The Facebook – Google Duopoly — Where They Differ?
Summary:
Facebook and Google differ fundamentally in the degree of adtech vertical integration. Facebook only has a significant internal supply side platform (SSP). Google has a significant SSP, ad exchange, and a demand side platform (DSP).
Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds. With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.
- Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
- Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions).
- Work to “shift up the demand curve” of advertisers by sharing user data with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.
Option 2 exposes Facebook to antitrust lawsuits. Option 1 and 3 are promising, but it relies on a sharing of user data with independent demand side platforms (DSPs) which has become problematic due to the Cambridge Analytica debacle.
We make the case for Option 3.
The Facebook – Google Duopoly
The intermediate market for digital ad impressions is now dominated by the Google – Facebook duopoly. In 2017, the duopoly’s total share of ad impression sales was estimated at 60.4% (see below).
In the fast growing digital native ad subset market, the duopoly’s share rose to 91.9%.
The data above largely reflects ads embedded in mobile and PC content. The market for real time ad impressions embedded in ad-supported streaming TV — as opposed to subscription-supported Netflix and Amazon Prime — is just beginning.
The Intermediate Market for Digital Ad Impressions
On the extreme demand-side of the digital ad impression market are advertisers wishing to buy ad impressions and on the extreme sell-side are content publishers selling ad impressions.
Between advertisers and publishers is an adtech intermediate market. It consists of supply-side platforms (SSPs) also dominated by Google and Facebook with Amazon being a fast riser in the SSP space.
Next comes ad exchanges where transactions and pricing takes place increasingly via real-time auctions. Google dominates with DoubleClick AdExchange. Facebook launched its own FBX in 2011 but let it slowly die over the next three years.
Next comes demand side platforms (DSPs), which is the most competitive segment. Google has its own internal DSP called DoubleClick Bid Manager which dominates ad buying both on Google’s “walled garden” of search and on its own subsidiary YouTube.
Facebook has an internal DSP called Facebook Ad Manager useful to small and medium business wishing to buy ads within its eponymous “walled garden.” But, Facebook seems to be holding back from customizing its internal DSP to cater to large advertisers with unique needs.
Because of the publicity surrounding Cambridge Analytica, Facebook is under enormous pressure to pull back all the ways its allows third parties to access its user data. We think it would be “throwing out the baby with the bathwater” if Facebook were to pullback of all adtech — SSP, AdEx, and DSP — within its “walled garden”.
Rather, it needs all the help it can in filtering out “lemons” ala George Akerlof’s iconic economics paper “A Market for Lemons”. It is in Facebook’s own interest to foster independent DSP’s with “clean room” access to data (see below).
The Focus of Antitrust Concerns
The sheer scale of the Google – Facebook duopoly is the current focus of antitrust concerns. But, the extent of the duopoly’s vertical integration — owning the full vertical stack of businesses from content publishing to a SSP to an ad exchange to a DSP — needs to be analyzed in much greater detail by adtech experts for potential antitrust violations.
Antitrust concerns so far has focused on the supply side with the most recent flare-up being Facebook’s decision to limit third-party news feeds inserted into the social graphs of Facebook users.
This supply-side focus on content is understandable as such developments hurt the job prospects of the very paid tech and business writers [ not us 😉 ] who write about Google and Facebook.
In contrast, we think a recent development on the demand-side deserves more attention. This is because it signals that Facebook is seeking to deflect antitrust concerns by actively assisting in the development of strong, independent DSPs.
Facebook’s Effort to Foster Strong Independent DSPs
In December 2017, TechCrunch published an article describing how an internal Facebook team of 100 engineers has been working with big advertisers to develop their own customized DSPs.
Right off the bat, this revelation is a clear sign that Facebook today does not intend on repeating the anticompetitive tactics used by Microsoft in the mid 1990s. Back then, Microsoft used its control over the dominant Windows PC operating system to throttle the ability of users to replace Microsoft’s own default browser with a popular third-party browser developed by Netscape.
