“Data Driven Thinking” is written by members of the media community and contains fresh ideas on the digital revolution in media.
Today’s column is written by Eric Picard, CEO at Rare Crowds.
Ad tech is a fascinating and constantly evolving space. We’ve seen several ‘waves’ of evolution in ad tech over the years, and I believe we’re just about to enter another. The cycles of investment and innovation are clearly linked, and we can trace this all back to the late 90’s when the first companies entered the advertising technology space.
The early days were about the basics – we needed ways to function as a scalable industry, ways to reach users more effectively, systems to sell ads at scale, systems to buy ads at scale, analytics systems, targeting systems, and rich media advertising technology.
There was lots of investment and hard work in building out these 1.0 version systems in the space. Then the dot-com bubble imploded in 2001, and a lot of companies went out of business. Investment in the core infrastructure ground to a halt for years. The price of inventory dropped so far and so fast that it took several years before investment in infrastructure could be justified.
We saw this wave last from 1996 through 2001 or 2002 – and during that dot-com meltdown, we saw massive consolidation of companies who were all competing for a piece of a pie that dramatically shrank. But this consolidation was inevitable, since venture firms generally invest on a five to ten year cycle of return – meaning that they want companies to exit within an ideally 8 year window (or less).
The second wave was really about two things: Paid Search and what I think of as the “rise of the ad networks.” Paid search is a phenomenon most of us understand pretty well, but the ad network phase of the market – really from 2001 to 2007 was really about arbitrage and remnant ad monetization. Someone realized that since we had electronic access to all this inventory, we could create a ‘waterfall’ of inventory from the primary sales source to secondary sources, and eventually a ‘daisy-chain’ of sources that created massive new problems of its own. But the genie was out of the bottle, and this massive supply of inventory that isn’t sold in any other industry was loosed.
It’s actually a little sad to me, because as an industry we flooded the market with super cheap remnant inventory that has caused many problems. But that massive over-supply of inventory did allow the third wave of ad tech innovation to get catalyzed.
Most people believe that the third wave was around ad exchanges, real-time buying and selling, data companies, and what I like to call programmatic buying and selling systems. But those were really just side effects. The third wave was really about building out the next generation infrastructure of advertising. Platforms like AppNexus and Right Media are not just exchanges; they’re fundamentally the next generation infrastructure for the industry. Even the legacy infrastructure of the space got dramatic architectural overhauls in this period – culminated by the most critical system in our space (DoubleClick for Publishers) getting a massive Google-sponsored overhaul that among other thing opened up the system via extensive APIs so that other technology companies could plug in.
Across the board, this new infrastructure has allowed the myriad ad tech companies to have something to plug into. This current world of data and real-time transactions is now pretty mature, and it’s extending across media types. Significant financial investments have been made in the third wave – and most of the money spent in the space has been used to duplicate functionality – rather than innovate significantly on top of what’s been built. Some call these “Me too” investments in companies that are following earlier startups and refining the model recursively. That makes a lot of sense, because generally it’s the first group of companies and the third group of companies in a ‘wave’ that get traction. But it leads to a lot of redundancy in the market that is bound to be corrected.
This wave lasted from about 2005 to 2011, when new investments began to be centered on the precepts that happened in Wave 3 – which really was a transition toward ad exchanges (then RTB) and big data.
That’s the same pattern we’ve seen over and over, so I’m confident of where the industry stands today and that we’re starting to enter a new phase. This third major ad tech wave was faster than the first, but a lot of that’s because the pace of technology adoption has sped up significantly with web services and APIs becoming a standard way of operating.
This new wave of innovation we’re entering is really about taking advantage of the changes that have now propagated across the industry. For the first time you can build an ad tech company without having to create every component in the ‘stack’ yourself. Startups can make use of all the other systems out there, access them via APIs, truly execute in the cloud, and build a real company without massive infrastructure costs. That’s an amazing thing to participate in, and it wasn’t feasible even 3 years ago.
