Is the SEM Industry heading for Consolidation?

Compared to the search engine business on which it is based, the Search Engine Marketing industry is incredibly fragmented, not only in the number and size of companies, but also in their level of technological sophistication and their fundamental approach to online marketing.

I’m wondering: Is this a sustainable situation or is the SEM industry heading for consolidation?

Search Engine Marketing has grown to about a $30 Billion dollar a year industry, dominated by a single publisher. But only about 10 years ago there were scores of search engines, each of which brought in a pittance compared to what Google now makes.

In terms of the number of competitors, the search engine marketing industry looks like the search engine industry did about 10 years ago. (Here I’m defining ‘the SEM industry’ loosely to mean SEM firms – with or without proprietary software platforms – the tools available in Google’s AdWords UI, and in-house efforts, even they are only one person, part-time, with a spreadsheet).

As Google’s revenue has poured in, the SEM industry has gone along for the ride – making it comparatively easy for firms to multiply, survive and grow and keeping the direct, cut-throat competition to a minimum.

As a result, many major players exist and each seems to have their own unique approach to account management. Marin Software, which claims to manage over $1 Billion per year in ad spend, uses a bid technology based on rare-event statistics. Efficient Frontier (also a manager of about $1 Billion per year) uses an approach they claim is conceptually loosely related to Modern Portfolio Theory. Acquisio’s software uses a ‘rules based’ approach in which users specify sets of ‘if-then’ statements which are executed on a regular basis. The Rimm-Kaufman Group uses a secretive approach they only describe as “adaptive“. Trada embraces crowdsourcing.

These approaches can’t all be optimal, can they? Certainly, one of them must be “the best”.

Perhaps, and perhaps not. First, not all of these firms serve the exact same market. Trada’s customers are small- and medium-sized businesses who spend $3,000 or more per month while Marin’s spend $3,000 or more per day. So, the approach that’s best for one market might not be for another.

On the other hand, historical reasons clearly play a large role in explaining the industry’s current fragmentation. It has been so easy to start to an SEM firm that at some point one of the biggest difficulties became choosing a distinctive name.

Michael Porter has done more than just about anyone to explain why certain industries and companies are the sizes and profitability that they are. Looking at the SEM industry through his ‘Five Forces’ theory might give insight in where the industry is headed:

1. Threat of New Entrants

Rapidly rising barriers-to-entry have dramatically slowed the rate at which new SEM companies are being formed. Those that are starting up, though, unlike those 5 years ago, tend to be starting larger and better funded with experienced top managers who have jumped ship from other enterprises. They don’t need to explain the value of pay-per-click (PPC) advertising to new clients and they don’t need to explain the basic mechanics of PPC either, the way that older companies had to when they were young. However, these new firms are entering a space with some major players who have slick, easy-to-use interfaces, lots of data storage/processing horsepower, rapidly maturing software, experienced marketers, developed reputations, and, of course, established client lists.

2. Bargaining Power of Customers

As the sophistication of the search engine and the search engine marketing industry have grown over the past decade, so has the sophistication of the SEM industry’s customers. Even the jeweler using PPC to drive traffic to her blog now recognizes why bidding for the top position on all of her keywords is a losing proposition. Many large clients, especially those who derive a large portion of their sales online, see proficiency in PPC as a core competency and, thus, are often as knowledgeable about PPC as the account manager they hire or the makers of the software they use.

With increasing sophistication has come increasing demands from customers. Pat of this demand is for deeper, more-powerful SEM features to facilitate keyword management, bidding and analysis, and also to derive larger-picture ‘business intelligence’. It’s no longer sufficient to show that sales from red Ping Pong paddles is up 20% month-over-month, clients now want to know: “Do I need to tell my supplier to make more ‘red ping pong paddles’?”

Another part of this demand is for broader platforms that handle not only SEM but also SEO (and banner advertising and Facebook and so on). The days of SEM-only firms are dwindling away as advertisers increasingly want ‘one stop shopping’ for their advertising needs. They might have already been around the block with one or two other SEM vendors before and in cases where performance is sub-par, really only the difficulty and risk of switching to a new SEM agency / software platform is keeping customers in place.

3. Bargaining Power of Suppliers

There’s one big player in the supplier-of-text-ad-space market, and I don’t think it’s necessary to waste too much time describing the immense power they have. Two things might be worthwhile to note: One is the apparent increased willingness Google is having to offer features for free in AdWords that were formerly done by SEM firms (like Google’s ‘Automated Rules’ – apparently a direct stab at the rules-based technology of firms like Acquisio). A second thing to note is the increasing demand being placed by Google on SEM firms through a growing need to do SEM in conjunction with SEO and, with Google incorporating more signals from social media sites into its ranking algorithm, the increasing demand placed on coordinating SEM/SEO with Social Media activities as well. Much as with the demands being placed by customers, these demands by Google are heralding the end of the SEM-only marketing firm.

4. Threat of Substitutes

This point is not about Bing or Twitter or Quora. Those are substitutes for Google’s search engine. This point is not concerned with substitutes for a search engine, but rather substitutes for search engine marketing. Incorporating rules-based bidding functionality into AdWords’ user interface is a threat to Acquisio, but not to Acquisio’s customers. They could simply start getting from Google what they were paying for from Acquisio. But the need for a person to enter the rules and monitor the performance would remain. That is, the need for search engine marketing efforts would not be substituted for in that case.

What is a major threat the search engine marketing efforts is simply increased automation of these efforts by ever more sophisticated functionality. In my ‘Prediction for Online Marketing‘ I suggested that the labor-intensiveness of SEM is a transitory phenomenon which should diminish as algorithms handle things formerly done by hand, like bidding and, as Alex Cohen of ClickEquations suggests, even the entire concept of keywords that need to be selected and managed, via keywordless advertising.

The last factor Porter lists is:

5. Competitiveness within Industry

As the number of companies who have never tried PPC diminishes and the potential of advertisers to increase their monthly spending maxes out, SEM firms increasingly are doing something that was unheard of just a few years ago: actively targeting competitor’s clients. The biggest factor inhibiting competitiveness, though, is the relative difficulty of doing side-by-side comparisons of SEM vendors and their platforms. Advertisers will A/B test their landing page elements, ad text, and bids, but not their SEM agency. There is no equivalent of Consumer Reports or government crash testing to do fair comparisons. As long as it remains tough, time-consuming and/or risky to switch vendors, even sub-optimal performance is tolerated.

From Porter’s ‘Five Forces’ perspective, all signs seem to point toward consolidation and automation as greater value is delivered with less human input. The big question that remains for me is: How long can the friction of switching costs and the difficulty of head-to-head performance comparisons hold off these mounting forces?

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UPDATE:Media and Marketing M&A (Merger & Acquisition Activity) Soars in 2012‘, AdAge, 28 December 2012

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