Google's Threat to Ad and Affiliate Networks

How big a threat is Google to the affiliate and other ad networks? This question is hotly debated in the Internet industry, and is also of importance to investors in ValueClick (VCLK) which owns the most visible affiliate network, Commission Junction, has its own ad network and recently acquired FastClick.

The argument that Google threatens other forms of Internet advertising, including pay-for-performance and pay-per-page-view, is straightforward. An advertiser can pay for pageviews, clicks, or a commission on purchases. But at the end of the day the advertiser always asks the same questions: How much did it cost me to acquire a customer, make a sale, or generate $1 of profit? Based on readily available data, payment per thousand page views can be translated into (effective) payment per click, and (effective or actual) payment per click can be translated into a percentage payment per sale. At the end of the day, there's no difference between these different forms of advertising. One can be translated into another.

Take pay-per-click ads. Google enables advertisers to purchase pay-per-click ads across multiple web sites, without even knowing which sites the ads show up on. Some of those sites will be low quality, and maybe even subject to click-fraud. But the advertiser can look at the results of a compaign, calculate the rate of conversion to sale, and bid for keywords accordingly. It doesn't matter to the advertiser that some sites suffer from click-fraud; the impact of that is simply to drag down the price-per-click of that keyword, because the advertiser is translating price-per-click into price-per-sale. That, by the way, is why click-fraud is not an issue for advertisers.

Click fraud is an issue, however, for web site owners. If you own a web site that attracts high quality traffic, then the revenue you generate from selling pay-per-click ads is dragged down by other sites that suffer from low-quality traffic or click-fraud. The price of keyword ads is set by advertisers based on average performance across a network. So low-quality sites get a higher price-per-click than they deserve and high-quality sites get a lower-price-per click than they deserve. From the advertiser's perspective it all evens out; but from the site owner's perspective it certainly doesn't.

So until now, if you ran a high-quality site it wasn't worth using pay-per-click ads because your revenue (price-per-click) would have been dragged down by low-quality sites. Instead, you would have chosen to sign up with an affiliate network that would pay you based on the conversion-to-sale success of your ads. Since you have high-quality traffic, a higher proportion of it should convert to sale, so you'll make more money than the low-quality sites, and more money than the average price-per-click.

This is why Google's introduction of onsite advertising threatens other ad and affiliate networks. If advertisers can buy pay-per-click ads from your site and measure their success, then the price of a pay-per-click ad will converge with the effective price of CPM-based ads and affiliate deals for that site. When ads are site-specific, the price of all three types of ads (based on page views, clicks or sales commission) converge to the same effective rate. And then Google has an advantage, because Google's ad prices are set via an ongoing auction, and it will maximise revenue for the site owner by interchanging CPM-based and CPC-based ads.

But the article on the Internet Stock Blog that argued exactly this point (Google Introduces Onsite Advertiser Sign-Up; The Threat To Other Ad and Affiliate Networks Grows) elicited two very different responses from affiliate marketing experts. Jeff Molander agreed, even writing:

Prediction: Multi-channel retail and DM advertisers will view Google's announcement with a new set of glasses and ValueClick will acquire a contextual ad platform/network in the first half of 2006.

But Beth Kirsch, manager of affilate marketing for LowerMyBills.com, disputed the assertion that site-specific ads are a threat to affilate networks. She wrote:

...content sites are not really high producing affiliates (even though we all like them) because, in general, content sites earn more money on a CPC or CPM. Those sites left the affiliate networks long ago because they did not drive much revenue from affiliate marketing compared to other advertising options. However, affiliates that made more on a CPA or a rev-share stuck around.

...These direct marketing companies are nimble, quick and fill in the holes in an advertiser’s marketing and provide significant value when managed correctly. Also, these companies make more from affiliate marketing then they do from AdSense.

Jeff agrees that Google's introduction of onsite advertising is a threat to the other networks; Beth disagrees, arguing that those networks contain members who benefit more from affiliate marketing than other forms of ads. Specifically, Beth lists the following type of affiliates:

1. Loyality/Incentive -- Fat Wallet (Tim Storm), Cashbaq (David Lewis)
2. Search -- Traffic Junction (Ben Flux), Imwave (Adam Veiner), Clicks2Customers (Vinny Lingham)
3. Coupon Sites -- FlamingoWorld.com (Connie Berg)
4. Email publishers -- Datren Media

5. Downloads -- WhenU - most of these affiliates are gone from networks
6. Shopping -- Shopping.com
7. Portals
8. Content/Blogs

and argues that content sites long ago switched to AdSense, but the others will stick around with affiliate ads and the other ad networks.

You can judge for yourself between these two viewpoints. Personally, I think that Google (and maybe Yahoo) will gradually drive most of the other ad networks out of business. Affiliate networks will be left with a small base of loyalty and coupon sites, whose business model is based on arbitraging traffic and acting as outsourced marketing vehicles for larger companies. In Jeff Molander's words,

A majority of multi-channel marketers/advertisers have already realized that affiliate marketing is all about search and loyalty sites. How long before advertisers realize that affiliate marketing is not scalable and this is its primary flaw?

If ValueClick has cleaned up its affiliate network as Beth states, its challenge going forward -- in both its Commission Junction and FastClick businesses -- will be sustainable growth.

Comments

[Jeff Molander_:]

David...
Hitting nail squarely on head again. Excellent job in adding the needed perspective. Without this kind of perspective we're lost.

In my opinion, "in general, content sites earn more money on a CPC or CPM" translates to "publishers (read: not affiliates/nimble/sear... individuals who game search ranging from Marchex to people working in undies) who have valued, legitimate READERS (read: not TRAFFIC)."

"However, affiliates that made more on a CPA or a rev-share stuck around" translates more honestly to "CPA affiliates figured out how to use data feeds, leverage basic direct response tactics, employ adware/spyware (without being detected) and game search engines so as to 'shuttle traffic'; this was/is their primary MO versus having loyal readers." The affiliate networks? They facilitate it all. Take it from someone who created one.

Indeed, they are "nimble, quick and fill in the holes" (I might suggest the darker ones) but it's really all about the short term when you boil it down. Affiliate marketing is a short term play. Don't take it from me, though, talk to the advertisers!

2005 Dec 13 12:30 PM

[Jeff Molander_:]

Also, David, your readers might enjoy this DMNews article and a related story here discussing Avon.

2005 Dec 13 12:37 PM

[bkirsch:]

"Don’t take it from me, though, talk to the advertisers!"

I am an advertier. I work for the second largest advertiser on the web.

As a say all the time this is a high risk-high reward channel and you need to manage it correctly. You talk to advertisers who don't manage it correctly, that is why they need to hire you. :) There are tons of advertisers that do manage this channel correctly and they are not canibilizing sales, but you never mention them.

Seems to me you are just trying to get more consulting gigs again.

We're used to it by now. :)

2005 Dec 13 09:55 PM

[Jeff Molander_:]

Josh...
thanks for contributing your insights. I think I understand your point and it centers on, partially at least, the "branding and reach" campaigns versus the direct response campaigns. Specifically, each have different objectives and therefore cannot be compared. The numbers that David provides make perfect sense but when you mix in market realities regarding commonly defined objectives it gets hairy. I hope I'm understanding you correctly.

2005 Dec 14 01:35 PM