they are needed. This is an astonishing insight, but it falls short. Hayek, I have to assume, never bought a car.

The price system may be the best way to make sense of decentralized knowledge when the resource being apportioned is tin, as in Hayek's example. But when we go to buy a car, we have many choices at any given price point. The cars, although similar in most regards, are different, and we can't choose on price alone. Choosing the car that is best for us requires more information. Some of this information (mpg, how it looks) we can find out ourselves, if we know to look. But in many cases putting the onus on the potential consumer to discover all possible choices is inefficient. When looking for a place to buy produce, I will not know to look for the farmers' market that I do not know exists. Advertising is key here.

I believe that after an efficient price system, an efficient matching of people with the provider of a product or service that is most appropriate to them is the economic problem.  When Jeff Hammerbacher laments that "The best minds of my generation are thinking about how to make people click ads," I think he's falling for a technocratic idea long discredited, one that only engineers still believe: perfectibility.  Jeff is young, and very smart. He may believe that there is a single best product or service in each category that can be found using the appropriate Google search. And perhaps he believes that he himself should be the person who can decide what people really want, as Theodore Vail did, or Henry Ford tried to do, or Steve Jobs tries to do. Because if he didn't believe in his own omniscience, and if he personally would prefer not to have some other person making his choices for him, then he would have to agree that each person needs information to make the right choices for themselves. In that case, if I put an ad in front of someone, and that person decides to click it, then I must be solving a very difficult problem indeed.

Getting a click means that you have shown the clicker something valuable to them. If you don't believe in perfectibility--in making peoples' choices for them--then the click is a win.

* * * * *

I make a sharp distinction in my ad-tech investing between better matching and persuasion.  I only invest in the former (although sharp lines can not always be drawn.) The data-driven media buying and ad placement companies that are a large part of my portfolio are all clearly aimed at putting the appropriate information in front of the right person****.  I see companies that I think will be successful persuaders, but I don't invest in these; they make me uneasy. I suppose you could say that I'm not very businesslike in that regard, that I don't appreciate the art of selling, that I don't appreciate the art of advertising, that I don't appreciate the cultural value of advertising, that I don't have a sense of humor. I guess that's all true.  But, in my opinion, the companies that make the biggest difference to their customers are the ones that make their lives better.  While I recognize that the customer of the ad-tech company is the advertiser, not the potential consumer, and that the advertiser's life is certainly better if it sells more product, I'm not buying it. While being once-removed from treating the consumer like a mark may ameliorate the ethical considerations, it does not make it good business, not in the long-term.

[Edit, five hours later: I will revise something I wrote forever. So, on the blog, I try to finish and then hit publish. This time, as soon as I did, I realized I had not closed the loop on the argument.

Here's my point: if you believe in perfectibility, that your product is the best one for everybody, you probably also believe that all you need to do is buy mass media ads telling everybody about the existence of your better mousetrap. If you have lost the belief in the perfect, then you will feel the need to compete for the attention of people on other than the facts, because the facts don't differentiate you. Competing on facts is better for society, and for the regular person who sees ads.

The people who are thinking about how to get people to click on ads are of two types: those who just want you to click on the ad, and those who want to put an ad in front of you that would be valuable for you to click on. Saying that the latter is somehow of ephemeral benefit is misunderstanding what is economically worthwhile. By matching the right ad to the right person, we can provide information even while allowing everyone to have their own individual tastes.]

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* OK, that deserves some caveats.  I did invest in an ad network... two weeks before their IPO. I sold in the IPO. There was free money like that in 1999. I also heavily invested in the interactive agencies but, and this is my point, none of them would stand for being characterized as purveyors of advertising or, in many cases, any sort of marketing at all. Jeff Dachis' infamous difficulty in describing what Razorfish did on 60 Minutes being a case in point. It wasn't until Agency.com acquired iTraffic that any of the companies I worked with became involved with display advertising in any meaningful way.
** The Mirror Makers: A History of American Advertising and Its Creators, pp. 49-51.
*** Ibid, p.76.
**** While these technologies can also be used to put a persuasive ad in front of the person most liable to be persuaded, I don't think this use provides as much lift, and I hope it will be squeezed out.

OpenRTB and Architectural Innovation

I sent out a good number of emails on Sunday asking for opinions on OpenRTB.  People were mainly dismissive, partly because of the secretive way in which it was concocted, partly because some think Google is better accomodated than challenged, but mainly because the current goals of the spec are slight.  After reading the spec, I was a bit underwhelmed myself.  But I've changed my mind.

