It’s hard to invest in ad tech these days. Why? The ecosystem is so concentrated.
Google and Facebook are the only active buyers in the market place. Google dominates search and contextual ads in addition to video ads. Facebook owns 28% of display ad inventory. Other players like Aol and Yahoo are riding into the sunset and Microsoft has all but given up acquiring or building, favoring investment. As ad networks migrated to exchanges, power concentrated further. After all, market places are winner take all.
In my view, only an antitrust ruling against Google (right or wrong) would have enough disruptive power to change these dynamics. Perhaps an AppNexus IPO will impact the market, too, but to a much smaller extent.
But this market dynamic isn’t just constrained to ad tech. In fact, the mechanics of social networks and data based businesses reinforce initially small data advantages or user base advantage that soon compound to magnificent power differentials. Google’s search became significantly better over time because they had more clicks. More data led to better algorithms and so on. More users and activity on LinkedIn built the user base – same for Facebook and Zynga. Successful iOS applications convinced new developers to build atop Apple’s platform. Amazon’s expertise in operating at scale has been rewarded with eCommerce dominance (and subsequent pricing power in acquisitions) as well as infrastructure dominance (AWS). Instagram and Branchout both have seen compounding growth for the same reasons.
Despite the record amount of cash tech companies carry on their balance sheet (somewhere close to $250B for the top 6), it’s more important than ever for startups to build sustainable standalone businesses. Why? There is no reward for second place in these markets because there are so few buyers in most of these consumer markets.
I have no doubt that market winners will find tremendous exit valuations (Instagram) because the disruptive risk is so great. Chris Dixon points out that it was rational for Facebook to buy a big potential threat for just 1% of their expected market cap. But second place companies won’t find these premiums often because the buyer set is limited and the second place competitor is often much smaller than the winner (because of the social network and data network power compounding effects).
With these kinds of winner take all market place dynamics, your business has to be able to stand on its own as a valuable company. And if you reach the scale that interests one of these big buyers, I’d advise you to go all in. It’s time to get some more competition in these sectors.