Where to Spend Your Time

If you're building an online advertising business or one supported by advertising, the numbers released by eMarketer today--their forecast of online advertising spend over the next few years--might be of some help in deciding what kind of advertising spend to target.

Here are the subcategories and the compound annual growth rate of each category from 2006 through 2011, sorted by CAGR:

 Rich media/video  35.6%
Lead generation   22.9%
Paid search       19.5%
Classified        17.8%
Display ads       17.3%
E-Mail            13.3%
Sponsorships       0.6%

   All            20.0%

Rich media/video advertising is pretty competitive, but there's not nearly as much energy being spent making lead gen a better business.

Bad News is Bad News and Good News is Bad News Too

I wasn't really planning on talking about the impact of the credit crisis on online advertising anymore, but I just read Blodget's take on the news that online financial advertising was up 10% in the third quarter (compared to the third quarter of last year) while online advertising in general was only up 1.3%.

The beauty of blogging versus other forms of writing is that I can flog my personal beliefs no matter what the evidence. So can Henry. Personally, I try to let my beliefs change when confronted with evidence to the contrary. Henry prefers "anecdotes" that support his conclusions.

Things can always change, but it remains my contention that advertisers will respond to difficulty in finding new customers by increasing ad spend in accountable media. Like online.

The mortgage crisis is the result of mortgage lenders seeking customers who were bad risks. Fees for servicing these subprime mortgages are high and the borrowers are eager to borrow so easy to find. The non-risk-adjusted ROI on subprime borrowers is astronomical. Risk-adjusted: not so good.

The appropriate response by mortgage lenders is to tighten credit standards and give money to a smaller segment of borrowers, those more likely to pay. To find these borrowers, the lenders still have to advertise to the same pool of people because the amount of money spent targeting potential subprime borrowers specifically was a small piece of the ad pie. The ROI may decline, but the dollar spending doesn't.

Some financial firms will stop advertising, sure, because the impact of their prior mismanagement will leave them unable to invest in the future. The ones who do this should be put high up on the list of likely bankruptcies.

Every Hundred Years Media Changes...

...And it did, some six or seven years ago.

Read Dare Obasanjo commenting on Danny Sullivan's article in Advertising Age on what is evolution and what is revolution in online advertising.

The bottom line: the revolution is helping the consumer find what they want, not in finding better ways to get the consumer to buy what you're selling.

Facebook Got Gamed

As Homer Simpson says: "I'm no super-genius... or are I?"

About thirty seconds after reading the news about Facebook's new advertising initiatives I blasted them as "overreaching." I think that was obvious to anyone who's involved in advertising and seen the various privacy debates and debacles over the years.

So why did smart marketers like Coke lend their name to the initiative if they knew it was going to fail?

Probably because they didn't know it was going to fail. They probably suspected it was going to fail, but they couldn't be sure. If I was the evil genius running marketing at Coke (no offense, Joe, Carol) my thinking would be:

1. If Facebook succeeds, Coke gets a premier spot at the table and a brand boost for being savvy about the intertubes thing;
2. If they fail, we back away slowly and say they misrepresented what they were doing and we would never be involved in anything so disrespectful of our customers, never.

And, even if Facebook gets beaten up for their overreaching, next time around the public is more used to the idea that their privacy is an illusion. The erosion of our expectations of privacy has taken place slowly over the past hundred years, two steps forward, one step back.

In other words, Facebook was cannon fodder.

The Facebook partnership with Coke was no partnership, it was a free option for Coke and the other "landmark partners." Coke almost certainly knew how this was going to play out before they agreed to participate. They didn't throw Facebook under the bus after things went sour, that was the plan all along.

What is Privacy?

My grandmother used to tell me never to do anything that I wouldn't want to see on the front page of the newspaper. Maybe she lived up to this ethical standard, but she'd be the only one. Substitute "internet" for "newspaper" and here we are.

In today's NY Times, there's an article about Facebook backing off its too aggressive advertising policy. No surprise.

The article had an interesting comment from an exec of a top interactive agency:

Isn’t this community getting a little hypocritical?... Now, all of a sudden, they don’t want to share something?

Well just because they want to share something doesn't mean they want to share it with you. I often have to remind my five year old of that.

More generally, though, the issue isn't revealing personal facts--people do that all the time in every human venue--the issue is having control over the personal facts you reveal.

There is a certain hypocrisy at work, but it's not a 50-million-strong mass hypocrisy. It's the hypocrisy of the media companies that back off personal targeting when it is exposed to their users but keep doing it when it's "behind the scenes, where consumers do not notice it."

Into the Open, Into the Closed

When Fred Wilson said "open is the new closed" he was echoing Seth Goldstein's "closed is the new open", even if it sounds like he wasn't. I had a long incoherent post (what else is new?) about opening a few weeks ago. Here's a summary: every opening exposes something else that's closed.

Opening up a platform allows closed apps to better utilize it. The exposure of new closed opportunities creates new companies, creates new markets. This is good. It commoditizes the open layer--lowering prices--while creating the monetary incentive to innovate in the new closed layer.

There are two ways to play the opening: creating the open and riding the open. Seth rides the open by building a company that creates, distributes and monetizes closed widgets. Fred and USV creates the open by funding new, disruptive, businesses that commoditize the previously closed. Bug and Clickable are two good examples of companies that won't earn the rents afforded the closed but might garner smaller margins on much larger volumes.

Matchbox Branding

Kids' toys are an interesting business. The velocity of the viral marketing of kids' chatter is exceeded only by that of currency traders' jokes, it seems. One day every kid in town is playing on Club Penguin, the next they're all on WebKinz.

My kids are pretty impressed with brands in an enforcing-important-social-norms sort of way. Playing with the same toys is a way of building community, I suppose, much like listening to the same sorts of music or watching the same TV shows is for adults.

My son got a Matchbox car on Saturday, a Mini-Cooper. How much does Matchbox pay to license the image of the car? I'm sure Matchbox does pay BMW something. But shouldn't it be the other way around? It's the ultimate in product-placement. Every time I look at one of my son's Matchbox replicas of a late 60s muscle car, I get the sort of product lust I never get from ads, left over from the Matchbox cars from when I was a kid. What better way to create product pressure for high-end cars fifteen years from now than molding the brains of five year old boys?

Conversation

Robin Hanson over at Overcoming Bias, one of my favorite blogs, is contemplating stopping his contributions. He says

I've been wondering for a while if I should be blogging. Blogging is less of a conversation than I'd hoped, even among blog coauthors. It feels great to quickly put an idea "out there" in an accessible form, but I'm not sure such ideas have much chance to be built on by others. And it does take time.

Why does it not seem like a conversation? Maybe because Robin's expecting people to comment more?

Fred Wilson, a while ago, said "A blog without comments is a one way medium. And that's not as good as a conversation." I disagree.

If you have something to say, why not blog it and link? Then people can comment on your input in a way that's trackable but is asynchronous. I'll comment when I already have an opinion. But when I need to think about something, I'm not going to go back and find the post and then comment. What would happen to this post if I put it as a comment to Fred's July post linked-to above? I'd be talking to the air.

Professors do research; they also teach seminars. In their research they publish and cite and other researchers read the articles and then respond and cite. In the seminars the professors talk and the students comment. The latter is a great way for the students and professors to learn about the state of play as it stands. The former, though, is the best known way to advance the state of play.

Robin and Eliezer have changed the way I think. I'm not smart enough to comment in real time, but that makes their blog no less valuable. Please don't stop, Robin.

Advertising: More of the Same, More More More

I've been puzzling over where behavioral targeting takes advertising for the past few months (i.e. here.) It crystallized for me this morning when I started reading IBM's "The End of Advertising as we know It". (I only read the first page, though, so this post isn't an endorsement of whatever IBM went on to say.)

All of the targeting technologies: contextual, behavioral, social, etc. say they will rid the advertising world of it's primal problem: the half of advertising spend that's wasted but we don't know which half. We will call this Bernbach's Law, because I feel like it.

People have misread Bernbach's Law to say that the half of advertising that is wasted can be recaptured, thus doubling ROI. While this may be true in certain cases--like when you have a CMO much smarter than all the other CMOs--I don't believe it's true if everyone uses the same targeting.

Advertising is two interlinked markets. The first is the media market. Media companies spend money creating content to draw eyeballs and then sell access to those eyeballs. The media business is highly competitive so we should expect that media company pricing is driven primarily by the cost of producing and distributing content. (Both of these costs have changed with the advent of the internet, but we're going to take that as a given.)

The second market is companies making products or services and trying to find customers by letting people know about them through advertising. The cost of marketing is built into the cost of the product, so advertisers are less sensitive to the absolute ROI of advertising as they are to their ROI compared to their competitors. (If everybody has an equal handicap, what that handicap is barely matters.)

