1. Business demographics

    To the extent that demographics matter in media and advertising, it’s all about the consumer, right? Er…wrong. For lack of a better term, “business demographics” are an under-appreciated concept, especially in context of the media and marketing industries. We’ve previously argued that as a medium whose decision-makers are not people, per se, but corporations, the most appropriate unit of analysis to understand the industry is its underlying components – businesses. Consumers do matter of course, but only after we first understand what is set in place by the frameworks in which the decision-makers operate.

    Most simply illustrated, we can all appreciate that a small e-commerce advertiser is unlikely to allocate any money to TV…not because it doesn’t work, but because at the unit costs that TV requires for campaigns paired with the business goals the marketer has, TV wouldn’t make sense. And as for larger advertisers whose marketing goals are very brand-driven, not every medium will work as well as TV. These considerations help explain the fallacy that time spent with media should equate to ad spending. But they are only among the factors which explain why the concept is wrong. The changing nature of an economy’s underlying businesses is another.

    This matters because many elements of ad spending are pre-determined by the sizes or other characteristics of the businesses competing within a given industry. That large brands spend differently than smaller ones has vast implications, for example. Consider the United States in 1987: 77% of companies with fewer than 10 employees accounted for 13% of the country’s total business receipts. 20 years later a slightly larger share of businesses in the economy were of comparable size, but accounted for under 9% of receipts. Companies with between 10 and 499 employees declined slightly as a percentage of the economy’s total, but their percentage of business receipts declined substantially, falling from 41% to 30%. Meanwhile, enterprises with more than 500 people grew from 0.2% of total enterprises towards 0.3%, but grew the share of the economy’s receipts from 46% to 62%.

    The implications of such trends are illustrated, we think, in the shift of ad spending from local to national media. If smaller (read: more local and regionally oriented) companies account for a smaller share of the economy as they lost market share to larger competitors (who compete on a national basis, supporting their efforts with national media) we would expect diminished growth from media focused on local territories. Sure enough, over a 20 year period, local media underperformed national by about 3% each year. Our guess is that by the time the US Census Bureau releases 2012 data reflecting the post-2008 financial crisis world, the business demographic trends will be even more extreme. Magna Global’s estimates already convey that national media rose from 40% of mass media ad spending in 2007 towards 50% by 2012. Local fell by a matching amount, from 60% to 50%.

    Source: Pivotal Research analysis of US Census Bureau and Magna Global data

    More anecdotally, we can characterize the shift in ad spending out of local media and into national media as “the Macy’s effect”: over recent decades, retailers went from being smaller and regionally oriented to being substantially larger and more nationally oriented in their budget setting processes. Comparisons across other countries should also yield similar insights about the nature of the United States vs. other countries. Identical comparisons are challenged by inconsistent data availability across countries on similar company-size breaks, but the share of the economy’s employees inside of companies of a certain size is available and broadly serves to illustrate the key point.

    Source: Pivotal Research analysis of US Census Bureau. Note that US and Germany data is for 2011; UK data is for 2013.

    On the surface, the substantially higher share of the economy in smaller and mid-sized businesses should have some impact on media and marketing budget allocations across different economies. For example, the fact that businesses with fewer than ten employees account for more than double the percentage of the UK’s national employees vs. what those kinds of businesses account for in the United States may help explain why paid search is much more proportionately important in the UK than in the US given the relative value that small enterprises will find in paid search vs. other media.

    Further, consider Germany and its Mittlestand, or the country’s small and mid-sized businesses. Our analysis of data on Germany highlights that the country comprises many more of these kinds of companies vs. the United States. At least compared to the US, the skew of companies would seem to favor the potential for a company such as Salesforce.com, which has recently announced expanded efforts to sell its products there. As Salesforce.com has a dominant position as a salesforce automation tool among small and medium sized enterprises (vs. a less significant one among larger companies) Germany should be proportionately more important for the country relative to the US.

    Quantifying the specific impact of changes in business demographics or differences in this demography across countries can be difficult to tie directly to the growth trends for any particular sellers of media or marketing services. But the trends that follow from these changes are very real, and warrant much more attention than most observers provide.

