 |
Internet Marketing · eMarketing · Internet Advertising · Online Branding |
|
Internet Marketing · eMarketing · Internet Advertising · Online Branding |
|
|
|
||
| ADVERTISING BY ICONOCAST |
||
When Exposure-Based Web Advertising Stops Making Sense
(And What CDNOW Did About It)*
Donna L. Hoffman and Thomas P. Novak
eLab
http://ecommerce.vanderbilt.edu/
Owen Graduate School of Management
Vanderbilt University
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
1
When Exposure-Based Web Advertising Stops Making Sense
(And What CDNOW Did About It)*
Donna L. Hoffman and Thomas P. Novak
eLab
http://ecommerce.vanderbilt.edu/
Owen Graduate School of Management
Vanderbilt University
Contact:
Professor Donna L. Hoffman
Hoffman@ecommerce.vanderbilt.edu
615-343-6904
615-343-1378 Linda Roberts, assistant
615-343-7177 fax
*This paper appears in print as: Hoffman, D.L. and T.P. Novak (2000), "How to Acquire Customers
on the Web," May/June, Harvard Business Review, 179-188.
Author note
Donna Hoffman and Tom Novak are the co-founders of eLab, the Electronic Commerce
Research Laboratory, and marketing professors at Vanderbilt University’s Owen Graduate
School of Management in Nashville, Tennessee. For more information on Internet advertising
strategy and related issues, see http://ecommerce.vanderbilt.edu/.
Draft Date: January 2000
elab.vanderbilt.edu
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
2
When Exposure-Based Web Advertising Stops Making Sense
(And What CDNOW Did About It)
Internet advertising is rapidly emerging as a key strategic tool in the battle for online customers.
Managerial attention is increasingly shifting to online advertising as a viable mechanism for
generating traffic and stimulating trial at consumer-oriented Web sites. According to eMarketer,
total Internet advertising revenues exceeded $3 billion in 1999 and the category is growing far
faster (112%) than traditional mass media advertising vehicles like cable (13%), television (7%),
and print (6.2%).
For the first time ever, in 1998 Internet advertising surpassed outdoor advertising expenditures
(estimated at $1.6 billion for 1998) and is poised to overtake business papers soon. A recent
PricewaterhouseCoopers survey put fourth quarter 1998 advertising spending up 95 percent over
the same quarter a year earlier, and 34 percent higher than the third quarter of 1998. The Internet
advertising industry has now logged over three years of revenue growth and online advertising
revenues are expected to hit nearly $13 billion by 20031. The increasing popularity of the Internet
as a communication medium and online retailing environment for consumers makes it clear that
online advertising deserves serious and focused management attention.
Advertising on Web sites is attractive because it represents an innovative media buy for many
firms, while at the same time retaining comforting parallels to existing marketing efforts in the
“real world”. While these parallels may appear to reduce the risk of initial online commercial
efforts, in our experience they also carry a different risk of obscuring more innovative media
strategies that ultimately represent the path to greater online profits.
Optimal online advertising takes advantage of the fact that the Internet is a many-to-many
communication model that reverses the traditional one-to-many broadcasting paradigm. Because
it is interactive, firms can not only address consumers, but consumers can communicate with
firms and provide content of their own to the medium. Much to the chagrin of many firms, this
consumer-supplied content is quite often out of their direct control.
The Web allows an unprecedented level of consumer choice in an environment that economists
would argue approaches one of full information. Additionally, consumers have much more
control over the consumption of content online, compared to traditional media. These factors are
causing the balance of power to shift in favor of consumers. It is against this complex and rapidly
evolving backdrop that firms are struggling to develop coherent Internet advertising strategies.
As with advertising programs in the real world, online managers want to know whether
advertising is achieving the company's business objectives. Traditionally, however, advertising
has not been able to provide meaningful measurements of results. At best, conventional
broadcast and print advertising has only allowed measurement of the mass amount of advertising
1 Although, for perspective, it’s important to note that the online advertising industry still represents only
about 2 percent of the total $170 billion advertising industry overall.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
3
delivered - as opposed to actually consumed - usually expressed in terms of exposures or
impressions and at best broken down by demographic or psychographic segments.
Thus, for managers seeking measurable results from online advertising, traditional media models
offer little guidance, and may even hinder the process of capturing the value in consumer
response in virtual environments. Further, the Web possesses unique characteristics compared to
conventional media. These differences warrant new strategies. Borrowing advertising practices
and metaphors from traditional media like exposure-based advertising pricing models and
billboard-like “banner ads” is likely to be appropriate only for limited advertising objectives such
as awareness in the context of branding goals.
