The following piece was written by Eric Reyes and appeared in the Blue Book Guide to Ad Networks and Exchanges in November, 2009.

As ad networks keep proliferating, some industry watchers are asking whether there is an ad network bubble and whether consolidation will keep it from popping.

Everyone has an opinion about ad networks, especially those working for one of the estimated 400-plus large and small shops in the U.S. And these networks do many different things. Vertical ad networks are different from big, horizontal ad networks. The behavioral targeting networks are different from up-and coming semantic targeting networks. If you travel the hushed halls of these ad networks, the whispers seem to seep through the walls: The crash is coming! The crash is coming!

While 2008 and most of 2009 were considered the worst of times for most industries during the recent economic crisis, for the ad world, specifically the ad network universe, the hurt, experts predict, will hit in 2010 or 2011. But even so, there are just as many experts who say the ad network marketplace is robust and will continue to be so. Just look at the sheer number of us, they say. In fact, a recent survey by Collective Media found that advertisers and interactive agencies continue to invest in ad networks. Up to 90 percent of those surveyed said they want to work with ad networks this year. That is about 5 percent more than the past year. The survey also found that more than half said they could spend up to 15 percent of their online budgets for ad networks.

Some disagree that it is all sweetness and light, going as far as to say there is an ad network bubble – that no market can sustain the number of companies all doing essentially the same thing. Even in the face of the best earnings, the utter abundance of ad networks will lead to mergers, closings, bankruptcy. But that was a year ago and the ad networks are still here. In fact, niche ad networks have raised $1.5 billion in the last five years from venture capitalists, according to VentureSource. It also states that the top 25 companies have taken nearly $1.2 billion of that total. More than three-quarters of that cash has been raised in the past three years. That’s just new companies and not the more than $250 million that went to Adify, Blue Lithium, Quigo, Tacoda, Third Screen Media and others.

So, where’s the panic coming from? There were a few high-profile flameouts in the last year or so that got some attention. Most notably, early last year, ESPN let go of all its ad networks it was working with, saying, essentially, that it didn’t like the lack of control it had over the kind of ads being served. Around the same time, the Washington Post shuttered its 16-month-old blog ad network, citing the “innovation” that was coming.

In these two cases, the ad networks may have been underperforming for the bean counters, but what seemed to irk them more was that the ad networks dealt in “remnant” inventory and that the automated placement of the unsold inventory amounted to tarnishing the host site’s value. At the time, Martha Stewart Living Omnimedia president Wenda Harris Millard infamously stated that selling Web inventory like “pork bellies” would cheapen brands.

That name-calling did not seem to hurt the fortunes of ad networks, as they continued to see healthy ad spend. “The market itself can bear [hundreds of ad networks], since there is clearly demand right now which I don’t see diminishing,” said Michael Sprouse, CMO at Epic Advertising. “We have believed that the number of ad networks will continue to grow into the many thousands,” said Paul Edmondson, CEO of Yield- Build. “Super-large ad networks will prefer to have direct relationships with publishers, but will go to exchanges for some inventory.”

In fact, firms such as eMarketer see no end in sight. It predicts U.S. online ad spend to exceed $50 billion in 2012. It was $21.1 billion in 2007. That’s the spend on everything online-related, including display ads, video, classified, search ads and lead generation, but not mobile ad spend. Warren Lee, partner at Canaan Partners, noted two reasons ad networks continue to thrive: The hours people spend online just keep going up – 12 hours per week, according to a Forrester survey. This, of course, encourages online ad spend. The second reason is that the number of websites keeps going up. This makes it difficult for advertisers and agencies to know which sites to work with. This is where ad networks help out.

Some believe that ad networks are still riding high simply because agencies have yet to launch in earnest their own in-house networks. Predictions state that 2010 and 2011 will be the challenging years as agencies divert their spend into their own systems. If an agency does only in-house work and sells one-quarter of the inventory that an outside network did, but at a 10 times better CPM, it is a money-maker. With online advertising expected to experience continued growth into the next decade, ad networks doing some simple math may prove or disprove their viability. Layoffs, on the other hand, will be inevitable as networks that bring in between $20 million and $40 million and have more than 100 employees find they simply can’t pay that many people with what they bring in. Panic will ensue.

And what comes with panic – consolidation. “There will no doubt be consolidation in the ad network market,” said Dave Martin, vice president of interactive media at Ignite. “Only the best will survive and they will likely become part of larger media companies who can compliment their offerings with cost-effective reach.”

