Why the open exchange model is ideal for online advertising

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An increasing amount of attention is being paid to new exchange based models for advertising sales, and a healthy debate has begun over its value for selling ads across different mediums.

While some view the exchange model for advertising as a non traditional approach to a traditional business, others feel that it could benefit both buyers and sellers by allowing them to connect on a common platform and trade more efficiently through direct relationships.

We've seen Google attempt to apply its search auction marketplace to graphical and video ads, and then to print and radio ads. EBay recently partnered with a group of advertisers to launch the e-Media Exchange, an auction marketplace for TV ads. Critics of both have been vocal.

Meanwhile, we're witnessing the introduction of marketplaces and exchanges for the online advertising industry, which is a medium that may lend itself best to the exchange model due to the increasingly quantifiable nature of the online ad unit.

What is fueling the sudden interest in exchange models for advertising? And why the opposition?

When one considers the introduction of exchange models in other industries such as NASDAQ or eBay, it was a legacy of market friction that eventually paved the way for open exchanges. This evolution occurred in-spite of tremendous resistance from those whose revenue models were threatened.

There are many different ways to think about friction in the online advertising market. This includes click fraud, viruses being transmitted via ads, ads showing up on inappropriate content, lack of pricing standards and an imbalance of information regarding supply and demand which favors certain large ad networks.

More importantly, the lack of transparency in online advertising breeds inefficiency for buyers and sellers. While online advertising has been widely hailed as the most efficient advertising medium ever, it may be the least efficient marketplace.

Today, buyers don't always know where their ads are showing up, or if they're getting a fair price for media. Sellers don't know what ads will appear on their site, and can't be sure they're getting the greatest revenue for each impression. If friction creates challenges for both buyer and seller, and exchanges reduce friction - why so much concern over the evolution of exchange models?

Commodity Breeds Efficiency

Both buyers and sellers have legitimate concerns about exchanges. Many sellers feel that an exchange will commoditize ad space, and drive down pricing. This fear is justified, particularly if sellers are pressured to put premium ad space up for auction. However, massive chunks of ad inventory are already commoditized, they're just inefficiently commoditized.

Publishers that sell non-premium ad spots accept that certain types of inventory are a commodity; however they've limited the breadth of demand for that inventory. By embracing media exchanges, publishers can dramatically increase the competition for commoditized ad inventory and drive up yields.

So long as publishers continue to create a distinction between premium and non-premium ad inventory, they run little risk of commoditizing their inventory by selling through an exchange -- they just get more for the inventory that is already a commodity.

Buyers have similar concerns. Shouldn't an efficient marketplace drive up prices? Possibly, but publishers wouldn't sell this way unless there was a chance to increase CPM yield. The challenge for advertisers is less about pricing and more about value. Whether an advertiser's success metric is branding, direct response or some combination of the two, the lack of transparency in the market makes it difficult for marketers to determine the value of each part of their media buy.

About a hundred years ago, department store innovator John Wanamaker said, "Half the money I spend on advertising is wasted; the trouble is I don't know which half." Online advertising's trackability allows advertisers to know which half of their advertising doesn't work, but the lack of transparency in the market makes is difficult to do anything about it. An exchange allows advertisers to discover the value of each ad impression, and make informed bidding decisions. This may increase the CPM price advertisers need to pay to get the most valuable inventory, but it also eliminates extraordinary waste.

Ironically, ad networks - arguably those whose models are most threatened by exchanges - have been the earliest adopters. Forward thinking networks understand that providing access to quality inventory is a better long-term strategy than hiding supply and demand information in black boxes. The slowest to move will be the entrenched networks. They happen to be most favored by the friction in today's markets.

Expect the debate over exchanges for advertising to continue. History suggests that the market will move in this direction for many types of media, and as the model is proven, fears and opposition will subside.

If Wanamaker were with us today, he'd probably embrace exchanges as a fair and efficient way to do business. This time around, he'll know exactly which half of his advertising budget is being wasted.

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