twitter
facebook 
| Understanding Microsoft's Advertising Business |
| Aug. 27, 2007 |
With the acquisitions of aQuantive and AdECN completed in Aug. 2007, Microsoft has become a major player in the advertising industry. Where it once operated exclusively as an online publisher, it now owns an advertising agency and tools and services for advertisers and publishers. With these assets, it hopes to build an advertising technology platform to capitalize on the shift of advertising budgets to new media and demands for greater accountability from advertisers. To reach this goal, the company will have to reconcile conflicting business lines and stay ahead of Google's similar expansion. Partners that serve the advertising industry could find new opportunities as Microsoft begins to sell advertising software and services through its traditional software channels. Competitors might find Microsoft lowering prices on some of its products—particularly consumer software—and trying to subsidize products through advertisements. At the same time, Microsoft may open its advertising platform to ISVs, enabling them to experiment with new advertising-supported business models. From Publisher to Platform Builder Microsoft has sold advertising on MSN and related Web sites since the mid-1990s, and as of June 2007, it is the third-largest online publisher with annual revenue of US$1.84 billion, falling short only of Yahoo (US$5.63 billion in 2006) and Google (US$10.49 billion in 2006). Microsoft has continued to invest in online ad publishing over the past few years; it has built its own search engine and search advertising platform, created tools to help advertisers target their messages more effectively on Microsoft sites, and updated its online services to try to attract more users and retain them for longer. Recent deals include the 2006 acquisition of Massive, which allows Microsoft to sell advertising space within Xbox 360 games; and partnerships with Digg, Facebook, and Piczo to let Microsoft sell advertising on these sites. All of these initiatives helped Microsoft's advertising revenue grow 21% in the fiscal year ending June 2007. There's still considerable upside in online advertising, according to Yusuf Mehdi, who was Microsoft's chief advertising strategist for the last two years before being appointed to a new position overseeing strategic partnerships. Mehdi notes that only 4% of total advertising budgets go to online advertising, while consumers spend a considerably greater percentage of their time online. Consequently, Microsoft expects online advertising to account for 10% of overall advertising expenditures by the end of the decade. However, online advertising has limits. Mehdi says that advertisers and agencies feel the process of buying online advertising is too complicated, with formats and tools varying widely among publishers. The process is also insufficiently transparent, making it hard to calculate return on investment (ROI). (These problems are more pronounced in display advertising, which is Microsoft's traditional area of strength, than in search advertising, where Microsoft trails Google and Yahoo.) Finally, advertisers don't want to conduct online campaigns separately from other media such as TV and print, and they would like more automation and clearer ways to measure ROI across media. Microsoft believes it can help meet these demands by expanding beyond online ad publishing and creating a unified advertising platform that will eventually extend across multiple media. Most of the company's recent acquisitions in this space—particularly aQuantive—are an effort to assemble all of the pieces necessary to build and market this platform. With an ad platform that addresses all media, Microsoft would be in a position to take a cut of an industry worth US$600 billion, a figure that includes revenue not only from direct purchases of advertising in all media but also goods and services surrounding that business. Microsoft's continued investment in online ad publishing and its expansion toward a more comprehensive advertising platform are driven in part by its envy of Google's growth trajectory and its fear that Google will encroach on its core businesses. Google is essentially an advertising company—nearly 99% of its 2006 revenue came from advertising—and Google is growing at a much faster rate than Microsoft. One telling statistic is that Google's total quarterly revenue surpassed Microsoft's revenue from desktop versions of Windows for the first time in the quarter ending June 30, 2007. In May 2007, Google expanded further into ad platforms with its US$3.1 billion acquisition of DoubleClick, reportedly beating out Microsoft in a competitive bidding process. In the long term, Google's emphasis on online applications (such as its Docs & Spreadsheets suite) poses a threat to Microsoft's traditional model of selling thick-client software applications. A Survey of the Pieces As of the close of the aQuantive and AdECN acquisitions, Microsoft now has the following advertising-related businesses:
