The Ad Tech Tax Explained

It Ain't What You Think

Welcome back to GHAT.  Today is a philosophical examination of motive and incentive in ad tech in order to explain the ad tech tax, which doesn’t seem to be going anywhere even though everyone keeps complaining about it.   My thesis is that most people who complain about the ad tech tax think it exists because people are greedy, or dumb, or short-sighted.  I think most people are wrong.  

If we engage in deep thinking about the various forces within the ad tech value chain, we can uncover how everyone acting in good faith can result in a remarkably inefficient ecosystem.  It is only with this understanding that we can transform it.

Please note, as with most of my writing, my intention is to bring the ideal independent digital marketing world into being, not reflecting on the “reality” of the world today.  I also have no horses in this race, and enjoy partnerships with all of the entities described here.  This is not meant to castigate anyone – merely to explain why the world as it is probably isn’t going anywhere soon unless there’s a meaningful disruptive force.  I also believe that independent marketing infrastructure is the lifeblood of the open web, and to the extent that we care about the decentralized distribution of information, it is our duty to improve these technologies to the best of our ability.  On to the discussion.

The villain of today’s article is something we all know well.  It’s been around as long as I’ve been in ad tech, and certainly before, and it’s not going anywhere any time soon.  The villain in ad tech is the Revenue Share.

Loss Aversion

For the uninitiated, a revenue share refers to paying a vendor a % of revenue as opposed to a flat fee – the attractive part of revenue shares being that they’re directly proportional to the amount of money spent on or paid for media, with no “guaranteed” fees..  The reason revenue shares work is because of a game theory concept called Loss Aversion (read more here https://en.wikipedia.org/wiki/Loss_aversion), the TLDR of loss aversion is that people hate paying and losing money, especially publishers in my experience, and they hate it so much that they will sacrifice potential expected value (ie. make less money over all) as long as they can avoid something being framed as a loss.  An example, which all media people will identify with – which do you think your average publisher would prefer : 

• Publisher pays vendor $3 guaranteed, has a 70% chance to make $10 (publisher is net +7)

• Publisher pays vendor $0 guaranteed, has a 70% chance to make $10, but has to pay $8 of the $10 (publisher is net +2)

Publishers will pick the second option almost every time.  This is because the 30% chance of losing $3 is untenable to them; the notion of a guaranteed cost without guaranteed revenue is unacceptable.  This, even though the expected value of the first option is meaningfully higher!

And the rabbit hole goes further!  Not only does loss aversion cause non-optimal decision making, which you could also say is just an outsourcing of the risk associated with technology costs, but because of the nuances of ad tech, it actually creates the illusion of fully aligned incentives that are not quite there.  In many scenarios, it would make sense that a revenue should align two parties who both want to maximize the total value of a thing – a % of revenue means you want the revenue number to be as high as possible.  However, in the world of unified auctions, it does not totally mean that. This is kind of a complicated theory, so buckle up, but it is actually the case.

Demand Inelasticity

The thing that breaks the incentive structure of revenue shares is bid jamming (article here https://www.garethhatesadtech.com/p/bid-jammin).  The net effect of bid jamming is demand inelasticity wherein the bid variability for differential supply paths within a single auction is so high that the additional share of voice generated by a reduction in vendor take rate (read: taking a lower revenue share) is actually negligible.  I know because I tried this.  I built an SSP, got bids from the trade desk, and took zero vig, and guess what?  It didn’t win any more than any other supply path!  

When it comes to incentives, SSPs/Exchanges now have a strange decision to make.  I, as an SSP, do not increase my share of voice (or increase it minimally) by reducing my fees.  Therefore, I can assume that my a priori share of voice is actually somewhat static – so I am now incentivized, in order to maximize my margin, to either increase my SOV in other ways (hello ID bridging and curation), or to maximize my margin, because me taking higher fees won’t decrease my revenue, just that silly publisher’s.  Additionally, for ID bridging and for Curation, I only care that they increase my share of voice with their differentiated bids – if I can, I want to scoop off as much margin as possible and not pass additional cash to the publisher.  Because of this demand inelasticity, my optimization is not to maximize the size of my payout to publishers, my optimization is to maximize my SOV and my margin.  Increase Publisher Revenue? Yes.  Maximize? No.

