We looked at the man behind the curtain. Then we got bored and looked at something else.

I am either proud or dismayed to report that Reaction Wheel is the top organic result on Google for searches like "Is Advertising Good or Bad?"

For your amusement, traffic from these searches over the past year.


Concern over whether advertising is good or bad peaked in November and has declined since (February is, so far, looking like January.)

Prepping for a meeting with someone who wants to become a VC

Like pretty much everyone else on earth, it took only a few months at my first full-time job to convince me that what I had always thought I wanted to do was not what I wanted to do for even one more day. So I went and talked to a ton of people about careers and eventually landed in the living room of an accomplished venture capitalist.

This, I decided, was the perfect job. How, I asked him, do I get to be a venture capitalist? His advice: either start and run or have a senior operational role at a successful company and, after you retire in your 50s use your extensive experience and network to pick winners and assist young founders.

There are great investors who did not follow this path, but they give that advice regardless. I also did not follow that path, but it's the advice I would give, if I gave advice on becoming a venture capitalist.

But when asked, I generally go a different route: why do you want to be a venture capitalist at all? I believe that getting the financing of innovation right is one of the primary institutional drivers of societal wealth creation. And I believe that venture capital is how that is best done right now. But VCs are, at the core of it, allocators of capital. Nothing more.

It's understandable that an entrepreneur who gets grilled by a VC might think "I wish I was on that side of the table," but this can't really account for the entrepreneurs' fascination with VC (no one leaves a meeting with their mortgage provider thinking this, for instance.) Maybe many of the people who want to be venture capitalists have fallen for the grass is always greener fallacy: things we know little about seem more appealing than those we know intimately. So let's dispel some myths.

1. I will get to build great companies.

No, the entrepreneurs build the companies. If you find yourself building the company, you've invested in the wrong entrepreneur. Venture capitalists should not manage companies, they should manage investments. One of my hard-learned rules of thumb is that if in the process of looking at a potential investment I find myself having ideas for the company other than those of the founder, I am the wrong investor for the company and the company is the wrong investment for me.

Like other financial intermediaries, VCs need to be in the flow of information to do their jobs well. Using this information to help the entrepreneurs--for hiring, introductions, pricing/market knowledge, etc.--is a useful and expected part of what the VC does. VCs tend to have far more experience in the investment and exit processes, and good ones will help the entrepreneurs understand and execute these. VCs also have seen plenty of success and failure, so can offer advice on management. These are ways the VCs can help entrepreneurs; but none of them even approach "building" the company.

Because the companies I've invested in have created not only thousands of jobs, but thousands of good jobs, I feel like I'm a productive member of society. But I never make the mistake of believing that I've been the primary driver of that job creation: the entrepreneur is.

2. I will get to shape the future.

No, not really. VCs are reactive, don't let them convince you otherwise. The legendary Michael Moritz wisely notes "I rarely think about big themes. The business is like bird spotting. I don't try to pick out the flock. Each one is different and I try to find an interestingly complected bird in a flock rather than try to make an observation about an entire flock." VCs don't decide which companies get started, entrepreneurs do. VCs just decide which of these to fund. In this sense, VCs no more shape the future of their industries than mortgage bankers shape the future of real estate development. Influence? Yes. Shape? No.

3. I will be in the know.

I talk to dozens of people in the industry every week. I sit on boards of companies. I advise companies. But there's no way I know half as much about any specific thing about my very narrowly defined industry (interactive ad tech) as any entrepreneur I talk to. I know a little bit about a lot of things, all of it told to me by people with a big stake in making me believe what they believe. This makes most of the information suspect. It also means that I don't see opportunities as quickly as people inside companies, who deal with the day-to-day frustrations (great companies are most often founded in response to everyday problems.) Better to be a consultant for this.

4. I will be respected.

Actually, no one will know what to make of you. There are so few venture capitalists in the world that--outside of the small pond of the entrepreneurial sector--no one will know what the hell you're talking about. Fred Wilson says in a Fast Company article "when I go out to dinner with my wife and another couple or two [in New York] and I talk about the things that we're investing in, people just look at me like I'm crazy." You want respect, recognition? Become a doctor.