The Web belies John Wanamaker’s oft-quoted lament that "I know half the money I spend on
advertising is wasted, but I can never find out which half.” For the manager concerned with
reaching business objectives, the Web promises the precise quantification of the effectiveness of
a particular advertising campaign in terms of those objectives - for the first time in the history of
media. But how should the manager use online advertising to reach those objectives?
Base Online Advertising on Performance, Not CPMs
Traditional broadcast media rely on exposure based pricing models, where the cost of an ad is a
function of the total number of impressions delivered by the vehicle. The way for a broadcaster to
maximize profits under this cost-per-thousand (CPM) model is to deliver the largest possible
audience to the advertiser. Although exposing a broad demographic target to a commercial
message can satisfy awareness and branding objectives, smaller, more targeted segments with
whom the firm can interact are actually worth much more if they are exactly the customers most
likely to give the desired market response.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
4
Exhibit 1:
Link Online Advertising Efforts to Business Objectives
[Sidebar to figure: Online, managers must confront two sets of objectives, broadly characterized
as customer acquisition and customer retention. Customer acquisition includes generating initial
traffic to the site and building the online brand identity. Customer retention involves attracting
visitors over time – visitors who engage in the desired customer responses (for example,
responding to requests for demographic information or purchasing an online offering) on a
regular basis. In other words, the objective here is to convert casual visitors into regular online
customers. In the parlance of traditional marketing, the manager can think of these as the trial
and repeat problems, respectively. Research shows that the Web is unquestionably useful as a
branding mechanism, largely through the development of brand image and efforts focused at
brand reinforcement. In the case of such objectives, exposure-based pricing metrics such as flat
fee sponsorships, CPMs, and even CPC -cost-per-click - (i.e. click-through rate) models may be
appropriate. Yet, the real strength of the Web lies in the fact that it is the ideal medium for
implementing an interactive direct model of sales response. This means that the Web is ideally
suited to generate - and track - product leads, collect real-time information on customer tastes,
and seamlessly satisfy the ultimate fulfillment of the order. In these cases, the best metrics are
unquestionably those tied directly to interactive customer behavior. These include
measurements based on frequency of visits, time spent at the site, navigation patterns at the
site, and, as we discuss in this article, pay-for-performance models in which the advertiser pays
only when the desired response has been achieved.]
Flat fees
Web Advertising
Hierarchy of Effects
Awareness
Passive Interest
Active Interest
Purchase
Retention
Site Traffic
Loyalty
Interactivity
Exposure
Market
Response
Branding
Web Marketing Objective Web Pricing Metric
CPMs
Customer Acquisition
Customer Retention
Click-through
Pay for Performance
Duration
Time
Browsing
Depth
Visit
Frequency
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
5
Despite the fact that the Internet promises to be the most accountable medium ever, Internet
advertising efforts at the end of the twentieth century still favor banner ads based on exposurebased
CPM or click-through rate metrics. The primary reasons for this are that such metrics are
widely understood by traditional media executives and are easy to implement.
But, are current online advertising efforts effective? Motivated by a desire to draw executable
analogies with traditional media, managerial efforts to date have focused on advertising on those
Web sites with the largest numbers of visitors. But treating the Internet as if it were just another
mass medium like TV or print leads to suboptimal media plans. Web “portals” like Yahoo and
MSN, two of the largest Web sites in 1999 in terms of traffic, necessarily attract the widest
variety of consumers. Yet viewing individual Web consumers seeking customized online
experiences as largely interchangeable units of a mass “audience” – reflecting the traditional
broadcast bias of “more is better” - is actually hindering the development of more effective
targeted ad strategies.
Of course, portals can segment within their site and target specific pages and/or sections for
specific advertisers. The question becomes whether ad rates are overly influenced or inflated by
the total number of visitors for an ad buy that is actually targeted to only a subset of these
visitors. That is, would someone pay more for a particular number of exposures to a targeted ad
at Yahoo than they would for that same number of exposures at a lower-traffic site that was as
equally well-targeted?
Predictably, online managers are increasingly dissatisfied with banner ads and flat fee portal
deals. A recent benchmarking survey revealed that a majority of leading executives in the US
marketing and advertising industry would invest more heavily in Internet advertising if only they
could measure the return on their online investment. It should not surprise the reader that these
same executives complain that Internet advertising CPMs and CPCs are too expensive.