Notwithstanding the antitrust motivation for supporting independent DSPs, Facebook’s initiative is good from a pure business perspective. Facebook realizes that improving ROI on purchased ad impressions via reduced information asymmetry translates into a willingness by advertisers to make higher bids for “peaches” instead of “lemons” ala George Akerlof’s iconic economics paper “The Market for Lemons”.
Indeed, we see the current digital ad impression market as the “mother of all markets for lemons” including the following list of extreme conditions for markets with information asymmetry between sellers and buyers:
- zero marginal cost on both sides creating lemons and traps
- dueling artificial intelligence (AI) on both sides morphing sell-side lemons and buy-side traps
- real-time auctions
- low latency rendering and fill of ad after purchase of impression
- double interrelated information asymmetry (see below)
Facebook’s Options For Increasing Revenue
Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds. With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.
- Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
- Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions) which it in effect has done by limiting outside news feeds.
Facebook Option 2: Shift up the Supply Curve
- Work to “shift up the demand curve” of advertisers by working with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.
Facebook Option 3: Shift up the Demand Curve
Facebook is signaling that it is giving option 3 a try.
Here is a great quote from an April 2017 adExchanger article on digital ad prices as a reflection of quality and the opportunity for Facebook to receive higher prices — shift up the demand curve — from advertisers and agencies using more discriminating DSPs.:
We buy it cheaper” used to be the lead differentiator in a pitch. Today, agencies that lead with “We can buy digital cheaper” have a sign taped to their back that says, “We buy lots of fraud.” Low prices in digital media are not only no longer a badge of honor, they’re a warning sign.
Here is a quote from the TechCrunch article on the ROI improvement coming from DSPs built with the assistance of the Facebook engineering team:
Facebook says that on average, clients working with the solutions engineering team see their return on ad spend improve by 100 percent.
The article mentioned that after working with the Facebook team to improve the performance of its own internal DSP, the mobile game company MZ (formerly Machine Zone), has spun off its internal DSP as an independent business called Cognant ®.
It should be noted that even before the spin-off, MZ was already the largest “direct response” advertiser in the world and likely on Facebook itself.
As Facebook’s largest direct response advertiser, MZ was the likely first recipient of access to Facebook user data located in “clean rooms” on Facebook servers. Here is a February 28, 2017 description by AdExchanger of the linkage:
Google and Facebook are each responding to advertiser demands for more data. Facebook does data-sharing deals on the DL with large marketers that push for it.
In so-called “clean rooms,” for example, advertisers can compare their first-party data with impression-level Facebook campaign delivery data using laptops that have never touched the internet. Facebook also allows certain large advertisers to create a private instance on its server to run advanced analytics.
We would expect Google to lag behind Facebook as Google’s supply of ad impressions is more elastic. Google can increase revenue via increasing the supply of impressions especially on its YouTube subsidiary.
Facebook has no room in its “wall-garden” for more ad impressions. It will be interesting to see how much Facebook derives revenue from its retargeting business outside its “walled garden.” Otherwise, the only way Facebook can increase revenue is by working to improve ROI on the demand side and “shift up the demand curve.”
Facebook antitrust lawsuits will inevitably dwell on ad price trends as measured by cost-per-click (CPC). Consider the following graph showing that Facebook’s CPC rose 136% in the first six months of 2017.
How much of the above trend was due to Facebook asserting it’s pricing power and how much of that trend was due to other factors?
For example, the upward trend could be due in part to a secular improvement in ad ROI delivered by independent DSPs with help of Facebook supplied application programming interfaces (APIs), thus reducing information asymmetry on the part of buyers.
Of course, it takes more than API hooks for a DSP to deliver significant improvements in ad ROI. It takes a DSP that can build a sophisticated real-time programmatic bid engine and a real-time predictive analytics platform that feeds off Facebook-supplied user data and spits out bids with improved click-through rates.
In sum, Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.
At the same time, working with independent DSPs to improve ad buy ROI and a willingness to pay higher price is a way out of its conundrum of growing revenue while limiting ad impressions in its “walled garden”.
