Mobile Advertising: Check In, Then, Check Out

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Paul Sagawa / Artur Pylak

203.901.1633 / 203.901.1634

sagawa@ / pylak@sector-sovereign.com

February 24, 2011

Mobile Advertising: Check In, Then, Check Out

  • Internet advertising has grown at a better than 17% CAGR over the past decade to comprise 10% of the US market, or ~$24B in 2010. Comparatively, mobile advertising remains small – eMarketer estimates just $750M in mobile ads for 2010 (likely not including mobile search). However, from this small base, US mobile advertising is expected to grow to $5B or roughly 15% of total on-line advertising by 2015, with global projections 3X higher. With the proliferation of smartphones and tablets, we believe that the market can maintain better than 20% annual growth through the end of the decade, eventually overtaking on-line ad spending intended for a stationary audience
  • The biggest driver for the mobile market has been dramatic growth of smartphones and tablets. The total number of US smartphone subscribers is expected to nearly double from 60M 2010 to 109M in 2015. Similarly, the iPad launched in 2010 with nearly 15M units sold worldwide. A flood of competitive Android-based products are coming to market, with Gartner projecting more than 200M total tablets to be sold world-wide in 2014. Assuming the US to be roughly a third of the global market, the American installed base of tablet users could also push 100M by mid-decade
  • The emergence of apps as the primary content delivery mechanism on a more standardized population of smartphones and tablets has made serving this rapidly expanding community with advertising a simpler proposition. Ads can be sold and served beyond carrier and device limitations, potentially reaching the full installed base of a specific OS platform. With Apple and Google having established large and relatively cohesive mobile communities accessible via common app stores, mobile audiences have reached critical mass for advertisers
  • Mobile has several intrinsic benefits for advertisers. First, it is even more targeted than traditional internet advertising, as mobile platforms are not typically shared by multiple users and demographic and platform information about the user are available. Second, the ability to pinpoint the location of a mobile user is invaluable for delivering advertising close to the time and place of a purchase decision. Third, the pocket portability of mobile devices allows the paperless delivery of tickets and coupons for direct redemption, and eventually, of mobile payments at point of purchase. These advantages increase the precision and effectiveness of advertising, enabling delivery to the right audience and increasing the potential of completing a sale
  • Both Apple and Google have made mobile advertising a strategic priority, evidenced by Google winning a fierce bidding war between the two for mobile ad pioneer AdMob in late 2009. Apple countered by acquiring AdMob’s primary competitor Quattro Wireless and rebranding it as iAd. Google has revealed that it generated roughly $1B in mobile ad revenue in 2010, half from the US, while Apple has not indicated its progress with iAd
  • Characteristically, Google’s mobile advertising strategy has been broad, coupling mobile search with app linked display advertising across its own and its competitors’ platforms, while seeking to partner with app developers, content providers and carriers to establish an entrenched end-to-end advertising and mobile payments ecosystem. Apple has been more targeted, seeking to establish a high premium for access to its famously rabid customer base, with significant restrictions on the ability of its app, content and carrier partners to participate
  • In contrast, Facebook has been quiet on the mobile front, with no discernable revenues, but this could soon change. The social network juggernaut has begun to push its 200M mobile app users to use its Places “check-in” facility, and recently acquired “stealth-mode” hyper-local advertising Seattle start-up Rel8tion. Moreover, HTC recently announced a trio of Android-based smartphones with dedicated Facebook buttons
  • Many wireless network operators are exploring ways to gain a viable stake in mobile advertising. AT&T has announced a mobile software development kit (SDK) to leverage its yellow pages asset in pursuing the local advertising market. Telefonica is attempting to create a 25 country one-stop shop for advertising in its served markets. While Apple appears to be unwilling to cut operators into its advertising strategy, Google seems willing to leave a modest role for them. The recently announced Microsoft/Nokia alliance would seem to be even more open to sharing the advertising opportunity with its carrier partners, who will be vital if the platform is to survive, much less thrive
  • Location-based services (LBS) start-ups will also vie for the nascent mobile advertising market. The $6B+ valuation placed on Groupon, and the buzz around companies like Foursquare, Yelp, and Gowalla reflect the extraordinary potential of tying on-line advertising and promotion directly to physical buying experiences. These businesses could revolutionize local advertising and promotion, and co-opt tens of billions of dollars in spending that is not well documented in national advertising statistics, thus adding to the potential of the whole mobile advertising market. Google has already made a run at Groupon and Facebook acquired the aforementioned Rel8tion, while Amazon has yet to “check-in” to the local LBS market
  • Handicapping the battle of the titans, we believe that Google, followed by Facebook are best positioned to capture the mobile advertising opportunity. Apple will be aggressive, but is limited by its closed ecosystem and premium pricing philosophy. Amazon has the business assets to make a play, but has been slow out of the gate. We are not optimistic that carriers can insert themselves in this market, but believe that one or more of the LBS companies may break-out to independent success

