Engagement Rate is the Margin Squeeze in Digital Advertising

Engagement Rate is the Margin Squeeze in Digital Advertising

Engagement rate, the percentage of the audiences that consumes a particular piece of editorial content, creates the biggest squeeze on digital advertising profits.  The advertising profit contribution of media is defined by the advertising revenue produced from page views minus the costs to create the content and sell the advertising. Unlike print media that uses circulation and pass-along rate to define a sellable inventory of page views, digital media uses audience size and engagement rate.  While pass-along rate acts as a page view multiplier on circulation, engagement rate is a page view filter on audience size.  The consequence is that the engagement rate puts a squeeze on advertising profit margins.

To illustrate this point, the infographic below benchmarks the advertising profit contribution of ad sales and editorial of print vs. digital.  As in previous comparisons, this example assumes the print product is a 50-page magazine with 30 advertisements which means for every additional page of editorial the sales team needs to sell 0.6 ad placements.  On the other hand, for every page of editorial in digital the sales teams typically needs to sell 4 ad placements which is an increase of 6.7 times more insertion orders vs. print.  On the surface, it appears like the increased cost of sales would result in more revenue (i.e., 4 ads vs. 0.6) but this is where engagement rate impacts the revenue and profits.

Scout® Research consistently finds that the engagement rate for an individual piece of the editorial is rarely above 10%.  Average engagement rates across all editorial within a site are usually below 10%.  So at a 10% average engagement rate, which is very good, a page of digital editorial in the infographic example will generate 50,000 sellable advertising impressions (i.e., 100,000 members X 10% engagement rate X 4 ads per page view + 20% additional from fly-bys).  In contrast, the 0.6 ads per page in print multiplied by 100,000 circulations and the 1.75 pass-along rate results in 105,000 sellable advertising impressions.  To make up for the drop in sellable impressions, the digital editorial team has to create two times more content.

In other words, to get to the same revenue assuming digital and print CPM consistency, the digital team has to sell 6.7 times more advertising and produce 2 times more content.  This is the advertising profit margin squeeze.

Engagement rate has at least two immediate implications.

The first is that given the impact on advertising profits, engagement rate is an important new metric for managing digital.  The engagement rate informs the publisher about the priorities for profits.  With a low engagement rate, a publisher needs to improve profits through audience development.  With a high engagement rate, a publisher needs to improve profits through more editorial.

The second implication is that engagement rate creates a structurally different profit model for digital advertising compared to print.  A structural difference that cannot be overcome except through diversification of the revenue model or a rethinking of advertising.…

How to Calculate the Breakeven Point for Digital Subscriptions

How to Calculate the Breakeven Point for Digital Subscriptions

In subscription-based business models, maximizing customer lifetime value is understood to be a key success factor to a profitable business. But how do you know at what point a customer relationship turns profitable? While there are obvious differences between customers, it turns out you can calculate your average customer lifetime to reach the breakeven point using your existing operating metrics. So how is this done?

Here is the standard operational metrics are known by every online service:

  • Customer Acquisition Ratio (CACR)  – the sales and marketing costs to sign up a new customer as a ratio to revenue acquired
  • Customer Renewal Cost ratio (CRCR) – the sales and marketing costs of closing a renewal as a ratio to revenue renewed
  • Research and Development ratio (RD) – the cost to invest in and make improvements to the service as a ratio to revenue
  • Gross Margins (GM) – revenues minus the costs associated with hosting a service and providing customer support
  • General and Administrative ratio (GA) – the cost associated with finance, management, and other functions as a ratio to revenue
  • Churn Rate (CR) – the percentage of revenue not renewed at the end of a subscription term
  • Profit Margin (PM) – the percentage of revenue that are profits

With these operational numbers, the profitability of a customer relationship can be calculated as the total lifetime subscription revenue minus the total costs. The total subscription revenue would be the number of subscription terms multiplied by the subscription price, minus any churn. The total cost would be the customer acquisition costs, customer retention costs, and prorated G&A, R&D, and operational costs. Expressed as a calculation, it would appear as follows:

As demonstrated by the calculation, the total number of terms (i.e. CL, or customer lifetime) is critical to profitability. The equation can be turned into operational metrics by dividing by subscription price to create ratios of each cost in relation to revenues. The result is the following equation:

So by digging out the old math knowledge, solving the average customer lifetime to the breakeven point can be done using the following equation:

At breakeven, profit margin (PM) equals zero which allows the equation to be solved.