What does this mean for the future of targeting? What happens when everyone uses targeting and targeting is perfect, when Bernbach's law is no longer true?

If advertisers could put their ad only in front of the fifty people who are likely to buy the product rather than the hundred that might or might not, those other fifty ad slots go begging. Half the advertising inventory will not be bought. This 50% drop in demand should drastically cut prices.

On the other hand, if an advertiser can target better, she should be willing to spend more to get in front of that targeted audience. But how much more? Twice as much? Does the advertiser end up paying less, resulting in lower overall media revenues? Or does media benefit by being able to charge premium prices for all of their inventory?

Here's my prediction: media revenues will rise overall. Media companies that don't participate in the targeting arms race will lose, of course, but otherwise costs of creating and distributing content will remain the same except that the cost of the targeting technology will have to be added in. CPMs will climb as much as is needed to make up for the fewer ad slots bought.

Advertisers will have the same ROIs that they always have had and the cost of the targeting technology will get passed along to consumer prices.

Consumers have always paid for the media they consume by paying more for products that advertise. Now they will pay more to see fewer (albeit more intrusive) ads.

I Don't Mind Being Friends with Brands, I Just Don't Want to Have to be Friendly to My Friends Brand-Friends

Reading the press and opinion on Facebook's new targeted advertising system. I think Facebook is overreaching, they're asking too much. They've given us a container for widgets and a few of their own substandard built-ins (email, pictures, feed.) While free they accumulated the real value: a ton of users' social graphs. Now that they have them, they want to charge (through untrammeled advertising) a huge amount for users to access their own data. The best analogy is probably the old CDDB bait-and-switch.

Seth talks about distinguishing open from closed. I'm not sure why he's confused, we used to talk about this all the time, and he was open's most eloquent dead-philosopher-namedropping proponent. I direct him to go back and read AttentionTrust's principles. Open means the platform gives up trying to control how the user uses it, giving up trying to own the data about the user. Open is the opposite of the walled garden. A platform's implementation can be proprietary, but that doesn't mean it's closed. Open is better for the user, it means giving the user control over what they do and can do. Open is better for the platform as well, it means allowing the user (and others) to innovate and then being able to spread that innovation to other users.

We've been given small taste of openness. Now I can't do without it. So I want to know: where's the OpenSocial portable social graph widget? Can we move that to the top of the priority list?

Here's what I want: a PSG widget that I can import into my NetVibes page that will let other authorized widgets see my social graph (or a specific subset of it) and can communicate with my friends' PSG widgets (embedded in any OpenSocial platform), so they can exchange feed-items. I don't want to be beholden to a single widget container, I don't want anyone to be able to hold my data hostage.

John Anderton, you could use a Guinness right now.

I've got a lot on my mind. You can see it by reading about the weird variety of things I've posted about in the last three months. For the most part it's about the future of marketing. Much of it is, uh, aspirational (read: wishful thinking.)

Greg posts about behavioral targeting: he's tired of it. I think he means he's tired of hearing about how it's the new marketing revolution. Me too. It's not new. Behavioral targeting is what marketing has always been, we're just better at it now.

I don't like behavioral targeting. Not because I don't think it effectively sells product. I don't like it because I think it's destructive of identity. It's interesting that, on the one hand, we have companies like Facebook flourishing because they protect the privacy of the social graph while, at the same time, marketers undermine that privacy to sell things.

If there's one thing the explosion in communication forms (or even the popularity of Twitter) proves, it's that our identities are mappable to our relationships. Relationships require trust, trust requires intimacy, the willingness to be intimate requires the ability to enforce privacy. Without the ability to enforce privacy, we won't form real relationships.

I'm waiting for the first viable social network whose technology does not allow it to violate the expectations of privacy that Facebook built itself on and is now jettisoning. I think it will take the form of individual open-source widgets embedded in a web page that is nothing more than a way to regulate the communications between the widgets. Anyone?

Keep Your Content Close, but Your Friends Closer

Would you rather spend your time finding the needle in the haystack or the haystack on the needle?

Randall Stross writes an interesting article about OpenSocial in today's New York Times. I'm still muddling my way through where I think the widget ecosystem brings the internet, but Stross says something that contradicts one of my earliest conclusions.

He quotes Joe Kraus from Google saying that the point of OpenSocial is to allow social networks to be mobile: you could embed a widget exposing your network of friends into Craigslist, for example, porting your trusted community into your ecommerce. Interesting.

But backwards. It's far more likely that you will embed a Craigslist widget in your social network page than vice versa, in my opinion. Facebook profiles are home pages, people keep them open in the background while they work so they can keep on top of what their network is doing. It's also far more likely that your friends will see your Craigslist posting if you embed it on your homepage than someone searching Craigslist will run across something posted by a friend.

Okay, its not a dichotomy like that. I know there will be hybrid models. But the fundamental question is: will social features be embedded in content sites or content features in social networks? I'm tempted to say there is a matrix of networking and content features and that there will be opportunities at each matrix juncture, but that's not how it works in real life.

I think social networks become the predominant form of navigation and that pointers to content get distributed through them. This is what is happening--with increasing momentum--now. Why Mr. Kraus and Mr. Stross thinks otherwise is a mystery to me. But I'm certainly open to the possibility that I'm wrong.

The Sense in Irrationality

There's a more cynical view of why it is relatively unusual for businesspeople to go back on their word than the one I posted about a couple of days ago. I mentioned that the cost of redress when treated unfairly often made it economically irrational to try to enforce a broken contract. I said that more contracts aren't broken because people are naturally trustworthy.

Another reason may be that people are often quite economically irrational.

There's an experiment in behavioural economics known as the Ultimatum Game. This game gives one person a certain amount of money and asks them to split it however they want with a second person. If that person accepts, then both people get the money as allocated by the first person. If the second person refuses, however, neither gets anything. The game is played once, anonymously.

The rational strategy for the second person is to accept any split that offers them anything. The alternative is to get nothing. Thus, the rational strategy for the first person is to offer the minimum amount to the second person.

This is not what happens. Although it varies from culture to culture, any split offering less than 20% to the second player is usually rejected. People are willing to act somewhat irrationally to enforce an idea of justice. Economists, who often base their theories on the idea that each person is an autonomous unit making only decisions that benefit themselves, can not explain this result. But it's easily explained as a group dynamic: if everyone was willing to personally accept some cost to punish the unjust, there would no longer be any injustice. It wouldn't pay.

Turtles All the Way Down

I had a dream last night about the protocol stack. Now, don't get me wrong, I love the idea of the protocol stack, but it wasn't that sort of dream.

Did you ever read George Polya's How to Solve It? I read this book when I was young and it introduced me to the idea of a heuristic--a generalized problem-solving approach. Polya's book has descriptions of a long list of heuristics, it's pretty amazing. You and I spend a lot of our time trying to make sense of complicated situations. Heuristics can help order the problem and suggest a solution approach. The idea of the protocol stack is one of my favorite heuristics.

Why was I dreaming about the protocol stack, aside from the usual warnings from my unconscious to get a life? The protocol stack clearly shows that each platform is an application, and vice-versa. For instance, a web site is an application on a platform: the web browser. The browser is an application on the HTTP platform. HTTP is an application on the TCP platform, etc., all the way down the stack. (And, to those who say there must be some bottom layer that is pure platform and not application, I say "very clever, but it's turtles all the way down.")

When I was at Prodigy, some twelve years ago, we were in the middle of the switch from closed network to open network. Prodigy as an application was forced to become Prodigy as a platform. Prodigy had to reinvent itself as an ISP.

This change slightly preceded the change from web browsers being "closed" to "open" (they were never quite as closed as the walled gardens of Prodigy, AOL and Compuserve, but there major players certainly tried their hardest to make HTML proprietary and otherwise embed their version of the browser as the standard.) It seems the each layer of the stack starts closed and becomes open.

So, the dream was about openness climbing the stack, starting way down and working its way up. The physical/data link layer (telecom) was closed and became open, then the network/transport layer, then the session/presentation layer. Since then openness has been climbing the application layers (the OSI model, since it's a network model, doesn't bother to subdivide the application layer.)

What happens when a layer opens? First there is a huge amount of activity and attention. Then it becomes commoditized and disappears from sight. Fifteen years ago I followed the gyrations of the data link layer with great fascination: wondering when SS7 would be rolled out, would ATM or packet switching win? Huge investments by the telecoms were at stake. Then decisions were made, a path was chosen and I couldn't tell you now who runs the backbones and how. I don't need to know.