It’s no wonder then that managers are seeking an alternative to the exposure-based advertising
model. With the total number of Web pages rapidly approaching one billion (800 million at last
count) – and many of those commercial and seeking advertising - there is now significant unsold
inventory in the online advertising industry. Online properties, the so-called “dot-coms,” are
increasingly buying ads in offline media. Combined with the fact that consumers no longer
“click-through” banner ads at the rates they used to – average click-through rates have
plummeted from their giddy highs of 10% or more a few years ago to an average of under 1% -
mean that CPMs have fallen dramatically in the past few years. Average CPMs are now near $30,
down from $40 only two years ago, although prices vary widely depending on the Web site and
can range from a low of a few dollars on some advertising networks up to a high of around $100
or more for one of the top portals.
But since the objective online is to attract and retain customers, the critical issue is customer
acquisition costs. Using current figures, a CPM of $35 means that the cost to expose a single
visitor to a banner ad is 3.5 cents, or $0.035 per impression. This doesn’t sound so bad, except
that the objective is not mere exposure, but some sort of response. Now suppose (generously)
that the clickthrough rate is 1%. This means that the net cost to the advertiser to attract a single
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
6
potential customer is $3.50 (since the clickthrough rate is $3.50). If the conversion to purchase
rate is 1%, then the customer acquisition cost is $350. With overpriced CPMs and trivial
clickthrough rates, the customer acquisition costs through banner ads at many commercial Web
sites are almost triple those of traditional media. And for expensive flat fee sponsorship deals
with portals, the situation may be even worse. Recent studies show that after two or more years
online, most consumers bypass portals altogether when navigating e-commerce sites. No wonder
that advertisers are choking on customer acquisition costs that can easily exceed $500 or more on
the top portals.
But the real problems arise when we consider the net result of such advertising efforts over the
lifetime value of each customer. Even the following simple example illustrates the problem. For
sake of argument, let’s assume that the average online customer spends $50 at an advertiser’s
Web site on her initial visit. Further assume that our advertiser’s gross profit margin is 20%, so
that the average customer provides $10 average profit on that initial transaction. Now, let’s
assume that 50% of the advertiser’s customers return on another visit and click their way through
to an additional $100 worth of purchases. This gives another $10 of gross profit. If another 10%
of the site’s customers come back and conduct yet another $100 worth of business, that’s another
$2 and so on. In this way, the gross profit per customer approaches $25. As long as the
advertising costs per customer are below $25, no problem. But remember that the cost per
customer is $350, which means, when the advertiser does the math, that the site is actually losing
$325 per customer!
So, while Internet advertising continues to gain legitimacy - consumer advertisers, not the
computing industry, lead the industry in online spending – it is not surprising that managers are
still confused about what the Web represents as a marketing medium. In effect, there is no broad
sense of the best strategies for success. Simply put, advertisers are unsure how to measure the
return on their advertising dollars. It is clear that moving to methods that tie advertising to sales
is the way to prove the effectiveness of Internet advertising. Not only that, but many executives,
particularly those at large firms, have clearly signaled that their skittishness in embracing online
advertising rests primarily with the need to prove accountability.
Not surprisingly, advertisers are demanding, and receiving, accountability. Procter & Gamble,
the nation’s leading traditional advertiser, was one of the first companies to move to resultsoriented
pricing for Web based advertising. In April 1996, Yahoo agreed to Procter & Gamble’s
requirement that it be paid only for the click-through on P&G’s banner ads, and not on the basis
of mere exposures. This is because clickthroughs represent a measure of active interest in the
advertiser’s message, as opposed to the passive interest a consumer is assumed to show when she
browses a page containing an advertiser’s banner ad.
We argued above that the unique characteristics of the Web are causing the balance of power to
shift in the direction of the consumer. The Web’s ability to provide measures of accountability is
also shifting the balance of power between the Web sites that serve as vehicles for advertising
(what we call the Web provider) and the advertisers, giving rise to more collaborative
relationships among them. The Web provider naturally favors guaranteed revenues from
delivering “eyeballs” under the argument that moving to a results-oriented model holds that Web
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
7
provider “hostage to the creative.” Yet the Web advertiser rightly reasons that it makes no sense
to pay for that “half” of advertising, now precisely measurable in terms of business objectives,
which is wasted.