Mobile: The Holy Grail for Modern Advertisers

In a keynote address last week at the Mobile World Congress in Barcelona, Martin Sorrell, CEO of ad giant WPP, indicated that while mobile apps are the “holy grail” of the advertising industry and have “gained weight,” they still have a long way to go be because mobile advertising is “highly fragmented.” At the same conference, Alexandre Mars, head of mobile at Publicis Groupe indicated that advertisers willingness to invest in mobile has increased with advertisers going from $50-$100K for “one-off mobile projects” to strategic and longer term budgets of $1-$3M. Clearly the mobile market is front and center on the mind of today’s mad men.

However, with excitement comes confusion. The market is fragmented, with several competing platforms and no standard hardware configuration. Location awareness and individual targeting bring substantial privacy concerns. Indeed, advertising on mobiles has not yet established consistent standards for what is delivered and how. Of course, internet advertising faced the same issues when it initially emerged at the end of the last millennium and their resolution fueled dramatic uptake – on-line ads are now 10% of the total US advertising market, and growing rapidly (Exhibit 1).

We see the early trajectory of internet advertising as a worst case scenario for mobile. The lessons gained via the desktop experience will soften the speed bumps, while advertisers much further up the learning curve as to the benefits of the new medium. The happy confluence of new technologies – smartphones, tablets, apps, 4G, cloud applications, social networking, location based services, etc. – make mobile unique in its ability to deliver rich messages to the right people at precisely the right time. As such, we see mobile advertising as poised to grow faster than its traditional on-line counterpart, and expect it to eventually overtake internet ads pitched to fixed access points.

Déjà vu All Over Again

Since the late 1990s, Internet advertising has emerged as a viable business model and source of monetizing internet delivered content and services. Despite some setbacks between 2000 and 2002 due to economic conditions and the composition of internet advertisers, revenue from Internet advertising quadrupled from $6B to almost $23B in the US between 2002 and 2008 growing at a 25% CAGR over the period, rising to more than 10% of total American ad spending (Exhibit 2). The internet’s growing share of the ad market to date has largely come at the expense of newspapers and yellow pages, with the biggest traditional categories – television and magazine – avoiding share loss, at least until now.

As more Americans gain access to the internet through their living room TVs, as the quality of content delivery over networks improves, and as more and better content is made available on-line, magazine and television ad markets are becoming addressable. Industry projections forecast annual internet advertising growth of 12% through 2015, share gain against an overall market which tends to mirror the economy but conservative to our eyes (Exhibit 3). Mobile is a big part of this, with expectations that it will go from 3% of total on-line ad spending now to 15% in 2015, growing at a 44% annual clip along the way.

As impressive as this may seem, we believe current mobile forecasts grossly underestimate the impact of recent advances in mobile technologies and proliferation of internet video ads. A recent disclosure from Google that it was on track to realize $1B in mobile advertising revenue for 2010 throws some of these forecasts into question – for example, eMarketer had projected the entire mobile advertising industry at $750M before Google’s revelation (Exhibit 4). Against what is obviously a higher baseline, we still believe that mobile advertising revenues will maintain a better than 20% annual growth rate through the end of the decade, eventually overtaking fixed internet advertising.

For a Small Fee, of Course

Mobile advertising has existed for most of the past decade in the form of SMS text messages. Spend on text message advertising has been small in aggregate relative to major forms of advertising, but it has made up a large portion of mobile advertising at about 44% in 2010 (Exhibit 5). SMS was one of the first mobile data technologies and has a capability to reach most mobile phones, not just advanced smartphone devices. Despite simplicity and reach, SMS messaging has not been widely adopted as an advertising platform because of its nature and pricing. SMS text messaging is widely considered intrusive by users. Also, SMS pricing schemes require users to pay for text messages received from parties other than the service provider. Most SMS advertising has been to mobile users that have opted-in for such campaigns and, as a result, a small target base.

AT&T was the subject of consumer complaints when it sent text messages to several million of its users advertising the 2009 premiere of American Idol to encourage AT&T subscribers to vote for their favorite contestants. Ironically, the only way to vote for contestants in the program is via AT&T Text messaging for a small fee. Consumer complaints over the campaign led the FTC to investigate and determine that the campaign was not spam and would have violated rules “only if it cost recipients or was deceptive in some way, and did not allow recipients to turn off future messages.” SMS Messaging is forecast to decline to 24% of mobile advertising as mobile display, search, and video advertising grows driven by smartphone adoption and the continued proliferation of tablet devices.