5. I will be powerful.

Really? That's why you want to be a VC? To lord it over as-yet-unfinanced start-ups? Oh dear.

6. I will make a lot of money.

Check out the Forbes 400. First check out the Finance & Investments section. Lots of hedge fund operators and a bunch of LBO types. Even a couple of PE folk. Even, maybe, one who is sympathetic to early-stage tech (Jonathan Nelson of Providence Equity Partners.) Then, over on the Technology & Medicine list (Forbes doesn't even consider VCs financiers!) are the few VCs: Ram Shriram (#272), John Doerr (#277), Michael Moritz (#277) and Vinod Khosla (#347). The most successful and senior venture investors of our time can't even crack the top 250. Vinod Khosla, who's a frickin genius, is barely on the list. On the other hand, there are plenty of young hedgies way up there.

More positively, the vast majority of people on the tech list are entrepreneurs. If you want to make real money, become an entrepreneur. If you're not an entrepreneur, go work for a hedge fund (added bonus: getting a job at a hedge fund is easier than getting hired as a VC.)

7. Okay, I will make good money without taking a huge amount of risk.

Institutional venture capital does pay well. And if you're successful, very well. Probably, all else being equal, it pays as well as being an investment banker. But when it comes to risk, the bargain is not so good. If you don't make the big-time as an investment banker, you can fail gracefully into a CFO spot or move to an advisory boutique. In either case, you get to keep your membership at the country club. If you fail as a VC, you get to move into a VP spot at a startup. There's nothing wrong with that, but the surety of making enough to pay the mortgage payments on a $1mm home is not there.

8. It looks like fun.

It is fun, mostly. I'll give you that.

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So, my advice: if you're an entrepreneur, be an entrepreneur. If you're not, then go work for a startup. Or, if fame, fortune and the respect and/or awe of others is important to you, be an investment banker or lawyer or doctor or consultant. Really, deciding to be a venture investor is an entirely irrational choice.

Of course, it's what I do, so who am I to say?

I think there are very good reasons to choose venture capital as a career, but they tend to be softer, more complicated reasons than those I hear from people who say they want to be VCs. If you can articulate those reasons after reading the above, then maybe it's worth exploring.

In which we are the protagonists in the low comedy of our economy

This morning I was rereading Merton and Bodie's "A Conceptual Framework for Analyzing the Financial Environment" in The Global Financial System: a Functional Perspective, published in 1995 but still immensely interesting*. This passage, though, ended the paper:

In the traditional bank arrangement, there is a mismatch between the liquidity of the deposits issued by the bank and the loans backing those deposits. Indeed, it is this mismatch in liquidity that is often cited as the root cause for banking panics...

The current environment of low and secularly declining transactions costs for securitization supports a hierarchical and incremental chaining approach as an efficient means for providing liquidity. Liquidity is enhanced whenever a collection of assets is "repackaged," and the resulting collection of assets created have a smaller bid-ask spread than the original assets. Thus highly illiquid and opaque assets can be financed with short-term debt instruments. Portfolios of the more liquid of those securities, in turn, can be used as assets to back other securities that will have even greater liquidity, and so on.

Thus, at each link in the chain, the differential in liquidity is relatively small. Cumulatively, it is possible to create virtually perfectly liquid securities while minimizing the danger to the system of ever experiencing a "crisis" because of a mismatch between the liquidity of an intermediary's assets and liabilities.

The idea is appealing on the face of it, but we can't, obviously, still believe it. If I was going to criticize, I think I would start with how the authors seem to be confusing instrument-level liquidity with institutional-level and how these could be quite different markets. But this is pretty unsatisfying, if only because these institutions are just collections of individual assets anyway.