    Brian Wieser, CFA
    Senior Research Analyst
    Pivotal Research Group
    200 Park Avenue, West Mezzanine
    New York, NY 10166
    (t) 212-514-4682
    (m) 917-734-1980
    (e) brian@pvtl.com

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  3. Faceboook’s Revenue Drivers: Small Business Edition

    from 7/24/14: Madison & Wall: Agency Consolidation: Activist Edition

    Facebook posted another quarter of remarkable growth this past week, adding more than $1bn in ad revenue year over year, on pace to a year that should see $11-12 billion in total ad revenue. One of the generally unheralded sources of growth behind this number has been small businesses. Facebook announced on its earnings call that the company now has 1.5 million active advertisers, up from 1 million a year earlier and 500,000 at the end of 2012. By definition, most businesses are small, and so it’s safe to say that small businesses account for the vast majority of advertisers, by number of advertisers. Straight-lining this growth, we can guess that Facebook would have had an average of 900,000 advertisers over the course of 2013 and should end up with 1.5 million on average for 2014. But how much money is all of this small business activity contributing or how much is each one spending? We don’t know specifically, although we can make a guess.

    WPP’s CEO Sir Martin Sorrell has indicated in the past that his holding company’s customers spent $439mm on Facebook in 2013 and was likely to spend $650mm to $700mm this year. WPP media agencies account for around 30% of global media agency spending (a good proxy for spending by large brands), and assuming that WPP comes out on the high end of the 2013 spending range, we could estimate that global media agency customers spent $1.5bn of Facebook’s $7.0bn in ad revenue last year and are on pace to spend more like $2.3bn of Facebook’s revenue this year. Considering the number of advertisers driving the aforementioned agency-driven spending are likely in the low thousands – a rounding error against the 1.5mm figure – we can quantify that all other advertisers are spending an average of $6,000 each in 2014, vs. $5000 in 2013. We can probably assume that e-commerce based marketers and developers (as well as large brands buying directly) account for a large share of the non-agency-driven spending. If it’s something like a third or event half it would mean that the likely figure for typical spend levels among small businesses is in the low thousands of dollars annually, or well in excess of $1bn in annual revenue at this point in time.

    This would make small businesses an important contribution to Facebook’s growth over the past two years. But how much room is there to go from this segment of the advertising industry for Facebook? Our analysis of new data from the Internal Revenue Service affirms a trend we have been noting for several years: the typical small-medium sized business advertiser (which we define here as the 5.8mm US corporations with assets under $250mm and who account for 30% of all ad spending, or $78bn by the IRS’ estimation) is spending in the low 10s of thousands of dollars per year, and that number is generally declining over time. On this estimate there are millions of additional advertisers and many thousands of dollars in spending to potentially capture.

    For points of reference, we have previously estimated that Google has captured around $10,000 per year from its typical small business advertisers and that Yellow Pages advertising captures around $5,000 per year from its advertisers. If Google self-service advertisers were typical of all small advertisers, it would suggest saturation was looming among this segment of the market (which would be consistent with our estimates of slow growth for Google on self-service paid search). Conversely, if the IRS data is correct, it would suggest that – considering Google’s total revenue generated in the US in total was only $18bn in 2011 (and that large brands and e-commerce-based companies certainly accounted for several billion dollars of this total), there is room for them to potentially grow by capturing spending from more advertisers not presently buying from them. We note this assumes away that many small businesses will have used Google and then churned away, while others may not consider search to be an appropriate ad vehicle for a given business.

    Facebook has highlighted many of the ways it is working to help small businesses use its advertising products and clearly offers something different than either Google, Yellow Pages or other companies can offer. Perhaps there is limited overlap in their customer bases, and the Google and Facebook platforms are actually complementary. While we have historically presumed that at least some of Facebook’s small business growth must be coming from either or both of these competing sources, we’re somewhat less clear on that premise at this point. What is clear to us is that to the extent that the company continues to focus on finding new ways to help the millions of businesses on Facebook but not yet advertising, the company seemingly has a significant pool of advertising spending to capture, helping to sustain more growth ahead.

    ___________________
    Brian Wieser, CFA
    Senior Research Analyst
    Pivotal Research Group
    200 Park Avenue, West Mezzanine
    New York, NY 10166
    (t) 212-514-4682
    (m) 917-734-1980
    (e) brian@pvtl.com

  4. Why Ad Tech Matters to Media

    from email dated 7/31/14

    Many investors and industry participants we interact with are sometimes surprised to learn that we don’t formally cover companies commonly characterized as focused on “ad tech” given the volumes of research we do and commentary we provide on the sector and its components. But as we articulate in this week’s Madison & Wall, there is very good reason we spend so much time on it and why other observers who also don’t formally cover the sector need to care: ad tech is, at its heart, the modern day guts of the advertising industry. How it evolves and is applied by “traditional” and “digital” media companies alike will go a long way towards driving the broader industry’s relative winners and losers in years ahead.

