• by Joe Mandese  @mp_joemandese, February 2, 2009

Is there an automated solution to the supply dilemma?

The rapid growth of the online advertising marketplace has made the Internet the envy of other major media, but publishers are beginning to realize that they may actually have too much of a good thing. There's a hidden price in the rapidly expanding supply of online advertising inventory and it appears, quite literally, to be the price people pay for it.

Unlike the relatively fixed supply of other major media, the Internet's virtually infinite capacity for creating advertising inventory has been expanding faster than the growth in demand from advertisers, leaving much of it - possibly most of it - unsold.

No one knew exactly how big a dilemma this was for online publishers until last summer when the Interactive Advertising Bureau and consultant Bain & Co. released the findings of what is likely the first study to actually benchmark it. The results were startling. It showed that the typical Web publisher sells only about 10 percent of the display ads it has available for sale. The rest is sold through third-party "intermediaries" - ad networks, verticals, exchanges, and some new variations on those themes - at vastly discounted rates that are depressing the average price paid for an online display ad.

This phenomenon is far from new. It's just that the industry is finally beginning to put some dimensions around it. The overcapacity issue is as old as the online advertising marketplace, and it was a dilemma that created an opportunity for the first wave of display advertising networks like aol's Advertising.com.

Taking a page out of the broadcasting industry's "unwired network" playbook, the first generation of ad networks began aggregating unsold advertising into broad reach buys at cheap - what some might term "commoditized" - rates. But the Internet's advertising capacity continued to expand at levels that even broad reach advertising networks were unable to fill, so a second wave of intermediaries emerged with methods to refine ad network reach and make it far more targeted, and far more valuable to prospective advertisers.

Too Much, Too Soon
Savvy entrepreneurs developed systems for targeting online users based on their online usage behavior, or on the context of the pages they were visiting, to create pseudo user profiles that would match valuable consumer targets for advertisers willing to pay a premium for it. But the Internet's supply continued to expand, and even hyper-effective behavioral and contextual networks like Tacoda, Revenue Science, and AlmondNet couldn't fill the capacity. And since nature abhors a vacuum, yet another wave of online ad inventory aggregators blossomed. This time, vertical advertising networks leveraged the Web's reach across specific consumer interests like health, finance, sports, technology, or men's and women's interests. But this wasn't without repercussions.

The rapid rise of vertical ad networks has moved so fast that it has actually created its own secondary marketplace - one that has been largely invisible to Madison Ave., but which is once again reshaping the value equation in the endlessly expanding supply of online inventory.

This new market goes by an especially clunky handle known as online ad network optimization, or oano, but its goal is to create simplicity, structure and, most important, value for the rapidly expanding ad network marketplace. In terms of advertising dollars, this new market is still relatively small - less than 1 percent of the $20 billion online display advertising marketplace - but in terms of transaction volume, it is growing fast.

"Every second, 2,000 transactions are occurring across our technology," boasts Frank Addante, CEO of the Rubicon Project, one the companies that identified a need for yet another middleman to step in and provide structure for the rapidly growing online display marketplace. Rubicon, and its main competitor PubMatic, launched over the past couple of years because they saw that the rapid rise of ad networks were creating a new set of ad inventory management issues. So they stepped in to fill the void. At one level, these firms play matchmaker between publishers and ad networks, conducting research to determine which ad network will provide the best revenue yield for a publisher's inventory, and conversely, which publisher's revenues will generate the best results for an ad network.

Beyond that they provide an array of research, analytics and inventory management services that are once again automating a part of the business that had largely been built on human interaction. A technological solution was a no-brainer, says PubMatic's president Rajeev Goel, noting that the number of advertising networks that publishers and advertisers had to deal with grew, in only a few years, from a handful to upward of 400.

"Fundamentally, they are networks of networks," says Keith Richman, CEO of Break Media, a company that is both a publisher of branded Web sites, as well as an operator of vertical advertising networks aimed at the young men's marketplace.