“Lemons” and Antitrust: Why Facebook and MZ Are AdTech Frenemies — DSP Cognant
(Postscript: July 11, 2018)
Adexchanger reported that MZ has shut down its independent DSP business Cognant and laid off all 125 employees as well as half of its in-house media buyers.
(Published: March 1, 2018)
Summary:
Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.
Facebook is signaling that it does not intend on being “the Microsoft of the 1990s” by throttling competition on the demand side of the ad impression market.
Furthermore, this cooperation makes sense from a pure business perspective as Facebook is “shifting up the demand curve” of advertisers by working with independent DSPs to improve ROI on ad buys resulting in a willingness to pay higher prices.
Facebook wants to reduce information asymmetry in the ad impression market. It is in its own interest to help make it a market of “peaches” not “lemons” ala George Akerlof’s iconic economics paper “A Market for Lemons”
Indeed, we see the current digital ad impression market as the “mother of all markets for lemons” accompanied by a whole new lexicon — clickbait, click farms, fake news, brand safety, and walled gardens.
The Intermediate Market for Digital Ad Impressions
The intermediate market for digital ad impressions is now dominated by the Google – Facebook duopoly. In 2017, the duopoly’s total share of ad impression sales was estimated at 60.4% (see below) .
In the fast growing digital native ad subset market, the duopoly’s share rose to 91.9%.
On the extreme demand-side of the digital ad impression market are advertisers wishing to buy ad impressions and on the extreme sell-side are content publishers selling ad impressions. In between is a complex web of software intermediaries that would dumbfound (and still does) Madison Avenue.
The data above largely reflects ads embedded in mobile and PC content. The market for real time ad impressions embedded in ad-supported streaming TV — as opposed to subscription-supported Netflix and Amazon Prime — is just beginning.
The value of the impressions to advertisers is a function of viewer eyeballs, associated data, and engagement as measured by time spent on the site. Sheer eyeballs without data is of little value to advertisers as exemplified by Twitter. Facebook and Google Search/YouTube dominate because of all three — eyeballs, data, and engagement.
If you ask people in the tech world what is the business of Facebook and Google, they would not say social networking or internet search or video delivery. They would say the two dominate the performance marketing business — selling ads with quantifiable (as opposed to estimable ala Nielsen) results as in costs per click or impression.
Between advertisers and publishers is an adtech intermediate market. It consists of supply-side platforms (SSPs) also dominated by Google and Facebook with Amazon being a fast riser in the SSP space.
Next comes ad exchanges where transactions and pricing takes place increasingly via real-time auctions. Google dominates with DoubleClick AdExchange. Facebook launched its own FBX in 2011 but let it slowly die over the next three years.
Next comes demand side platforms (DSPs), which is the most competitive segment. Google has its own internal DSP called DoubleClick Bid Manager which dominates ad buying both on Google’s “walled garden” of search and on its own subsidiary YouTube.
Facebook has an internal DSP called Facebook Ad Manager useful to small and medium business wishing to buy ads within its eponymous “walled garden.” But, Facebook seems to be holding back from customizing its internal DSP to cater to large advertisers with unique needs.
Because of the publicity surrounding Cambridge Analytica, Facebook is under enormous pressure to pull back all the ways its allows third parties to access its user data. We think it would be “throwing out the baby with the bathwater” if Facebook were to pullback of all adtech — SSP, AdEx, and DSP — within its “walled garden”.
Rather, it needs all the help it can in filtering out “lemons”. It is in Facebook’s own interest to foster independent DSP’s with “clean room” access (see below) to data.
The Focus of Antitrust Concerns
The sheer scale of the Google – Facebook duopoly is the current focus of antitrust concerns. But, the extent of the duopoly’s vertical integration — owning the full vertical stack of businesses from content publishing to a SSP to an ad exchange to a DSP — needs to be analyzed in much greater detail by adtech experts for potential antitrust violations.
