I have been learning a lot about digital advertising and mobile as my interest in music has expanded into video and media more generally. Along the way, I’ve been struck by the resemblance the evolving digital advertising space bears to the early days of electronic trading on Wall Street (naturally, I’m also not the first to make this connection).
I thought I would try unpacking the analogy a bit here to see how well it holds up and whether there are any lessons that could be learned from the equities markets. (This thought exercise takes up some space so for those so inclined, I’ve made it easy to skip to just the predictions and/or the lessons.) For an interesting read on the advent of electronic trading, I highly recommend Michael Lewis’s Flash Boys – very entertaining, even for someone like myself who lived it first hand.
It used to be that advertisers worked with agencies to place ads directly with publishers, an arrangement not unlike the way investors used to work directly with brokers to buy and sell equities. In this analogy, the agency would be similar to the broker-dealer, but you could also think of agencies as financial advisers more generally. The advertiser, then, would be the investor looking to put money to work (buy ad space), and the publisher’s are the ones holding assets available for sale (inventory). The financial adviser, who is frequently also affiliated with a broker, helps the investor decide how to allocate capital across assets and facilitates the transaction.
At a more granular level, media buyers place the ads with the publishers, an arrangement that resembles the over-the-counter trading in finance, but pooling liquidity leads to more efficient markets. Hence the emergence of exchanges in finance and ad networks in digital advertising.
I’m careful to note here the ad networks – not ad exchanges – are the analog to stock exchanges such as the NYSE because historically the exchanges were isolated pools of liquidity. That changed with electronic communication networks (ECNs), a better analog for ad exchanges, which I’ll get to discussing next. .
ECNs emerged to take out the middlemen and make matching buyers and sellers easier, more efficient and direct. ECNs actually began connecting different exchanges so all of an investor’s order flow could (hypothetically) be directed at one ECN rather than having to parse the order flow across multiple exchanges, much as today’s ad exchanges might connect several ad networks. With Reg NMS this connectivity also became the law of the land in the financial world.
Because of this new capability, Reg NMS actually mandated that all the disparate pools of liquidity be connected and brokers guarantee best execution on market orders. So what are the analogs in Finance for the demand side platforms (DSPs) and sell side platforms (SSPs) in digital advertising?
DSPs I would liken to direct market access (DMA) tools. These allow both institutional investors and individual investors (think eTrade) to book their orders directly (rather than call up a broker to book it on their behalf). SSPs I would liken to the algorithmic trading strategies that now dominate most of the equities trading volume.
Soon human trading was displaced by algorithms on both the buy-side and the sell-side. There were algos for yield optimization when selling large volumes of equities and algos for buying on market momentum. Depending on the algorithm, comparisons can be drawn to both DSPs and SSPs.
Enabling all of this, of course, are the information brokers who trade in data. Both worlds, finance and advertising, make extensive use of such third-party data to inform their trading strategies, and today, hedge funds continue to build out their big data capabilities to gain better market insights.
Eventually stock exchanges started consolidating and acquiring ECNs, and brokers started building smart order routers and crossing networks and accruing dark pools of liquidity. Similarly, we are seeing some of the same consolidation in digital advertising (although the space remains highly fragmented), with companies rolling up ad networks, exchanges, DSPs and SSPs (and there’s evidence analogs to dark pools and crossing networks may even be cropping up in advertising).
What Comes Next
So returning to my original thought question, what might be learned from Finance to help predict the future of digital advertising?
I think we are going to see agency holding companies evolve their business models in a manner similar to investment banks like Goldman Sachs. Developing creative will still offer attractive profit margins, similar to IPOs and other new issuances at investment banks, and lower margin, technology enabled services will become table stakes, akin to a lot of the basic brokerage services offered to institutional investors today.
Some of the capabilities that used to reside at the broker moved in-house over to the investor side so I think we’ll see more brands getting involved in directly managing their ad campaigns. Growth at the agencies will come from support for higher margin integrated marketing, which I see as the analog to running a multi-asset hedge fund.
In an always-on world, breaking through the cacophony of advertising messages won’t happen in the digital space. Brands and their marketers will have to go offline, designing authentic, emotional experiences, backed up with digital artifacts that customers can use to tell and retell the story behind it all. That is the future of integrated marketing.
Hungry for returns (e.g. customer engagement) advertisers will come to agencies to craft these more complex, integrated marketing campaigns, of which digital will be one component. Of course, calculating financial returns is much more straightforward so market growth will be dependent on the continued refinement of tools for calculating Marketing ROI, using Big Data, as well as other more amorphous measures.
While I was on Wall Street, I saw old-school brokerage houses acquire software companies to catch up, but I also saw tech companies evolve into financial institutions. The same will happen in advertising. Technology providers will add advisory services and compete more with agencies in every area outside of creative (the analog to issuing financial instruments), although even the creative side may come under pressure. Industry insiders are already making similar predictions.
What about valuable lessons? Beware the specter of regulators. Just as high-frequency traders are coming under scrutiny, with accusations that they are manipulating markets with their orders, at some point the industry will have to deal with bots and other faux traffic. Unfortunately, I don’t believe in any industry’s ability to self-regulate. “Just trust us,” didn’t work for the financial system, and it’s not going to work in digital advertising.
More regulation is coming, and if industry as a whole cannot be counted on to reform itself, it will be imperative for individual companies to anticipate looming regulations and position their business model for minimum disruption. This was one of my investing hypotheses when I was on the Haas SRI Fund – socially responsible companies may incur more costs in the short run but have more morale authority to influence regulation, incur fewer costs to adjust to new regulations (having accelerated some of those costs through CSR initiatives) and are subject to fewer fines for misconduct (having created a culture of responsibility).
Now that you’ve made it all the way to the end – far further than the average online reader – I hope you will consider commenting. Where do you think my analogies breakdown? Do you agree with my predictions? Are there any lessons to be learned or predictions that can be made about digital advertising based on what has happened in electronic trading?