The Pricing Battle: CPM vs. Rev-Share

Two heavyweight teams stare across at each other, engaged in a tug of war.

On one side are the Web’s content players, including the mighty portals America Online, Yahoo and Microsoft Network. On the other side are the Web’s diverse retailers, ranging from e-tailers such as Amazon and eToys to clicks-and-mortar titans like Barnes & Noble and Toys ‘R’ Us. The taut rope connecting them is the currency of the new economy: online marketing deals. Each side is pulling the rope with all its might, as if its very existence depended on it. With the recent collapse of the dot-com stock bubble, the rope is now near its breaking point.

At stake is how online marketing gets priced and measured. Should marketers pay based on how many eyeballs they reach or only for the small fraction of viewers who take out their credit card and make a purchase? Let’s consider both sides.

Content companies such as Lycos or iVillage are in the media business, the same as magazine publishers and TV networks, which means they’re good at attracting and retaining an audience by informing or entertaining them. They make money by selling various marketers access to that audience. In their view, the way to price such access is on the basis of how many pairs of eyeballs a particular marketing message hits. They strongly prefer to get paid based on how many people see an ad – not just on how many are moved to action by it.

In content companies of all sizes, the preferred pricing model is cost per thousand impressions. Prices have been rising in the past two years, so that marketers can expect to pay $25 to $75 CPM for placement on prime portal real estate.

Online retailers, however, hold a completely contradictory point of view. Increasingly, they are unwilling to invest in the Web as a branding medium. They are measuring their online marketing expenditures exclusively based on customer acquisition costs. The best retailers are working diligently on reducing the cost to acquire a customer below the lifetime value of that customer. Why? Because that is the key to profitability for a retailer. And as the stock prices of online retailers swirl around the drain, a demonstrable path to profitability will mean the difference between life and death for many.

Right now, every online retailer is re-evaluating its marketing spending, attempting to shift as much of it as possible to “pay for performance.” What that means in practice is that they are saying no to CPM-based deals and are structuring their marketing deals solely on the basis of sales-driven deals. The buzzword for this approach is “rev-share.”

The tug of war comes down to this: CPM vs. rev-share. On the surface, this appears to be a conflict about risk. The content companies ask, “Why should I take on the risk of whether the ad you place on my site has enough sizzle to capture people’s attention, get them to click and spur them to buy?” The online retailers ask, “Why should I pay you for displaying my marketing message where it generates no economic value, when the Internet makes it possible to target and track performance?” But beneath the surface lies a far more serious dispute: economics.

A typical rev-share deal delivers a 10 percent commission to a content site on every sale it drives to the online retailer. If the average order totals $30, the content site will rack up commissions at the rate of $3 per sale.

That might sound good when you first hear it. However, for most retailers, only one out of 50 visitors to an ad decide to make a purchase (a conversion rate of 2 percent). Worse still, readers are getting better at ignoring online ads.

At this point, an ad is considered successful even if only one out of 200 viewers clicks on it (a click-through rate of 0.5 percent). As a result, to drive a sale to an online retailer, a content company needs to display an ad 200 x 50 times. That’s 10,000 impressions to generate a single sale (and its $3 sales commission). Reckoned in CPM, that’s $3 for 10 “thousand impressions,” or, literally, a meager 30 cents CPM. Compare that to the $25 to $75 CPM rate cards at top-tier content sites, and you appreciate the magnitude of the gulf between the worlds of commerce and content.

Will major portals begin to drown in unsold ad inventory and be forced to accept the higher risks and lesser economics of pay-for-performance deals demanded by the online retailers? Or will online retailers, competing against each other for customers this holiday season, eventually cave in and pay the high rents for portal real estate on a CPM basis? Either way, it’s sure to be a battle worth watching.

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