Changing the Game

Enter the iPhone in June 2007, Android in October 2008, and iPad in April 2010. The introduction of these platforms has dramatically altered the smartphone landscape once dominated by Blackberry and Palm and not only introduced the word “app” into the consumer vernacular, but created a rich mobile internet experience ripe for consumers and advertising. Apple made the smartphone sexy, cool, and easy to use with a crisp display that has led the category since introduction. Google followed with a similar touchscreen interface, but allowed customizability for technophiles that demand more OS openness and with it a choice of hardware. Apple once again disrupted the tech balance with the unprecedented introduction of the iPad, which sold 14.8M units in 2010, the same calendar year it was introduced creating a new product class. More such devices are on the way with HP, Motorola, and RIMM announcing and showcasing tablet products at January’s CES. Media tablet forecasts are in the range of 44M-67M device shipments for 2011 and growth in excess of 100% of 2010 shipments (Exhibit 6).

The sheer number of these devices offering rich mobile experiences combined with new capabilities offered by enhanced 3G and 4G services and a proliferation of apps catering to location based services creates new opportunities for advertisers to reach target consumers on the go. Shoppers can get the latest deals as they stroll through a shopping mall, while restaurants can whet the palates of potential diners with menus and lunch/dinner specials as they pass by. There are over 350,000 apps available via Apple’s app store and over 130,000 on Google’s Android market. Gartner estimates that Ad-driven apps generated over $850M in 2010 and are forecast to be an $18.4B market in 2014 (Exhibit 7). These revenue figures do not include consumer paid apps, which are forecast to be an even larger market with a value of almost $40B in 2014. Furthermore, ad-driven location based services are on track to increase from $200M in 2010 to $5.2B in 2014 (Exhibit 8).

A ComScore study based on Q4 2010 data indicates mobile users have become more sophisticated, using devices for a range of uses beyond just talking or text messaging (Exhibit 9). Social networking, classifieds, and retail were the fastest growing content categories in the US between December 2009 and 2010; subscribers accessing social networking were up 56% to 57.9M users, classifieds up 55% to 17M users, and online retail up 53% to about 16M users. The same study also examined mobile activities among all mobile subscribers in the US. 40% of subscribers access news, 36% use an internet browser, 31% use email, 25% access weather information and use their devices for social networking, 18% use navigation, and 10% use phones for restaurant information. The majority of these activities use dedicated apps with real estate for advertising and are poised for sustained double digit growth in the medium term.

Ad Wars

The potential of mobile advertising has led to a rush of tech players scrambling to acquire any smaller player that has potentially figured out Mobile Advertising (Exhibit 10). This is evident in recent friction between two favorite tech incumbents: Apple and Google. Google undermined Apple by outbidding for mobile advertising startup AdMob in November 2009 for $750M versus Apple’s $600M bid and attracting the attention and scrutiny of the FTC. The transaction was ultimately approved in May 2010. Apple, determined to enter the mobile advertising market and not known for being an acquirer, made the third largest acquisition in its history paying $275M for Quattro wireless.

Both companies have somewhat different approaches to monetizing mobile ads. Google has rolled AdMob into its organization and has disclosed that it is on track to earn $1B in mobile revenue for 2010 during its Q3 2010 earnings call. However, integration of AdMob has not gone smoothly with the departure of key talent: AdMob founder Omar Hamoui left Google in November 2010 (five months after the acquisition closed) for a new mobile startup and a number of other former AdMob employees followed suit as of February 2011. Despite the departure of some key personalities for what seem to be mostly cultural reasons, Google has a presence across platforms with AdMob. It serves Android, and iPhone apps, as well as other browser enabled smartphones including RIMM devices. As of 2/22/2011, AdMob served approximately 460B cumulative ad impressions. It’s unlikely a smartphone user has not encountered an AdMob network ad.

Apple on the other hand has decided to go big with mobile advertising to compete for Television ad dollars. It rebranded its Quattro acquisition as “iAd” following the Apple nomenclature of iEverything and instituted some steep buy-in: a $1M campaign minimum and pricing of $0.01 per impression and $2 per click (Exhibit 11). Ads occur within Apple iOS apps, and are generally vetted by Apple before becoming active. CPM estimates vary by quality of campaign, but could vary wildly depending on the range of common industry standard click through rates. With a click through rate of 1% (considered realistic for the 50th percentile of campaigns) the composite CPM is $30, almost on par with television. With a click through rate of 3% (realistic for the most engaging ad campaigns or top 90th percentile of campaigns), the CPM rises to $70 and fewer ad impressions are served. Average banner ad click-through rates for desktop accessed ads have fallen over time and are now well below 1%.