In a post in April, I talked about architectural considerations in ecosystem design, taking the engineering concept of End-to-End as an analogy.   In that post I was pushing for architectural change because innovation is highly dependent on a layered and modular architecture*.  Architecture is important.

But architectural change is also interesting in determining winners and losers, and that was my deeper motivation.  From a (technically astute) businessperson's point of view, the article to read is Rebecca Henderson and Kim Clark's Architectural Innovation: the Reconfiguration of Existing Product Technologies and the Failure of Established Firms.  They point out that "architectural" change favors innovators over incumbents.

In laying out their thesis, the authors talk about the failures of incumbent firms in adapting to relatively minor market changes, despite their deep expertise in the core components of the new products being built**.  They also make the distinction between incremental change, radical change and architectural change to draw attention to the fact that seemingly minor changes in the architecture of a system are actually more likely to cause incumbent dislocation than radical changes in the underlying technology.  This is an extremely important point.

The essence of architectural innovation is the reconfiguration of an established system to link together existing components in a new way... Architectural innovation is often triggered by a change in a component... that creates new interactions and new linkages with other components in the established product...

Established firms often have a surprising degree of difficulty in adapting to architectural innovation. Incremental innovation tends to reinforce the competitive positions of established firms, since it builds on their core competencies... In contrast, radical innovation creates unmistakable challenges for established firms, since it destroys the usefulness of their existing capabilities...

Architectural innovation presents established firms with a more subtle challenge... established organizations require significant time (and resources) to identify a particular innovation as architectural, since architectural innovations can often initially be accomodated within old frameworks.  Radical innovation tends to be obviously radical--the need for new modes of learning and new skills becomes quickly apparent... the introduction of new linkages is much harder to spot.  Since the core concepts of the design remain untouched, the organization may mistakenly believe that it understands the new technology***.

Dismissing OpenRTB as not being really anything very interesting at all is missing the point.  OpenRTB is not radical change, it barely qualifies as incremental change.  But it is architectural change.  It is the reconfiguration of existing linkages, or the beginning of it

Architectural change is subtle.  It is ignorable, for the time being.  But it may--may--be enough to change the existing architecture, the architecture that is more and more contained within Google.  Those that realize this and adapt to it will prosper.  Those that dismiss it--either because it is too subtle or because they are a large incumbent and ignore those who profess to compete with them--might find themselves Xeroxed.

There's a subtle belief in our VC-backed community that technological innovation is the sine qua non, the ne plus ultra.  Build a better mousetrap and the world will beat a path to your door.  Unfortunately, we're wrong.  Build a better technology and the incumbent will copy your innovation: they will notice a better technology pretty quickly.  What we need to do is change the competitive dynamic by shaping the architecture of the ecosystem.  This is something we can do without the permission of the Incumbent, and something the Incumbent will have a hard time responding to.

OpenRTB is just as start.  But the more new linkages we can create in the ecosystem, the better chance we have to compete based on merit.

-----

* An overview of this argument and its consequences was brought to my attention by Brad Burnham somewhat after I wrote about it: Internet Architecture and Innovation.  I want to say that this book is really excellent, because it looks like it, but I haven't had the time to do anything but flip through it yet.
** I am not in love with their chosen examples.  In both cases the lower-cost/lower-functionality disruptive (as in Innovator's Dilemma disruptive) element is also present, so as natural experiments they leave something to be desired.  Christensen, in fact, draws heavily from Henderson's work in his book--IMHO, more heavily than he seems to admit.  His description of this paper, in Dilemma, mentions their thesis primarily as a study in organizational structure.  Christensen then talks about "value networks" instead of architecture--and Dilemma is an essential read--but I think Henderson and Kim's work is more directly to the point here.
*** Read the article, really.  The case studies alone are worth it (and might give some comfort to those of us who despair at the ever-incipient chaos in our little sub-industry by highlighting that this is not something we managed to invent ourselves but is, in fact, normal.)

Online Ad Tech Curriculum: Links

[I am going to make additions/changes to the list by editing the post itself.  I think that's better than cluttering everyones' feed.]