    Pivotal’s US Advertising Universe Comparables

    We include here comparable operating and valuation metrics for companies under our coverage.

    Pivotal’s US Advertising Forecast

    We also include our recent forecast for advertising in the United States.

    REPORT INCLUDING DISCLOSURES CAN BE FOUND HERE: Madison and Wall 8-1-14.pdf

    ____________________________

    Why Ad Tech Matters to Media

    Many investors and industry participants we interact with are sometimes surprised to learn that we don’t formally cover companies commonly characterized as focused on “ad tech” given the volumes of research we do and commentary we provide on the sector and its components. But there is very good reason we spend so much time on it: ad tech is, at its heart, the modern day guts of the advertising industry. How it evolves and is applied by “traditional” and “digital” media companies alike will go a long way towards driving the broader industry’s relative winners and losers in years ahead.

    The increasingly well-known alphabet-soup of products – the DSP (“demand side platform”), the SSP (“supply side platform”), the DMP (“data management platform”) – alongside others less prone to acronyms such as ad servers, exchanges, attribution tools, verification tools, etc. are growing in importance as automated media trading takes root. Consequently, ad tech matters to a wide range of companies – media owners, both “traditional” and “digital”, software companies, agencies and marketers – because of the degree to which the operations which underpin modern advertising are dependent on and benefit from automating processes and the application of data to media.

    To assess why ad tech matters to the broader industry, let’s consider some of the interests of key groups of its participants. “Digital” publishers want to drive revenue growth through improved inventory yields and growth in “share of wallet” from marketers or agencies while reducing costs, essential given the lack of control that most publishers have in the highly fragmented space in which they generally operate. Owners of today’s traditional media want to do much the same, but only if they feel they need to given the greater control they typically have over the ecosystems in which they generate the bulk of their revenues today. Agencies want to drive revenues from new service offerings (and replace a revenue stream of diminishing importance in traditional digital media buying) while finding new ways to add value to marketers at lower costs. Large brand-based marketers want lower cost execution and greater integration between the data they have about consumers, prospects and influencers and the media they buy. Smaller marketers may simply want simpler ways of accomplishing similar end-goals. Performance-based marketers may simply want better performance.

    As for the technology companies, the ambitions of some may be no more robust than carving out sustainable niche-focused opportunities with modest value enhancement for their customers. But others – and probably most – may wish to develop broad-based solutions which are intended to eventually extract a substantial share of the value that lies between the cost it takes to produce content and a marketer’s willingness to pay for placement of an ad near that content.

    In one sense, ad tech is a collection of tools that will help to produce and extract value from advertising in the near and far-off future. Who ends up producing value and who extracts it may not be one and the same. Will it be the developers and packagers of content (whether based in video, text or some other medium)? Or the technology companies who make the transactions happen? Or the intermediaries who simplify the execution of marketers’ needs? Or the marketers themselves, who can better cherry-pick increasingly atomic units of media to drive their business goals?

    First, consider the marketers. Large marketers will probably spend no differently on advertising with or without the presence of ad tech. Their budgets tend to be set as a function of the competitive dynamics within their respective industries. This is often because meaningful growth which might be attributable to advertising spending is difficult under the best of circumstances. However, marketers who can bring programmatic trading in-house, who can work with a minimum of “premium” content, who can perform regular testing to identify where disproportionately low cost / high value inventory exists AND whose assets (people and data) negate any technology vendor’s advantage over any other technology company may be able to capture more value from their media buying transactions with ad technologies. Budgets may not change, but the total volume of media bought for a given budget may rise for these marketers. Perhaps there will be first-mover advantages to those marketers who figure out how to get greater volumes of media value ahead of competitors given otherwise comparable budgets. Overall, our qualifiers probably limit the degree of ad tech’s benefits for much of the big brand marketing community, although performance-based marketers probably do much better in extracting value from the eco-system, by contrast.

    Next: consider the agencies. Agencies face ongoing scrutiny from the procurement professionals who commonly oversee or influence the marketing function at agencies’ biggest clients, as they effectively create conditions where agencies can really only manage for the profit margins their clients will collectively tolerate. Given this circumstance, we might suppose that agencies will not generally have an optimal incentive to attempt to extract the maximum value they can from technology companies or publishers if they will simply have to return that value to their clients. On the other hand, if agencies become as competitive in this sphere as they are in “traditional” media there will be growing incentives for agencies to use whatever market advantages they have to drive prices down, at least as they are reported to advertisers. Volume-based rebates or the use of data to drive better and cheaper outcomes may be ways to accomplish this. Certainly the use of data can then be considered as one way to use technology to effectively capture relatively more value than would otherwise be the case. As with our assessment of ad tech’s impact on marketers, we can imagine that the first movers may be better positioned to capture incremental market share vs. laggards. As an important side-note: under this characterization of agencies we would define entities such as WPP’s Xaxis as more like media owners or sell-side intermediaries, as that unit’s relationship with marketers is much more transactional than is the longer-term relationship which begets the “agent”-based relationship that most agencies will have with brands.