J. P. Morgan’s 2009 investment guide also predicts the fickle finger of the merger fates. The guide says, “We saw large portals make significant investments and acquisitions to strengthen their foothold in the ad network space. We believe large portals are naturally well positioned, as it is easier for both advertisers and publishers to fulfill all of their needs on fewer platforms, while a consolidated network yields greater leverage of technology and advertiser/publisher relationships.”

“So, are ad networks dying?” asked Julia Casale-Amorim, CMO of Casale Media. “Yes, some ad networks are dying, but the species is hardly facing extinction.” While we haven’t witnessed any high-profile exterminations, some experts do hear the sound of the largest ad networks sharpening their carving knives. “The impetus for acquisition is obvious,” said Emily Riley, online advertising analyst at Jupiter Research. “For the conglomerates, the potential to improve their portfolio of offerings to both advertisers and publishers as well as overpower their competition, theoretically lies in the control of ad servers and ad networks.”

In the opinion of Casale-Amorim, the majority of “these infantile networks use the same technology, the same platforms, and the same approach – each applying a different ‘sales spin’ to what are essentially identical offerings.” She added that many traffic in “air.” And as prices for premium-placed CPM have risen, the selling point of cheap cost-per-thousand diminishes to the smallest pinprick. If a big player such as ValueClick wants 25-cent CPM, why pay for a $10 CPM for premium placement? “Anyone who’s trying to tell you that reach is a key differentiator, you need to ask them ‘what else?’ It’s much more complicated than that,” said Jordan Rohan, managing partner at Clearmeadow Partners.

The J.P. Morgan report put it rather bluntly: “We expect larger players to gain share, and we think there may be further consolidation among private companies. We also see some companies
likely closing their business.”

The prognosis is not as grim as that, not if all the interested players can help keep ad networks plentiful and pellucid. Publishers, for example, don’t want to work with 15 or 20 different ad networks and spend the time it takes to manage the relationships. In fact, ad network optimization is now a legitimate business venture thanks to the proliferation of networks. For media buyers, they are looking more at results and hard data, since the song of the networks’ sales pitch sounds the same no matter who they are talking to. Even the economy gets some of the blame, for keeping the venture capital money at bay, just when ad networks need it to grow to the next level.

The next phase in the life of ad networks is undetermined. Some consensus involves agencies and exchanges. “Going forward, I see two emerging trends driving change in the near term,” said John Nardone, CEO of [x+1]. “First, ad exchanges will provide direct access to buyers, reducing the need for a sales force. Second, major agency holding companies like Omnicom and WPP will launch private ad networks, as they continue to acquire network infrastructure and targeting technology and platforms. They’ll bring a hard-to-beat combination of inventory aggregation and ad targeting capabilities.”

Ad exchanges, some say, will make it easy for people to create an ad network and then quickly and cheaply aggregate unsold inventory. Exchanges can find all that cheap inventory very quickly and are quite efficient and doing it as long as “quality” is not a concern. Since media buyers do not have time to sort through all the different content, the quality of the placement may suffer. It is undetermined whether exchanges will shorten the life of ad networks.

If consolidation accelerates, some suggest looking into ad network profit margins. Rohan noted that “ has 47 percent margins on 116 million uniques, ValueClick has 45 percent margins. Intermediaries receive about 45 cents for every dollar – you’re paying them almost half of your spend.” He added that many ad networks tout their nonexistent transparency. “Total transparency would mean that they transfer terabytes of data to you that you would have no idea what to do with,” Rohan said. He said that useful transparency for media buyers would be data-filtered to tell you the context surrounding the online conversions. “Typically you don’t know where all the conversions came from. Which sites did they visit, how many impressions before they converted, these are the kinds of data you need.”

The Online Publishers Association (OPA) threw a monkey wrench into the party in August when it released a study that basically said ad spend through ad networks was useless. The OPA study states that ads placed through ad networks and portals earned the smallest change for branding metrics, and in some cases made no difference at all. Pam Horan, president of OPA, said in the press, “Different environments produce different results.”

However the wind blows, ad networks seem to be here to stay. They have some righteous defenders, and growth or consolidation may depend on the rate of mend to the U.S. economy. “There are a host of networks that focus on adding value beyond supply aggregation in the equation that will not only exist, but thrive and grow,” said Michael Katz, president of InterClick. “It’s naive to underestimate networks, which tend to be hotbeds for innovation. And it’s instructive that the largest agency-holding companies are all building networks.”