The long siege of Corbenic

Darren Herman's article on AdExchanger this week is more important than it might seem at first read: it's the first time a major figure in our little adtech industry has pointed out that what we've built in terms of exchanges and platforms and data is just a small first step to what we will need to build over the next decade. Bear with me.

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1. The state of the state

Those of you who have been reading this blog for the past year know I've been thinking about several online display advertising paradoxes:

• "There is an oversupply of inventory" vs. time spent with media (i.e. supply of eyeball time) is decreasing (also here)
  
• Dozens of targeting startups pitching radical lift vs. being told by practically everyone in the industry that targeting does not appreciably increase lift
• The common industry lament that CPMs are falling rapidly vs. the data that seems to contradict that

One fact about what our industry is doing resolves all of these.

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2. What we are trying to do for marketers

The first internet marketing rant I heard was "the internet will create true one-to-one, accountable, ROI driven marketing!" That was in 1995.

Still waiting.

But it's true, or will be some day. The ability to dynamically maximize the ROI of your campaigns across all media in real-time is what our industry is building. To do this we need to be able to formulate hypotheses, test them, figure out the ROI, and reallocate into the highest ROI buys. And then, because humans are changeable beasts, we need to do it all over again, forever.

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3. What is Quality?

ROI is the value of the customer divided by the cost of acquiring them.

ROI = LTV / CPA

Computing this isn't as simple as it sounds.

Back in the day, at Prodigy, we kept track of each customer by when they started and by what marketing channel they arrived. For each marketing channel we would track the average lifecycle. That is, for a customer arriving in month x, 80% would stay one month (first month was free!), 40% would stay two months, 30% three months, 25% four months, etc.* The churn was different by marketing campaign because some campaigns got people for whom the product was wrong to sign up: they did not stay long.

We then multiplied the probability that any given person would remain in a given month by their contribution margin for that month (say $10, except in the free trial month, when it was -$10) and discounted all that back to month 0 using the company's cost of capital**. This was the customer lifetime value (LTV).

This is a complicated example. If you are promoting an offer where you get paid $2 every time you bring someone a customer, your LTV for that customer is, essentially, $2. But in most cases, the right customers are more likely to remain customers (unless you subsequently scare them away), and the wrong customers are less likely to remain customers, so the LTV is usually dependent on the marketing campaign.

Now, to the cost of acquiring a customer using display advertising. This part most of you know. I'm going to do it the simplest way, though.

CPA = Cost of media x Conversion = CPM/1000 x Conversion

Conversion here is number of people who see the ad divided by the number of people who become customers of the advertiser. That is, they convert from ad viewer to customer. Conversion is key, but it is an incredibly complicated thing to predict because it depends on: who the viewer is, what they are thinking at that moment, what they are looking to buy, where and when they are seeing the ad, what surrounds the ad, how many times they have seen the ad before, what the ad itself is, whether they are interested in what is being advertised, etc.

ROI = LTV /(CPM/1000 x Conversion)

None of LTV, CPM and Conversion are independent of the others, each depends on the particulars of the campaign (i.e. targeting high-net worth individuals changes CPMs , changes conversion, and changes LTV, the latter two in ways depending on the product.)

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4. What are we doing now?

What we measure now in the adtech industry is CPM. Some DSPs, with some clients, will claim that they are doing more. But if there is true integration of conversion into their buys--or any integrations that go much beyond "the CMO likes the results"--then it is extremely rare.

Because the adtech people can't measure conversion*** or LTV, they optimize CPM while trying to hold LTV and conversion constant. Using the same creative and target viewer, they find lower CPMs. This explains the puzzles I mention above.

• There isn't more eyeball time (i.e. supply), but we are putting ads in places that previously had no ads. On social networking sites, on UGC sites, on small sites, etc. We do this by using targeting data to find the few "right" viewers in the sea of "wrong" viewers. There isn't more attention to sell, we are just selling more ads per hour of attention. This is the increase in supply. (I mentioned this previously.)
• People do not see "lift" (i.e. increase in the conversion rate) by using targeting data because that's not what we are using it for. We are using targeting data to increase reach and find the same conversion rates at a lower CPM. Targeting data increases ROI by lowering CPMs, not increasing conversion.
• If CPMs are falling at the major media purveyors (as reported) then that is being made up for by increasing CPMs on social networks, etc. On average CPMs are not falling, but there is an equalization of CPMs happening across internet media. We hear the lament of the New York Times' of the world, but not the jubilation of everyone else. Facebook's ad revenue came not entirely by taking time spent with the NYTimes away, it also came by lowering their CPMs. You can find the same person you were targeting at the NYTimes on Facebook, for lower cost.
  

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5. What's next?

This is a great service to marketers. Adtech increases ROI. But it's transitory. Once enough ad dollars use a specific way of finding the right viewer on overlooked sites, the price of the inventory on those sites rises. We are right-pricing all the inventory on the internet after years of it being overpriced on the high-profile sites and underpriced everywhere else.