So, here we are, several tiers into the application layer, talking about social networking opening up. The New York Times reports a rumor that Google is trying to organize an alliance of Everyone But Facebook to create standards for application developers. This illustrates a general principal: once application openness becomes a virtue, there is a race to be the most open, resulting in a commoditized landscape of open platforms. There must be people at Google smiling at the collosal joke they just played on Microsoft: gaming them into valuing Facebook at $15 billion and then turning around and showing it up as AOL circa 2000.

The opportunity now moves from the commoditized platform up one tier, to the applications that ride on the platform. In this case, the widgets.

Better than Precious Ointment, Indeed

I was talking to an acquaintance recently who harbors serious doubts about capitalism. So much doubt that she can't imagine any positive human characteristic that can survive contact with the corrupting touch of big business. I said to her that the scaffolding of capitalism is trust. She scoffed.

No one understands the limits of capitalism better than a long-time capitalist, and maybe someday we'll be smart enough to create a better way to allocate capital than the invisible hand. Until then, I think that our basic human impulse to be true to our word is what makes our economy possible.

Most contracts in the business world are for a much lower dollar amount than the legal cost would be to enforce them. If you do business with someone who's not trustworthy, you'll eventually get stiffed. When you do, there's not a financially rational response other than to grin and bear it. And not do business with that person again.

Given this, it gives me faith in human nature to observe how infrequently people renege on contracts. The only explanation, imho, is that most people are basically trustworthy. The few that aren't, that consider their financial gain more important than their good name, should be avoided , no matter what they promise you.

Just Don't Look Down the Barrel When the Fuse is Still Smoldering

I've been remiss in writing, I know. What can I say? Income before pleasure.

I've bought into widget mania. I'm a little late. I recently realized that one of my persistent professional problems is that I like to work on things that should happen, rather than things that are about to happen. The bets with the steeper odds pay better, on average, because in business the vig is on the side of the gambler, not the house. Steep odds have more vigorish, percentage-wise (this is true, isn't it, always? I'm sure there's some sound financial reason for it that every actuary knows and I don't.) The flip-side is that my ideas have sometimes taken longer to play out than I expected.

But sometimes things that are on the verge of happening hang fire and then I'm tempted to get involved. Widgets have been with us forever, not just since Facebook opened up their platform. Actually, I'd like to appreciate Richard MacManus over at Read/WriteWeb for his post "Widgets are the new Black." A quote:

Over time I expect the big media companies will enable this kind of functionality [the ability to embed widgets] in their platforms too... That kind of mini-app within an app is where all this is headed, from a product perspective. The bigger picture is that it opens up more opportunities for developers to leverage others platforms, and users to get more and varied sources of content.

Note that this was in June 2006, almost a full year before Facebook figured it out and did exactly as he predicted.

I Like Being a Contrarian

So it's a little disappointing to me that so many people agree with me.

Here's Paul Kedrosky on why Google's stock is trading up as investors anticipate a downturn in ad spending.

I'll have to find something else to obsess over.

I don't agree that Google is going to $2000 (or $1000) anytime soon, as Blodget predicted. (But I think most people who were outraged by his post didn't really read it very well.) The problem is, for Google to get to $2000 per share (at least in real terms), it would have to have a majority of the advertising spend in the world flow through its system (assuming they continue to be mediocre in every other line of business except search and being an ad rep.) I don't believe that will happen, because there's just too much money at stake for someone else not to figure out a way to take at least part of that market. No one gets to completely dominate a lucrative market without some sort of rationale for monopoly.

What's the Google monopoly rationale? Brand? Spending a few tens of billion will build you any brand you want, and if the result is a several hundred billion dollar market cap, it would be worth it. (Hint, hint, IAC.)

Technology? Google's technology is good, but it's not magic. Some 23 year old will think of something much, much better within the next five years. That's almost a truism.

Consumer data? Well, maybe. But if that's the case, I predict government intervention sooner rather than later.

Lock-in? Placing an ad through a Google competitor is just not that big an increase in work. And, frankly, the last thing the ad agencies (who still place most media dollars) want is a single provider: it makes them superfluous.

Network effects? I don't see any, but maybe I'm being blind.

Falling long-run marginal cost through the output range? No. eBay has that, but not Google. Or, if it does, it's de minimis compared to the price.

I don't think Google has the characteristics of a monopoly. I think that no one has come up with a better product yet. That will happen soon, if history is any guide.

So, my prediction for the maximum rational Google stock price? No more than $1000 per share. (Note that I put "rational" in there to cover myself.) Of course I sold my Amazon.com just prior to Blodget calling for Amazon to go to $400 in 1998, based on similar logic. So, my recommendation: when Google gets over $1000 per share, move all your money into TIPS, the bubble has become unsustainable.

On a different note: I completely agree with Blodget that if you are putting your money into individual stocks (and you're not a professional stock analyst) then you are an idiot. Or sadly divorced from reality, whichever. I recommend Vanguard's and Fidelity's low management fee, broad-based index funds. The fact is, the people you are buying your Google stock from invariably know more about it than you do and they have decided to sell.

Home Sales: Trees, meet Forest

I'm kind of busy right now, so blog posts will be a little shorter and further between.

The Insider counts the reported drop in new home sales to mean that Google will suffer. They haven't drawn a clear line from A to Z, but whatever.

Brad De Long puts up a graph putting this decline in perspective.

What does it mean? I don't know. But that's kinda the point.

Interestingly, I think Blodget believes that the decline in new home sales means there will be a recession that will impact consumer spending and thus the companies that market to them who will respond by cutting online advertising spend. While this is a rather long train of speculation to support, I'm personally more worried about the car immediately following the locomotive: that recession thing. That seems like a more interesting topic than Google's growth slowing from a gazillion percent a year to a bazillion percent a year.

Adteractive Acquired?

Here's a second-hand rumor that Apollo Group acquired Adteractive.

If what I knew of Adteractive is still remotely true, the acquisition would be material to Apollo and have to be disclosed. Nothing on Edgar to date. They disclosed a month or so ago that they were acquiring Aptimus for $48 million. Adteractive would go for more than that, unless they've seriously imploded.

Fred Wilson on Intellectual Property

Fred Wilson blogs his opinion on whether VCs should blog. The answer is somewhat self-evident, but his post is interesting reading, as always.

He quotes one Boston-area VC saying, essentially, that he's not giving away his hard-earned knowledge to anyone other than portfolio companies and potential portfolio companies. Fred thinks that intellectual property should be shared, out in the open.

I agree. I think there are two types of people: those who need to hoard the knowledge they have because they aren't getting new knowledge fast enough and those who can give away what they have because they are learning or generating new knowledge so quickly. Fred is clearly one of the latter. I think we should all aspire to be one of the latter.

As an aside, when I was a VC I found that what I learned had a very short halflife. I tried to give it away as quickly as possible because in a few weeks or months, it would become worthless. As I said here, yesterday's idea is yesterday's idea. The best way for a VC to keep the startup machinery healthy (and thus keep themselves in companies to fund) is to let entrepreneurs know what the current thinking is so they can come up with something entirely new. I doubt Fred shares intellectual property because he's an altruist: I think he wants to help people think of new ideas so that he continues to have plenty of investment opportunities. That's good business.

Weintraub on Lead Gen

Jay Weintraub--one of the few really knowledgeable people willing to write frankly about lead gen--writes about payday loan and subprime credit card lead gen. A pretty dense read, but information you'd otherwise have to spend a year and several hundred thousand dollars of misdirected email and mispriced offers to learn.

Mortgage Application Data

I'm not going to write about the mortgage market anymore (after this that is.) I'm not really interested in the mortgage market, I'm only interested in the marketing. I write about mortgages so much because mortgage lead gen and new car lead gen were the canaries in the coal mine for online lead generation and they remain the two most mature lead gen verticals.

That said, something about the reporting on the subprime mortgage market jitters kept bothering me. Holders of mortgage debt are having financial problems because some of that debt looks to be going bad. But what does this have to do with the underlying business of mortgage lending?

Here is some data on mortgage applications from the Mortgage Bankers Association. First, applications for purchase mortgages:

Note that the y-axis is clipped, showing 90 to 130 of this seasonally adjusted index (week of 1/2/2003 equals 100.) You'll notice that purchase mortgage applications peaked about two years ago, bottomed out a year ago and have been generally climbing since.

Now, refi:
Aside from the madness that was Spring 2003, applications have been generally climbing since beginning of 2006.

There does not seem to be a link between people defaulting on their subprime mortgages and mortgage applications, these two things are probably mostly disjoint.

My point is that mortgage originators are not having any trouble finding customers today that they didn't have in the first half of the year: there are just as many--if not more--applications. Lenders may not be accepting as many applications as they were, but the "end-customer pool" does not seem to be "drying up", as claimed in this Barron's article.