Aside from its “high roller” terms and pricing, Apple has maintained tight fisted control over the iAd ecosystem. Ad creatives and designs must be approved by Apple before being launched into iAd rotation, reminiscent of the gauntlet apps must run before appearing in the App store. Developers have often vented frustration with Apple’s rigid rules and policies that have added time to their software design process, but the big installed base of iPhone users and the lack of alternatives backed Apple’s demands. The iAd requirements are a bit riskier, as advertisers do have alternative means to deliver ads to Apple users via AdMob or other mobile advertising channels. Time is money in marketing, and adding a speed bump to the advertising creative process is likely to deter advertising partners accustomed to creative autonomy from dealing with Apple. This control makes Apple less attractive advertising partner absent these conditions. Apple has not disclosed much publicly about iAd performance since introduction of the platform in June 2010 other than an initial $60M in bookings at launch.

Everybody Else

Microsoft and Yahoo have been working to take on Google and Apple. The two companies inked a 10-year advertising deal in 2009 (approved in February 2010 by the FTC and EU regulators) where Microsoft will power the technology behind Yahoo search while Yahoo will become the exclusive worldwide relationship sales force for both companies’ premium search advertisers. Companies with budgets over $5,000/month on online advertising go through Yahoo’s sales force, while anyone under goes through a Microsoft self-service portal.

Both are assumed to have been growing mobile advertising capabilities organically. Microsoft already has digital advertising know-how with its $6B+ acquisition of aQuantative in 2007 and has offerings that reach 57% of active mobile web users across all platforms through its sites and apps. In terms of mobile M&A, not much is known about Redmond’s 2010 conquests other than the fact it spent $245M on acquisitions during its FY 2010, but some blogs have indicated the majority of the approximately 15 deals were under $10M. While it avoided butting heads with Apple or Google for a major mobile acquisition, Microsoft also unveiled an SDK for Mobile advertising on its Windows 7 Mobile platform. With the announced Nokia smartphone tie up, it is difficult to imagine the companies not aggressively pursuing advertising revenue with the Windows 7 platform, which seems destined to be the world number 3 mobile platform.

On its own, Yahoo’s mobile offerings leave a bit more to be desired. Yahoo is still the third most visited network of sites in the US behind Google and Facebook. At the Mobile World Congress in Barcelona last week, Yahoo CEO Carol Bartz unveiled Livestand, a magazine platform/application to personalize published content for users on devices that include tablets and smartphones. Bartz indicated during her keynote that click through rates for mobile ads on Yahoo pages double when user settings are tailored according to their own interests. Based on the demonstration, it simply looks like any other app.

Erstwhile smartphone leader Research in Motion, scrambling to stanch its market share hemorrhage, announced the Blackberry Advertising Service in September 2010 to complement its “Blackberry Application Platform.” One of the first television ads for the Blackberry’s application platform seemed to be a remake of an Apple iPhone ad in 2008 featuring the Urbanspoon application. Too little too late.

Late Check-in?

Despite enabling its users to start revolutions and topple authoritarian regimes in unstable parts of the world, Facebook currently has no mobile advertising offering, evident by the absence of ads on its mobile app across platforms as of early 2011. Facebook currently has over 200M mobile users worldwide out of its nearly 600M total users and mobile users are also likely to be twice as active as regular users. It is the largest and most captive audience in the mobile world.

The company did roll out its “Places” feature for mobile devices, which is similar to an offering by Foursquare, that allows users check-in to local establishments and partake in some local deals. But the “Places” feature has yet to be monetized. However, Facebook did acquire “Rel8tion,” a mobile advertising company in January 2011. Rel8tion’s product seems to be a system for synching a person’s geo and demographic information with available ad-inventory, likely a step in the direction of offering mobile ads. Though executives at the company have remained mum about discussing their mobile monetization strategy, Facebook is a most formidable entrant and likely, an eventual leader in location based services.

Happiness is the Smell of a New Car

Advertising spend by its nature is a zero sum game as advertisers allocate predetermined budgets that follow macroeconomic conditions across a spectrum of media. To invest in mobile, an average marketer’s ad dollars come out of other media such as newspapers, magazines, or outdoor. With the emergence of mobile advertising comes a greater demand for more sophisticated creative design work and a growing market for Madison Avenue its major ad holding companies: Interpublic, Omnicom, Publicis, and WPP.

