November 8, 2010

The Iron Law of Online Marketing: Why Your Ads (Almost Always) Can’t Be Your Competitive Advantage

There is only one interesting way to make money, in any field: develop and exploit a durable competitive advantage.1 Berkshire Hathaway wins because they are the buyer of first resort for good businesses that want to sell, and they can get cheap capital through superior underwriting; Facebook wins because to achieve parity with them, you have to recreate a 500 million-node social graph; the corner bodega turns a profit because that particular corner has a bodega and a half’s worth of foot traffic. In every one of these cases, it’s theoretically possible to compete with the incumbent, but there’s a better ROI in just letting them dominate the industry.

One thing these companies have in common is that their competitive advantage applies to the product or the process—either they can make the same thing for less money, or they can make something nobody else can make. What they don’t rely on is superior advertising. With good reason:

In the long term, the best advertising—the best creative, the best placement—will be sold to the high bidder. And the high bidder is whoever’s competitive advantage lets them earn more from a given customer.

Anyone Can Hire a Hired Gun

Last year, the law firm Quinn Emanuel won a trademark lawsuit for the Washington Redskins. A firmwide victory email followed. And what followed that was an email thread from a younger associate, questioning the firm’s views on Native American rights. A senior partner responded:

Bob and I represent clients, not causes. We like Native Americans. If Native Americans had hired Bob, the Redskins would have lost the case. But they didn’t. They hired someone else. So it was incumbent on Bob to kick their ass in court. It is really that simple.

This is an attitude shared by most of the high-performing professionals I know. Once they’ve agreed to work with someone, they’re going to do an awesome job. I’m sure there are people at Wieden+Kennedy who prefer Pepsi to Coke, but I’m sure they’re not going to let that get in the way of creating great ads that sell more Coke. And they’d do it for Pepsi if Pepsi had hired them, instead.

The advertising business is competitive, and the people who rise to the top are more so. They’re going to take the most lucrative clients they think they can get.

Which is another way of saying that Wieden+Kennedy isn’t Coke’s advantage at all, even though they make good ads. If Pepsi had a slightly higher market share and a slightly bigger budget, W+K would probably work for them instead.

Cost Per Customer < Lifetime Value of a Customer

It’s always hard to figure out exactly how profitable an ad is, especially if it’s an expensive TV spot that gets lots of play time in lots of audiences. Fortunately, there are some pretty efficient ad markets, perhaps the most efficient of which is Google Adwords. Adwords lets pretty much anyone bid to show an ad to someone searching a particular keyword. The term “Lawn Chairs,” for example, has a cost per click of $1.64—if I bid that amount, the ad will show up when people search for lawn chairs, and I’ll pay Google the amount of my bid for each click I get.

It’s pretty easy to see how that price gets determined. Some fraction of people who click on such an ad make a purchase. Those purchases vary in size, but there’s an average size in there somewhere, and that average size implies an average profit margin. Some of those customers will become repeat customers (especially if the site is smart enough to get their email address and sign them up for future offers). Add up the net present value of the marginal pretax profit from each outcome, adjusted for probability, and you’ve got your maximum bid. In this case, for example, the lawn chair company might argue that there’s a 4% chance of someone making a single purchase with an expected pretax profit of $25, and a 1% chance of becoming a repeat customer with an expected pretax value of $64. 4% of $25 + 1% of $64 = $1.64, the top bid.

This gives lawn chair companies very little flexibility in bidding up their ad spots. If another company scrimps on their follow-ups, and thus makes more money per one-time sale ($30, for example) in exchange for just doing one-time sales 5% of the time with no follow-ups, their expected marginal profit per clicker is $1.50; the first company can always outbid them.

Once again, the only way to make the ad more competitive is to change something about the business—to get cheaper chairs, or more attractive chairs, or to make the pricing scheme more profitable.

In the short term, the ads present opportunities; if nobody is bidding up to the point of zero net return, the top bidder has an automatic competitive advantage; they’re getting extra traffic, and it’s profitable. But that advantage is transient; it’s a matter of someone else adjusting their bid until the advantage diminishes to zero.

This applies to other fields; if ranking organically instead of paid search is attractive, it’s because you can afford to invest the time in it (or, for instance, hire the SEO company I work for). If you’re doing PR, the value of a given PR hit is proportionate to how much money you’ll make from your new customers; if you can’t make the most money, you probably can’t afford the best firm.

Certainly, relationships with agencies and advertising professionals can help you out, here. Perhaps Pepsi offered more than Coke, but Coke really likes the W+K guy they talk to. That’s a non-financial transaction, but it requires an expensive investment; among other things, you’d have to pick who will be the most desirable person to work with in advance, and figure out how to get them to do something that’s not in their immediate economic interest, but that does help you.

The closest thing to a competitive advantage in this field is mutual trust; when a client and an agency trust each other, they can do more productive work. But that’s a small fraction of the total value of the work done; enough to make a difference in degree, but rarely enough to create an absolute advantage. (When people ask why the iPod sells better than the Zune, the answer doesn’t have anything to do with how effectively TBWA can cooperate with Apple.)

Branded Advertising: The Uncertain Possibility of a Competitive Advantage

One of the most competitive search terms is “credit cards”: this search results page probably drives more revenue each day than any other page.

And yet, there’s a competitive advantage here: Visa, Mastercard, and American Express all have recognizable brand names. A random searcher is more likely to click on those sites, because he or she is probably familiar with each company’s reputation (or at least their ads). “CreditCards.com” and “CreditCardGuide.com” both have better domain names, and probably invest far more in SEO—but they can’t beat Amex for brand recognition, and they never will.

That’s one area where advertising can lead to a durable competitive advantage. You can’t just outbid Amex for their ad agency and expect the same reputation; instead, you have to spend decades investing in a consistent brand image in order to get that effect.

American Express’s competitive advantage came from a simple decision: they would over-invest in effective, brand-centric advertising. They would define themselves as the top of the market, regardless of what it cost. And they’d fight to maintain that position. Branded advertising is part of that strategy, but the all-or-nothing attitude is a bigger part of it.

If I’m Your Competitive Advantage, You Are Doomed

I work for an online marketing agency, so to some extent I’m attacking my own business when I say this, but: hiring a top marketing agency is never going to be the difference between success and failure. Being able to hire the top marketing company is the only way to ratify success. Ultimately, there are limits to how much of a given product can be sold. If the company that makes the most per sale (or gets the most sales out of every sales pitch) is working with the best agency, both sides make more than they otherwise would. Conversely, a good agency working with a bad product is a misallocation of resources on both sides.

I used to spend a lot of my time convincing prospective clients to work with me. But now I’ve reframed the issue: the point of a sales meeting is to figure out why they can afford to work with me: do they have an utterly unbeatable competitive advantage, for a signficant number of their customers—or am I not charging enough money?


[1]Boring ways to make money include: using leverage, being in an industry that turns out to boom, taking stupid risks that happen to pay off, or making decisions with high uncertainty and turning out to be right. For examples of how lucrative any of this can be, take a look at the cover of any business magazine more than a few years old, and see what’s happened since.(return)