Dissecting the "Obvious"

The Insider points to a Barron's story about the effect on Google of the sub-prime mortgage bubble popping. I feel like I'm beating a dead horse feeding a full horse here, but here are some quotes from the Barron's article--the meat of the article was an interview with a hedge fund manager, who we should not presume to be objective--and my thoughts.

It's hard to argue with his logic.

Oh, pshaw.

For loyal advertisers still open for business, it only makes sense for them to slash their ad budgets as their revenues slide because of industry woes.

That's the old "if you can't defend it, call it obvious" trick. Why does it make sense to slash ad budgets when revenues slide because of industry woes? If the woes were customer woes, perhaps. If the woes were operational woes, perhaps. But "industry" woes? Isn't that when you want to increase ad expenditures and grab market share?

On top of that, the going rates in key-word auctions are plunging because there are fewer eager bidders. Thus, the prices Google fetches for paid search are probably declining, especially as fewer Internet leads turn into actual transactions, the hedge-fund manager says.

Mortgage related keyword prices are not plunging, according to SEM specialists Reprise. Conversion rates on leads are not plunging, according to lead management specialists Kaleidico.

According to the fund manager's back-of-the envelope estimates, it could be costing some major lenders who spend millions on paid-search more than $10,000 for every lead that results in a closed loan -- an expensive marketing program. "The math doesn't work," he insists.

Where the heck did he get those numbers? I talked about this already: average cost to close a loan coming from internet marketing was $1,958 in 2006 (according to Fannie Mae.) The cost for online lead gen is, I estimate, more like half that. So this hedge fund guy is saying that close rates for people who have filled out a form with lots of personal information have been cut by 90% over the course of a few months.

Now, while this may have been true for a week or so in the midst of all the panicky coverage of the sub-prime "meltdown", I refuse to believe this is the new reality. Things change, but they don't change that quickly that fast when it comes to consumer behavior.

If he isn't pulling these numbers out of a hat then he's talking to originators who buy keywords for branding, not for ROI-driven customer acquisition. Those lenders pay indiscrimate prices and don't know how to drive from click to close. They were paying $10,000 for a customer a year ago and are paying close to the same now. Those companies will stop buying keywords and start buying leads, leaving the lead gen to the professionals.

Even if the ad cost per loan application is lower, the end-customer pool is drying up. The customers generated by Web ads are people who won't be able to afford homes under tighter credit and won't be able to refinance after having tossed their house keys back to the banks.

A font of misdirection! The customers generated by web ads often are sub-prime because those are the leads the originators wanted to buy. Purchase leads, the majority of leads generated went begging. So, if mortgage originators decide that if there is no more sub-prime business they're just going to take their call center and go home, then web ads will follow. If, on the other hand, they suck it up and start pitching purchase mortgages again, then web ads are still an excellent business to be in.

There are a lot of moving pieces here, but it pays to start with reality when trying to see what the future holds.

So When Does Forbes Apologize?

A month ago I took Forbes and Dan Lyons (aka Fake Steve Jobs) to task for his articles about SCO that turned out to be profoundly misguided.

To his credit, he has admitted that he got it wrong. I admire him for that.

The part that still bothers me is that his apology is "I got it wrong." Reporters are supposed to report, aren't they? While Lyons might be off the hook for me, I still wonder why Forbes feels the need to be a journal of opinion rather than reporting.

I Lied When I Said I Would Change

Just yesterday I said I was going to try and write less. I am going to try, but I'm telling you now that I'm going to be unsuccessful.

This Nielsen report on first half 2007 advertising spend is full of interesting conundrums! For instance, it reports that H1-07 ad spend is down 0.5% from H1-06, but that spend at the top ten advertisers is down 7.3%. That means (using conservative assumptions) that the rest of the advertisers actually increased their aggregate ad spend by 0.4%. Who benefits from advertising dollars going up at small advertisers? Search, perhaps?

Another conundrum: if you take out the auto manufacturers, ad spend increased. This is interesting because, by my calculations, US auto sales fell by 2.2% in H1-07 compared to H1-06. Historically this would have meant an increase in auto advertising. Perhaps the auto manufacturers' CMOs were a little slow on the uptake, or perhaps not.

The hard part of all this for me is that this report is about advertising spend in major media, not marketing spend by companies. Lead purchases would not show up in this. Direct marketing does not show up. My argument--that marketers will move dollars from non-accountable advertising to more accountable marketing, like lead gen--is neither supported nor contradicted by this data. I would love to see total marketing spend across the US economy (or even a representative subsector, like public companies) from H1-06 and H1-07. Anyone have that data?

Anybody Have an In With the Nobel Committee?

Read in the Post this morning that Nielsen reports that advertising spend decreased in the first half of 2007 compared to the first half of 2006. Is the dreaded advertising recession upon us?

Who cares? While overall ad spend was down 0.5% in the first half, online advertising was up 23%. Twenty-three percent? 23%. That's a lot.

Blodget's take is that the sky may still fall: "we still question how long this strength can continue if the overall pool of ad dollars shrinks..." Sorry to tell you Henry, but the overall pool just did shrink... and online grew like wildfire.

In reality, both Blodget's and my arguments are completely unaffected by this report. We had no economic turbulence in the first half to speak of. Why did ad dollars go down? I doubt anybody knows, but I'm guessing it has to do with the 50% of variability that has nothing to do with overall GDP growth. I'm in the process of building a ginormous spreadsheet with all available economic data from 1900 to today. Then I'll start doing statistical analysis to find the real drivers of ad spend growth or decline. I expect--when I'm done in five or six years--to be able to answer this question.

The really surprising thing in this report, to me, is that spend in national magazines grew by 8.4% while local magazines fell by 5.2%. What's up with that?

Two Months of Blogging

There used to be an idea that to understand something you had to try and do it. I think this is true: it's impossible to understand the beauty of a pencil sketch hanging in the Met unless you've taken pencil in hand and tried to sketch something yourself. What I have usually learned from this type of activity is that doing something that looks easy well is often incredibly difficult.

I've been blogging for two months today. My initial fears--that I wouldn't have enough to write about--have faded. In fact, I'm no longer quite sure how I could possibly have thought that. My problem, I think, is quite the opposite: I write too much.

Yesterday, Henrik Torstensson saw one of my posts and blogged about it (why, I don't know, it was one of worst posts I think.) His comment was short; he simply said what needed to be said and that was it. I guess that's why he's Sweden's top blogger. He's my new role model.

So, here are my goals for the next two months:

1. Pithier;
2. More graphs, fewer numbers;
3. More conversation, less oratory;
4. Pithier.

Anything I'm missing?

Data, Data, Who's Got the Data

The Insider says that

Unlike those who argue that Google's magical business will accelerate in a recession as advertisers spend only where they know they will get a great ROI, we think Google's growth will be hit by economic weakness...

Oh, Henry, who's arguing? This is just cocktail chatter. Without the cocktails, unfortunately.

Seriously, this is a really interesting question: what are the drivers of advertising spend? Certainly GDP growth and growth in advertising expenditures are correlated. The correlation is about 0.5 since the end of World War II, according to this data. (I wonder if the correlated part is the allegorical half that's wasted...) So an economic recession would often coincide with an advertising recession. But what's the mechanism for that decline? Decline in CPMs or decline in users of media? That is, is it driven by marketing departments or consumers? Is the decline caused by the economic decline, or are they both caused by some third thing? I can't answer these. I need a lot more data.

And there isn't a lot because advertising recessions are unusual. There have been only three since 1945, in nominal terms: in 1961 (decrease of 0.8% from the previous year), 1991 (-1.6%) and 2001 (-4.9%). Clearly the last one was the most significant: it was the disappearance of the dot-com spending. (If you hadn't had 2000's stupendous growth in dot-com related advertising there would have been no decline when it disappeared.) But yes, if there's a recession, we may have another ad recession.

Everybody gets hurt in an ad recession, but not equally. According to Piper Jaffray's research (sorry, no link), 2001 saw a fall-off in advertising expenditures of 6.7% from 2000 (why can't these people get together and agree on their numbers!) The loss in spend was not evenly distributed. In 2001 direct mail and yellow pages advertising did not decline. TV was hit the worst, magazines second, internet third, then newspaper and radio.

Accountable and local advertising did not decline during the worst ad recession since 1938. Why? Because businesses still need customers; they're just not willing to take as much risk.

