Sep 29, 2011

Online Video: The Media Industry’s New Frontier

The following interview was conducted with Ken Allen, a Vice President in Blackstone’s Advisory Practice, who leads Blackstone’s coverage of the Digital Media sector.

What are some of the macro trends you are seeing in the advertising industry today?

The advertising landscape is undergoing a dramatic transformation that began over a decade ago and that continues today.  We have gone from a world in which advertising was once broadcast to large, homogeneous audiences to one where highly tailored messages are targeted to specific individuals through multiple digital channels, often simultaneously.

The chart below shows the broad transformation that has taken place in the U.S. market.  As the online marketing channel has become more prevalent, increasing from only 5% of the total market in 2000 to 16% today, print has similarly experienced a dramatic decline, decreasing from a 38% share in 2000 to 22% today.  Underpinning these share shifts is the rise of online advertising technologies, in particular, Paid Search and Display advertising.

Importantly, as the previous data shows and contrary to the intuition of many, TV advertising’s share has actually increased in the past decade, implying that online has far from cannibalized TV as an advertising medium.  Television advertising’s resilience is primarily due to the fact that TV advertising, at least historically, has been fundamentally different from online advertising.  Online advertising is static in nature – Paid Search ads appear in the sidebar of our search results; banner ads appear as we read articles and browse web pages.  The Internet as we know it, to a large degree, has been a substitute for print media, such as the Yellow Pages, newspapers and magazines.  But it has not been a replacement for TV.  The advertising share shift has followed accordingly, with online advertising substituting for print advertising.  This dynamic is starting to change, however, as Online Video technologies continue to proliferate and as Internet Video becomes an increasingly viable substitute for television.

Another major trend we are seeing is that advertising is becoming more and more data-driven, in turn enabling a much higher degree of targeting.  A tremendous amount of data about our tastes and preferences is being generated through each interaction we have with our digital world, including web browsing, using our mobile phones, and using social media platforms.  This data is increasingly being analyzed in new ways to target each of us with the ad that has the highest probability of achieving a response from us at a particular point in time.  That ad could be shown as part of our search results, in the banner ads we are all familiar with, in the sidebar ads we see in Facebook, and, increasingly, through Online Video.

Why do you believe that Online Video has such tremendous potential as an advertising medium?

Despite the significant expansion of the online advertising channel over the past 10 years, the majority of online advertising today continues to be related to searching for specific products or services.  In other words, advertising online is typically targeted based on our intent; we search for something online, and we see advertisements that are related to what we were looking for.  This intent-based advertising is very different from what we typically experience when we see television commercials.  Rather, TV advertising is generally more focused on the branding of a product or service.  Such advertising is meant to connect with viewers on an emotional level and help customers – both existing and targeted – form a connection with a brand.  By its very nature, television advertising is also less targeted and more focused on reaching a wide audience.

The promise of Online Video is that advertisers can have the best of both worlds; e.g., high-impact branding that can be micro-targeted to a specific audience segment.  Until only recently, however, bandwidth limitations prohibited streaming video content and advertisements from reaching our desktops, mobile phones, or TVs.  With the massive investment that has been made in IP infrastructure over the past decade, bandwidth has finally gotten to the point where high-definition video is viewable through the various ‘endpoints’ we use to connect to the Internet.  This, in turn, has led to the relatively recent explosion of Online Video services, including Netflix, Hulu, YouTube, Apple TV, and Amazon.

Another key driver here is the effectiveness of Online Video advertising, which has been increasingly documented, whether you are looking at recall rates, viewing time, likability, etc.  This performance has led to CPMs that are on par with, or greater than, what we see in the offline world with TV.  Due to these underlying trends, we believe branding dollars will shift away from television and into the Online Video channel over time, much in the same way that advertising dollars shifted away from print and into online channels over the past decade.

Can you quantify the potential opportunity in Online Video?

Most forecasts for Online Video advertising assume a roughly $2 billion market today growing at nearly 40% per year to over $7 billion by 2015.  I think this forecast, which is primarily determined by taking today’s market and growing it at a constant rate into the future, potentially understates the long-run market size by a significant amount. The chart below shows the untapped potential we see in this market.  As the chart on the left shows, 82% of offline advertising dollars in the U.S. are directed at branding efforts (defined as TV, radio, print, and outdoor channels), versus only 18% targeted at direct response channels (defined as direct mail and directories).  This ratio inverts in the online world, with only 39% of the online dollars targeted at branding (Display and Video).  In other words, the ‘branding gap’ in the online world, based on offline ratios, is approximately $13 billion in the U.S. alone. Video is particularly well suited to target this gap, in our view.  When combined with the $2 billion being spent on Online Video advertising today, this implies a $15 billion potentially addressable market.

Additional support for this untapped market potential is provided by the chart on the right, which compares the number of Online Video impressions having advertisements to those without advertisements.  Today, only 12% of the total videos online currently have ads.  The monetization of only 15% of the ‘unfilled’ inventory, at current average CPM rates, again implies a nearly $15 billion potential market by 2015.  Clearly, the current low ad penetration is partially due to the high proportion of user-generated content; for such content we would not expect to see high ad penetration rates.  But the low penetration is also a function of the nascence of this market.  Over time, as the quality of content improves and monetization techniques such as video ad networks and ad insertion technologies proliferate, we would expect to see much higher ad penetration rates and monetization of this largely untapped opportunity.

What are some of the implications you see regarding the advertising landscape?  Who are the winners and who are the losers?

I believe that the Online Video industry has the potential to impact the TV industry in the same way that the Internet impacted the print industry.  We see many of the same precursors: dramatically improved bandwidth, new and disruptive technologies (YouTube, Hulu, etc.), the fragmentation of content, and new ways of accessing content that go ‘over-the-top’ of traditional, entrenched distribution channels.  Innovation is occurring at a dizzying pace right now and I believe it is only a matter of time before we see an over-the-top video platform become successfully integrated with the television.

Given these trends, there is a war going on right now among players in the ecosystem to try and lock up two of the most strategic elements of the video value chain:  the end-point (TV, set-top-box, mobile handset, etc.) and the content that is distributed to that end-point.  Much of the partnership and acquisition activity we are observing among the major players in the ecosystem is aimed at maximizing share of content by solidifying rights to use that content.  Further, many of the distributors of Online Video are beginning to create proprietary content of their own.  Examples include Google, which is reportedly spending hundreds of millions of dollars to create original content on YouTube, and Netflix, which is doing the same through its streaming video service.  The end-point is a similarly prized battleground, where the various service providers are fighting to gain a large strategic footprint.

In addition to the larger players, we also believe a new crop of technology providers are showing tremendous potential, such as the video ad networks, ad insertion players, and online video platforms (OVPs), which are increasingly enabling the ecosystem with new and innovative technologies.

The losers will be incumbents who elect not to embrace these trends.  We have seen such a phenomenon before with other types of media:  first with print, then with books and music.  Video, I believe, will be next.