Having a foot in each the publisher and the ad network world gives Richman a unique perspective, and his reasons for working with Rubicon are telling. Richman says Break Media decided to concentrate all of its sales and marketing resources around selling its most valuable inventories - what he calls "highly integrated campaigns" built around the specific needs of advertisers that require a lot of effort, but yield relatively high ad revenue returns.

"The other piece of our inventory is the general banner ads that show up and are, I believe, going to become less and less valuable over time. That's not the best place for us to focus our time and energy," he says, explaining that that particular portion of Break's inventory is outsourced to Rubicon.

"Anybody that can solve a problem like that for you and take it away from you, and show you any lift at all is going to be able to make a business out of it," he says.

The Value of Surplus
The ad network optimizers say they actually do much more than that, and have effectively created a new, more efficient aftermarket for online advertising by looking broadly across an array of networks and publishers to unlock where the greatest market values are. Part of that, they say, comes from enriching the data that publishers have about users or how ads show up on their pages that make them more effective for advertisers.

PubMatic, for example, has more than 50 variables it utilizes to enhance the effectiveness of ads placed on a publisher's site. One for example, optimizes the color scheme of a display ad based on upward of 77 million possible color combinations. The rapid expansion of the advertising network marketplace has also gotten Madison Ave.'s attention, and some of the biggest and most technologically savvy agencies are beginning to develop their own plays for tapping and monetizing online inventory surplus.

One of those plans was unveiled in November, during the omma Ad Networks conference. During a keynote at the conference, Havas Digital CEO Don Epperson went public with what he called a "virtual brand network" system developed by the agency that adds a new twist to online ad aggregation by tapping the unique insights the agency has about its clients' brands and incorporating them into an online ad procurement system. Havas Digital built the new system on the backbone of Artemis, a powerful database that already has profiles on about a third of the global online population. By matching the agency's knowledge of consumers with the needs of its brands, Epperson said it is in the best position to understand what value a piece of online ad inventory has for a given client at a given time.

Varick Media Management, a start-up spun off from mdc Partners' Kirshenbaum Bond + Partners, has developed a similar approach, and other big agency holding companies including Publicis Groupe's VivaKi, wpp and Interpublic's Mediabrands have also gotten into the ad network management business.

And why not? As the iab and Bain study shows, more and more of the business is shifting to intermediaries. Between 2006 and 2007, use of ad networks by publishers jumped six-fold, from only 5 percent of all ad impressions sold in 2006 to 30 percent in 2007. Given the continued explosion of inventory, the expansion of networks, and the turn in the economy, PubMatic's Goel estimates the percentage could be as high as 35 percent or 40 percent today.

The problem, says John Frelinghuysen, the Bain executive who authored the study, is that the surplus capacity and increasing reliance on advertising networks threatens the "premium nature" of publishers' brands, a development that could begin to commoditize the value of the premium inventory sold directly by publishers to advertisers. That would indeed be a problem, because according to the Bain study, the 10 percent of display advertising inventory sold directly by publishers accounts for 70 percent of their total advertising revenues.

The Consequences of Sprawl
Fear over such commoditization is what sparked a bit of a range war within the online publishing industry last year, as big, branded publishers like Martha Stewart Living Omnimedia and Forbes.com took strong positions that ad networks were denigrating the premium value of their brands. During a speech at the iab's annual conference in February 2008, Wenda Harris Millard, MSLO President of Media, went so far as to liken the situation to trading "pork bellies." As sensational as the quote may have been, it got the industry thinking about the fundamental shift that was affecting the underlying value of the display advertising business.

At first, IAB President-CEO Randall Rothenberg says he was "mystified" by that reaction, but after reviewing the findings of the Bain study he said he had an epiphany about the change taking place in the online advertising marketplace.

"By the time I got to page 4 or page 5 of the report, I said, 'Oh my god, this is outlet malls 1985,'" recalls Rothenberg, referring to the emergence of the off-price retail venues created by big-brand marketers during the 1970s and 1980s to help them deal with their own excess supply of merchandise.

The analogy came easily to Rothenberg, who grew up with the concepts of retail marketing, supply-chain and channel management. His father was a top retail industry researcher, and he even conferred with his dad to see if his theory fit.