These companies are likely to undergo another seismic shift in patterns like that experienced with the emergence of digital advertising and are in a position of heightened risk. While they currently have a large exposure to traditional channels such as television, print, and radio, they will move more of their business and offerings to include mobile. The holding companies are uniquely positioned maintaining existing relationships with the largest advertisers (and budgets) in the world. They’ve bolstered their digital resources acquiring specialty ad houses and forming relationships with key interactive advertising networks.

However, advertising is not a capital intensive business or one that relies on long term intellectual property. Ad campaigns are born and die overnight with a simple goal to influence consumer purchasing decisions. Only a subset of the most successful ad campaigns last beyond a year. The agencies are fundamentally a professional services business where the most creative and most connected thrive. As a result, there is room for new entrants. The threat is most likely to come from new laser focused agencies focused on unique mobile offerings that can demonstrate an ROI. The agency holding companies also risk a brain drain of losing enterprising talent to strike out on their own to form these companies. Agency family maps constantly evolve as the holding companies acquire or form new boutique ad houses. Mobile will play out similarly to general internet advertising as Madison Avenue will buy out the most creative boutique mobile ad houses with the deepest relationships in the long run.

Not Invited to the Party

Each mobile carrier has had some advertising initiative since the advent of data enable phones, but the paradigm has changed with the emergence of smartphone platforms in favor of handset platform owners and emerging location based services providers. Verizon continues to maintain its mobile web advertising network within its own browser/sites, while AT&T has developed an advertising network around its yp.com (Yellow Pages) property. It announced an SDK in Q4 2010 and is planning catering to the hyper-local ad market. Aside from serving ads on their own web properties and Apps, the major mobile carriers appear to have been largely shut out of mobile advertising opportunities, at least within the Apple ecosystem, but may have some room to participate with Google and may have some opportunity with Nokia/Microsoft.

Winners and Losers

We believe that internet advertising as a whole will continue increasing at a rate greater than 10% driven by mobile advertising and more sophisticated formats/technologies that enable video. We see mobile sustaining a growth rate in excess of 20% to the end of the decade. The clear winners are the smartphone platform leaders. We believe Google’s strategy of proliferating Android as widely as possible will prove wildly successful, as the company leverages the expertise it has gained as the clear leader in Internet advertising to drive advantage in the mobile arena. Moreover, scale across all e-advertising media – i.e. search, display, video, mobile – and the strength and breadth of its ecosystem partners put it at the pole at the start of the race (Exhibit 12).

Apple is also an obvious winner, although its premium pricing and tight platform control limit the breadth of its participation. If Apple sticks to its own platforms, as it seems genetically presupposed to do, we believe that it will be addressing just a modest part of the overall mobile advertising market. While we are loath to discount Apple’s ability to do anything, we do not see them challenging Google for the top spot.

Microsoft has shored up its position with its recent agreements with Yahoo and Nokia. Together, the three companies should be able to craft a viable position to take a slice of this lucrative and fast growing opportunity. RIMM still has a sizeable and loyal installed user base, but its app store and advertising offerings are poorly positioned and its market share has been in decline. We see RIMM as a loser.

Social networks and location based services providers, most of which are currently private or in start-up mode are well positioned for a growth market, but will emerge as winners or losers based on execution. Given Facebook’s user base size and influence, the current lack of a mobile advertising vehicle would be concerning to any early investor, but we’re confident they will emerge with a compelling location based advertising offering access to 200M+ mobile Facebook users.

Wireless carriers are in varying degrees of exposure to mobile advertising. AT&T appears to be the best positioned because of its yp.com property. Verizon is engaged in mobile advertising to a lesser degree within its own browser and sites. Sprint, Clearwire, and T-mobile have little exposure to mobile advertising and have little leverage against Google and other device manufacturers.

The three major ad holding companies: Omnicom, Publicis, and WPP are likely to shift resources to mobile advertising creating new agency brands at the expense of other mediums such as Television, Newpapers, Magazines, Outdoor, etc. These companies are largely professional services business models and have exposure to all of advertising, but all have the risk of relative share loss to each other, and to the creative capabilities of dedicated on-line competitors. As such, each could be either winner or loser, depending on execution. We believe that it is too early to make the call.

Ultimately, the biggest losers will likely be the companies unable to leverage their traditional media assets – television networks, magazines, newspapers, etc. – into the mobile internet. While some will establish brand and position in the on-line world, we suspect most will drop the ball in managing the transition.

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