An Exit for Affiliate Networks?

Right Media, aQuantive, and 24/7 Real Media all had something in common besides the technology platforms for which they were ostensibly acquired. Each had an ad network component to their business. It’s safe to say that the multi-hundred million, and in aQuantive’s case more than a billion dollars, offered had others in the ad network space, e.g., Casale Media and Blue Lithium wondering whether they might go next. Lost in the discussion which focused heavily on Valueclick as the largest "independent" were those in the lead generation space and affiliate networks. The lead generation space saw two exciting exits recently. The first, announced just yesterday, had Halyard Education partners, acquirers of eLearners, snapping up online education front runner World Class Strategy for an undisclosed sum (but a greater than $100 million price tag would not be unexpected). The second involved online shopping comparison and lead generation stalwart Nextag who realized their dream of a billion dollar exit, when according to sources, two private investors took a controlling stake. Which brings us to the affiliate networking space.

By now, most people have heard of Azoogle Ads’ desires to go public. The company took in $48 million in a private placement round led by TA Associates in February 2005. They entered the crowded and nebulous space of email back in 2001, transforming themselves into a CPA network that in less than two years went from company with a funny name to serious contender. We remember hearing reports of how they, seemingly out of nowhere, knocked Advertising.com out of the email advertising business. Equally impressive, the company known for its email publishers transformed itself into one that had leading publishers of all major traffic types, including perhaps the largest base of search affiliates. As they evolve their business, they will most likely have their exit, but the CPA network space from which they grew, while rich in revenues, has some serious hurdles for others with aspirations of an exit. Here’s our take on why:

· Not easy to regulate – Anyone can lie their way into an account, take a link, and ultimately do whatever they want; on the less cynical side, even legitimate publishers, including large businesses will make mistakes, and when they do, it’s often the network that takes the heat. Ask AzoogleAds about the mobile space or CPA Empire and its MySpace phishing issue. Affiliates follow the advice most husbands do, they ask for forgiveness instead of asking for permission.

· Little to no barriers to entry – One of the things that makes the affiliate so fun but so frustrating to those who have built a multi-hundred million dollar company, almost any can enter easily. For a few thousand dollars, you can license competent technology and open your virtual doors. We start to see some barriers around the offer, but given the desire for distribution, rarely will you see an offer only appear on just one network.

· Heavily commoditized – The similarity and prevalence of offers also leads to this space having a highly commoditized feel. As soon as one person introduces a new offer or feature, e.g. weekly wires to top affiliates, it doesn’t take long for others to copy.

· Low Margin business – Getting traction means paying out the most, compared to another, and paying out the most means taking little margin. Being a bigger network doesn’t mean having better margins either. If you have a 30 person company, and assuming an average of 10k/month per person to cover salary and overhead, you have operating expenses of $3 million. Given that a network can consider itself fortunate to earn 20%, that means they must make more than 15 million in yearly revenue just to break even, and that doesn’t leave them any room for reinvestment. It’s a vicious cycle too. The more you earn, the more you have to give away, which means you must do a lot more volume to actually earn more.

· Not about technology – As we mentioned before, almost no technology barrier exists. The If I wanted to enter the space today, I’d take the true.com approach and apply it to a network; I’d raise 10 million then overpay for a few key offers to lure affiliates; but even that would not guarantee me success. The CPA network / affiliate space is a tracking business, and tracking doesn’t require the best technology (DirectTrack anyone). Google and even Right Media grew because of their technology. The downside to the affiliate space is that to date (and this comes back to the point about low margins) growth comes from lowering margins, not from any technology efficiency.

· 90/10 rule – The affiliates that make you the most money are hard to come by, and instead of 80/20, chances are your business will look more like 90/10. Plus, when your big guys grow to a certain point, they start to go direct or the understand the leverage they have, and you end up making less on them. The successful networks today take a portfolio approach, varying payout by affiliate and offer to manage margins, all while looking for any means to lock up distribution in a business where the same offer is often just one URL away.

· Push vs. pull – Exchanges and other ad networks such as Advertising.com offer both sides of the equation. They, in essence, play decision maker when they receive an ad request. CPA networks don’t. Getting back to their primarily simplistic tracking and reporting functions, they are static interfaces by which others interact. As much if not more business can flow through them, but they have less value because they are simply shelf space. Think of a grocery store. They make low margins for the same reason. And, it’s one of the reasons that today’s networks often end up being more than just the network. They make offers, buy inventory, and many manage email lists, each an activity that requires either more risk or adds more value and thus potentially higher margins.

· It’s a people business – This isn’t a bad thing, but think of the biggest companies in our space. You work with their technology not their people. This applies heavily to those thinking of an exit. CPA networks don’t require contracts so advertisers and publishers are free to go. The glue in both, especially on the distribution side are the account managers and in most cases, the founders. When you buy a company you can buy sales relationships, but in the affiliate space, you can’t buy the relationship. You buy the company that has the person that has the relationship; that is not sustainable. It’s brokering, and brokering can be a great business, but when you don’t broker your own product, it’s a business that doesn’t have much enterprise value. Take your small to mid-size mortgage brokerage who doesn’t originate. They can make a great living, but they won’t become the next Countrywide. What makes those shops, and many networks, so good are the sales people there, and again you don’t buy sales people. You buy technology, exclusivity, and process.

That said, it’s still a great and fun business; one that always has a role and will continue to excite. But, don’t enter it if you only want an exit.