I think the better answer may be that it wasn't securitization at all at fault in the recent difficulties. Of course, at the rate we're ruling out causes, we may eventually have to accept the sole remaining explanation for the near-seizing up of our vaunted financial system--no matter how improbable it may be: collectively we're no smarter than a troop of chimpanzees.

OK, maybe it's not that improbable.

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* We're having a contest to see who can have the most boring Saturday. I'm winning.

If the ad exchanges aren't exchanges, what are they?

I should note that I don't claim to have had an original thought in my post yesterday on why ad exchanges are not like financial markets/exchanges*. In addition to Huayin Wang's insight in the comments, @jonathanmendez points me to a Cogblog post touching on this, and Jordan Mitchell of Rubicon mentions his own post from several months ago.

I love this stuff, excellent reading.

Keep in mind, though, that exchanges are only one type of market. Most commodities are not traded on exchanges. Most things are not bought and sold on exchanges. So, while I defend talking about the stock market as an analogy and as a way to think about what ancillary companies can exist in the ecosystem and how important they will be, maybe it would be useful to specify what the marketplace for ads is, not just what it is not. I'll try to blog on that next week.

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* My ex-trader friend, mentioned yesterday, scoffed at my use of the word "exchange" in our conversation, saying "if it's an exchange, then the CFTC would like to talk to you."

The limits of the exchange analogy in the ad marketplace

huayin commented on Open source the ad exchange just now on an issue that has been top of my mind for a while. He says

We need to be cautious of the limitation of any analogy... In my 2c, Ad Exchange marketplace is an order of magnitude more complex than NYSE! The current ad buying/selling ecosystem already underscores this intrinsic complexity...

He's right, of course. There's a sort of intellectual shorthand (laziness?) in equating the financial marketplaces and the ad marketplaces. It's not just me; my friend Roger Ehrenberg, who knows the financial markets inside and out, also makes this analogy. But it's a useful tool in predicting and shaping the future.

Ads aren't commodifiable in the sense that, say, soybeans are. I talked about one reason (among many) for this in Information and markets 2. Ads right now, especially with the BT, CT and other data layered on top, are way too varied to be traded on exchanges like commodities. But the ad marketplace is also not as bazaar-like as eBay. Nor is it as consumer or producer dominated as many commodity spot markets (live cattle, say, or soybeans) which are not on exchanges*.

The stock/commodity exchange ecosystems are large, high volume, complicated, economically significant and there are a lot of people who would spend a lot of money for the slightest edge. There is also a ton of public information on what works, how well it works, and its the economic effect. Try finding that for the live cattle market, which may in some respects be a better comparison. Centuries of central clearinghouses, risk sharing, information transparency, spot vs. future markets, intermediaries, analytics, etc. can teach us some useful lessons. Not to mention the reasons and limitations on the evolution of markets from haggling to fixed-price to auction to exchange to derivatives. This history deserves some thought as we try to build a coherent ad marketplace.

I think there's a better way of doing things in the ad market. There has to be, it's such a mess right now. So, despite the limitations of the analogy, it's better than starting from scratch.

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* I was talking to a ex-trader friend of mine this morning about this very subject. I asked him why the CBOT had spot markets in butter (note the trading hours: 11:05-11:15am, M-F) but not soybeans. He said it was for sentimental reasons. He also said that the betting among the traders about how many minutes the butter spot market would take to clear (7 minutes vs. 8, say) exceeded the dollar amount of the actual trades in butter.

Apple acquires Quattro

A couple of months ago I said Apple had to acquire some advertising DNA. Now they are, by buying Quattro Wireless.

I'm not sure why Google, Apple and Microsoft all need to compete in all of each others' lines of business. It seems to me that Apple's incipient stranglehold on the mobile internet put Google into a "the best defense is a good offense" mode. This, in turn, caused Apple to respond in kind. In some more rational world, Apple would provide the platform, Google would provide ad services, and a million developers would provide content. I assume that someday we will arrive at that point, but the path to get there is murky.