The Web as a Direct Model of Sales Response
A dot-com that wants to communicate with its customers need not be tethered to exposure-based
advertising practices on loan from traditional media. Already, more and more firms are
recognizing that the Web is the perfect medium for an interactive direct model of sales response.
Savvy Web providers, instead of viewing themselves in traditional media vehicle terms, are
increasingly building unique cooperative marketing arrangements with Web advertisers where
both share the responsibility for achieving marketing objectives. These pay-for-performance
advertising strategies – either being paid (Web provider) or only paying (Web advertiser) when
some form of e-commerce is actually generated - executed jointly by Web providers and Web
advertisers, offer the most innovative and effective set of strategic options for managers
interested in achieving results-oriented objectives on the Web. They also enable resourceful Web
advertisers to get their money’s worth and are more likely to lead to long-term online
profitability. Pay-for-performance advertising works and keeps Web advertisers focused on what
counts: knowing exactly how their marketing efforts pay off.
In pay-for-performance ad strategies, the Web provider displaying the ad shares more in the risks
and rewards of advertising placement than has traditionally been the case. The revenue gained by
achieving a particular market response, such as a product sale, is shared between the Web
advertiser and the Web provider.
Thus, the Web provider markets an offering for a Web advertiser on its site and is compensated
by the Web advertiser according to quantifiable performance. The reliance on market response
puts more responsibility on the Web provider for results and the Web advertiser and Web
provider function more as active partners in a cooperative arrangement than would otherwise be
the case under the mass media driven impression-based advertising pricing models. This new and
evolving form of online advertising turns traditional media rules literally inside out.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
8
Exhibit 2: Pay-for-Performance Advertising
Web
Advertiser
Web Provider
Web Provider
Web Provider
Web Provider
Market
Response
Market
Response
commission
commission
How It Works at CDNOW
The Evolution of CDNOW’s Pay-for-Performance Strategy
Despite the fact that Amazon.com garners most of the media attention for pay-for-performance
Internet advertising – what Amazon.com calls its “Associates Program” and what is now called
affiliate advertising in the industry – CDNOW, launched in August 1994, actually pioneered
what is rapidly becoming an important new form of new media advertising. Indeed, by 2004,
Forrester Research estimates that half of the projected $33 billion in worldwide online
advertising spending will be performance-based. Jupiter Communications further estimates that
fully twenty-five percent of Internet retail sales will be acquired through sites using the affiliate
advertising model by 2002.
In November 1994, almost a full year before Amazon.com even launched its Web site, CDNOW
began its Buy Web program. In this first application of what have come to be known as
“affiliate” or “associate” programs, CDNOW introduced the idea of click-through purchasing
through independent online storefronts. The idea was that music-oriented Web sites could
review or list albums on their pages that their visitors might be interested in purchasing and offer
a link that would take the visitor directly to CDNOW where it was available for purchase.
Jason Olim, CDNOW’s CEO and co-founder, explains that the idea for this type of “remote
purchasing” actually arose as a result of conversations with Geffen Records in the fall of 1994.
Executives there wanted the ability to sell artist discs directly from their site but didn’t want to do
it themselves and wondered if they could link to CDNOW for fulfillment. Olim realized that
CDNOW could link directly from the artist on Geffen’s Web site to his Web site, bypassing the
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
9
CDNOW home page and going directly to the artist’s discography page. In this way, CDNOW
linked Geffen Records to CDNOW and the affiliate advertising format was born.
Creating this shared interest between Geffen and CDNOW – at the time with no specific
exchange of value around the link - was an important inspiration because it represented the most
powerful way for both Geffen, and especially CDNOW, to build their online businesses in these
early days of the commercial Web. In the fall of 1994, the main way to promote a commercial
Web site was to get it listed on the now defunct NCSA Mosaic’s “What’s New” page or the
Global Network Navigator’s Whole Internet Catalog page. In those early days of the Web’s
commercial development, the concept of online advertising had yet to emerge as a mechanism
for building and directing traffic. Thus, Geffen and CDNOW could cooperate and share
responsibility for achieving their respective business objectives. In this win-win advertising
strategy, Geffen promoted and enabled the sale of its artists’ discs online and CDNOW actually
sold the discs.
Following this advance, CDNOW formally introduced the concept as “BuyWeb” in the fall of
1994. Olim believed this would be a very powerful way to promote the site. At first, it was
simply a technology that allowed Web site owners, referred to as “members,” to link directly to
an artist’s page. Over time, the BuyWeb program grew. In 1994, CDNOW had a dozen or so
members, but no money changed hands.
