The Price Fallacy
Wal-Mart sold more than three-hundred billion dollars worth of goods last year, in other words, almost one-billion dollars per day in revenue. On any day, the company will earn more than the yearly revenue of Advertising.com, ValueClick, Adteractive, and AzoogleAds combined. Wal-Mart will do in two weeks what analysts predict will be spent on all of Internet advertising in 2006. Wal-Mart is so big, so dominant, that it will earn more in a year than Sears / Kmart ($38 billion), JC Penny ($18 billion), Safeway ($38 billion), Albertson’s ($40 billion), Target ($56 billion), and Home Depot ($81 billion) combined. This is to say that Wal-Mart makes almost four times more than the next closest company, and six times more than its nearest competitor. Its power goes unrivaled, and its ability to dictate pricing can push suppliers’ to the precipice of financial collapse.
That last point is the most important, at least as it pertains to helping explain the price fallacy that exists in parts of online advertising. That fallacy actually comes from shopping at places like Wal-Mart and its wholesale counterpart Sam’s Club. There, a single item, say a can of soda, might cost fifty-cents. Buy six and the price per unit drops to thirty-five. Buy a dozen and it goes down even further. The more units you buy, the lower the price per unit. This happens through economies of scale. The stores can sell it to us for less because the manufacturers charge them less. The manufacturers charge the stores less because their cost per unit drops the more they make, and big orders mean larger amounts of money coming in more digestible and predictable chunks.
Wal-Mart, with its size and power can, and has, thrown this equation off balance. Wal-Mart moves so many more units than the next nearest company that it can do what no other company can. Rather than going by the manufacturer’s cost, they demand a price that a seller of a product must meet or beat if they want access to Wal-Mart’s customer flow. Merchants will realize some economies of scale by working with Wal-Mart, but the savings will not match the price pressure put upon them by the behemoth. They will earn less per unit on those shipped via Wal-Mart. In economic speak, the marginal cost exceeds the marginal benefit. In some cases, those selling through Wal-Mart will as a result seek to modify their processes in order to reduce costs so that they do not outweigh the benefits. It is a vicious cycle of efficiency that has lead to many companies having to outsource jobs that were previously stateside, and much debate about Wal-Mart.
Lead generation hasn’t led to buyers of leads having to outsource, but the market does share certain key aspects in common with Wal-Mart, chief among them is that reality does not mirror what the initial logic would suggest. Working with Wal-Mart would seem like a company’s dream and guaranteed money. It’s not obvious how working with them could potentially increase costs. The same holds true for performance-based advertising online, in particular lead generation. More volume does not come at a reduced cost. The biggest mental hurdle with performance-based online advertising is that unit costs increase as the desire for volume increases.
As mentioned, economies of scale has trained us to assume that the more we buy of something the less it should cost per unit. Like extracting oil, though, this is not always the case. Oil is a scarce resource; there is only so much in existence. The question around oil is not how much is left but how much can be produced, i.e. the supply. In a given reserve, the early oil is the easiest and cheapest. Costs increase as the reserves empty out. This is the key to understanding lead generation pricing. The easiest and cheapest leads come first. The more you buy (extract) the more it costs, as leads are in many ways a non-renewable resource. Unlike oil, we will not use up every lead – the constantly evolving economy and population insures fresh supply. The demand for new leads, however, laps the natural market growth, insuring costs per leads will both increase over time and as volume for leads increases.
Admittedly, I have a fascination for Wal-Mart and their pricing strategies with vendors. It is something that occurs because they control so much more of the market than the next nearest competitor. That isn’t the case for any online company – buyer, seller, even Google. Regardless of the stretch, I still insisted on working them into this piece. Ultimately, the important thing to remember is that buying leads is not the same as buying fixed price media. Were you to buy media in bulk on a fixed price, you would get a price break – that is guaranteed revenue for the owner of the inventory, and they would lower the price in order to secure the revenue. Leads, though, are not guaranteed for the seller. Each lead must be earned, and the incremental cost to acquire a lead increases with each one for the sellers and thus the buyers. Over the past six years the market has shown this to be the case across countless verticals. When companies ask for more money for increased volume they do so as a reflection of their costs not in attempt to fleece the lead buyers. We illustrate why in the continuation of this labor of love here.