    Third: look at digital publishers. Media owners historically generated value because they were good at producing content that was distinct enough to encourage marketers to want to buy advertising inventory adjacent to that content. With only one vendor for any particular premium opportunity, media owners captured the bulk of the value in any transaction. This is reflected in the relatively high profit margins that many kinds of media owners have historically enjoyed vs. other industry participants. However, the shift of emphasis away from buying on context (a model which drove the early success of portals and top-tier vertical sites on the web) towards buying on audiences wherever they might be found makes advertisers and their agencies increasingly indifferent towards specific content. Data drives much of the decisioning because of this audience-based focus, and so the publisher with the most inventory to sell (against which greater volumes of narrowly defined audiences may be found for a given price) and/or the most useful data should win market share. Plus, with so much fragmentation and the absence of scale associated with any one piece of digital media content, it becomes easier to be increasingly indifferent towards which premium content an advertiser or agency might buy even if they still want to buy audience-based content. Overall, given these circumstances, marketers and agencies possess an improved ability to walk away from a negotiation, shifting pricing power (and value extraction) from sellers to buyer. At least this should be true for digital inventory sold on a stand-alone basis and the digital publishers who produce it.

    By contrast, “traditional” media owners are reasonably well-positioned to selectively determine which inventory they want to trade in an automated fashion and should be net beneficiaries. So long as most advertisers continue to buy most of the inventory the traditional owners produce on the basis of an adjacency model (the notion that ads are more valuable when they are associated with a media brand, which still holds for most of the traditional media world), media owners can call the shots. To the extent they can identify certain inventory will otherwise go unsold or under-monetized and that they further control who can buy that inventory (specifically, not the advertisers who might buy in a traditional manner and be forced to take the otherwise unsold media as part of a bundled sale), there is likely relative upside for traditional media owners. Put differently, a traditional media owner should be able to improve inventory yields without much risk to core properties so long as their advertisers do not generally shift spending away from the adjacency model and so long gas ad tech helps those media owners capture revenues from new advertisers or new budget sources.

    Lastly consider the ad tech companies and other digital media intermediaries (such as managed services companies) collectively. When advertisers allocate growing shares of their budgets towards audience-based buying, identification of inventory with target audiences is paramount to them. Automating the sourcing of supply is equally critical given the labor that would otherwise be associated with these buys. Meanwhile, the resulting commoditization of so much digital inventory means yield management is increasingly critical to publishers. Demand discovery is important to them as well as to long-tail publishers, who would otherwise find it difficult to monetize any inventory without the automation associated with ad tech. This suggests strongly that a significant share of value can be realized by ad tech companies so long as they produce outcomes that are better than alternatives to the companies they work with AND so long as ad tech competition which might otherwise drive pricing down is somewhat restrained. In general, it seems unlikely that ad tech can retain all of the value that it collectively produces. Certainly there will be real (and profitable) stand-alone enterprises that emerge from this sector. However, it seems that the publishers who apply these technologies to their own businesses (whether by building or buying them) will probably make their own businesses better off and capture a substantial share of the economic value the technologies produce. And they may also produce side businesses that allow for off-site monetization, too. We’ve already seen many such examples, with each of Facebook, AOL and Twitter successfully building and buying business units and companies towards these ends. It would seem inevitable that traditional media companies will benefit from buying technologies that help apply ad tech to their businesses, too (certainly Comcast has been particularly active in this regard over the years).

    Picking the winners and losers from ad tech in a simplistic way is unlikely to be fully accurate. Even our characterizations above are highly subjective and are conditional on a wide range of factors. However, the one thing we think we can say with some accuracy is that ad tech and the implications that follow from it will matter to virtually all of the ad-supported media industry, and thus it matters to all investors and observers to track its ongoing evolution.


    ___________________
    Brian Wieser, CFA
    Senior Research Analyst
    Pivotal Research Group
    200 Park Avenue, West Mezzanine
    New York, NY 10166
    (t) 212-514-4682
    (m) 917-734-1980
    (e) brian@pvtl.com

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