The riskiness of forms of advertising--and by riskiness I mean the variance of cost to acquire a customer--in decreasing order, is:

1. Buying a spot with no metrics
2. Buying a measurable impression
3. Buying a click or call
4. Buying a lead or action
5. Buying a customer

Note that the risk decreases as accountability increases (Is this necessarily so? It would seem to imply that advertising dollars are rationally allocated--laugh all you want, but it seems to be true. I'll have to noodle that.) If there is an ad recession, the riskiest forms of advertising will be hurt the worst. Guerilla Marketing and other forms of marketing with absolutely no way to infer their reach just stop. Print/TV/Radio get hurt.

But there aren't many ways to buy a customer yet, so the money can't reach up that far. Buying leads and buying actions will benefit the most, growth-wise, but off a small base. I think perhaps Google benefits the most, dollar-wise.

When I say "benefits the most" I mean, of course, "gets hurt the least." Ad recessions hit all players to some extent. If there is one, Google will grow more slowly than they would have otherwise, but they will still grow.

[BTW, I am not advocating buying Google stock. In my opinion--which is worth what you're paying for it--Google is wildly overvalued, ad recession or not.]

Garbage Out

AdWeek has an article summarizing findings from a McKinsey study on online marketing. The question posed to a bunch of marketing execs who market online was, essentially, why aren't you marketing more online?

The answers:

• 52%: insufficient metrics to measure impact;
  
• 41%: insufficient in-house capabilities;
• 33%: the difficulty of convincing management;
• 24%: limited reach of digital tools;
• 18%: insufficient capabilities at agency.

Um, what? Insufficient metrics? Compared to what? Online has metrics and that's more than you can say about almost all other media except for direct mail and telemarketing. Parsing the above answers, I think the upshot is that at least two-thirds and probably more like 80% of marketing execs simply don't know what they are doing when it comes to the internet.

From the article:

...although a majority ... find online vehicles to be more efficient than traditional advertising, the relative newness of the medium and its still developing benchmark data make it a hard sell internally to bosses who demand accountability... the multiplicity of online channels can make it difficult to isolate what's working and what's not...

I agree it's more efficient, but not accountable? The beauty of online versus most other media is that you can isolate what's working and what's not. Is TV accountable? Newspaper? Radio? This is truly an odd survey and frankly, I can't make sense of the results. Am I missing something? Do I just not get it?

My opinion? To coin a phrase, online advertising is clearly the worst form of marketing, except all the others that have been tried from time to time.

Here's an alternative survey.

You aren't increasing your online advertising spend because:

1. Janice, could you print out my email for me to read, please?
2. Do you mind closing the door? I'm working on my putting.
3. That's not going to impress my buddies at halftime during the Superbowl.
4. Accountability? You trying to get me fired?

McKinsey, feel free.

Thinking About Tomorrow

Fred Wilson is worried. He thinks that the internet industry is headed for a rough patch. He says this is a gut feeling, but coming from Fred a gut feeling can't be discounted.

I agree with Fred about the cyclicality of the venture industry. Startups start, get funded and get traction. Imitators follow. At some point, the best few in each category go public or are acquired, most of the rest fail or go sideways. This has started.

In the past month I've had many people approach me about starting companies much like those recently acquired. These entrepreneurs are looking at recent exit valuations. But the opportunity is gone. Being part of the first wave is usually pretty critical. If you're not, then you can't just compete with the early companies, you need to displace them. This requires a revolutionary change in product, not just improvement.

When startups fail, they tend to fail in tranches, soon after the choice few are acquired or go public. This is not driven by the larger economy, it's driven by the disappearance of exit opportunities, and thus funding, for these money-losing firms.

In a nutshell, here's what is and will be happening:

1. Large companies can't see where growth in their core businesses is going to come from;
2. They invest in the best of the entrepreneurial ventures, paying whatever it takes, hoping to create growth;
3. Other entrepreneurs see the crazy valuations and start me-too companies;
4. After a year or so, the acquirors realize they overpaid;
   
5. Both the companies that weren't acquired in the first go-round and the me-too companies find no buyers;
6. Investors, realizing that valuations will not be what they hoped, either fold or offer down rounds, effectively killing off the company;
   
7. Meanwhile, entrepreneurs that are focussed on disrupting the way things are done rather than on a quick exit are starting companies that will be the Tacodas of2012.

The answer isn't to worry about eventual failures, it's to encourage startups that aren't at all like the success stories of today. If you're an entrepreneur, don't start an ad network now, don't start a behavioural targetting company now. I can't even tell you what to start now: if I could tell you, then it would be something not to start, if you know what I mean.

If you start something I haven't even thought of, then you've got a shot.

MacMall Sucks

Today MacMall delivered me a new MacBook Pro. It is a brick. Won't boot, right out of the box. I called MacMall. They told me it is Apple's problem, not theirs, they're just a reseller. After complaining vociferously for half an hour, they agreed to repair it. So now I get a refurbished computer for the price of a new one. They refused to replace it, they refused to let me return it.

Their rationale? I quote:

If you asked a friend to buy something for you in a foreign country and they brought it back and it didn't work, would you blame your friend?

Dear MacMall, I am not your friend. I am a customer. Don't pretend that you are doing me a favor by selling me a computer.

Maybe I've been spoiled by companies that actually care about their customers, like Amazon.com, who--the few times I have had problems--ships me a new product before they even receive the defective one back. That's why I've been a loyal Amazon.com customer for twelve years.

Absent the "customer service" people getting a clue, I'll never buy from MacMall again.

More Data to Chew On

I was thinking about Bill Rice's point that not all mortgage originator cost cutting is cuts to revenue generation capacity and some data that Josh Reich sent me a couple of weeks ago popped into my head.

Below is a chart of relative volume of a couple of Countrywide's origination sources: retail and correspondent originations from July 2006 to July 2007. Retail originations stayed between 31% and 35% of all originations while correspondent originations rose from 38% to 49%.
Why? Maybe Fannie Mae's Mortgage Focus 2006 Executive Summary's analysis of costs of origination suggest the answer (sorry, I don't have a link to the actual document.) Average cost to originate a closed loan in 2006 for the retail channel: $3,581. For the correspondent channel: $2,512. The industry is moving to cheaper ways to originate loans.

My point? The average cost to originate a closed loan for the internet/call center channel was a paltry $1,958. I have good reason to believe that the cheapest sub-sector of internet/call center is lead generation (versus, say, the lender's own site.) As lenders try to originate ever more cheaply in this difficult earnings environment, the most rational way to do it would be to direct more resources to buying leads.

I'm Not So Lonely I Could Cry... Anymore

Bill Rice took his sweet time to weigh in on what the mortgage mess will do to online advertising. But I'm glad he did, because his opinion is well reasoned, supported by data, and clearly written (a refreshing change for readers of this blog, no doubt.)

And I'm not just saying that because I agree with him.

Saturday Potlatch

It's the weekend and the baby is napping, so let's talk about something different.

An old friend of mine told me an even older story recently. I'll let her tell her version of the story when she starts her blog. Here's the one I tell my children.

Once upon a time there was a tribe of people who lived near the ocean. Everybody in the tribe liked to give the things they had to other people. They weren't afraid to give away things because they knew that everyone else in the tribe liked to give gifts also, so no one would ever end up with nothing, no matter how much they gave. The people who gave the most away were the people that everyone else looked up to, so everyone worked hard to produce more to give away. Sometimes there would be gigantic parties where someone would give away absolutely everything he owned.

Then outsiders arrived and saw this custom that was so different from theirs. Their custom was to keep what you earned from your own labor and only give it up in exchange for something of equal value. They decided the tribe's custom was worthless. They called it demonic and then outlawed it. The tribe sank into poverty.

My friend's version, which sounds like the Nigerian version of this tale, via the Girl Scouts, has a happy ending. Mine doesn't. But mine has the virtue of being historical. Several tribes in the Pacific Northwest practiced some version of a gift economy before the custom was outlawed in 1885 after protests by missionaries.

Gift economies are interesting. Capitalists argue that without markets there is no motivation to produce. In a gift economy the motivation is status, not goods and status often has more utility than goods. The fatal objection to gift economies is that they do not allocate resources well. This is hard to argue with: it is difficult enough to maximize your own utility, directing your production to maximize the utility of a group is harder. As the group grows, it becomes unwieldy or impossible. The feedback on production in a gift economy ("how happy were they to receive my gift?") is less direct or timely than the feedback in a market economy (price.)

Because of this lack of timely feedback, gift economies can easily mismatch supply and demand in the short- to medium-term, wasting resources. If it is easy to catch fish, a tribe member may decide to catch far more fish than the tribe could eat in order to give the biggest gift.

Gift economies, because they do not depend on material exchange, avoid both one of the failings of the market economy and communism's fatal flaws. Because goods are given freely, no one is poor. But because there are rewards for production, no one underproduces.

