"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 Alex Kelleher, founder and CEO at Cognitive Match.
Advertising technology is mostly paid for on a usage basis: serve more ads, make more money. This has been true of media buying, ad optimization, ad verification and so on — all adding cents or dollars to an overall CPM cost for showing an ad.
But is this sustainable? Or will the downward pressure on per-thousand pricing, and the recognition that quality, not quantity, is what advertisers want to pay for, force a shift to a longer-term enterprise model?
Enterprise or Software-as-a-Service (SaaS) pricing means that I charge you a fixed fee per month or year to use my product. Ideally, that locks you into a long-term contract, which allows me over time to maximize my profits. You get the benefit of using my software as much as you like for the same price. In addition, I’ll charge you for value-added services instead of trying to wrap some service into the CPM I charge you or enforcing minimums, upfront charges and so forth.
This model is the future of ad tech for five key reasons.
1. Platforms, not black boxes
Companies such as Rocket Fuel, Turn, The Trade Desk and Quantcast are not trying to deliver a black box to meet their advertisers’ end goals of showing some ads and making some sales. They are building platforms that allow agencies and advertisers to transparently manage spending across all channels, including mobile, social, video, Web and search. The game is competing with Google’s self-serve platform and getting product embedded into their customers. That’s where the long-term value lies.
2. Product = product + service
In building companies that maximize value for shareholders, scalability is always seen as key. The idea of building out a company with more people is less attractive than building out a customer base with a product you endlessly replicate. However, most buyers of advertising technology will take a long time to learn how to self-serve, and therefore will need help. Help equals people’s time, which the ad tech companies then have to pay for. So they wrap that cost into the overall CPM, which is difficult to sell.
Enterprise software addressed this a long time ago by pricing product and service separately, and making product a predictable, fixed fee over a long period of time. Companies from IBM to Omniture make billions this way, and still scale very nicely.
3. CPMs aren’t going up
CPMs, particularly outside of the sexy new mobile and social areas, aren’t exactly soaring. Commodity does that: As things get cheaper to deliver, people expect to pay less for them. Only charging for ads that are viewable, verified and not served to robots or fraudsters has the same downward pressure — fewer ads are shown with greater effect. This creates an immediate conflict of interest. As an ad tech provider charging CPMs, I would want to do everything I can to increase ads shown to achieve the same advertiser outcome. SaaS pricing allows that pressure to fall away, so providers and advertisers can focus on getting the job done for the least reasonable price. Budgets can then be spent on things like service, making up the lost revenue for providers and boosting their profitability. That’s a win.
4. Venture capital loves contracted revenues
Most of Terence Kawaja’s logo salad of startup companies in the ad tech space is fueled by venture capital. Venture capitalists invest for one reason: to return funds to their LPs. This makes them perversely risk-averse. The concept of an insertion order with a customer that can be canceled within 48 hours leaves them with sleepless nights. What they really want to do is go to bed, safe in the knowledge that their startup has a contract that will take months, or years to cancel. They can easily value such businesses based on forward cash flows, and then they can sell them for much healthier multiples. So they are now desperately seeking places to put their investments that have this, because CPM for a new piece of the ad stack just doesn’t do it for them anymore.
5. The stock market loves contracted revenues
We’re back in a period of frothy IPOs and a rush to go public. Guess what the markets love, just like VCs. Certainty of revenues and a clean and understandable business model. Rather than media buys, which excite by their size but then disappoint with margins, SaaS models generally are very clear as to the profit built in and how they scale.
Will the change happen overnight? Of course not, and some of the ad business will stay the same because media buying makes a lot of sense on a CPM basis. But everything else — the layers of technology that end up with showing an ad in that media buy — is positioned for pricing as a licensed platform and service fees, which are essentially consulting fees. This will liberate ad tech companies from the stress of IO-to-IO business, and help venture capitalists sleep at night.