On Middlemen: Angel Investor Jerry Neumann Discusses The Online Advertising Value Chain

Middlemen ReactionAdExchanger.com recently asked several members of the advertising ecosystem about “Middlemen” and, specifically:

  • “Are there too many parties trying to insert themselves into the online advertising value chain? How do you see this playing out?”

The following contribution is from Jerry Neumann, an angel investor in The Trade Desk, 33Across, Domdex, CPM Advisors and Flurry and a co-founder of Root Markets, a quantitative marketing pioneer.

Once there was only one intermediary: the black box, the ad networks, AdSense.  They operated on a model that I’m personally familar with from raising children: you get what you get and you don’t get upset. Then the producers and users of ad inventory decided to grow up and take control of their own process -deconstruct the black boxes and start to learn themselves what works and why.

A network of intermediaries sprang up -densely interconnected but none irreplaceable (but still each their own little black box.).  With this network, marketers and publishers can access and control data and learn by monitoring the seams between the various companies.  They can also swap out any given intermediary for another if they think they will get better results.  This evolutionary process, while painful, is leading us to not just better advertising, but better marketing.  And the more atomic the process–the more intermediaries there are–the better our ability to experiment and discover.

But, then the issue becomes not how many intermediaries there are, but how much of the spend they are consuming.  Several commentators, Jonathan Mendez particularly well, have noted that publishers get only about 20% of the marketer spend.  For marketers, a better way to say this is that up to 80% of their interactive budget is spent on transaction fees.  This is way too high: it should be less than 40%. In this sense, there are too many intermediaries, each intent on taking a large enough chunk out of the media spend that they might someday be worth what they promised their investors.  The marketers are torn between wanting more granularity and wanting less transactional overhead.

The publishers think they want fewer intermediaries, but absent higher demand for inventory, having fewer intermediaries will not raise publisher CPMs.  The opposite is true. If you don’t believe me, plug AdSense back in and see what the single intermediary–Google–nets you.  Publishers right now are price takers.  There are two ways they can increase CPMs: make the marketers dumber by forcing them to forgo the quantitative marketing tools they have adopted, or make themselves smarter by adopting some quantitative marketing tools themselves.  The smart ones are working on the latter.  This means more intermediaries, not fewer.

In the next few years, the tension between having many intermediaries–allowing control of and learning from the process–and having few intermediaries-reducing transaction costs–will be resolved by there being three direct intermediaries at most: buyer’s agent, seller’s agent and marketplace (supported by various technology and data providers, who will not themselves be intermediaries.)  To get there, each intermediary must become completely transparent to its clients.  No more black boxes.  Buyer’s agents and seller’s agents must move away from being arbitrageurs and return to the traditional professional services function of trusted adviser.

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  1. Patrick

    I’m curious where you came up with the 40% figure as an appropriate percentage for transaction costs. It seems somewhat arbitrary and I’d be interested to know if there were other markets you used for comparison.

    The questions of “too many” intermediaries is the wrong question in the first place. It begs answers like arbitrary transaction cost limits. The test of any intermediary is whether they add value.

    This has been demonstrated over and over again- AdNet optimizers (Rubicon, Pubmatic, AdMeld) are an intermediary and take 10-15% of publisher’s gross network revenue. But they tend to increase publisher revenue by more than their fee, otherwise nobody would use them. This results in a lower % of revenue for publisher, but more actual revenue, which is how we keep score around here…

    As a publisher I would much rather take 20% of a $10 CPM, achievable through the intelligent use of intermediaries, than 60% of a $3 cpm which I might achieve with fewer intermediaries.

  2. Patrick —

    Fair point. But the essence of progress is to provide services for less than what they are worth to the user of those services. The NYSE does not charge 20% for use of their exchange, even though that is probably less than what it would be worth to its customers (absent any competition.) What something is worth to you has little bearing on what it should cost, in a competitive market.

    My thinking on transaction fees is that ad agencies traditionally charged 15% for a service that was probably more labor intensive than the interactive media buying world being created. I generously gave seller’s agents the same percentage (although in the old media world rep firms made less) and then gave the marketplace 5% (although, again, most marketplaces–except for small volume, high touch ones like auctionhouses and real-estate agencies–charge less. And then I added another 5% for miscellaneous. In this sense I think I was being extremely conservative. My own personal estimation is that the transaction fees will be less than 20% in ten years.


  3. At first the point about transparency makes perfect sense, why would any agent volunteer to take some from margins he created and hand it over. However thinking deeper does it not create a reality of intermediates investing more in relationship management then in delivering actual results? Doesn’t modern capitalism mean providing a scale for agents to compete on their performance? Or in other words, won’t loosely-coupled arbitragers ultimately creates harsher completion that in turn will drive transaction fees down to equilibrium faster?

    • @Tomer,

      The idea of a mess of competitors making a pricing efficient is fine in theory, it just doesn’t seem to hold in practice. For whatever reason–information asymmetries and dynamic competitive positioning are my best guesses–perfect markets don’t seem to happen too often.

      The classic progression of a marketplace from bazaar (arbitrageurs) to exchange (transparent pricing) is always accompanied by improved efficiency and lower transaction costs. This is the information asymmetry problem solved.

      There is also some analytical work that suggests that in the absence of uniform competition, price dispersion can increase (cf. Frank and Lamiraud, “Choice, Price Competition and Complexity in Markets for Health Insurance”, http://www.nber.org/papers/w13817). While this work is for consumer search, I think the principal holds that for complicated products that are not easily comparable, the search cost is high, so inefficient pricing can persist. In a market where companies are one day a platform, the next an exchange and the next ad ops solutions, I think figuring out what any solution will cost might be more than the cost of the solution.

  4. @Patrick, While obviously the point for publishers is absolute CPM maximization, the point Jerry makes is that with 80 points of margin, there is so much slack in the system that appropriate competition should drive it out. If you were an ad network taking 40 points of margin, could you offer whatever Rubicon does for free or for 5 points instead of 15 to take share? Theoretically yes, and theoretically, at scale, there is more than enough cash flow to support this. None of these layers of infrastructure are so complex that some level of integration horizontally or vertically doesn’t seem appropriate. And this margin compression happens up and down the value chain. If a network will do all of that at 45% margins, why not 40%? Why not 35%. Given that the value is improved yield, every point of margin cuts into the value proposition. It seems likely that the final answer is an incredibly lean technology solution.

    Exchanges have rocked the network business to its core. Networks ran at 40% and made great money, but then exchanges turned it from a rep business to a tech platform business and fixed margins at 15-20%. Now, networks that thought they were the last line of monetization find themselves preempted by exchanges and as exchanges add advertisers, improving the yield, being an impression aggregator has basically gone away as a business. The Valueclicks and Ad.com’s of the world have seen their business fundamentally change – all due to margin compression brought on by exchanges. And this wasn’t some incremental competition. This was instant value destruction Innovator’s Dilemma-style. The big networks with monster reach couldn’t cut their margins in half because they were big companies with P&L commitments. Now they are doomed.

    Hmmm, that is a rambling comment.