(For an illustration showing how these components relate to each other, see "Components of Microsoft's Advertising Business".) Today, most of these businesses operate independently and many of them will have to remain functionally independent to stay competitive. For example, if Avenue A | Razorfish tried to favor Live Search by refusing to place search advertisements on Google, it would lose clients. This separation is reflected in the way Microsoft has organized its new business units. For example, all existing aQuantive business units will continue to report to the company's former CEO, Brian McAndrews, and will not be consolidated with Microsoft's publishing businesses. (For a simplified organizational chart, see "Advertising Organization, Fall 2007".) Microsoft is also a large purchaser of advertising, and is a client of Avenue A | Razorfish. However, according to Mehdi, Microsoft won't consolidate all its outbound advertising with Avenue A | Razorfish, but will continue to employ the numerous agencies it works with today. Publishing Microsoft currently sells the following types of advertising:
A sales force called Digital Advertising Solutions, created in 2006, helps advertisers implement campaigns across all Microsoft and affiliated properties. Over the years, Microsoft has built or acquired several technology platforms for its online properties, such as AdCenter (which started as a platform for buying search keywords), Content Ads (a recent addition to AdCenter for buying contextual ads), AdExpert (display ads), Microsoft Direct Response (remnant inventory), Massive (in-game advertising), and ScreenTonic (advertising on mobile devices). The company may consolidate some of these platforms. Microsoft's publishing business will remain independent from the other parts of Microsoft's advertising business, and will work with them on the same basis as any third-party publisher. For example, MSN will sell high-demand inventory through a variety of advertising agencies (not just Avenue A | Razorfish) and will sell leftover inventory through a variety of syndication networks (not just Drive PM). At the same time, Microsoft will achieve some synergy between its publishing and other advertising businesses. Microsoft collects a significant amount of data about users through methods such as cookies (which can track users as they travel among Microsoft and affiliated sites), search queries, and Live IDs (which can be associated with information about specific ID holders such as their name, e-mail address, and Zip code). Hypothetically, for example, the company might discover that males between the ages of 18 and 24 spend most of their online time following links from site to site, rather than returning frequently to a search engine. Avenue A | Razorfish and Atlas could then use this information to help advertisers balance their search and display advertising purchases appropriately. Advertising Agencies AQuantive has an advertising agency at its roots. Based in Seattle, WA, Avenue A was founded in 1997 to help advertisers reach consumers on the relatively new medium of the Internet. The company changed its name to aQuantive in 2003 to reflect its increasing diversification, and in 2004, it acquired interactive marketing and consulting firm Razorfish for US$160 million and integrated it into the same unit as Avenue A. Over the years, the company has also acquired other online advertising and marketing firms including Amnesia (based in Australia), DNA (United Kingdom), Duke (France), e-Crusade (Hong Kong), i-Frontier (Philadelphia, PA), and Neue Digitale (Germany). These agencies, which make up aQuantive's Digital Marketing Services (DMS) group, design and implement advertising campaigns, as well as online marketing initiatives, such as designing Web sites for a particular product launch. They boast dozens of clients in many industries from consumer technology (Microsoft and Sony Computer Entertainment) to automobiles (Ford and Toyota) to banking (Capital One).They compete against other agencies including conglomerates such as Publicis Groupe and WPP. The agencies are the core of aQuantive's business. In the quarter ending June 30, 2007, the DMS group contributed US$94.2 million in revenue, or about 60% of the company's total, and had operating profits of US$13.0 million, or about 41% of the company's total. AQuantive operated its advertising agencies independently from its other businesses. For example, while Avenue A | Razorfish might refer customers to aQuantive's Atlas tools, it was not obligated to do so, and the two businesses had separate and autonomous business models. According to Microsoft, this separation remains in place and will be extended to Microsoft's other businesses. For example, Avenue A | Razorfish will refer business to Microsoft's Digital Advertising Solutions group, but will not give it undue favor over other publishers, and will not necessarily promote Silverlight (Microsoft's emerging technology for creating interactive Web applications and sites) over its entrenched competitor, Adobe Flash. This separation, although necessary for the agencies to retain clients, will limit the synergies between the agencies and Microsoft's other advertising-related businesses, and could create some conflicts. For example, a client might insist on a significant advertising buy on Google Search rather than on Live Search. These conflicts, combined with the high-touch sales model, suggest that Microsoft might eventually spin off this line of business. Tools In Apr. 2001, aQuantive (still called