Victims of Pay-per-Click Ad Inflation

by: David Jackson

The most striking theme that ran through the Q4 financial results of Internet companies, irrespective of size, was the impact of rising pay-per-click ad prices. The winners were the ad brokers - Google and Yahoo. The losers were companies that rely on advertising to attract traffic, as their marketing expenses grew faster than their revenues.

This is a critical theme for investors (rather than short-term traders). Do you own stocks in companies that are dependent on advertising and helpless in the face of rising costs? Here's a list of the victims, with the relevant stats and comments from The Internet Stock Blog's write-up of their Q4 results or recent SEC filings:

Victims of PPC Ad Inflation


Marketing expense up 44% year over year to $58 million. Net sales
up 26% year over year excluding exchange rate impact, 31% including
exchange-rate impact.

Although Amazon's marketing expense is relatively small (the company's strategy is to allocate marketing to lowering the price to customers of goods or shipping), it's highly significant that Amazon's marketing expense grew much faster than revenue (44% versus 31%).

Question: Amazon says: "We expect absolute amounts spent in marketing to increase over time." But why? If Amazon has the most efficient infrastructure and the strongest brand, that should allow it to offer the lowest prices and to boost revenue without marketing.

BFLY - Bluefly

Sales, marketing and fulfillment costs up 13% to $4.28 million. Revenue up 3.7% to $14.5 million.

More evidence of increased online marketing costs? BFLY's customer acquisition costs were up 34.1%.

DIET - eDiets

Sales and marketing expense rose 14% to $7.2 million, an astonishing 74% of membership revenue.

eDiet's challenges: (1) the cost of acquiring customers is rising (due to rising online advertising prices); (2) eDiet's suffers from high customer churn; (3) the company doesn't make enough money from each customer during the subscription period; (4) barriers to entry seem to be very low, and (5) other online diet companies seem to be outspending eDiets.


The CEO said: "We have proven our ability to grow net sales, but I was brought on board to take a hard look at this business, and to leverage its sales growth and produce long-term, sustained profitability. I very strongly believe that has an exciting opportunity, but we need to invest in our brand, marketing and technology. Our fiscal 2005 guidance reflects that plan."

Companies' guidance for Q1 and full year 2005 is revealing which Internet companies are capable of attracting traffic, generating revenues at reasonable mark-ups and thus predicting strong profitability, and which are dependent on pay-per-click ads that are rising in price. Guidance from and Monster Worldwide is the flip side of the coin of Google's guidance: the better Google's search busienss does, the more expensive traffic generation is for e-tailers that advertise.

EBAY - eBay

Although seeing "Bubble-like" search pricing, eBay plans on keeping marketing expenses in a 20%ish band of revenue.


SG&A of $5.6 million rose to 9.6% of revenue from 8.9% a year earlier. The reason? "Additional advertising and promotional expenses that led to the Company's strong customer growth, higher personnel costs to expand's management team and additional regulatory costs of being a public company."

Advertising costs up 53% year over year to 3.6% of sales. In Q3 they were 3.2% of sales.


Note: revenue growth of 36% outpaced growth in marketing expense of 24%.

INSW - InsWeb

INSW's marketing expense woes are typical of the industry-wide rise in advertising costs. INSW reported in its Q4 results that direct marketing costs rose 95% to $2.45 million from $1.26 a million year earlier. Direct marketing costs accounted for 63% of revenue in 4Q04, versus 30% a year earlier.


Sales and marketing was $2.6 million versus $1.5 million. Revenue of $7.1 million was up 34%, in line with consensus.

Noted: Yet another Internet company with rocketing marketing costs. From the press release: "The company increased marketing activity in 2004 as part of its strategy to provide long-term benefits to its brands, particularly As a result, sales and marketing costs for full year 2004 were $8.8 million, compared to $6.6 million for full year 2003. Sales and marketing costs were $2.6 million in the fourth quarter of 2004, compared to $1.5 million in the fourth quarter of 2003." And later: "Guidance for first quarter revenue, Adjusted EBIDTA, and net income (loss) reflects several factors, including seasonality in advertising revenues and increased marketing expenses related to its "Come Together" campaign."

MNST - Monster Worldwide

Monster said Q1 EPS would come in at $0.16-$0.17, lower than the  consensus of $0.18. Q4 results were strong: online revenue rose 28% organically (64% including acquisitions) year over year and 9% sequentially, and operating margins widened to 23% from 18% a year earlier. But the revenue growth came from targeting small and medium businesses and increasing Monster's sales force, and those factors raised projected expenses for Q1.

Here's what the company said about guidance in its press release: "Expense levels in the first quarter are expected to increase due to seasonally higher marketing and promotion expenses in North America and a strategic investment in marketing activities in Europe. As a result, earnings are expected to be in the range of $0.16 to $0.17, an increase over the $0.11 reported in the first quarter of 2004."

ODMO - Odimo

Note that marketing costs rose from 9% of revs in 2003 to 12% in 2004. The S-1 comments: "Marketing expenses for the nine months ended September 30, 2004 increased 100.8% to $3.8 million from $1.9 million for the nine months ended September 30, 2003. The increase was primarily due to increased online advertising costs." But it gets worse: for the September 2004 quarter alone, marketing costs increased 247%!


Offline retailers are increasingly focusing on their online channels. Unlike the pure-play online retailers, they are able to drive traffic to their web sites from their stores and circulars. With relatively higher marketing costs than its multi-channel rivals, Overstock needs to offer compelling prices to attract customers.

PCLN - Priceline

Online advertising cost rose to $8.52 million from $4.06 million. (Offline advertising fell slightly to $6.02 million.) Revenue of $195 million up 8.2% and slightly below consensus estimate of $195.13.

PRVD - Provide Commerce

Sales & Marketing at $7.5 million was up from $5.3 million a year earlier, but declined slightly as a % of revenue to 23%.


Online marketing expense rose 61% year over year to 82% of revenue.

SPRK - Spark Networks

JDate accounted for less 2004 revenue than ($24 million versus $35 million) but much more gross profit ($22 million versus $10 million). The reason? Direct marketing costs for JDate were only 7% of revenues, versus 71% for Subscriber acquisition costs were dramatically lower ($8.09 versus $43.29) and monthly revenue per subscriber higher ($28.42 versus $22.16).

From the S-1: "In general, the costs of online advertising have recently increased substantially and we expect those costs to continue to increase as long as the demand for online advertising remains robust. If we are not able to reduce our other operating costs, increase our paying subscriber base or increase revenue per paying subscriber to offset these anticipated increases, our profitability will be adversely affected."


Sales and marketing was $3.57 million, up from $1.86 milllion. Revenue of $9.5 million, up 29%, was in line with consensus of $9.51 million.

Note: you can find brief summaries and comments on these companies' Q4 earnings in the Earnings results category. Quotes from Q4 conference calls are in the Conf call quotes category. You can view all the articles about each of these companies by looking under the relevant ticker category.

Full disclosure: at the time of writing I'm long SHOP.