The Implication

Knowing your breakeven point on customer relationships enables you to identify the source of profits. You can segment customers quickly into profitable and unprofitable categories. With that segmentation, you can identify what drives profitability and what are leading indicators of churn. In other words, you can optimize your revenues and profits. Scout Research is developing a customer relationship calculator and benchmarking tool for use on our site, which will perform these calculations for you.  Look for an announcement in the near future on the availability of the calculator.…

Manufacturing Scarcity to Drive Publisher Profits

Manufacturing Scarcity to Drive Publisher Profits

I’ve recently been hearing a lot of chatter about scarcity in the publishing world. If you listen to studies (e.g., Pew), twitterers (e.g., paywall), and bloggers (e.g., Jeff Jarvis), manufacturing scarcity sounds impossible – even unethical. But in reality, publishers have the absolute need to manufacture scarcity to drive profitable revenue.
From the business ethics perspective, it is a common business practice to manufacture scarcity for profitability.  Take a look at how the airline industry is finally returning to profitability after a decade of losses; most of this profit is generated because of the reduction in capacity (a.k.a., artificial scarcity).  Auto manufacturers often retain pricing premiums by limiting production (a.k.a., artificial scarcity).  In the entertainment industry, movie releases first go to theatres, then to purchase, then to rental (a.k.a., artificial scarcity).  Remember limited edition iPods?  All kinds of products have limited production/editions to create artificial scarcity.  Simply put, artificial scarcity creates profitable revenue.
In terms of the viability of the idea in the publishing world, of course, publishers can manufacture scarcity.  While scarcity based on the distribution (e.g., print) is gone, manufacturing scarcity in the digital world is not impossible, only different.  Kevin Kelly’s blog post, Better Than Free, speaks to eight value-generating qualities for manufacturing scarcity on the commoditized web (good read although he overlooks scarce content). It supports the idea that scarcity must now be based on differentiated value to the audience.
Here are a few quick examples of both B2C and B2B publishers that manufacture scarcity.  Consumer Reports has always relied on the limited availability of their content to generate profits.  BabyCenter creates a unique experience through the personalization of content to match the stage of pregnancy and throughout childhood.  Rolling Stone is leveraging its archive to create scarcity and new revenue.   TechCrunch and GigaOM are good examples of building revenue from physical events that complement their content.  The FT’s use of a paywall shows how scarcity can be dialled in for specific audience segments.
Benchmarking other publishers, experimenting with user experience, and evaluating paywalls are some options for figuring out how to create differentiated value (i.e., manufacture scarcity) and drive profits. Scarcity is a concept that we all need to get comfortable with.…

Importance of Analyzing Unit Cost of Engagement in Advertising

Importance of Analyzing Unit Cost of Engagement in Advertising

For publishers, analyzing the unit cost of engagement in advertising identifies revenue optimization opportunities.  In the next few blog entries, I’ll explore why and how to analyze the unit cost of engagement for ad orders.  This first entry in the series addresses the following questions:

  • What is engagement?
  • What is the unit cost of engagement, and how is it calculated?
  • Why is calculating unit cost important?

What is engagement? For advertisers and publishers, engagement is the length of time the audience spends with media and ad.  Engagement is one of the few scarce commodities on the Web.  An audience member’s options for news, entertainment, socializing, purchasing, and learning are exploding, and like it or not even with the mobile explosion, any one person has a limited amount of time to provide on any given day.  A publisher’s success is premised on maximizing its share of audience time (i.e., engagement) and the revenue it produces.

Today, the publisher’s standard for engagement mistakenly measures the page views rather than the length of time.  Using today’s standard, there is no difference between impressions that last 1 second, 10 seconds, or 2 minutes which of course doesn’t make sense.  Research has shown that the longer a person is exposed to a web page containing an advertisement the more likely they are to remember the advertisement.  Additionally, engagement enhances direct response advertising as a recent study published by TidalTV showed click-through rates of targeted ads increase as engagement increases.

What is the unit cost of engagement? Using a length of time as the measure for engagement, the unit price of engagement is simply the price paid by an advertiser for each second an impression is delivered to an audience member.

"Demand Map for Advertising"

How do you calculate it? The simple answer is to take the total revenue of an ad order and divide it by the total length of all impressions delivered as part of the order.  The chart to the right illustrates the unit cost of engagement.  In this chart, two advertisers pay the same $100 CPM rate to a media publisher for the same target audience.  The first advertiser’s order resulted in 5,000 impressions with an average length of 10 seconds each or a rate of $0.01/second.  The second advertiser’s order resulted in 5,000 impressions with an average length of 120 seconds each or a rate of $0.00083/second (12X lower rate for engagement).