But there are declining returns to this strategy, as the inventory becomes more rationally priced. I've heard some rumblings to this effect already, although I think we have another couple of years before it becomes widespread.

Step two is to focus on conversion. This is what Darren was implying in his article. But to know conversion, there has to be integration back into the marketer: did this particular instance of an ad result in a product being sold? When this feedback loop is in place****, marketer's agents can start to use the algorithms they used to find low CPMs to find higher conversion rates. This will be a sea-change. But implementing it will be difficult because it requires substantial tech investment at the marketer, as well as procedural and probably cultural change. It's also one of the primary reasons the DSPs will have to choose between being a marketer's agent--working directly with marketers--or a technology provider to marketer's agents.

Step two is now. If you are starting a company to do this, contact me.

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6. Step 3

Step 3 is the end of advertising. It is using marketing communication to increase LTV.

Kotler spends less than 5% of his seminal textbook on advertising, the rest is about customer value, loyalty, product strategy, pricing, etc. But in the adtech world, it's all about advertising/direct marketing/promotion. When we can measure the effect of marketing communications on LTV, that will change.

Increasing LTV means keeping customers, not getting them. It means figuring out what customers want and building or changing your product to keep them. It means finding the right pricing, providing the right customer service and out-innovating your competitors.

And that is the holy grail of marketing.

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* These numbers are illustrative, but directionally correct. I don't remember the real numbers. It's been a long time.
** I don't really want to explain contribution margin, discounting and cost of capital. This post is going to be long enough as it is. Ask Fred Wilson on Monday.
*** Click-through is not conversion. If you've ever been in lead-gen you know you can easily and cheaply generate poor quality click-through. Free i-pod, anyone?
**** Outside of the arbitrage world, where it is being done now. The arbitragers are and always have been the smartest people in marketing.

Tweet Congress: we want jobs and innovation

If a great company shows up on my doorstep, I try to invest in it. If two great companies show up on my doorstep, I try to invest in both of them.

I think it's pretty much agreed that at this point, the bottleneck in startup formation is not money, it's great entrepreneurs and great teams. We've also pretty much settled that startups are the engine of job growth and innovation. If we had a way to increase the number of startups in this country, the entire country would benefit.

The Startup Visa does this and it just took a big step forward, with legislation introduced in the Senate. That's great, but what it really means is that while the hard work may be over, the bruising work is yet to come. Now that this bill has a chance to become law, opponents will emerge to try and kill it. Nervous congresspeople will try to avoid taking a stand on something as controversial as "immigration" (no matter the uncontroversial merits of this particular bill.) We need to let them know we want this to pass.

Brad Feld and Paul Graham did the hard work, now it's our turn. Luckily, our work isn't so hard: go to the Startup Visa site, it has a tool to tweet your congresspeople about the bill.

I can't think of a single rational reason this bill is not a win for everyone. But unless we proactively push our elected representatives to pass it, chances are it will get lost in the twisty corridors of the Capitol, as so many good ideas do. So, go, now, and support it!

Kicked to the curb

I'm a believer in publisher's agents (also known as publisher brokers or--the dreaded TLA*--SSPs.) I think it's pretty obvious that they are a necessary precursor to a reasonably efficient marketplace**.

But a lot of people don't agree with me. Important people. Like Google, and Microsoft.

I've written before that I think publishers showing up in a data-driven marketplace without an agent risk getting ripped off. The value to publishers is pretty clear: if you don't have a good idea what each piece of inventory is worth to buyers, you risk mispricing it. Having an agent with the technology, data and information flow to more accurately value your inventory is critical. Publishers I know who implement the simplest of information/data-driven pricing strategies see an immediate uptick in CPMs. Right now it's easy because so few are doing it; it will get harder. As it gets harder, publishers will need better and better agents.

But the publisher agents are also critical to the marketplaces. The pub agents provide a crucial service to the exchanges: they vet publisher quality (a huge problem at the smaller exchanges), facilitate the back-office functions and will, eventually, act as credit assurance. Right now the big exchanges are reluctant to work with smaller publishers: Google, for instance, pushes them into AdSense--this looks to me like an internal political problem, in part. Microsoft, reportedly, views the pub brokers as skimming margin that is rightfully theirs. That is, they view others making money on services MSFT doesn't offer to customers they don't want as illegitimate, even though MSFT would make more money thereby.

In my opinion, Google and Microsoft are impeding progress in display. Google has a franchise to protect and Microsoft is just plain ambivalent about success. Impeding progress is a good way to get yourself disrupted.

Publishers are realizing the value of publisher agents. At some point, a critical volume of inventory will flow through pub agents and then an interesting thing will happen: the pub agents and marketer agents will all decide, en masse, to join or form an exchange--one that excludes retail buyers and sellers--and the other marketplaces will become illiquid backwaters.
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* Three-letter acronym.
** Full disclosure, I'm an advisor to PubGears.

