LUMAScapesmap the constellations and clusters of the digital advertising universe. For many years, that universe, like our own, was ever-expanding. But also like our universe, theres debate about whether it will continue to expand or end in a big crunch. I would argue the latter is happening and happening now.
Its been difficult for small adtech firms to raise capital for a while, and we are beginning to see the inevitable consequences of that capital shortage. In this respect, the adtech sector is due for a correction; Im hardly alone in predicting it. But contrary to what you may have heard, thats not because adtech is dead or dying. The industry just needs to shed dead weight.
Dead weight in the form of small me-too companies, purveyors of point solutions and standalone tools for optimizing, verifying and measuring advertising. Undifferentiated companies with wide gaps between the narrative of what their tech does and the reality of the value that that tech provides. Dead weight in the form of companies founded within the last five years that are now burning through the last of their A rounds.
That doesnt mean the entire space of adtech is doomed, though. Its just facing an important and overdue reckoning with the hard realities that face any business. Namely you have to be a well-run business, you have to add real value, solve real problems and have a path to profit. Thats true of any startup, in any space.
Im constantly asked what I think of adtechs terrible reputation within the investment community. My response is the same: There are bad and good companies in any investment category, and innovation is still happening in this space. That said, there are characteristics of adtech that make it harder to separate the good from the bad.
Adtech over the past few years bears a resemblance to the mortgage industry during the sub-prime days. Which is to say, a lack of transparency has contributed to an environment where a lot of people are throwing a lot of money around for short-term gain without a lot of concern for creating long-term value. Sooner or later, the truth emerges and all that cash gets vaporized.
In the case of adtech, fraud has run rampant, and marketers have justly felt like theyve often been throwing away money (because many of them have). In 2010, a marketer using a programmatic exchange would not expect to confirm that the ad would be seen by a human and not a bot (some two-thirds of them werent seen by humans), or be sure that the ad was actually viewable in the first place (about half of them were). We took those conditions for granted.
Even Facebook, as savvy a customer as any, was fooled. The company bought video ad server LiveRail in 2014 for $400 million to $500 million. Two years later, Facebook effectively shut the company down with the rationale being that it couldnt vouch for much of LiveRails traffic because it was rife with fraud.
Adtech is a massive category, and those paying attention know that change and innovation is happening in the space more so than ever.
A market beset by such transparency issues was easy to exploit. You could put together an adtech startup without a great deal of tech just a lot of salesmanship: hire a sales team, have limited tech, resell a mix of good and suspect inventory and make money.
That strategy is much less tenable these days. Transparency is increasing. Advertising is now checked for viewability, screened for non-human traffic and tied to actual sales performance by an increasingly sophisticated suite of measurement tools that look well beyond the click. With digital advertising climbing out of the shadows, it will be harder for me-too players to growth-hack their way to success by manufacturing scale. And its going to expose a lot of dead weight for what it is.
It is indeed time for these smaller players to fall by the wayside. The question becomes, then, whats left in the wake of this correction?
The answer is simple: fewer, but healthier adtech companies, poised for growth and worthy of investment.
Not all adtech businesses fit this description, but plenty do. Enough, indeed, to make the adtech space a lively and promising one for those businesses built on solid foundations, as well as for the investors smart enough to spot them.
Criteo and The Trade Desk fit the bill. The latter just recently going public. As the companys S-1 filing with the SEC outlines, The Trade Desks business is very healthy. In 2015, it posted $113.8 million in revenues, which was up 155.5 percent year-over-year. The company is also profitable, netting $39.2 million in EBITDA, which was up 589 percent. The company also has $37.6 million in cash on hand.
Good adtech companies like Criteo and The Trade Desk meet a set of proven criteria. Good adtech companies derive their competitive advantage from three main areas: They own or enable unique supply, have unique data or own the advertiser relationships as a tech provider versus a service provider.
Owning and enabling supply means having unique and/or enabling access to advertising inventory connected with the valuable audiences advertisers need to reach. Having unique data means providing the insight and intelligence to help advertisers target and optimize messages to those consumers. And having the advertiser relationships as a tech provider means providing the software and technology tools that advertisers need to create and deploy campaigns to those consumers.
In contrast, a badtech company relies on arbitrage and, in effect, rents traffic rather than owning it. Many adtech companies buy their supply by making revenue commitments and guarantees to publishers, effectively making their reach a liability rather than an asset. The tech is primarily a new ad execution that can easily be replicated.
Other instances of badtech take the form of new ad units designed to maximize short-term performance stats, gaming the measurement standards that still reward clicks and views instead of real engagement. Often these badtech tactics compromise the user experience and lead to ad blocking. The badtech might generate some impressive numbers, but really what its doing is prioritizing short-term gains at the expense of the long-term relationship between brands, publishers and consumers.
Think back to 2002. In the hangover of the dot-com bust, squeamish investors were very skeptical about the entirety of technology. Theyre the ones that missed out on Baidu (2005), Facebook (2004) and Twitter (founded in 2006). Meanwhile, the investors (like Jim Breyer), bankers (like Michael Grimes) and entrepreneurs (like Mark Zuckerberg) made their way through a no-nonsense environment and created some of the most valuable companies in the world.
It may be a stretch to claim that our category will pull out a Facebook, but the lesson is clear: As many investors ran, the good investors and entrepreneurs kept innovating and reaped the huge benefits. Adtech is a massive category, and those paying attention know that change and innovation is happening in the space more so than ever.
That innovation is creating real value and is separating the winners from the also-rans. The big crunch that is coming will leave the shining stars intact and help them shine even brighter.