The Aggregate Effect is not Intuitive

Let’s illustrate this. For example, each new ad tech entrant adds 15% to the total CPM in the transaction, through some sort of value add – be it increased outcome rates, some kind of auction manipulation, whatever. Without demand inelasticity, aka in a perfect market, if they pass 100% of the 15% through to the publisher, they would maximize their share of voice, and for every reduction to that 15% they extracted in fees, their share of voice would decrease proportionally because the bid would decrease.  However, because demand is inelastic, this is not the case.  The additional fees subtracted from the bids generally do not lead to a reduction in share of voice, or at least not cleanly or linearly. So what’s the net result?  The vendor is incentivized to take as high of a fee as possible while still maintaining their edge in the auction – which is often super, super, high.  We’re talking 15% of value and a 14% fee – but still transact.

This math, I believe, is what has sent our industry awry.   Every vendor does this math, and if they’re truly adding 15% of value, they can charge the 14%...and publishers are still happy with their 1% lift because they’ve taken no risk!   There’s no real incentive to upset the apple cart here either – you’d think vendor competition would have them squeezing one another, but with everyone adding different kinds of value (and weird price inelasticity in a given auction due to throttling and whatnot), it’s a phenomenon that hasn’t come into vogue.  Even with SSPs, the biggest commodity players in the industry, I’ve observed that meaningful reductions in take rate don’t lead to proportional increases in share of voice.

Publishers don’t care because they live in a world of header bidding – even if the SSPs and Curators generated $10 of surplus value, if they take $9 of it and pay the publisher $1, the publisher is still coming out ahead.  

And this, my friends, has been happening over, and over, and over with tech layer and tech vendor after tech layer and tech vendor.  The revenue share, and specifically the sell-side revenue share, has created an environment where the lion’s share of the surplus value created by independent ad tech vendors has gone to those ad tech vendors.  But, I would argue, the vendors are not to blame!  This is the expressed preference of publishers, who are allergic to costs and loss averse. Things are especially muddy in the exchange space, due to price inelasticity and entrenched relationships between DSPs and SSPs, and that’s why we do see innovation in the header bidding management layer (RTK, my company, did not charge revenue shares for our software.  We were the only ones in the space not to do so at the time, this was in 2015.  We included an ad exchange in it, but even with zero revenue share, my friends at TTD meaningfully throttled down our supply path, though it was probably our fault – RIP).  This is also why I don’t like Curation.  It is inarguable that Curation helps publishers, just like it is inarguable that SSPs help publishers, but the problem I have with it is that it’s just another rev share – publishers have become vessels for new technology to ride along, but get paid a measly wage for their services.

Why should we care?

We should care because our competition here, X, Google, Facebook, etc, does not have this value siphon draining dollars from their ecosystem.  Every incremental % of value that they create is funneled into making their technologies more effective or their content better.  And until we figure this out, and fix the massive revenue leaks in our industry, we will lose to them more and more.  AppLovin, in an ecosystem that grew up and came into being after the DSP and SSP existed, does not operate and make most of their money in RTB.  It is important to understand why.

What can we do?

Apart from publishers changing their behavior, which I will not hold my breath for, I think the onus is on DSPs to really dig into bid jamming and select single supply paths to publishers.  I don’t mean SPO to 3 or 4, I mean SPO to one.  If the demand inelasticity goes away a lot of these problems fix themselves and people actually have to compete on take rate.  I won’t hold my breath for this either, but it would go a long way.

There are other solutions, but I’m going to use them in my products, SO I’m not going to spill all of my secrets to you here :).