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