A VC friend asked what he should read to better understand the online advertising market.  At the time I thought I could offer some decent advice.  But as I started to think about it I realized that the stuff you need to know to know how this stuff works is scattered all over the place.  Simple things--like a flowchart of how an ad is delivered to someone visiting a site, complete with multiple ad servers, redirects, etc.--I can't find.

So I figured I'd start making a list.  It's nowhere near complete.  In fact, it's sort of off-the-cuff.  I could use some help improving it.  If you were going to point someone to a few resources that would improve their knowledge of the fundamentals--not the news, not the opinion--of the online ad business, what would they be?

In no particular order.

Books and articles:
Randall Rothenberg, Where the Suckers Moon: The Life and Death of an Advertising Campaign (link to Amazon)
The book to read on the messy details of how an ad campaign gets made with all the wacky interplay between agency and client.

Mark Tungate, Adland: A Global History of Advertising (link to Amazon)
The other day someone tried to tell me just how little I knew about the history of the agency world.  Upon pressing him, I learned he got all his info from watching Mad Men.  I told him to read this book.

Dean Donaldson, Online Advertising History (PDF)
A good--if woefully incomplete--history of online advertising.  And the only one I could find out there.  Part of Donaldson's master's degree program.

Kyle Bagwell, The Economic Analysis of Advertising (PDF)
What does advertising do and what is its societal purpose?  Bagwell provides a nice survey of the various academic work over the years.  In the end you might be underwhelmed by how little we know, but there it is.

Demetrios Vakratsas; Tim Ambler, How Advertising Works: What Do We Really Know? (JSTOR link, unfree*.)
If Bagwell is top-down, this is bottom-up.  Various cognitive models of advertising.

Gerard Tellis, Advertising's Role in Capitalist Markets (PDF)
I think it's important to note that advertising is a necessary part of our economic system.  If it were not, it would not be much use thinking about it.

Core Online Ad Enabling Technologies:
Cookies:
Cookies are one of the core technologies used in web advertising. 
GoverningWithCode.org, Cookies (PDF)
Flash Cookies Explained (HTML)


Ad Servers:
Understanding ad serving is one of the trickiest parts of understanding the online ad infrastructure. 
Eric Picard, Ad Serving 101, Revised (HTML)
Pointed to this by Ian Thomas, below, but his link is broken.

Why do Publishers and Marketers have Separate Ad Servers? (HTML)
There's more to it than this, but it's a start.

Ad Tags:
Operative's Blog on Ad Tags (HTML)
How to Read Doubleclick Ad Tags and Ad Tag Variables (HTML)

Promotional material:
OpenX White Papers
Pubmatic White Papers
In general I find industry whitepapers to be self-serving.  Doesn't mean you can't learn something from them, though.  These two companies have some informative stuff.

Terry Kawaja/GCA Savvian, Display Advertising Technology Landscape (PDF)
DeSilva+Phillips Online Ad Networks: Monetizing the Long Tail (PDF)
DeSilva+Phillips Ad Exchanges, RTB, and the Future of Online Advertising (PDF)
Investment Bank whitepapers.  When these reports are good, they're invaluable in their industry coverage.

Government Scrutiny:

FTC, Self-Regulatory Principles for Online Behavioral Advertising (PDF)
The Office of Fair Trading Online Targeting of Advertising and Prices (PDFs)
Some of the most informative publicly available industry coverage is in the reports prepared for government agencies looking at whether and how to regulate.

Blogs:
Bloggers are flaky and difficult people who write about whatever they please whenever they please.  Um, present company excepted.  So, instead of plugging blogs, some posts I think are worth reading.  All of these are from bloggers in my feed.  They're not all the bloggers in my feed, of course, but posts specific to this discussion.

Jay Weintraub, Risk, Arbitrage, and The Root of (Much) Evil
Ian Thomas, Online Advertising 101 series
Mike Nolet, RTB Part I (and parts Ia, Ib, II, III)
Jonathan Mendez, The True Media Value Delta
Brent Halliburton, The Chaos of Second Price Auctions
Greg Hills, Shouldn't It be Cheaper if I Buy More?
Darren Herman, Advertising to Audiences

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* If you head to your library, and they have access to JSTOR, you can get it for free.

The future of free media

Monday's Wall Street Journal article on cookie tracking was a bit underwhelming. So although (a) we've been having the same conversation over and over again since 1996 without getting anywhere*, (b) the article was a bit misleading and maddeningly vague, and (c) industry rumor has it that the church/state divide at the Journal does not quite live up to the J-school ideal, I am siding with Jeff Jarvis in believing that News Corp is not well enough organized to stage a conspiracy: the article was just poorly done.

