I Want My Slice of the Pie: A Look at Startups and Ad Spending

Howard Lindzon wrote a fairly straightforward and blunt post about “Freemium“ and “Business Development” yesterday that I would have to mostly agree with. One area in particular that he outlined and I quote:

Waaaaay to much revenue being left on the table by Web 2.0 companies and way too many Web 2.0 companies being started and funded without revenue number one on their mind. It is really time to start caring if you are a founder and a VC.

His posting led me into thinking about the startup market in general and what’s actually occuring from a macrolevel, so I spent some time doing some back of the envelope calculations and I put together some charts/graphics. Lets analyze it together (please comment).

This post is relevant if you’re competing for a slice of the [American] pie: US advertising dollars. In the recent years, I’ve been building business and reviewing business plans and financial models (for friends and companies that I advise) that revolve around advertising dollars as the sole revenue source. This is not a bad thing, but it may not be ideal either if you’re not familiar with how advertising dollars are spent.

Stepping back to 30,000 feet, we’re going to discuss The Eyeball War. This is a term that I came up with (or someone else did that I’m not aware of) where startups are building companies who hope to generate revenue by aggregating enough eyeballs to sell into advertisers.  The thought process here is that if you aggregate 1MM eyeballs together, it’s worth more than having 200,000 eyeballs.

Silicon Valley was heating up in the late 80s and this contributed to the first “Internet” only startups in the early 90s. It became “cool” to be a “click” shop or a “clicks and mortar” store and we began hearing that in the Industry Standard or Red Herring. The ecosystem surrounding web-only startups was forming it’s foundations and the ability to build these companies became a bit easier.

One of the first major acquisitions in the space happened in 1998 when MSFT acquired Hotmail (congrats, Tim Draper) in 1998. This major acquisition provided entrepreneurs both big and small the lucrative vision to start building companies who could aggregate eyeballs online to monetize them later. Eventually, these companies could be sold to larger media conglomerates or tech companies who have the monetization abilities that could turn on a ’spigot’ of revenue.

Life was good through the late 90s… lots of innovation, some garages got famous, and the IPO market made billionaires. We had a dip in 2001 that was felt throughout many industries and in 2003, we saw the digital media and technology market heat up again. The Eyeball War was back. Lots of innovation in the technology space led to venture money chasing new startups being created to capitalize on making life easier (GTD) or connecting users (social networking) amongst many other things. Building a technical infrastructure that could support millions of users didn’t always follow with building a business model that could account for the users. With over 250 websites generating millions of eyeballs each, competition for the almighty ad dollar became tough (and still is- due to competition).

This is where I personally have an issue. We have thousands of sites competing for a piece of the advertising pie today… the problem is, innovation is outpacing ad spending at this point. This means that if your business is relying on advertising revenue as a sole source of revenue, you better be speaking the same language of the ad agencies and brands today. Love agencies or hate them, if you don’t speak their language, you won’t capture a piece of the billions of dollars they control each year.

Think about your competition. It’s not just your direct competitors anymore. RSS is competing with in-game advertising who is competing with Internet video. Podcasting and social media ads are competing with each other. Any innovation that is occuring on the Internet is in competition with each other, whether you talk to an ad agency or a brand directly. If you’re too ahead of the curve for an advertiser and don’t build a sustainable revenue pipeline (not just a one-off deal), rethink your model. Building cool technology is amazing and for the dozen (note, not plural) startups that the big guys acquire each year is inspiring, but are you going to be one of them? If you look at the chances of that happening, it’s probably not very good. Time to build a solid business.

In 2002, there were 167,196,688 US Internet Users. US Advertisers were spending about $6,000,000,000 to market their product/service to these users. That’s about $35.89 per US Internet User.

If there were 1,000 startups chasing the $35.89 per user and the top 20% of the sites (200) took 80% of the revenue, the remaining 800 startups/sites are chasing the remaining $7.18. Yikes. The numbers don’t look so lucrative, do they? The only way to do real revenue is to aggregate enough volume to make up for it (many, many eyeballs) which bring us to the Longtail Model. The issue that I have with the Long Tail play is how many sites can utilize this? You’re either a top 20% site capturing real brand advertising dollars or you’re a Long Tail play being mostly monetized by the ad networks and exchanges.

So with all of this, I don’t mean to put a dampen on startups chasing the all mighty advertising dollar. I’m not the first to do this analysis.  Venture Capitalists do this every day and they still continue to invest in this area.  There must be something here.

There are more advertising dollars flowing into the Internet on a yearly basis, but we need to reevaluate how we’re conducting business. Returning to Howard Lindzon’s rant that I signaled out early in this posting, “it’s time to really start caring.”

Technology is a commodity. Anyone with a few developer friends or some cash can have anything build or re-enginneered. You build a sustainable business through relationships and creativity. Keep this in mind as you entrepreneer in the coming years - and try and build a sustainable revenue model from day one. Your VC money generally will run-out and you may take a down-round of funding; that’s never fun.

If you are going to try summiting the ad-supported business model mountain, keep the following in mind:

• Not all ad agencies are created equal and your brand many have multiple agencies. Make sure you’re dealing with the right one.
• When trying to figure out whether or not to have a direct (straight to brand) or agency approach for ad sales, look at your top 50 list of favorite advertisers and see what they prefer. Don’t piss off the agency if you can help it.
• You’re one of 100-250 companies who are talking with the agency on a daily basis. Keep that in mind. As special as you think you are, there are 100-250 other “special” companies.
• Research and statistics. If you don’t have it - get it. Agencies typically have to justify to their clients why they want to carve out money and spend it with you. If you don’t have research or statistics on why advertising with you makes sense, don’t waste their time. 99% of the time, this is needed. Spend $15-30k on research (OTX, Nielsen, Dynamic Logic, etc) and then approach the agencies.
• Sometimes, brands will want to do emerging media opportunities in-house. Make sure you have the righ person to champion you inside of the brand. You will need a champion which will be someone who pushes you through many layers of politics and the like.
• Just because an agency buys from you once, doesn’t mean they will re-up with you for the next campaign. Campaigns have a target audience and a specific message and this may change from campaign to campaign. Don’t be surprised if an agency doesn’t buy from you even though they had a successful campaign the first time around.
• Try to stay top of mind with media buysers and planners, but don’t annoy them. Like I said above, they are dealing with 100-250 different folks just like you - so time is limited. “Poke” them every now and then… but do not be annoying.
• Know the difference between a media agency and a creative agency and when to go to either.

Being an entrepreneur is extremely exciting. Do not get caught up in The War for Eyeballs because you’re competing with so many other companies. Remember that users will pay for a service if they derive value. If you can build a service that has value to a lot of people, then you have a big business. Nothing is new anymore, remember old-school business philosophy. Take care of your users and they’ll take care of you.

Darren Herman is a digital media enthusiast and serial entrepreneur. Herman writes about technology, entrepreneurship and digital media at his blog, http://www.darrenherman.com.