But gift economies are unstable. They require the cooperation of the entire tribe. In a form of the Prisoner's Dilemma, all players are better off if they cooperate, but if players start to defect (in this case, not give gifts but keep taking them, becoming freeriders) then all players would do better to defect. It takes strong cultural and ethical constraints to keep people from defecting.

Unstable equilibra exist, of course. You can balance a coin on its edge and it will balance for quite a while, provided there is no outside disturbance. Gift economies exist all over the place: from the open source movement to academic research. The participants in these economies are so much better off from them that there is plenty of extra to leak out to the rest of us, who do not contribute.

Why do gift economies work with knowledge goods? Because knowledge, once created, can be widely distributed at almost no cost. The misallocated resource problem of gift economies is minimized when production cost goes to zero. Resource wastage is a minor effect when the ratio of output to input is so enormous.

But these modern gift economies are still unstable. I wonder if we should worry about the entrepreneurial model of academics (I will call it the "Stanford Model" although it's much more widespread than that.) In the last thirty years (and remember that the current model of academics freely sharing the results of their research with each other is at least 400 years old) research performed in universities has begun to be used to start companies, get patents and otherwise be owned rather than given away freely. At what point do these defections cause all academic research to be closed? And what would that cost society?

I'm Only a Contrarian Because No One Will Agree With Me

I'm feeling a little lonely in my belief that marketers will react to lower sales by increasing marketing spend. Now even Niki Scevak disagrees with me. And there's this happy song sung in a minor key over at CNN.

Let's step back from the trees to see the forest. Imagine the CMO walking into the CEO's office. He closes the door, pulls out a chart showing declining revenue and says "Boss, Customers are getting harder to find." The CEO says "What should we do?" The CMO says "I suggest we cut back on advertising."

Is that what you'd say if you were the CMO? Is that what you'd want the CMO to say if you were the CEO?

When times are tough and firms have to cut expenses to stay in business--like dot-coms in 2001--marketing dollars decline, mainly because they can. It's painful to cut personnel, rent, etc., but telling the wiseacres from your agency to go pound pavement is sort of satisfying. Right now, Countrywide aside (and to some extent not even them anymore), operating firms are not facing restructuring. The people going out of business are the hedge funds, and they don't advertise.

I just saw a research note from Sandeep Aggarwal over at Oppenheimer. He has revised his growth estimates for online advertising down, from 26% to 25% for 2007 over 2006, and from 24% to 23% for 2008 over 2007. Considering that these estimates have a pretty large variance to begin with, I consider this no change at all. He also said that the least affected online advertising sector would be search marketing.

If It Wasn't Obvious

The "top SEM firm in the country" is Reprise Media, natch. I figured you knew that already.

I've Recently Switched from Entrails

I love a good argument. I'm still waiting for one.

The Insider keeps insisting they're right about the coming online ad implosion that the mortgage crisis will cause. But they can't cite a shred of evidence. Their latest post says that the online ad slowdown of the first half of the year is evidence that Countrywide's current liquidity problems are having an effect. Because, you know, online media buyers can time-travel.

Here's some real data. My friends over at the top SEM firm in the country, who know more about CPC than anyone outside of some dimly lit basement room in the Googleplex, tell me that mortgage-related keyword CPCs are essentially unchanged from the beginning of the year through last week.

I'll also note that the top sponsored result when I type "mortgage" into Google is Countrywide.

Another friend in the mortgage lead generation business tells me that business is booming for him, although in purchase leads, not subprime or refi.

What does this mean? To me it says that ad spending in mortgage has remained constant but that there's a shift away from the high-margin mortgage products to the vanilla. Countrywide will suffer, as will the other mortgage purveyors, from reduced profit margins, but Google et al will not.

The Insider prefers to look at the big picture, while I prefer to read tea leaves. Time will tell.

If You Don't Go to Someone's Funeral, They Won't Come to Yours

We had a wiki at my last company. We also had a rule that people had to post or update their posts every week. We had to have a rule or noone would do it.

At one of my previous employers, one of the world's largest consulting companies, there was a Knowledge Management initiative. It resulted in a shelf full of process and best-practice manuals. Noone ever looked at them, that I knew of.

So how is knowledge transmitted in learn-as-you-work industries? Through apprenticeships, cooperation with coworkers, mentor/mentee relationships and the like. Through face-to-face trust relationships.

But the internet has changed the nature of relationships. Face-to-face relationships are now augmented by virtual ones and, in some case, replaced by them. Regardless, knowledge transfer requires two things that are usually neglected in favor of tools and schemas: motivation and trust.

Motivation has been created in many ways online. From monetary payment to peer recognition. But, as Yogi Berra said in the quote that titles this post, relationships require a quid pro quo also.

How are trust networks built and maintained in the absence of personal contact?

Can Corporate VCs Compete?

Techcrunch just reported that Google will be investing $10 million in 'green' startups. This set me on a whole train of thought about corporate VC and under what conditions it can compete with standalone VCs. I was once a corporate VC, so this was a subject dear to my heart.

The best research I could find on this subject was done by Harvard professor Josh Lerner. My take away was corporate VCs can only compete when they invest in companies that are complementary to their existing lines of business. Oddly enough, almost no corporate venture capitalists follow this strategy. The reason: existing business units kick and scream when the company invests in start-ups that either take dollars away from their development programs or might one day grow up to be competitors. Corporate politics trumps common sense in most cases.

But, after that rumination and before I could take Google to task for making a rookie mistake (common as it may be), I read the press release. It's not Google spending the money, it's Google.org, their philanthropic entity.

Never mind!

Some Data to Chew On

Why am I asking you to do my dirty work? Here's some data on the US new car market: cars sold and dealer advertising dollars. Why cars? I wanted an industry subject to cyclical downturns resulting from exogenous effects, like the current mortgage downturn. Also, I wanted an industry where I already had a whole bunch of data on my hard drive.


The correlation coefficient is -0.8. Although this data set is way too small to be very significant, it's pretty darn suggestive. Data is all from the NADA.

I Can't Argue with That

A few weeks ago the Silicon Alley Insider predicted that the implosion in the subprime market would drastically cut online ad spending by mortgage purveyors, thus hurting the earnings of the online media folk. I don't agree.

Now it seems that, on the one hand, they think I might be right, but, on the other hand, they think I might be wrong. Personally, I'd like to see some actual analysis here: is there a correlation between an industry's product becoming less attractive and the ad spending by that industry? Well, obviously. The real question: is that correlation positive or negative?

I'm guessing negative. When it's harder to attract customers to a profitable product, you spend more on marketing, not less. There has to be some data on this. Anyone, anyone...?

Just Don't Increase my Property Taxes, OK?

Free Exchange, the Economist's blog, pointed me to this paper by Alan Krueger. The paper talks about one of my favorite subjects to while away my idle brain cycles with: is economic inequality in itself a bad thing? The negative answer ("why are you looking in my pocket?" as an old boss used to put it) is fairly simple to understand analytically. The positive answer less so, except from a values point of view.

Krueger argues that one of the primary drivers behind the US' recent increase in income inequality is inequality in education. This doesn't say that income inequality is bad in itself, but that income inequality is concomitant with a lack of skilled workers in an age where higher education is needed to be skilled. So, even if you think income inequality isn't an issue, you probably agree that the dearth of skilled workers is. Solve one, solve the other. Increased educational spending kills two birds with one stone feeds two birds with one piece of cake (as a sunny friend of mine says.)

An interesting point Krueger makes is that disadvantaged families have a higher implied discount rate when evaluating the decision on how much to spend for schooling. I wonder if this is a rational constraint or an evolutionary one. It would seem the latter, given Krueger's calculations on the actual returns to the educational investment. An evolutionary 'swing for the fences' strategy manifesting itself as a discount rate--a measure of the expectation of variability, not downside--would be an interesting hypothesis.

Intellectual Property is Not Property

I was reading an article in the Sunday New York Times about the fashion industry trying to get Congress to pass laws outlawing knock-offs and it started me thinking. And don't worry, once I get this off my chest I'll start thinking about lead gen again, I promise.

I should note, first-off, that I think the worries of the fashion industry are ridiculous. Perhaps this is a guy's point of view, but I get annoyed when the buttons fall off my Paul Stuart suits soon after I buy them. I expect the defining aspect of higher-priced goods to be quality, and I'm pretty sure that quality costs money to produce, justifying a higher price tag. But, that aside, the really interesting question raised by the article is about getting compensated for ideas.