One point I made two months ago bears repeating. In mobile advertising on the iPhone, Apple has something that nobody else does: they know who you are. They have software on your computer that connects to your phone and to the internet. They also probably have your credit card number and address. They can link behavior between your mobile, your web and your real life*. This puts everyone else trying to target ads at a massive disadvantage. It is also a privacy nightmare.

[Update: Read Greg Yardley's take on the deal.]

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* I don't know if this is true or not of Google on Android devices. Anyone?

Open Source the Ad Exchange

My last post, long and long-winded and written when you should all have been out celebrating, sent more traffic my way than any other post in this sleepy blog's history. I think the prospect of a new year and (in a sense) a new decade, makes us all a bit introspective and open to thinking the why about our path through the world. I'm glad people found it worth a read.

But it's January now, and Monday. Back to work.

*****

My work thesis since I left Omnicom in 2001 was that the advertising ecosystem was stuck in the 1970s without even the consolation of the three-martini lunch. Ad agencies--and thus advertisers--seemed to be following a rather indirect path towards connecting the right person with the right product. Efficacy was low, efficiency was poor and ROI tracking was primarily hand waving. "One to one marketing", an idea that the internet could make real, was still used as an exciting cliche in pitch decks and book titles, but never implemented in actual marketing campaigns.

So I spent my time investing in and starting companies aimed at changing that. From early (too early, it seems) location-based marketing in Platial and exchanges in Root Markets, to tracking in Pinch Media, to data targeting in 33Across and Domdex and to demand side platforms in CPM Advisors.

But when Google launched their Ad Exchange four months ago, I decided the thesis was played out. An open marketplace can be the apotheosis of efficiency and efficacy. And if Google is putting its muscle behind that, then the rest is just filling in the blanks. While filling in the blanks is probably a better investment philosophy in the short term, it's not the right place for investors like me who are putting smaller amounts of money to work for longer periods of time.

Then Google acquired Teracent. Then it was said that Google was looking to acquire a demand side platform. I also heard that Google was restricting sellers' agents from working with AdX.

The key to making the exchange-as-platform useful is making it a platform. If the New York Stock Exchange owned a brokerage firm, that would be a problem. If they owned a research firm, or an underwriter, that would be absurd. But Google is, in essence, trying to do all these things. The strategy seems to be to make the exchange easy to use for advertisers and consumers because those are Google's real customers.

This is a bad long-term strategy. Small producers of say, soybeans, are not equipped to show up on the floor of the CBOT and sell their September crop in open-outcry. And you and I are not prepared to go up against Goldman Sachs in selling our shares of GOOG on the Nasdaq. In both cases, we'd get taken. That's why there are intermediaries. If Google doesn't allow outside firms to be intermediaries then small producers and consumers will get arbitraged, and the information generated by the market will be poor quality. The hoped-for efficiencies will not appear.

Google knows this, of course. So why are they doing it this way?

In 2008, the NYSE Euronext Group had revenue of $4.7 billion and operating income (backing out one-time impairment charges and merger expenses) of about $1.1 billion. In 2008, the CME Group had revenue of $2.6 billion and income before taxes of $1.2 billion. The stock and commodities markets are each a couple of orders of magnitude bigger than the advertising market. Even if the ad exchanges facilitated the introduction of derivatives, like ad futures and the like, the future of ad exchanges are companies with a few hundreds of millions of dollars in revenue.

Being an exchange is not where the real money is made in the stock and commodities markets. The big money is made at places like Goldman Sachs. This is not to downplay the central importance of the exchanges: Goldman would be a much smaller and less profitable company if there weren't exchanges. The ad markets will end up similarly, with exchanges that are crucial to the ecosystem but not that big financially, and much more profitable firms that use the exchange platforms.

Historically, exchanges have been cooperatively owned entities, in existence to facilitate the business of their members. Google, with AdX, is in the wrong side of the business. The best move, for them and for the markets, would be to spin AdX out into a Mozilla-like non-profit foundation and then work on the hard problem: figuring out how to use the newly generated information and efficiencies to make advertising more useful.

I jumped the gun. In this sector, there is a lot more to do.