Lately there has been so much negative press about online advertising companies offering targeted ads. Why? I think it's a mere matter of arithmetics.
Let's consider three companies, Acme Inc that sells anvils; Local Times, a newspaper; and an online advertising company we will call Foofle.
It costs $4 to manufacture an anvil. Acme wants to make some profit on each anvil, so it sets the price at $5.
Acme makes some anvils and waits for somebody to buy them. Nobody knows that Acme exists, so no one buys anvils from them and they lose money.
Losing money motivates them to get smarter. They figure out that they need to somehow tell people that these anvils are available for sale. In other words, they need to do marketing. They are hesitant to spend money on marketing, because that will cut into their profit. But what are you gonna do?
So they place an ad with Local Times.
The newspaper charges Acme $0.01 per copy. 10,000 people buy Local Times. 200 of them see the ad, like it, come to the store and buy an anvil. 200 / 10,000 = 2%. This is called 2% conversion rate.
All this marketing cost Acme 10,000 * $0.01 = $100.
Their total cost including advertising was $4 * 200 + $100 = $900.
They did not raise the price to pay for marketing, so the revenue was $5 * 200 = $1000.
They made a profit of: $1000 - $900 = $100.
Let's summarize: they invested $100 into marketing and got an extra $100 in profits. This is called 100% Return On Investment (ROI). This number, ROI, is the most important number that any advertiser looks at. They are always thinking: for each $1 we invest into marketing, how much additional profit will we make? Here's the key point: ROI has to be a positive number, otherwise the director of marketing gets fired! So this director of marketing constantly monitors the ROI and is always on a lookout for the highest ROI he can get.
So Acme discovers Foofle, which is an online advertising company that sells targeted advertising. Foofle also charges $0.01 for each time it shows the ad to a customer. The only difference is Foofle happens to know something about the customers' personal interests. Based on that knowledge, it tries to show more relevant ads to the customer. This is targeted advertising. It is not a 100% guarantee, but statistically it improves the chances of the advertising being effective. As a result Foofle's conversion rate is a bit higher, it's 3%. Just like Local Times, Foofle shows the ad 10,000 times. The conversion rate it 3%, so Acme sells 300 anvils. Repeating the above calculation:
Cost: $4300 + $100 = $1,300
Revenue: $5300 = $1,500
Profit: $1,500 - $1,300 = $200
ROI: $200/$100 = 200%
So, of course, the advertiser drops Local Times and goes with Foofle, because Foofle provides a higher ROI.
Acme Inc benefitted, because they invested a little and got a lot of profit from that.
Foofle benefitted, because they got $0.01 per display of the ad, while it only cost them $0.0001 to actually show the ad.
The customer benefitted in at least three ways:
- First of all, he got the anvil he wanted.
- Second, he did not have to pay more for it. Why not? That's because Acme did not have to raise the price to pay for marketing. In fact, perhaps the customer paid less for it, because Acme had enough extra profit to sell the anvil at a discount.
- Third, instead of ads of dolls and tutus, the customer saw ads of anvils and video cameras, so he was happier or at least less annoyed.
Is any of the above evil? Silly question, right? Why would this be evil if it benefits everyone?
Well, not everyone. We forgot about Local Times. Local Times lost and Local Times is pissed at Foofle for stealing $100 in revenue they used to get from Acme Inc.
So when a journalist comes to Local Times and for $50 offers an article that calls Foofle evil, what does Local Times do? They make the only reasonable thing they can: they pay $50 to the journalist and put that article on the front page. Why? Here's why. Let's say some of the customers turn away from Foofle or disable targeted advertising on Foofle. This will lower ROI that Foofle can garner for the advertiser. Acme will be disappointed (remember that director of marketing who is always watching?) and come back to Local Times, which will bring $100 back. Local Times has spent $50 and got $100 of new revenue for it. Does this whole thing make Local Times evil? Not at all. They do what every business has to: maximize their own ROI.
However, reader beware! Next time you see a negative article about targeted advertising, check who published it. If the publisher is Local Times, make sure to remember that Local Times has to be biased against it if it wants to stay in business.
Disclaimer: I work for Google, but the above is nothing but my personal rambling opinion.