Duck, duck, goose on the demand side

Mike Walrath in an excellent article over at AdExchanger said "What we're really talking about here is the race to build the next-generation digital marketing services company." I would put it more strongly: the DSPs, the ad agencies and the ad networks are on a collision course*.

Once upon a time it was pretty easy to tell who was doing what. Ad agencies worked for marketers and rep firms worked for publishers too small to get the attention of the agencies. But the incredibly quick growth of digital advertising made a hash of all that. Ad networks once were digital rep firms, now they are impossible to categorize, except ad hoc. Digital media buyers once were agencies, now they are impossible to categorize, even ad hoc. There are hundreds of companies that have entered the digital display category in the last five years and almost all of them are difficult to categorize**.

GCA/Savvian put together a Display Advertising Technology Landscape map, showing some 140 companies in 21 categories. Almost every company on that map should be in multiple categories or will be in multiple categories in the next 12 months. Ad networks are becoming DSPs or exchanges, ad exchanges are becoming creative optimizers or DSPs, ad servers and optimizers are becoming exchanges, arbitragers are becoming DSPs or exchanges, rich media companies are becoming optimizers... you name it. It's chaos. Albeit the normal chaos of a promising market.

In broad strokes, I think the future of all this is inevitable. In a few years there will be three layers between the marketer and the publisher: the publisher's agent, the marketplace, and the marketer's agent. The agents will use technology developed by dedicated technology firms to some extent, and they will have proprietary technology to some extent. They will buy data from dedicated data firms to some extent and they will have proprietary data to some extent. The marketplaces will have their own technologies and will come in two flavors: 'exchanges' for fine-tuned purchases and OTC-type enablers for block purchases.

There will be various types of technology firms--from trafficking to API access to optimization--and there will be many types of data firms--from analytics to targeting to ROI estimation. But the number of players between marketer and publisher will shrink from six-ish to three***.

Here's my rough take, in qualitative visual form.

What happens to the agencies, the DSPs and the ad networks in this scenario?

Ad networks will need to choose between becoming a publisher's agent, becoming a marketer's agent, becoming a marketplace, becoming a technology provider or becoming an arbitrageur. They can't be all of these things--or even most of them--anymore, at least not on a large scale (many of them have already chosen a path.) Publishers and marketers aren't thrilled with the inherent conflicts of interest and built-in obfuscation of many of the larger ad nets. As alternatives become more available, they won't put up with them.

DSPs will need to choose between being a technology provider to marketer's agents or being a marketer's agent. Most of the DSPs I know have always claimed to want to be technology providers. They have been pushed into providing agency services because the agency media buyers have not had the requisite competencies to use the DSP tools. The DSPs responded by providing these skills for hire: some of them have become, by now, de facto media buying agencies. Some of them have begun buying media on behalf of marketers, rather than agencies. DSPs are now confronting the classic tradeoff between easy revenue growth as a professional services company and valuable revenue growth as a technology company****.

The agencies see the danger of being displaced as the primary owner of their customer, the marketer. There are two responses: buy or build. The ad agency holding companies will inevitably buy some of the DSPs that choose to become marketer's agents (as they bought the interactive agencies and the SEMs.) The ad agencies will also begin to build in-house expertise in using the DSPs. This will be painful for them because they will be competing to hire people who understand numbers, and these people are far more expensive than their traditional hires. If an agency wants to hire someone with the analytical skills that would enable them to work at an investment bank, then they will need to pay them like an investment bank. How this sits with the purchasing departments of the major marketers--who sometimes seem more concerned with cost than efficiency--remains to be seen.

There won't be one winner, but three years from now there will be fewer than ten companies dominating the marketer's agent piece of the world. The foundations that lead to this dominance will be laid this year.

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* I talk about this incessantly in person but have not written about it because I have every type of conflict of interest here: financial, professional, personal, sentimental, intellectual, moral, etc. Proceed with caution.

** I have a notebook where I have 500+ companies listed under 25+ different categories, all digital display ad tech (no traditional digital agencies or ad networks, that would probably triple the count.) I didn't put this together on purpose, it was a result of talking to entrepreneurs about their potential competitors, so the count is probably low by quite a bit. I tried making a 'map', but found that it was physically impossible in two dimensions. GCA/Savvian did it by simplifying several aspects of their presentation and limiting it to the Web and internet video.

*** In many--most, if you count by dollars rather than impressions--cases, the actual number of players is currently one: the agency. The agency places the buy directly with the publisher. This also will change as publishers realize that if they don't have an agent representing them they are not maximizing revenue. It's interesting that almost no large marketers do their own media buying, but almost all large publishers do their own media selling. That may have made sense when there was one newspaper in each town and three TV stations, but not any more.

**** I have heard from one holding company exec, re one of the DSPs: "we would buy them if they valued themselves as an agency, but they keep insisting they're a technology company." Agencies sell for 6-10 times forward earnings. Tech companies sell for 40 times hope. If you somehow think the former is better, your VC wants a word with you.

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.