These arguments are nominally about privacy. And providing privacy is a worthy but complicated** goal. But given the general level of philosophical confusion about privacy, I believe much of the commentary (and the comments to the commentary) is motivated by a hostility to advertising in general.

If you hate advertising, you hate advertising. Arguing that not paying for music means a diminished supply of quality music does not sway the downloader. Not paying for media--in whatever sense of pay--means a diminished supply of quality media. This argument does not sway the hater of advertising, but I'm not trying to convince them. Advertising provides something important: free (as in beer) media. This may not mean much to Rupert Murdoch--who can afford to pay cash for his media--but it means something to society. And it should mean something to those of us who are trying to find a way to make quality ad-supported online media a viable proposition.

Paying cash for media is regressive. High cover prices exclude those with less disposable income. (This strategy is used purposefully by mixed-model high-end media outlets to produce a demographic appealling to better-paying advertisers.) Advertising democratizes media***. And media allows a democracy.

Online media is suffering. Susan Athey and Joshua Gans say "the adoption of targeting... leads to higher impression prices, higher profits, and higher social welfare." Online media is in dire need of profits, much less higher profits. The alternative to targeting is the pay-wall. The FTC, in thinking about targeting, needs to seriously weigh the regressive impact of limiting advertising against the opinion of news outlets like the Wall Street Journal, who have consciously set out to exclude those who don't have a spare $363 per year to spend on something they can get elsewhere for the nuisance cost of seeing a few ads.

-----
* i.e., The Financial Times, February 12, 1996, "This Bug in Your PC is a Smart Cookie"; and San Jose Mercury News, February 13, 1996, "Web 'Cookies' May be Spying on You."
** If you can quickly and simply articulate what privacy is and why it is important, I will quickly and simply point you to a counter-example. Privacy is not a single thing, it seems more like a bundle of things, so it defies easy analysis.
*** A fact evidenced by laws compelling certain content to be aired "free." This content, naturally, is usually sporting events, but that's a rant of a different color. Hansen & Kyhl "Pay-per-view broadcasting of outstanding events: consequences of a ban" talks about the EU directive of 1989.

The last days of the ad exchange

Darren Herman wants a conflict-free ad exchange. So do I. We assume there could be one because we look at the much bigger and more efficient financial markets and see they are run on exchanges. But, in reality, the financial world has moved on from exchanges, and so will the ad world.

An article of faith: markets inevitably evolve from inefficient middlemen/arbitrageurs to efficient, transparent and fair crossing platforms. From Bazaar to Exchange. And then they live happily ever after.

But wait, consider this: of the buy and sell orders UBS handles in NASDAQ-listed stocks, it sends less than 5% to an exchange. The rest it internalizes (the infamous "dark pool"). That is, UBS matches buyers and sellers of stocks amongst their own brokerage customers.

Brokerages avoid exchanges. Instead, these days they tend to either be market-makers, internalizing as much of their trading as possible, or sell their order flow to third-party market makers, like Knight Trading*.

Internalization allows brokerage firms to minimize exchange fees, keep the bid-ask spread for themselves, and avoid giving information to competitors. Internalization does not provide transparency and fairness, like an exchange does, and that is part of its draw for the market-makers. Putting your orders into the exchange, where everyone can see them, is like a poker game where everyone else can see your cards. Exchanges level the playing field, and if you're smarter than average, you dislike level playing fields**.

Exchanges were the best way to minimize transaction costs when communication was cheap but computing power was expensive. That time is past.

*****

All the major ad exchanges are now owned by some of the biggest online media companies. AdX: Google. RMX: Yahoo! AdECN: Microsoft. They are no longer open markets, they are internal markets. As Yahoo! turns off Invite Media and everyone else contemplates the same, the media companies start to look like silos. Google's acquisition of Invite is the final clue. Invite is their e-Trade, the customer UI that allows easy access to their inventory. Whatever audience you're buying, Google can find it in their content network. So can Yahoo!, to an extent, and Microsoft and AOL and FAN and Akamai. If they don't happen to have an audience in house, they will buy order flow by subsidizing publishers to come into their content networks. Each of these companies can internalize all orders that come to them. They will not interoperate*** and they do not need to interoperate.