By 1995, there were a few hundred affiliate members in the BuyWeb program. At that time,
CDNOW launched a revenue sharing arrangement where they began to pay small commissions to
Web site owners who used the technology. This gave member Web sites the inducement they
needed to join the program, and provided them with an important opportunity to make money on
the Internet. CDNOW created a methodology that enabled them to track purchases that online
customers made and pay the referring Web sites 3% of the revenues from the discs that CDNOW
sold that were directly attributable to the links. The technology allowed CDNOW to explicitly
track when a visitor clicked through from say, the Geffen site, by encoding the Geffen name in
the URL. Subsequently, the commission percentage was raised to 15%.
In this way, small Web sites like Lauri's Dreamy World and Mass Confusion Music created value
for CDNOW by recommending various compact discs to their cyberbrowsers that could be
purchased on CDNOW's Web site. The links that such sites placed next to their music reviews
gave their visitors the option of effortlessly purchasing the reviewed disc on the CDNOW site.
Lauri's Dreamy World and Mass Confusion Music received value in the form of the commission
paid by CDNOW each time a visitor clicked on the CDNOW link and purchased the highlighted
CD.
The BuyWeb program evolved into “Cosmic Credit” in the spring of 1997. Unlike high-profile
Web portal sponsorship deals, CDNOW’s Cosmic Credit program targets low-volume,
nonprofessional sites of music fans. In late 1999, CDNOW created the Cosmic Music Network
on top of the Cosmic Credit program. The Cosmic Music Network builds on the success of the
Cosmic Credit program by allowing unsigned artists to put up a Web page at the CDNOW site,
upload music that fans can download for free, and link their work to more well-known bands
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
10
elsewhere in the CDNOW store. Today, CDNOW pays referring sites anywhere from 7% to 15%
on a sliding scale based on volume when visitors click through and make a purchase on the
CDNOW site.
The Cosmic Music Network is significant for a number of reasons. First, it gives CDNOW a
staggeringly large number of potential marketing partners. Second, the program, which has over
250,000 members, is one of CDNOW’s most significant sources of customer acquisition,
allowing the company to advertise to potential customers it would otherwise not be able to reach.
No way could CDNOW afford the administrative burden of buying advertising on all 250,000 of
these sites, and there is no market for an intermediary to do so cost-effectively. The mere
administrative expense of filing that many insertion orders would be prohibitive. But members
identify and sign themselves up automatically for the Cosmic Music Network with a few clicks
on CDNOW's site, so the system is not only affordable but grows naturally. As the Web expands,
so can this strategy, meaning that CDNOW can potentially enroll millions of members into the
program.
Third, and most important, unlike banner ads, revenue-sharing programs are "webby" by nature.
They build on the interconnections intrinsic to the Web and on the Web's ability to monitor and
track activity in real time. With the Cosmic Music Network, CDNOW knows for a fact how
many visitors arrive from each member's site and how many visitors are converted into buyers. In
this way, CDNOW can precisely calculate the relative effectiveness of each of its online
marketing investments. Armed with the number of visitors, the number of new customers, the
number of repeat customers referred from each member’s Web site, along with the profit
contribution of each customer, CDNOW has everything it needs to estimate the lifetime value of
a customer by source of acquisition. And with that figure, CDNOW has a very powerful
yardstick by which to measure the effectiveness and determine the proper mix of all its marketing
efforts.
The benefits of this new model of advertising should be readily apparent. With banner ads sold
on the basis of CPMs, there is simply no effective way for online advertisers to measure
consumer response. With BuyWeb, CDNOW knows for a fact how many visitors arrive from
each member site and how many are converted into buyers. In this way they are able to precisely
calculate the relative effectiveness of the media buy. Armed with the number of visitors, the
number of new customers, and the number of repeat customers referred from each member Web
site, they have the components to estimate the lifetime value of a customer by source of
acquisition. This accountability, more than anything else, is driving the trend toward pay-forperformance
advertising and shifting the balance of power in the industry.
No Good Early Options
In the early days of the commercial Web - around late 1994 and early 1995 - few Web publishers
or advertisers understood the value of the Web as an advertising medium, let alone what price to
assign to online advertising. Managers working with traditional media certainly understand the
value of a 30-second television spot or a classified ad in the back of the book, due to factors
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
11
including industry norms, program ratings, years of marketing research, and managerial
experience. But except for a handful of pioneering online programs like CDNOW’s BuyWeb,
which produced measurable results, there was simply no way to know.