Early on in my investing career I told an entrepreneur--re an argument about a NDA--"ideas aren't worth anything, execution is the only thing that matters." I was wrong, certainly. Ideas are worth something. But I was right about this: an idea does not make a business. Coming from consulting and advertising and venture capital and entrepreneurism, all businesses that rely on the constant production of ideas, I have come to the conclusion that you can make a living on producing ideas and you can make a living on taking an idea and executing it really well, but you can't make a living on owning an idea.

Unless you're a patent troll.

Which brings me back to what I was thinking when I read the article: is intellectual property worth protecting? I'm not going to go into the justice of it--except to say that ideas are not property in any sense that Locke would have recognized--I'm more interested in what is best for society.

The argument for intellectual property protection has historically been an economic one--"to promote the progress of science and useful arts"--not an ethical one. Do IP laws do this, promote the progress? Are consulting firms, advertising agencies, tech entrepreneurs, fashion designers and artists of all stripes at a disadvantage because they usually don't have protection for their ideas? (not the expressions of their ideas, these often are protected, but the ideas themselves.)

When it comes to patents, supporters like to argue that the pharmaceutical industry would not create new life-saving drugs if they did not have patent protection. Is this true? It seems so intuitively correct: no effort would be made without a reward, it's like a defining axiom of economics. But the flaw in this reasoning is the same flaw people often have when thinking about economics: that it's about money.

Who has been more intellectually creative over the past century: pharmaceutical companies or physicists? I can't answer, partly because there's no metric for creativity, but also because no matter what the metric, the two groups are both pretty far off the right end of the chart. And what do physicists get for their creativity? Fame? How many physicists can most people name? (Okay, present company excluded, because you're all a bunch of geeks.)

Physicists share knowledge because it's their culture, they generate knowledge for non-monetary reasons. I believe that scientists do what they do because thinking of new things is a reward in itself. Physicists love to be creative; people love to be creative. You can't buy creativity, you can only allow it. The old cliche that the best way to ruin an artist is to have people start paying for her work is a cliche because it has a grain of truth in it. What sense does it make to have a monetary reward (because that's what a government-granted monopoly is) for an inherently non-monetary activity?

What would the pharmaceutical industry look like if there was no patent protection? I think it's a question worthy of the rejection of preconceived notions. It would certainly be vastly different. But I would venture to guess that we would have just as many drugs; that our development path for new drugs would be faster, cheaper and more open; and that, in the end, we would all be much better off. All of us except for the pharma company executives, lawyers, lobbyists and shareholders, that is.

Previous Mortgage Origination Readjustments

It's a two post day because I'm out of town tomorrow and Thursday.

I was digging through mortgage origination data and found this interesting paper co-authored by some guy named Alan Greenspan. The paper uses the available data to suss out mortgage originations.


Purchase origination volume has been pretty steady over this time period (this is annual data.) But refinance has had its ups and downs. This seems pretty intuitive: when you have to buy a house, you have to buy a house, but you refinance when the stars align (i.e. lower interest rates, better investments elsewhere.)

Note the two downturns in refinance volume shown in the chart: in 2000 and 2004. Now think back to the online mortgage lead market in those years... I know it was a long time ago... think, think... internet years are so long...

Here's a hint: in 2000 LendingTree's revenue almost quintupled. And everyone here remembers 2004 and the ginormous growth in volume.

I know this is all circumstantial and the past is no predictor of future returns and you get what you pay for, and I'm not getting any investment bank analyst job offers (that's not a solicitation, btw. Ugh. Uh, unless you're paying a LOT), etc. But I haven't found any data to contradict my point. I mean, aside from IACI going from $40 to below $30. But, hey, who knows what goes on at IAC anyway?

Whither Mortgage Lead Gen? More Thoughts.

I wrote about where mortgage lead gen was going last week and got quite a few responses from people I know in the industry. It's an interesting question, and a complicated one.

A few data points. In "Mortgage Originations in a Down Market" Booz Allen says that the average retail cost per loan (meaning, in this case, the cost to the originator) is about $3,000. From their graphic it looks like about half that is sales cost.

My friend Bill Rice over at Kaleidico (a great lead management system company), who has an interesting vantage point on the industry, pegs the close rate of a mortgage lead at 2%-3% (although he points out that companies that use his LMS have a much higher close rate.) If we assume that two-thirds of the sales cost is lead acquisition, then the effective break-even cost per lead from the originator standpoint is between $20 and $30, higher if they use a LMS (or have otherwise implemented some sort of financial accountability in their handling of leads.) Note that this is the lead-gen versus all marketing break-even: the point at which it is more effective to buy leads than to do other sorts of marketing.

Here's the dynamic as I see it:

1. People looking for a mortgage become harder to find; the cost of marketing to them increases;
2. Mortgage originators decide to lower their marketing risk by doing less marketing themselves when they can buy leads at a lower effective cost-per-close;
3. Lead generators also have a harder time finding borrowers; this leads to fewer leads and a higher cost for generating a lead;
4. Higher demand and lower supply of leads increases the purchase price of a lead;
5. Each lead sells more times, lowering average close rates for everyone;
   
6. Originators with already low close rates can't compete;
7. Originators who know what they're doing get the additional business.

Note that the increased demand for leads at a higher price and the additional difficulty in generating them means an increase in mortgage advertising spend by lead generators, my point last week. Whether this is offset by the decrease in direct mortgage advertising by originators is beyond me.

Two other things I see happening:

• Originators will scramble to implement lead management systems;
• Providers of low-quality leads (those that have the lower close rates) will be squeezed out of business quickly (as Niki Scevak pointed out last week).

I'm still pondering the impact on internet advertising as a whole, but I think the impact on quality lead generators will be positive.

Do What I Say, Not What I Do

My wife pointed out after being told my argument in this post, that I've been asking to be paid in equity rather than cash for years. This is true.

I'm reminded of the difference between investing and speculating, as explained by a trader friend: if you make money it's investing, if you lose money it's speculation.

There are several points to be made here re asymmetrical risk, the nature of the firm and why certain tasks are outsourced in the first place, and the no-arbitrage theory of finance. But all I can say is that I'm glad we don't live in that alternate universe where I was unlucky. I'd never hear the end of it.

Blodget Thinks Otherwise

Henry Blodget, who is pretty damn smart, thinks that the mortgage mess will impact online ad spend. Worth a read.

I believe that the mortgage lenders will advertise less. But I think that means that they put their marketing dollars into buying leads. This means the lead generators advertise more. Since lead generators are too smart to buy anything but the ads that generate the highest blended ROI, this will cause a hit to the PPC media (either a drop in the CPC or a drop in volume, or both) and to the overpriced CPM media. It almost certainly means a pickup in email marketing.

Time to upgrade the spam shield, unless you're looking for a mortgage.

'Going Where the Money Is' Is Not a Strategy, It's the Lack of a Strategy

A couple of weeks ago I advised businesspeople to focus on their strengths and not get into their customers' businesses. I was thinking--because this is the situation that presents itself to me most frequently--of marketers, really good professional services people, deciding that the real money is in owning a piece of the product they are pushing.

The thinking is, if you're really good at selling a product, you get paid (essentially) by the hour while the owner of the product makes bazillions off of your marketing genius. Examples abound: Snapple, Vitamin Water, all those annoying kids' fad toys, etc.

Some marketers have come to me with the idea of buying busted brands and fixing them. Others want to be paid in equity by their clients. In my experience, it always ends in tears, either way.

The latter case is the subject of an article in the September 3 Forbes, "Squeezed: Prowling for new revenue, ad agencies are buying stakes in the brands they advertise." Advertising types asking their clients to pay with equity rather than cash.

Now anyone over the age of 24 is entirely aware that when people start to ask to be paid in illiquid equity rather than cold, hard cash, it's the biggest sell signal ever. Biggest Sell Signal Ever. Even more than the apocryphal taxi driver/shoe shinesman talking his portfolio while he works.

The article is unForbes-like in its passivity towards its subject. The penultimate paragraph has the money quote, though: Martin Sorrell says "adding equity causes all sorts of stresses and strains."

Sorrell is a piece of work, isn't he? One of the smartest men in professional services, a financier who built the second largest marketing company in the world through hard work and smarts. He doesn't really think equity causes stresses and strains. He's all about equity. What he's saying to his people is this: if the work is worth $100, get the $100 in cash; don't get $100 in illiquid equity. If the company can't sell that equity to someone else and get the $100 to pay the marketers, then it isn't worth $100, now is it? Conversely, the private equity firm that pays $100 for the equity knows how to manage the investment; the equity is worth $100 to them (but not to you.) Managing investments is a job, and being good at it is just as hard as being good at any other job. If you're good at marketing, market. And charge a fair rate and get it in cash that someone whose job is investing has put into the company.

Stresses and strains. When all the equity you've taken for your work turns out to be worth nothing, that's a formidable stress indeed.