By internalizing, these media companies get to keep the transaction costs and keep their market activity quiet. They also get benefits that the brokerage houses aren't allowed--because the brokerage houses are regulated--like pushing their own inventory even if there is a better deal for their customer somewhere else.

How this will play out: the major media companies will each buy or build DSP-like capabilities to allow data-driven access to their inventory. They will build out their network of publishers so they can fulfill any audience request internally (internally here meaning either their own inventory or that of their enfiefed publishers.) At that point media buyers will be faced with an array of relatively undifferentiated media companies to buy from, each offering to best place the media buyer's ads in its own audience.

Sound familiar? This was exactly the situation of the media buyers four years ago, vis a vis the ad networks. We have taken our two steps forward and are now taking one back, to a closed world where media sellers protect their margins by obfuscating what they are selling. Not with the complete opacity of the ad networks, but through the inability of buyers to learn because they are kept apart from the data and segmentation that guides their buy.

Media buyers need to figure out how they can hold their own against the big media company market makers. They need to build, buy or closely partner with a DSP, one that is direct connected to all the large media companies and pub brokers, and lets the media buyers have their own proprietary data, algorithms and results.

Tomorrow's online ad buying world will look a lot like yesterday's, only with more technology.

*****

Prediction without predictions is just prattle, so here are some:

1. There are not enough DSPs to go around. I count maybe ten indies that have technology up and running. A few more in the works that I know of. There are at least twice as many companies that will need to build or buy one. I don't expect more than two or three of the current indies to still be independent in 18 months.
2. Yahoo! will realize it needs to buy order flow. It will bring in some premium ad networks to provide audience balance in RMX by buying or partnering.
3. Direct connection between DSPs and pub brokers/publishers will proliferate, producing much fail among the technologically naive.
   
4. Third-party ad exchanges will stop calling themselves that and start calling themselves what they are, pub brokers.

*****

We've had a lot of innovation in the last five years. It's starting to worry the entrenched players. Their reaction is to move us from innovation to integration. There is some good in this: allowing audience buying, dynamic optimization and RTB at the major media companies is a big step forward. But there is a lot of bad also. There is still a lot of innovation that needs to happen, especially on the optimization side. And the publishers that aren't big enough to be market-makers themselves are going to be even worse off than they are now.

An independent ad exchange--really a private crossing network with a clearinghouse function--needs to exist. It will allow innovation to continue outside of the spotlight. But it needs to rise up organically from the industry, because there's no money to be made, no exit. The New York Stock Exchange was formed as a cooperative by a group of brokers who needed interconnection and interoperability. They didn't support it because they thought the entity itself would be valuable, they did it to make their own businesses more valuable. What we need now is our very own Buttonwood Agreement with the same aims and similar methods.

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* A brief survey of the market microstructure issues around internalization is here. But read it for its discussion of transparency.
** The leading proponents of the recission of NYSE Rule 390 in 2000 were the big brokerage houses. Cynical voices said this was because they were also the largest investors in the ECNs. But it seems obvious from a remove that the investments in the ECNs arose from the same cause as the desire to get rid of 390: the desire to trade in private.
*** This is where the financial services analogy starts to fall apart. The big market-makers interoperate not just through the exchanges but through ECNs and private crossing networks. The reality of financial markets makes this necessary. There is not, at this stage, and won't be for some time, the same need for interoperability between, say, Google and Yahoo!

Fiddling while Rome burns

I read Curt Hecht's AdExchanger interview this morning with puzzlement and, eventually, horror. Vivaki is drawing the precisely wrong conclusions from their evaluation of the situation.

[re Invite Media] Google realizes it's for the DFA stack, away from media, and they appreciate that it works just like search bid management or serving ads. It's a good thing for the industry that they're taking the interoperable view... I assume they'll eventually put them on the Google Stack, but for the time being we just want to keep progress going the way that it has been... I think [re the Invite Media acquisition] it's great that what you're seeing is some consistency where Omnicom and InterPublic Group... they both have come out supportive and positive.

If I'm reading this right, Vivaki thinks that Google wants a position in display like they have in search. Also, that Invite is not about media (I infer that it must, therefore, be about data.) And that even though Google is talking interoperability now, they will eventually integrate Invite into the rest of Google (making interoperability problematic, to say the least.) Oh, and they seem to think this is all peachy, and say that everyone else in the industry thinks so too.

