Want to Raise Online Display CPMs? Pull In Small Advertisers

These Companies Need to Be Bidding for Space on Ad Exchanges

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Wall Street analysts, covering Internet companies reliant on advertising revenue, have been preoccupied with falling CPCs (cost-per-click) and CPMs (cost-per-thousand impressions). Even as total ad dollars spent increases, these analysts fret because they believe advertisers are valuing ad inventory less and less, leading to lower bidding and ultimately lower profits for the Internet companies. What their economic analysis may have missed is something so simple and fundamental that it could be easily overlooked -- supply and demand.

The price of any ad is a function of how much supply and demand there is . In traditional media buying, the price discovery process looks more like a negotiation between a publisher, who has ad inventory (supply), and a buyer who has an ad that needs to run (demand). This process may be inefficient but generally still reflects the broader market value placed on such inventory. 

In general, online media ad inventory is being added almost exponentially with the explosion in page views from social-media channels and publishers. Economics tells us that if supply is increasing while demand stays constant, the price for the good must fall. Certainly there are more and more online advertisers, but not enough to counter the amount of ad inventory being added to the market. It's no wonder that prices keep falling.

The solution most people in the online ad ecosystem have focused on is bringing on large brand advertisers with big budgets. The more budget, the more is going to be spent, which is great for the publisher and any intermediary like ad exchanges. However, there's a fundamental limitation to how many big brand advertisers there are -- after all, there are only 500 Fortune 500 companies. 

The overlooked solution is to bring on small and medium-sized businesses. Tens of millions of these exist and many of them already buy online search ads; however, the vast majority of them do not buy online display ads for the simple reason that it's too costly and difficult to build a display ad. To make a search ad, you just need to type 70 characters. To make a display ad, you need text, images, animation, and design skill. As a result, a critical and vast source of demand goes untapped, even as supply expands.

That's the big-picture, macroeconomic way of looking at the ad world. The detailed, microeconomic way is to simply look at what happens at the ad-auction level where ad impressions are sold off every nanosecond. 

Most ad exchanges (run by Google, Yahoo or any publisher) rely on some form of  generalized second-price auctions (or Vickrey auction). Different ad buyers send their bids in for each ad impression, and the ad exchange picks the highest bidder, who then only needs to pay the price of the 2nd highest bid. The advantage of this system is that it makes everyone likely to reveal their true maximum bids. The downside is that you can't capture as much of the value assigned by the top bidders 

With so much ad inventory being auctioned but few bidders, the winning price isn't nearly as high as it could be. For example, if someone bids $10 CPM and someone else bids $1, then the winner is basically paying $1. Even if small and medium-size business display-ad buyers don't bid as high as $10, if they bid more than $1, like $3, then they push the ad inventory price up higher (now $3 vs the $1 it would have been). Due to sheer quantity, these business can be a powerful force in stabilizing ad-inventory pricing.

Small businesses and ad exchanges are a perfect match for each other. The busineses can now buy ads much more efficiently and publishers can enjoy better pricing. Analysts should stop asking, "Why are advertisers valuing ad inventory less?" and start asking, "What can be done to get more advertisers online?"

ABOUT THE AUTHOR
Victor Wong is co-founder and CEO of PaperG, a San Francisco-based technology startup focused on local display advertising.
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