The Technology/Application Dynamic Feedback Loop

I've been viewing from afar the reactions to Mark Cuban's post about the Internet Being Dead and Boring after reading Fred Wilson's opinion to the contrary. I didn't really have much to say about this, and I sort of agreed with Fred and hated saying so because I'm jealous that he got to see Wilco play at the Warsaw and I didn't. Then I read this, in Advancing Knowledge and the Knowledge Economy, and thought it might be worth pointing out:

The complementarities between the invention of new [information and communication technologies] and the coinvention of applications inject a dynamic feedback loop in which advances to ICTs lead to unpredictable inventions in applications, which in turn raise the return to improvement in ICTs.

Dominique Foray, the author of the chapter quoted--"Optimizing the Use of Knowledge"--goes on to point out the externalities generated by this feedback loop: falling investment costs due to user learning, and improvements in the technology by suppliers investing further in a winning product. Foray then says:

The coinvention of the related applications takes time! This is why the first episode of the "new economy" was characterized by productivity growth limited to the producer sector (the computer industry) prior to its impact on the many user sectors.

This is obviously more true today than it was when he wrote it a couple of years ago. It's also an interesting place to stand when looking at Wilson and Cuban's disagreement. Cuban talks about the internet as if it were the technologies, and these are not growing nearly as quickly in functionality as they had been. Wilson looks at the internet as the applications, and the experimentation and growth happening in applications is phenomenal.

Maybe they are both correct. But Wilson's point of view is more interesting because the growth in applications signals future growth in productivity in all parts of the economy, not just the computer/telecom industry. This, in its dynamic feedback turn, means that technology suppliers will eventually re-up their investment in the technology infrastructure, causing the continued improvement that Cuban misses so much.

So maybe both of them are correct today. But I'm guessing that five years from now Wilson will still be right, and Cuban will have become wrong.

What Happens to Mortgage Lead Gen Now?

People keep asking me what I think happens to the mortgage lead generation business in the long-anticipated chaos that is the mortgage business today. For those of you living in bubbles (how's the resale price of those holding up, btw?) the mortgage lead gen business has made plenty of hay in the last few years catering to the scramble by lenders to find high fee subprime and refinance mortgagees.

Now what? Subprime and refi were the leads that lenders paid the big money for. If subprime becomes the redheaded stepchild and casual refi can't generate quick homeowner cash like it used to, what happens to the lead generators?

This is a tough question. One the one hand, lenders need to continue to lend, that's what they do. If they have a harder time finding customers, they'll be willing to pay more for leads, benefiting the lead generators. On the other hand, generating leads in an environment where prospective customers are licking their overdrawn wounds becomes more expensive.

Couple this with the already small gross margin and the effects are difficult to predict. I assume the smaller players will exit the market or redirect their energies to lead gen categories that will prosper in this environment (lower profile subprime loans, for instance, credit repair, personal bankruptcy lawyers.) Even so, if the overall demand for online ad inventory doesn't go down, then the cost of generating a lead inevitably rises because click-through rates go down. So which rises more: the cost of generating the lead or the price that the lender is willing to pay?

I'm betting on the latter. I have several reasons to believe this, but I'm going to point, instead, to a document filed by LendingTree.com with the SEC when they were going through the process of their sale to USAI back in 2003. Look at page 31, where they show the results of various interest rate environments.

The conclusion? When interest rates were rising in Q2 2002, a difficult environment to sell mortgages in, the number of leads available for sale almost halved, just as we would have predicted. But, the percentage of these leads that were purchased by lenders grew from 50% to 83%, also as we would have predicted. The thing that threw them over the top, though? Keep in mind that a mortgage lead can be sold up to four times (no particularly compelling reason, it's just industry standard). The average number of times that each sold lead was sold rose from 2.1 to 3.1 times.

So, if you multiply these contrarily changing factors, all else being equal (ok, ok, I didn't verify that all else was equal--pari passu, you know, harumph--but I'm pretending to be an economist) the number of units sold went from 104 to 143 as the mortgage marketing environment got worse. This does not even take into account that LendingTree could charge more for each sold unit (I don't know that they did, but they could have, I suspect, without lowering the times sold per lead.)

What, you say? How could this be?

It may seem counterintuitive, but it's not. Here's the bottom line: when mortgage companies had a tough marketing environment, they outsourced their marketing to a company that specialized in marketing mortgages. That's just good business. And if it was good business then, I believe it will be good business now.

Radical Honesty: the New Marketing?

My friend Greg Yardley asks "What happens ... if due to the increased effectiveness of targeted advertising, we all experience a sudden uptick in the things we want?"

It's an interesting question. First, let's stipulate that no one has any more money to spend than they already do (the Bureau of Economic Analysis shows the personal savings rate at less than 1% of disposable income... not much for marketers to fight over.) We also have to note that having too many choices causes consumers to make suboptimal choices, a theory popularized in books like The Paradox of Choice (or, if you prefer, as I do, by Devo: "In ancient Rome there was a poem/About a dog who found two bones/He picked at one/He licked the other/He went in circles/He dropped dead.")

Clearly, if targeted marketing gets really good, we'll be alerted to more products that we really want but can't afford. One result will be that we replace products we almost wanted with products we really did (in Greg's example, we'll get the chocolate covered bacon burger instead of the suboptimal caramel covered bacon burger. Or vice versa in my case.) Another result will be that we'll be unhappy ("Look at all the things I can't afford. Waah.")

But in the spirit of advancing the Science of Marketing, what's the best path for these advances to take? What moves us forward at the highest speed?

Let's talk about this paradox of choice/behavioral economics bunkum. I prefer to think of the problem of too many choices as an information cost problem, not a my-poor-brain-is-too-small-please-make-my-choices-for-me problem. In the words of X: "there are seven kinds of Coke/500 kinds of cigarettes/This freedom of choice in the USA drives everybody crazy." (woohoo, this Amazon.com associate thing could turn out to be a firehose of earnings!) Comparing two products is relatively easy, comparing 500 kinds of cigarettes is impossible without some sort of tool. Given the difficulty of deciding between Kools and, I don't know, Salem Lights, I think many people just throw up their hands and walk away. Or they just go with the biggest brand, the Marlboros (do you want the hard pack or the soft pack?) It's easy to explain suboptimal results from too much choice as a cost of search.

This dovetails with the problem of not being able to afford more than we consume already. We have too many choices, we need to decide what to buy and which brand of those things to buy. How do we maximize our spending utility?

Clearly, comparison tools are one solution. But there's not many tools out there except for ones around big-ticket items like cars, or ones that are internal to a brand (i.e. do you want this Dell or that Dell.) And what is out there isn't so easy to use. I'd be curious to know why this is. Regardless, I think it's clear that consumers' desire to maximize spending utility, coupled with the shrinking cost of searching for product information, will cause people to rely much more heavily on finding the products they want themselves, rather than waiting to hear some marketer's pitch.

My theory is that consumer-driven product search is what will flip marketing from being a shotgun used by marketers to being a tweezer used by consumers. We know the general outlines of what we need and want and how much expendable income we have (more or less.) We will, more and more, search for the type of thing they want rather than be told. What happens then and how should marketers respond?

I was emailing a friend about sea-kayaking the other day. Gmail started showing me various ads targeted to the keyword kayak. I ignored them all. Instead, I searched for sea-kayaking and looked for a site that could recommend trips. I don't trust the ads, I trust the sites that don't advertise. I trust the enthusiast sites, the user-driven content, the blogs from people who have actually been there. How can a marketer reach me?

Traditionally marketers have done PR, paid for product placement, given away free product, let journalists have an advance look. All for the understood quid pro quo of rave reviews (how many test drive invitations do you think a journalist would get after a pan?) Aside from consumers having become quite cynical about this (at least in my imagination), this is no longer viable: you can't give a free kayaking trip to the writer of every sea-kayaking blog. So what do you do now?

Here's what I would do: give all the information anyone could possibly need to compare your product to others away. For free (as in speech, not beer.) If you're a car manufacturer, create an open API to your database of car specification. Cooperate to make the data fields standard across the industry. Put up a library of photos and videos that anyone can put on their site in any way they choose (they won't put them up otherwise, bloggers hate being manipulated.) Let every blogger easily compare your new car to any other new car, or old car for that matter. The fact is, a blogger who runs a Mustang enthusiast site is only going to savage your new Mustang if it really sucks. If you believe your product is at all competitive, even if only on its own terms, then make it easy for the new media to judge it on its merits.

My grandfather, a notable curmudgeon, once said that marketing is the art of getting people to buy things they do not want. Perhaps it was. That strategy will no longer work. Targeted marketing will eat itself.