This presented a dilemma for those managers who wished to advertise online. CPMs were
inflated and flat fee deals were even worse. There were no guarantees and there was no
rationality to the market. It didn’t take much for the would-be online advertiser to see that
current CPMs were a bad buy.
Many of the early online selling efforts were conducted by magazine sales people with little
experience regarding how new media actually worked. In the absence of such knowledge, they
quite literally invented CPM rates in the low $70s or charged flat fees from $5000 to $10000 per
month to advertise on some of the earliest commercial Web sites. As such, the media buy in
those early days worked something like this. The advertising salesperson would say, “The
magazine has 100,000 readers. This Web site has 100,000 subscribers. The magazine charges
$10,000 for a full page. The Web site will charge $10,000 a month.”
Then, CDNOW would ask the salesperson, as any online advertiser might, “Okay. What will I
get for that? For example, how many visitors?” The sales response was “No guarantee on
visitors to your site. No guarantee on click through. No guarantee on impressions.” Although
they quickly gave on impressions, Web providers, borrowing again from traditional print
advertising norms, would talk about their “circulation,” which in this context actually meant their
unaudited number of unique visitors.
It didn’t take long for CDNOW to determine that those current CPMs were inflated and an
obvious bad buy. At the flat rate of $10,000, the ad would never even generate enough revenues
to cover its costs. Consider the following. Suppose the price of a single banner ad exposure (i.e.
one page view) was 7 cents, since the Web provider demanded a $70 CPM, and that 1% of the
visitors that saw the banner actually clicked through. In that case, a single click cost seven
dollars. But since only a small percentage of those visitors to CDNOW through that link were
actually converted into paying customers, the customer acquisition costs were actually sky high.
Assuming a 1% conversion rate, the cost to acquire that new customer was $700.
CDNOW’s early forays evaluating customer-buying patterns enabled them to estimate the value
of each CDNOW customer. In this way, they were able to determine how much each customer
would contribute to gross profit over time. Because $700 was more than the value of a customer,
they knew the cost of advertising was too high.
Customer Acquisition and Advertising Strategy
In the five years since CDNOW first introduced the concept of pay-for-performance advertising,
the firm now finds itself with a much wider array of strategic advertising options to choose from.
For example, CDNOW will pay a CPM with guarantees if it is inside their cost of acquiring a
customer. In fact, they regularly buy advertising on the basis of exposures and visits, as long as
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
12
the media buy keeps them on the “right side” of their customer acquisition costs. This makes
sense for CDNOW since it knows exactly what the cost per customer is and, therefore, the value
of a single customer.
A critical component of CDNOW’s advertising strategy is the careful management of the sources
of customer acquisition. CDNOW acquires customers from eight different sources: (1) The
Cosmic Credit program - a risk-mitigating strategy at a low price; (2) Strategic partnerships,
usually exclusive, with powerful partners such as Yahoo and Lycos, - some are risk-mitigating
but they come at a high price; (3) Online advertisements like banner ads - not risk mitigating,
moderately expensive, but risk is managed through careful selection of sites; (4) Word of mouth
– the most powerful online source of customers and for CDNOW, as for many successful online
retailers, where the lion’s share of its customers come from; (5) Radio; (6) TV; (7) PR and (8) a
trivial number of free links that CDNOW did not purchase directly or enter into a specific
relationship with.
CDNOW further segments its customers according to whether it “tags” them or not. A tagged
customer is a new customer that CDNOW is able to specifically identify as acquired through
either the Cosmic Credit program, one of its strategic partnerships, or a banner ad. Fifty percent
of CDNOW’s advertising budget is placed with strategic partners and online ads. Customers
acquired through tagged sources account for 40% of CDNOW’s new customers.
Untagged customers are those who type CDNOW’s Web location directly into the browser or
follow a free link. Powerful, though largely unaccountable, forms of offline advertising
undoubtedly influence these customers, including word of mouth, radio and television spots,
publicity campaigns, and a small number of free Web links. These untagged sources account for
60% of customers new to CDNOW. The company allocates 50% of its advertising dollars to TV
and radio. Word of mouth customers are considered free.
Despite the fact that CDNOW does not know the path by which its untagged customers were
acquired, it is still able to judge the overall value of its different offline advertising efforts. For
example, market tests provide information on TV and radio advertising, and surveys give
information on the impact of publicity.
However, the accountability inherent in the Web means that CDNOW can determine precisely
how effective each of its online advertising efforts are, including which creative works best and
which sites make for the most effective vehicles. Note that this powerful accountability is unique
to online media.