Avenue A) expanded beyond its origins with the Atlas Digital Marketing Suite, a set of tools for advertisers and agencies to help plan and track online campaigns. In Dec. 2006, aQuantive acquired Accipiter, which created tools for publishers to serve advertisements on their sites, for US$30.3 million in cash, and incorporated it into the same Digital Marketing Technology (DMT) unit as Atlas. (As a publisher, Microsoft has used tools from Atlas and Accipiter.) The DMT group's flagship product is the Atlas Media Console, an application set that helps advertisers plan and implement online advertising campaigns, including finding sites on which to advertise, buying space on those sites electronically, rotating creative elements (e.g., specific images used in banner ads) without involving publishers, scheduling delivery, and tracking views and conversions. The division also produces specialized tools for managing specific types of online campaigns, including video, "rich" (interactive) media, and paid search campaigns that span multiple search engines. For publishers, the division offers a similar array of tools, including tools that link publishers with Atlas advertising customers (e.g., a profiling tool that lets publishers promote their site to Atlas advertisers who are seeking particular demographics). Notable competitors are DoubleClick (which is being acquired by Google) and 24/7 Real Media (which was acquired by advertising agency conglomerate WPP in July 2007). The DMT unit contributes less revenue to aQuantive than the advertising agencies (US$40.2 million in the June 2007 quarter), but is much more profitable, with US$15.6 million in operating profits, or 49% of aQuantive's total for that quarter. These tools are the most logical fit for Microsoft's existing businesses, and were probably the main driver of Microsoft's aQuantive acquisition. For example, as a publisher, Microsoft can employ Atlas publishing tools to reach advertisers more effectively, and could incorporate Atlas technologies into its platform for ads published on its sites. In addition, Microsoft might eventually sell these tools alongside its traditional software offerings. According to Mehdi, the company's Platform Evangelism group will promote them, and they might become available for channel partners to resell and for customers to buy through volume licensing agreements. At the same time, conflicts could still arise. For example, for Atlas to remain useful, it will have to allow advertisers to buy inventory on a wide variety of sites, not just Microsoft sites. Advertising Network In Apr. 2004, aQuantive rolled out an online advertising network called DRIVEpm (the "pm" stands for "performance media"), and in July 2004 it acquired another network, MediaBrokers, which is based in the United Kingdom. (That acquisition also included MediaBrokers' sister company, TechnologyBrokers, which was a major European reseller of Atlas.) These networks, along with lead-generation firm Franchise Gator (acquired in May 2006), make up aQuantive's Digital Performance Media (DPM) unit. Advertising networks use a combination of human brokers and automated tools to link publishers with advertisers. Essentially, publishers sell display-advertising inventory (that is, space on which display ads can be placed) to the network, which then matches this inventory with advertisers seeking a particular demographic or quantity of traffic. Some publishers (including Microsoft) sell only leftover inventory through advertising networks, while others work exclusively with networks. On the other end, advertisers and agencies tend to shop with a multiple networks, seeking the best fits for a particular campaign. Microsoft's advertising networks face a lot of competitors, including DoubleClick (Google), 24/7 Media (WPP), Advertising.com (acquired by AOL in 2004), ValueClick, and many smaller players. Consequently, DPM is the smallest part of aQuantive's business, contributing only US$21.6 million in revenue and US$3.1 million in profit in the June 2007 quarter. DRIVEpm already receives some business through other aQuantive business units—Avenue A | Razorfish buys advertising on the network, and Atlas tools enable advertisers and publishers to link up to the network—and Microsoft uses it (among other networks) to place unused inventory. In addition, like other advertising networks, DRIVEpm uses cookies to track users across all sites where it places an advertisement, giving aQuantive (and now Microsoft) a wealth of user-behavior data which can then be used to improve its other tools and services. However, because there are so many competing advertising networks, perceived conflicts of interest could particularly hurt DRIVEpm; if advertisers suspect that DRIVEpm is a dumping ground for unsold Microsoft inventory, they can easily move to competitors. Advertising Exchange After announcing its plans to acquire aQuantive, Microsoft acquired AdECN, a privately held company that operates an online advertising exchange. Conceptually, such exchanges are similar to advertising networks: publishers place unused inventory up for bid on these exchanges, and advertisers or agencies then bid for particular pieces of inventory. However, exchanges are fully automated and more transparent than advertising networks. AdECN