It Doesn’t Matter if Advertising Works or Not

According to internal eBay testing, no.  Randomized controlled trials with Google search engine marketing provided little to no results, and it seems like a large portion of their advertising budget is just wasted.  Their budget mostly goes to show ads to those who would still have ended up at eBay anyway.  As Tim Fernholz notes, there are a few gigantic caveats:

  • Your mileage may vary. eBay is a gigantic retailer, and if somebody has not heard of eBay in the year 2014, they are not a potential eBay customer – they’re also probably not Googling things.  This isn’t true if you’re a nobody, where effective search-engine marketing is often the single best way to spread awareness of the product.
  • Long-term effects might be important.  The tests show only immediate results – whereas in the long term, cutting down advertising might hurt sales a great deal.  But running even very short-term RCTs at a company like eBay can be very difficult, it’s unlikely they’ll be able to do this for a year.

I would add a further point: eBay’s advertising makes competing with eBay more costly.  Partially there is just the opportunity cost – your customers see ads that aren’t yours.  More importantly, you’re helping your competitors’ bottom lines.  Search engine ads are allocated via a competitive marketplace with competing firms bidding to place advertisements.  Every bid that eBay doesn’t place makes the marketplace less competitive and allows their competitors to place ads more cheaply.  This in turn makes their advertising more cost-effective.  In many areas, for example online auctions, eBay is such a huge player that the spot prices for ads will probably dive a great deal, juicing their competitor’s return on investment.  In the long term, that’s a serious competitive threat, which it is entirely within eBay’s power to avoid.  Even if the return on advertising to them is low or negative, it might still make sense for eBay to spend billions on search engine marketing simply because they are the biggest and can best afford the cost.

Search engine marketing is an asymmetric weapon in a number of ways.  It is more useful to the new and weak, and can drive growth very quickly.  But when competing with an incumbent in a large category, it may well be too expensive.  It also suggests that new consumer-facing startups competing with digital-native incumbents (e.g., eBay) will face systematically high marketing costs that will require massive amounts of capital.  Interestingly, despite this logic and some high-profile news to the contrary, there does not appear to be a long-term upwards trend in the size of venture capital funding rounds.  This might be an issue of incomparability – for example, perhaps in recent years staff-heavy enterprise startups have been supplanted by thinly-staffed consumer startups that are plugging a greater share of money into advertising.  Impossible to say with the data publicly available.

If you are trying to strategically decide what kind of company to start or what market to enter, the takeaway seems clear – the idea of easily scaling up to competitive size with an established incumbent through SEM is probably an illusion.  You will face systematically higher costs than you expect, and will need to deploy more of your capital than you think to advertising instead of staffing and product.  As for Google, it doesn’t seem like they should be that concerned.  The logic of the situation clearly suggests that even if advertising doesn’t work, the money should keep flowing in for the foreseeable future, either from established firms or heavily leveraged VC-backed startups but mostly both.

The startup world: an extremely elaborate mechanism to redistribute teachers’ retirement money to Google.

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