"He agreed," Rothenberg says, likening the current emergence of ad networks, exchanges, and optimization firms to an alternate distribution channel for liquidating excess branded online advertising inventory the way big branded retailers began utilizing outlet centers 30 years ago.

"It was back in the days before supply-chain management was understood, and marketers were manufacturing too much stuff. It wasn't distressed, they just had too much stuff and they needed a place to dump it," Rothenberg explains. So they began by opening outlet centers in rural areas away from their main retail locations to avoid tarnishing the value of their premium outlets. But over time, Rothenberg says, marketers began to realize incremental values from the outlet centers.

"They realized they had uncovered new consumer markets for their products. In some cases, it was access to consumer markets that they hadn't accessed before. In other cases, it was the same consumer markets, but reaching them at different price points than they had before," he explains. "What began as a dumping ground for excess inventory that existed because there wasn't enough awareness of supply chain management evolved into a very well-considered strategy for utilizing a secondary channel. And that looked to me to be something that is going on in our industry now."

According to Rothenberg, the online ad industry is still stuck in the early phase of that secondary channel, but it is rapidly evolving into new forms and models that will likely find a better equilibrium than the kind of pork-belly reputation it has recently taken on.

"It took the retail industry 30 years to figure out a sophisticated way to use it, but we're operating on Internet time, so it will take us two or three years," he predicted.

Brokering the Next Ad Exchange
Rubicon's Addante concurs that publishers, to date, "have done a really poor job" of managing their secondary sales channels, and that, in turn, is distressing some of their premium value. But he says network optimization firms like Rubicon are part of the solution, because if they don't create value for all sides of the equation - the publisher, the ad network, and ultimately, the advertiser - they would not continue to exist. Instead, he says they are growing, because they are adding value to the market that publishers could not manage on their own.

Among other things, he says they are able to monitor and effectively police the placement of ads to ensure that they are appearing on the right sites for the right reasons. Rubicon even has a certification process that it requires ad networks to go through, and it keeps an eagle eye on how and where they place ads to ensure things like competitive conflicts do not occur, or that unscrupulous ads fronting for viruses and spyware don't sneak their way into the system.

"USA Today doesn't want the New York Times' ads showing up on its site, but that has happened, because an advertising network placed them there," he says. "We make sure that doesn't happen."

If ad network optimizers are the latest manifestation in the evolution of the online advertising marketplace, what might be next? Well, the iab's Rothenberg points to "media-branded networks" being created by leading publishers such as Martha Stewart's "Martha's Circle" or Forbes.com's business and finance blog network. They're not doing it in the spirit of "if you can't beat them, join them," but to extend the reach of their own premium brands across Web content that they have a direct affinity with - for consumers and advertisers alike.

Another iteration is the emergence of the kind of marketer brand networks being created by advertising agencies. Havas Digital's Epperson downplays the notion that his shop is looking to compete directly with conventional advertising networks. He says Havas Digital is simply looking to leverage its data and insights on behalf of its clients' brands, and that it will work with ad networks, publishers, exchanges, and any other intermediaries to accomplish that.

Darren Herman, president of mdc's Varick Media Management, is a bit brasher in his view of Madison Ave.'s role. He says agencies will ultimately supplant advertising networks altogether, and will begin creating their own virtual brand networks by working directly with publishers, as well as online advertising exchanges. Under his scenario, agencies will function more like Wall Street brokers, trading inventory on one or several open-market exchanges.

At least one ad network and Web site operator isn't so sanguine about Madison Ave.'s potential to dominate the equation.

"The agencies are the big wild card in all of this. What role will they have in this space?" asks Break's Richman. "When I meet with them I get really jazzed, because they know so much about what their brands want, but they've never been that great about creating technology. So what I think will happen is that the agencies will become part of the pool that needs to be managed. They're going to become another Advertising.com. They might become a better Advertising.com, but you're still going to need somebody to manage the Havas network, the Omnicom network, the Interpublic network, etc."

The supply chain, such as it is, will continue to evolve and the next iteration of inventory that emerges will undoubtedly shift the ground beneath everyone's feet once again, creating new relationships, opportunities and another vacuum. And, of course, somebody will step in to fill the void.