So we’ll continue to see more of what’s happened in the third wave – with infrastructure investments for those companies that got traction, but that’s really just a continuation of those third wave tech investments, which go through a defined lifecycle of seed, early, then growth stage investments. Increasingly we’ll see new tech companies sit across the now established wave 3 infrastructure and really take advantage of it.
Another part of what happened in Wave 3 was beyond infrastructure – it involved the scaled investment in big data. There have been massive investments in big data, which will continue as those investments move into the growth phase. But what’s then needed is companies that focus on what to do with all that data – how to leverage the results that the data miners have exposed.
Wave 4 will really change the economics of advertising significantly – it won’t just be about increasing yield on remnant from $0.20 to $0.50. We’ll see new ad formats that take advantage of multi-modal use (cross device, cross scenario, dynamic creatives that inject richer experiences as well as information), and we’ll see new definitions of ad inventory, including new ad products, packages and bundles.
So I see the next five years as a period where a new herd of ad tech companies will step in and supercharge the space. All this infrastructure investment has been necessary, because the original ad tech platforms were built the wrong way to take advantage of modern programming methodologies. Now with modern platforms available pretty ubiquitously, we can start focusing on how to change the economics by taking advantage of that investment.
I also think we’re going to see massive consolidation of the third wave companies. Most of the redundancies in the market will be cleaned up. Today we have many competitors fighting over pieces of the space that can’t support the number of companies in competition – and this is clearly obvious to anyone studying the Lumascape charts.
Unfortunately some of the earlier players who now have customer traction are finding that their technology investments are functionally flawed – they were too early and built out architectures that don’t take advantage of the newer ways of developing software. So we’ll see some of these early players with revenue acquiring smaller newer players to take advantage of their newer more efficient and effective architectures.
Companies doing due diligence on acquisitions need to be really aware of this – that buying the leader in a specific space that’s been around since 2008 may mean that to really grow that business they’ll need to buy a smaller competitor too – and transition customers to the newer platform.
For the investment community it’s also very important to understand that while Wave 3 companies that survive the oncoming consolidation will be very big companies with very high revenues, it is by nature that these infrastructure heavy investments will have lower margins and high volume (low) pricing to hit their high revenues. They still will operate on technology/software revenue margins – over 80% gross margins are the standard that tech companies run after. But the Wave 3 companies have seen their gross revenue numbers be a bit lower than we’d like as an industry. This is because they are the equivalent of (very technically complex) plumbing for the industry. There are plenty of places where they invest in intelligence, but the vast majority of their costs and their value deal with massive scale that they can handle, while being open to all the players in the ecosystem to plug in and add value.
Being a Wave 4 company implicitly means that you are able to leverage the existing sunk cost of these companies’ investment. Thomas Friedman talks about this in “The World is Flat” – one of his core concepts is that every time an industry has seen (what he called) over-investment in enabling infrastructure, a massive economic benefit followed that had broad repercussions. He cites the example of railroad investment that enabled cheap travel and shipping that led to a massive explosion of growth in the United States. He cites the investment in data infrastructure globally that led to outsourcing of services to India and other third world countries on a massive scale. And frequently those leveraging the sunk cost of these infrastructure plays make much more money from their own investments than those who created the opportunity.
So what should investors be watching for as we enter this fourth wave of ad tech innovation?
- Companies that are built on light cloud-based architectures that can easily and quickly plug into many other systems, and that don’t need to invest in large infrastructure to grow
- Companies that take advantage of the significant investments in big data, but in ways that synthesize or add value to the big data analysis with their own algorithms and optimizations
- Companies that can focus the majority of technical resources on innovative and disruptive new technologies – especially those that either synthesize data, optimize the actions of other systems, or fundamentally change the way that money is made in the advertising ecosystem
- Companies that are able to achieve scale quickly because they can leverage the existing large open architectures of other systems from Wave 3, but that are fundamentally doing something different than the Wave 3 companies
- Companies that take advantage of multiple ecosystems or marketplaces (effectively) are both risky but will have extremely high rewards when they take off
This is an exciting time to be in this space – and I predict that we’ll see significant growth in revenue and capabilities as Wave 4 gets off the ground that vastly eclipse what we’ve seen in any of the other waves.