In any given time period, let’s assume for illustrative purposes that CDNOW’s cost per customer,
that is, its average cost of customer acquisition, is $50, calculated over all media and customers
acquired during that period. Then, Cosmic credit customers are nearly free, costing the company
around two dollars in terms of cost per customer, the strategic partnerships and television
advertising are higher than the average cost per customer. In this way, it is easy to see that there
are both expensive and inexpensive sources of customers, calculated against the average costper-
customer. But there are ancillary benefits to the higher cost of advertising, for example the
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
13
influence on word of mouth that helps to bring the costs down. Looked at another way,
CDNOW’s advertising budget brings in 45% of its new customers and the rest are free.
Exhibit 3: CDNOW’s Comprehensive Advertising Strategy Includes
Both Online and Offline Media
Media Type Budget
allocation
(%)
Contributed
customers (as
% of total).
Radio offline 16 8
TV offline 16 7
Print Offline 16 5
Strategic Partner online 24 20
Online Ads online 24 5
expensive
Subtotal: 96% 45%
Cosmic Credit online 2 15
Public Relations offline 2 5
Word of Mouth offline 0 30
Free links offline 0 5
cheap
Subtotal: 4% 55%
Total: 100% 100%
As Exhibit 3 makes clear (figures shown do not represent CDNOW’s actual advertising program
and are for illustrative purposes only), CDNOW has a highly comprehensive advertising strategy,
with programs in both offline and online media. Its programs are sophisticated and run the
gamut from pure revenue sharing deals to inventive hybrid programs. However, its pure CPM
buys are disappearing and even with its biggest and most powerful partners, CDNOW media
buys are sliding toward the revenue-sharing end of the distribution. Contributing to this shift is
the fact that the quality of CDNOW’s revenue-sharing partners, in terms of traffic and conversion
rates, are improving steadily.
Clearly, revenue sharing advertising strategies are an important element in the online advertiser’s
revenue model. They offer two key benefits to advertisers like CDNOW: they mitigate risk and
they provide opportunities for advertising to be purchased at lower prices. For CDNOW, the
value of the Cosmic Credit program will only increase with time. Once CDNOW acquires these
customers, they are highly likely to re-enter CDNOW directly at a later date, further increasing
the revenue stream.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
14
Revenue Sharing Today
CDNOW is far from alone in relying on a pay-for-performance advertising program to contribute
to its online revenues. Amazon.com launched its own “Associates Program” in 1996 and now has
over 350,000 affiliates. By one estimate, sixteen percent of online marketers participate in a
revenue sharing affiliate program. Thousands of other sites, including the successful online
marketers Rei.com and Dell Computers, have strong affiliate programs, though CDNOW and
Amazon have amassed the largest number of marketing partners. Barnes and Noble.com is
catching up with its rapidly growing program. The online company pays commissions ranging
between 5 and 7 percent and had well over 100,000 affiliates by mid-1999.
For many sites, affiliate programs are an important component of profitability. Payment is either
by flat fee or commission. Most commissions fall in the 8-12% range, though some can go as
high as 25%. In just the third quarter of 1998, the popular technology site CNET for example,
facilitated over $80 million in sales for dozens of its online advertisers, receiving a flat fee for
each and every referral in the process.
Affiliate programs are not only growing rapidly, but they are becoming increasingly
sophisticated. Third party networks like LinkShare and BeFree have emerged to offer
commercial Web sites the e-commerce opportunities, along with the management systems,
services, and software necessary for navigating the details of an affiliate program. In one of the
latest evolutions, firms like Vstore.com provide Web server space and design templates to mom
and pop vendors who want to set up shop on the Internet, but don’t possess the requisite technical
know-how and resources to do so independently. Such firms pay their affiliates commissions on
each sale generated through the storefront.
For Best Results, Don’t Forget Objectives
Critical to the success of revenue sharing programs is their lack of exclusivity. Most affiliate
programs are open to any site that wishes to participate. Details of the program are posted on the
Web advertiser's site for anyone to read. The process of becoming an affiliate is straightforward:
the prospective affiliate simply reads the contract, accepts the terms, and fills out a registration
form. Typically, the affiliate controls the content, creative, and placement of the ad. The Web
advertiser pays only for advertising that delivers its desired outcome. Note that the Web
advertiser does not pay affiliates for exposures based on page views, or mere click-throughs, but
only for click-throughs that result in actual leads or sales.