deals only with ad networks, and not individual advertisers or publishers. All bids are conducted on a cost-per-thousand (CPM) impression basis, and the highest bidder always wins—a process very similar to keyword purchasing for paid search advertising. The exchange takes a cut of each transaction. Advertising exchanges are relatively new, and AdECN did not report its number of customers or revenue. Its main competitor is Right Media (acquired by Yahoo in July 2007), although Microsoft argues that Right Media is not a true exchange because it offers more favorable placement to inventory from Yahoo. DoubleClick (Google) is also beta testing an exchange. Because of its business model, this advertising exchange must be completely independent from the other parts of Microsoft's advertising business. In fact, both Microsoft's ad networks (DRIVEpm and MediaBrokers) and competing networks will probably end up using AdECN and other exchanges to ensure that their publishers are getting the best possible price for their inventory. A Long-Term Play Microsoft's pursuit of advertising has been expensive. The company spent approximately US$6 billion on aQuantive and several hundred million dollars on other acquisitions, and expenditures on search and other areas have caused the company's Online business segment (formerly MSN) to fall from a profit of more than US$400 million in FY'05 to a US$732 million loss in FY'07. In addition, Microsoft's capital expenditures on online infrastructure, such as new data centers in Quincy, WA and San Antonio, TX, have increased from approximately US$100 million in FY'05 to an estimated US$700 million in FY'07. (Microsoft does not break out these numbers in its earnings reports, but offered estimates at a 2006 conference for advertisers.) Furthermore, Microsoft has low expectations from its advertising business in the short term. In the current fiscal year, which ends June 30, 2008, revenue from the Online segment is expected to grow no more than 13%, and the segment will continue to lose money. Microsoft does not expect the aQuantive acquisition to have any material effect on its revenue this year. Eventually, however, Microsoft imagines that advertising can become a core business along the lines of desktop software and enterprise software, suggesting an annual revenue contribution of more than US$10 billion and consistent profitability—characteristics that its Client (Windows desktop OSs), Business (Office and other business applications), and Server and Tools (Windows Server, SQL Server, and other infrastructure software) segments all possess today. To get to that point, the company will have to find or create considerable synergy between these disparate businesses—a difficult task, given the inherent conflicts between many of them. For instance, if the Digital Advertising Solutions group pressures Avenue A | Razorfish to guide more advertisers its way, or DRIVEpm wants MSN to contribute more inventory, difficult decisions will have to be made at the top levels of the company. Adding to the complexity are the logistical challenges that come with any major acquisition (aQuantive has more than 2,600 employees spread across more than 40 offices) and probable conflicts between longstanding Microsoft employees and employees at acquired companies. In addition, it's not exactly clear how Microsoft will assemble these disparate pieces into a cross-media advertising platform. Microsoft could try to extend models from online advertising to other media. For example, it could use real-time auctions to sell print advertising space, or offer automated tools to place TV commercials. However, developing such a platform will be challenging, and many incumbents will resist. In particular, offline publishers could refuse to cooperate (e.g., by not reporting useful data) in hopes of maintaining their current margins from advertising. In the meantime, Microsoft might have to spin off certain parts of its advertising business into independent companies. The advertising agencies seem particularly likely to go because, although they may be able to help Microsoft sell advertising platform products, they do not scale like Microsoft's traditional software businesses, and the only way to increase sales is to hire more people. Furthermore, the agencies are particularly vulnerable to perceived conflicts of interest. Finally, Microsoft's faces an unusually expert competitor: Google, a company that already earns most of its money from advertising and was one of the pioneers in automated tools for advertisers with its AdWords and AdSense platforms. Google-acquisition DoubleClick has long been recognized as a pioneer in other areas, such as online advertising networks. With the aQuantive acquisition, Microsoft gains many executives and workers with similar expertise in advertising, but such "outsiders" have historically not thrived at Microsoft. If the company tries too hard to squeeze its new businesses into traditional Microsoft patterns of development, organization, and sales, it may lose the expertise that it paid so dearly to acquire. Resources Digital Advertising Solutions is at advertising.microsoft.com. Links to more information about each of aQuantive's operating units are available at www.aquantive.com/operating/. AdECN is at www.adecn.com/. |
