Why the ad industry is ripe for consolidation

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The other day I was talking to a good friend of mine who is on the executive team at a startup in the ad technology space. We were talking about strategy -- and in the midst of the conversation, I suggested that since the company hadn't taken any money yet, it should strongly consider selling at its early "life stage" for $10-20 million now. He gasped and told me, "Are you kidding me? I'd put our valuation at between $100-200 million."

I stopped talking for a minute, and then said, "I'm not sure how you could possibly have the revenue to justify that." This is, after all, an early stage startup that only has been in business for a year or two, and I'm fairly familiar with the company and its customers; I know it's not doing more than $2-3 million of annual revenue right now.

And he said, "In (insert niche here) nobody is bought on a multiple of revenue -- it's always based on strategic value."

To which I replied, "That might be true of funding -- of course VCs and increasingly PE firms are betting on the long-term value of disruptive technologies. But for an acquisition, at least for a rational one, nobody is bought without some discussion of 'comps' for similar companies and revenue, and some 'reasonable' multiple is definitely a factor."

My friend rattled off several examples of companies that have been acquired (for what I see as irrational amounts of money) lately and some of his beliefs on their revenue pictures -- and we picked over the specifics of the acquisitions. And that's when I started to get worried.

This conversation has been rattling around in my head for days now, and I have to say I'm concerned about the market. I see this space as primed for consolidation. The Luma Partners display ecosystem slide is a perfect example of much that is wrong in our space:


As dollars move between advertisers and publishers, the folks sitting in the middle are trying to find a way to strip off some money as it passes through the ecosystem. The only way they're going to be able to strip some pennies off of the dollars as they flow through is if they provide some value back to the ecosystem. The problem is both the number of companies in this space and the exuberance of those companies for how they believe they'll participate. Many are not realistic on what they should be paid.

There's opportunity in this space; don't get me wrong. I wouldn't be invested so heavily in online advertising if I didn't believe that there is a strong opportunity for me and my company. But let's all be very clear about what that opportunity really looks like. The greater the provided value, the more money that the company in the middle can take away. So is the value a moderate improvement in efficiency -- or a substantial change in value? How significant is the change? At the end of the day, the market will bear only so much being stripped away, so only those companies that have disruptive technologies are going to be able to extract significant amounts of money.

It might be useful to look at what percentage of spend various vendors are able to extract today. Let's start with agencies, which are often the target of technology companies trying to find a place to disrupt the market through disintermediation. But that's crap. First of all, the agency lives in the power position in the ecosystem. And despite the kvetching of the technically minded who don't "get" what agencies do (nor even the difference between a creative and media agency), agencies provide a lot of value to the advertiser (their customers). Agencies are not easily disintermediated -- nobody has been able to disintermediate them so far.

Most startups vastly inflate the amount agencies get paid -- typically the number that is thrown out is somewhere between 15 and 20 percent of spend, which would be freakin' awesome if it were true. But those kinds of percentages went out of style in the ad space along with well-tailored suits, smoking a lot of cigarettes, and drinking whiskey and water like it's going out of style. Most big agencies no longer negotiate their contracts with the marketing team as an advertiser; they negotiate with procurement offices and negotiate for fixed margins -- very low margins, in many cases. They'd be psyched to claim 15 percent of spend. They'd be excited about 10 percent of spend -- even 5 percent, in some cases, would be cause for ecstatic celebration.