Open agreements maximize the potential number of Web providers who can deliver customers to
a particular Web site, and increase the opportunities for precise targeting. Such actions move the
Web advertiser away from the traditional exposure-based mass media model toward more
effective, targeted marketing programs. CDNOW, for example, uses its open revenue sharing
program to selectively target online customers with widely varying musical tastes ranging from
classical to rap music.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
15
An open program also encourages appropriate Web providers to self-identify to those Web
advertisers that market products relevant to the site's audience. As the Web provider now bears
the opportunity cost of an advertisement that fails to deliver the desired result, he or she must
carefully evaluate potential advertisers to determine which offer the best opportunities for
generating the desired market response.
Clearly, advertisers have an economic incentive to make their revenue sharing programs
available to all Web sites that wish to advertise the firm's message in exchange for payment if the
desired response is achieved. There are no theoretical restrictions, economic or otherwise, on the
potential number of sites a firm can use to distribute its message to consumers. Thus, the revenue
sharing model follows directly from the many-to-many communications model underlying the
Web. This contrasts the one-to-many broadcast model that rewards only those few marketing
channels that can attract the largest number of visitors.
In this results-oriented paradigm, advertising is priced as a simple function of the desired market
response. Measurable responses include key marketing objectives like unit sales, software
downloads, qualified leads, product inquiries, and the like. A prime advantage of revenue sharing
is that Web advertisers can quickly account for their advertising expenditures. With a traditional
impression-based ad buy, the advertiser must attempt to measure the desired outcome indirectly,
or worse, be forced to assume a relationship between exposures and objectives. Thus, resultsoriented
advertising is the answer for marketing managers who are being asked to justify new
media advertising budgets.
Because relationships are more cooperative under results-oriented advertising efforts, the
advertising effort is enhanced. Both the Web provider and the online advertiser share in the
responsibility for a successful effort. Compare this to the perverse situation in the broadcast
television medium, where despite declining audiences, advertisers are forced to pay the networks
ever-higher rates to reach fewer and fewer mass-market households. This situation persists only
because advertisers have no obvious mechanisms to demonstrate declining outcomes.
Forecasting the Future
As the number of commercial Web sites continues to explode, the marketing problems of
attracting target consumers to a particular Web site, engaging them interactively within the site,
and then securing repeat visits, have become acute. Pay-for-performance advertising programs
create a critical link in the value chain by delivering consumers, for a fee, to a particular
commercial Web destination.
Such programs are important because they suggest a new business model for Web-based
commercial efforts. Results-oriented advertising focuses management attention on the
development of a long-term marketing strategy, as opposed to short-term tactical media buys.
Characteristically, revenue sharing agreements often have an unspecified term extending into
perpetuity, with changes to the commission rate allowed as market forces dictate.
Hoffman & Novak (2000), When Exposure-Based Web Advertising Stops Making Sense
16
Mass media driven impression-based advertising will likely never completely disappear.
However, we predict that revenue sharing advertising strategies, motivated by the business
imperative of measurable results, will become increasingly prevalent as advertisers continue to
demand accountability for their Web advertising expenditures.
The large portals continue to face stiff pressure to move toward results-oriented pricing models
and away from straight CPMs. The pressure is felt most acutely from giant online advertisers
like Procter & Gamble. Significantly, actions of these advertisers offline may foreshadow what’s
in store online. The powerhouse P&G is joining firms such as Ford Motor Company, AT&T, and
Kraft, in the move away from straight commission structures to performance-based advertising
payments to its agencies in the physical world. Such activities will only accelerate the growth of
pay-for-performance advertising in the online world.
As the revenue sharing model proliferates, the need for additional infomediaries will naturally
arise. These ancillary intermediaries will most likely serve as clearinghouses and networks.
Some will serve Web publishers seeking favorable commission structures; others will support
Web advertisers seeking appropriate Web publishers as vehicles and coordination of commission
payments.
As the Web continues to mature as a uniquely addressable mass market, advertisers will seek out
specific target segments of potential customers and the corresponding Web sites that can deliver
those customers. This will contribute to the continued explosion in open revenue sharing
advertising programs. As pay-for-performance programs continue to proliferate, mom and pop
Web sites will be able to participate in the profit potential of the Web. This in turn will stimulate
more commercial entrants, and more customers for those entrants, into the online marketplace.
In this way, the Internet will begin to reach its potential as arguably the most important business
phenomenon of the new millenium.