My last post, long and long-winded and written when you should all have been out celebrating, sent more traffic my way than any other post in this sleepy blog’s history. I think the prospect of a new year and (in a sense) a new decade, makes us all a bit introspective and open to thinking the why about our path through the world. I’m glad people found it worth a read.
But it’s January now, and Monday. Back to work.
So I spent my time investing in and starting companies aimed at changing that. From early (too early, it seems) location-based marketing in Platial and exchanges in Root Markets, to tracking in Pinch Media, to data targeting in 33Across and Domdex and to demand side platforms in CPM Advisors.
But when Google launched their Ad Exchange four months ago, I decided the thesis was played out. An open marketplace can be the apotheosis of efficiency and efficacy. And if Google is putting its muscle behind that, then the rest is just filling in the blanks. While filling in the blanks is probably a better investment philosophy in the short term, it’s not the right place for investors like me who are putting smaller amounts of money to work for longer periods of time.
The key to making the exchange-as-platform useful is making it a platform. If the New York Stock Exchange owned a brokerage firm, that would be a problem. If they owned a research firm, or an underwriter, that would be absurd. But Google is, in essence, trying to do all these things. The strategy seems to be to make the exchange easy to use for advertisers and consumers because those are Google’s real customers.
This is a bad long-term strategy. Small producers of say, soybeans, are not equipped to show up on the floor of the CBOT and sell their September crop in open-outcry. And you and I are not prepared to go up against Goldman Sachs in selling our shares of GOOG on the Nasdaq. In both cases, we’d get taken. That’s why there are intermediaries. If Google doesn’t allow outside firms to be intermediaries then small producers and consumers will get arbitraged, and the information generated by the market will be poor quality. The hoped-for efficiencies will not appear.
Google knows this, of course. So why are they doing it this way?
In 2008, the NYSE Euronext Group had revenue of $4.7 billion and operating income (backing out one-time impairment charges and merger expenses) of about $1.1 billion. In 2008, the CME Group had revenue of $2.6 billion and income before taxes of $1.2 billion. The stock and commodities markets are each a couple of orders of magnitude bigger than the advertising market. Even if the ad exchanges facilitated the introduction of derivatives, like ad futures and the like, the future of ad exchanges are companies with a few hundreds of millions of dollars in revenue.
Being an exchange is not where the real money is made in the stock and commodities markets. The big money is made at places like Goldman Sachs. This is not to downplay the central importance of the exchanges: Goldman would be a much smaller and less profitable company if there weren’t exchanges. The ad markets will end up similarly, with exchanges that are crucial to the ecosystem but not that big financially, and much more profitable firms that use the exchange platforms.
Historically, exchanges have been cooperatively owned entities, in existence to facilitate the business of their members. Google, with AdX, is in the wrong side of the business. The best move, for them and for the markets, would be to spin AdX out into a Mozilla-like non-profit foundation and then work on the hard problem: figuring out how to use the newly generated information and efficiencies to make advertising more useful.
I jumped the gun. In this sector, there is a lot more to do.