This is why we can't have nice things.

For the sake of argument I'll grant that the agencies and their holding companies might not have been able to anticipate Google's dominance of search ads in the '00s. But let me nip future arguments in the bud: Google is trying to lock up display like it did search. Now you know. You're going into this particular battle with 20/20 foresight. If you do something stupid here, you've got no one to blame but yourself.

Google is a publisher and ad network. They make almost all of their considerable profit from people buying their ad inventory or that of their content partners. When any other piece of the value chain starts to look vaguely powerful, they commoditize it by buying and subsidizing someone who provides that piece. Urchin, Feedburner, Android, Teracent and (not yet subsidized, but mark my words) Invite Media.

In the short-term Vivaki will have lower costs. In the long-term the complement that will be commoditized is Vivaki. I know talk of disintermediating the agencies is as old as the DARPAnet, and I am usually one of the scoffers*. But this time it's different, for one important reason: data.

Google says that they are going to keep Invite as a separate entity. This is bull, as even Vivaki admits. The 2010 strategy du jour is to say one thing then do the opposite, and Google is a master of it**. Invite Media will be integrated with Google, and when it happens, a self-reinforcing cycle starts.

Brian Lesser said last week "we believe in the importance of proprietary technology to ensure the integrity of our client’s data... Every buy that an agency sends through a DSP makes that DSP smarter." If Google gives Invite access to the effectiveness and cost data from AdSense and GCN, Invite will have more data than anyone else in the business, by a long shot. By having more data, they can become more effective targeters, which will give them more market share, which will give them more data. This feedback cycle of proprietary learning will make it impossible for anyone else to compete in the market for targeting services. And Vivaki and the rest of the industry*** will end up as non-strategic customer service reps for Google's media planning and buying solution.

In fact, treating Invite as if Google's promise to leave it stand-alone were true is a mistake for everyone in the industry. It's easy to see, despite Neil Mohan's sweet-talking, that every DSP has to assume that each of their orders on the Google ad exchange will get seen by Invite. It's difficult to invest in novel strategies when you know your competition will see them in real-time. Almost everyone else in the industry has similar problems, or just the awful problem of potentially dealing with a single supplier/customer.

But the conundrum the other exchanges have is the most interesting. Vivaki implies that Microsoft is psyched about the Invite acquisition. That's ridiculous. The integration of Hotmail inventory and AdECN into Invite is not a result of Microsoft wanting to work with Google. Integrations take time, so this one certainly started (and was probably complete) before Microsoft even knew about the Invite acquisition. Moreover, while Microsoft has proven itself to be a difficult political environment for ad companies to thrive in, the people there are not stupid, not by a long shot. And being excited about giving your nemesis access to your trade secrets would be very, very stupid. The same is true of Yahoo! and AOL.

Because when Invite is integrated into Google, it seems reasonable to assume that Google will:

1. Start cherry-picking the other exchanges' best publishers; and
2. Start front-running the other exchanges, keeping the demand for themselves****.

By giving Invite access to their marketplaces, Microsoft, Yahoo! and AOL give Google access to data about position and price of every ad that runs through them. They would be giving Google the very data it needs to outcompete them. If the other exchanges allow this, they won't for long. Because if they do, they won't be in business for long.

Darren Herman said to me "it's like we're paying Google to take our business." It would be one thing if companies lose to Google because Google just flat-out does things better: there's no crying in baseball. But the game's barely started. Keeping progress going the way it has been is the wrong strategy. Recognize the threat and respond.

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* When entrepreneurs tell me "if the agencies don't adopt our technology the agencies will become irrelevant," I say "if the agencies don't adopt your technology, then you will become irrelevant." The agency owns their customer, the marketer, and they are good at and jealous of that ownership.
** Google's switch on mobile phones and Apple's bait-and-switch to app developers are two recent examples.
*** I was a little puzzled by Hecht taking everyone else's lip service on the Invite acquisition at face value. While everyone I know is still pondering what it means, no one is really fully on board. Of course they say they are, but when was the last time you heard a holding company executive (Martin Sorrell the exception proving the rule, as always) say anything revealing? For what agency execs really think, read Darren Herman's post on Dart and Atlas.
**** It's widely rumored in the industry that Google has a double standard in exchange pricing between people buying through Google's user interfaces and people buying through the exchange API. If Invite is an insider, it shouldn't surprise anyone if they get preferred access.