Why is calculating unit cost important?    With all other factors equal, research has shown that increased engagement improves ad campaign performance in both direct response and branding.  By calculating the unit cost of engagement for ad orders, publishers can identify which orders were overpriced and which were underpriced.

Overpriced orders have lower engagement per dollar and lower conversion/recall rate per dollar.  Advertisers with overpriced orders are less likely to advertise in the future representing revenue risk (e.g., the first advertiser in the example).  Underpriced orders have higher engagement per dollar and higher conversion/recall rate per dollar.  Advertisers with underpriced orders are more likely to accept a price increase to continue targeting the publisher’s audience (e.g., the second advertiser in the example).

By knowing which audience segments have higher engagement and which advertisers are receiving good value, publishers can price discriminate to optimize their revenues.  In the next post, I’ll cover the quantitative method for establishing the unit cost of engagement.…

The New Discipline in the Subscription Economy: Recurring Revenue Management

If you’re a subscription business, the most dramatic effects of trends like cloud computing and mobile won’t be felt in your company’s product line. The real disruption will be to your revenue model. Customers will not pay to own your products. Instead, they expect to pay for the value they receive by using your products. Revenue management is the common approach to solving the challenge of optimizing the revenue model.  Unfortunately, the rules of subscription models render traditional revenue management ineffective.  To manage revenue and profits in this case, companies need a new revenue management process to optimize the revenue model.

What is revenue management?

Revenue management is common practice in the distribution-centric Transaction Economy.  The goal is to maximize revenue and profits by pricing products to match customer demand.  Revenue management is pervasive in such industries as airlines, hotel rooms, surgery, advertising, retail, media and rental cars.  For example, airlines offer a passenger a seat between two cities defined by departure time, legroom, seat width, and associated service.  Because the product, in this case, a seat, is both standardized in terms of customer fulfilment and limited in inventory, the airline can forecast demand at specific prices from different customer segments and manage seat availability to optimize revenue.  The airline can forecast demand for higher-priced seats from business travellers that value last-minute bookings and sell the remaining inventory at a lower price to early purchasing leisure travellers who value cheap travel.  While the business traveller and the leisure traveller sitting next to each other expected the exact same product, each valued the trip differently and consequently paid a different price.  By selling the right standardized, inventory-constrained product to the right customer at the right price, the airline maximizes revenue and profit.

Why can’t traditional revenue management be used in the Subscription Economy?

Unfortunately, distribution-centric revenue management doesn’t work for the consumption-centric subscription business model.  For example, imagine if your cellular provider informed you that all the minutes of data transfer were sold out for the day and you could not buy anymore regardless of the price?!  Or imagine if you wanted to sign up for a subscription and the provider said they were sold out?!  These are principles of the distribution-centric revenue management process.

The revenue management process is different from subscription business models for two reasons as shown in the figure.  The first difference is that customer fulfilment is variable.  While each customer receives a standard subscription agreement, each of them will use the product differently.  Unlike the airline example where the airline defined customer fulfilment (i.e., a seat), in the Subscription Economy, customers define fulfilment based on their individual usage (e.g., amount of texting consumed in a cellular plan).  Customer demand can no longer be determined from purchase data alone.  Customer demand must be measured by usage data and purchase data together.

Second, for subscription business models, there is no limitation in inventory.  In other words, the differentiated value between customer segments cannot be derived simply from product availability (i.e., inventory management).  Unlike airlines that create differentiated value and revenue based on managing inventory of a particular product package (i.e., a seat), in the Subscription Economy, differentiated value and revenue opportunities have to be created by providing differentiated product packaging (e.g., different combinations of minutes, text, and data in a cellular plan).  Rate plan management replaces inventory management for revenue optimization.

These differences highlight why revenue management for subscription business models requires a new approach which the “use it or lose it” dynamic highlights the most. The “use it or lose it” dynamics states if the customer does not use your product at a level that matches the subscription agreement, the customer will cancel the subscription, and you’ll lose the revenue (A complete description of “use it or lose it” can be found here ).  So in the Subscription Economy, managing recurring revenue (i.e., the ability to proactively manage the subscription revenue model) boils down to matching the right rate plan to the right customer usage at the right price.

Why is recurring revenue management required?

Just as revenue management is a well-chronicled competitive advantage in Transaction Economy industries such as airlines, revenue management will be a requirement for …