Antitrust concerns so far has focused on the supply side with the most recent flare-up being Facebook’s decision to limit third-party news feeds inserted into the social graphs of Facebook users.
This supply-side focus on content is understandable as such developments hurt the job prospects of the very paid tech and business writers [ not us 😉 ] who write about Google and Facebook.
In contrast, this paper focuses on the demand-side and DSPs. We think a recent development on the demand-side deserves more attention. This is because it signals that Facebook is seeking to deflect antitrust concerns by actively assisting in the development of strong, independent DSPs.
Facebook’s Effort to Foster Strong Independent DSPs
In December 2017, Tech Crunch published an article describing how an internal Facebook team of 100 engineers has been working with big advertisers to develop their own customized DSPs.
Right off the bat, this revelation is a clear sign that Facebook today does not intend on repeating the anticompetitive tactics used by Microsoft in the mid 1990s. Back then, Microsoft used its control over the dominant Windows PC operating system to throttle the ability of users to replace Microsoft’s own default browser with a popular third-party browser developed by Netscape.
Notwithstanding the antitrust motivation for supporting independent DSPs, Facebook’s initiative is good from a pure business perspective. Facebook realizes that improving ROI on purchased ad impressions via reduced information asymmetry translates into a willingness by advertisers to make higher bids for “peaches” instead of “lemons” ala George Akerlof’s iconic economics paper “The Market for Lemons”.
Indeed, we see the current digital ad impression market as the “mother of all markets for lemons” including the following list of extreme conditions for markets with information asymmetry between sellers and buyers:
- zero marginal cost on both sides creating lemons and traps
- dueling artificial intelligence (AI) on both sides morphing sell-side lemons and buy-side traps
- real-time auctions
- low latency rendering and fill of ad after purchase of impression
- double interrelated information asymmetry (see below)
Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds. With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.
- Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
- Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions) which it in effect has done by limiting outside news feeds.
Facebook Option 2: Shift up the Supply Curve
- Work to “shift up the demand curve” of advertisers by working with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.
Facebook Option 3: Shift up the Demand Curve
Facebook is signaling that it is giving option 3 a try.
Here is a great quote from an April 2017 adExchanger article on digital ad prices as a reflection of quality and the opportunity for Facebook to receive higher prices — shift up the demand curve — from advertisers and agencies using more discriminating DSPs.
“We buy it cheaper” used to be the lead differentiator in a pitch. Today, agencies that lead with “We can buy digital cheaper” have a sign taped to their back that says, “We buy lots of fraud.” Low prices in digital media are not only no longer a badge of honor, they’re a warning sign.
Here is a quote from the Tech Crunch article on the ROI improvement coming from DSPs built with the assistance of the Facebook engineering team:
Facebook says that on average, clients working with the solutions engineering team see their return on ad spend improve by 100 percent.
The article mentioned that after working with the Facebook team to improve the performance of its own internal DSP, the mobile game company MZ (formerly Machine Zone), has spun off its internal DSP as an independent business called Cognant ®.
It should be noted that even before the spin-off, MZ was already the largest “direct response” advertiser in the world and likely on Facebook itself.
As Facebook’s largest direct response advertiser, MZ was the likely first recipient of access to Facebook user data located in “clean rooms” on Facebook servers. Here is a February 28, 2017 description by AdExchanger of the linkage:
Google and Facebook are each responding to advertiser demands for more data. Facebook does data-sharing deals on the DL with large marketers that push for it.
In so-called “clean rooms,” for example, advertisers can compare their first-party data with impression-level Facebook campaign delivery data using laptops that have never touched the internet. Facebook also allows certain large advertisers to create a private instance on its server to run advanced analytics.
MZ’ DSP is also likely an early adopter of the Unicorn startup Sprinklr for CRM and Martech:
Sprinklr is the most complete social media management system for the enterprise. We help the world’s largest brands do marketing, advertising, care, sales, research, and commerce on Facebook, Twitter, LinkedIn, and 21 other channels globally – all on one integrated platform.
A tight integration of Sprinklr + MZ’s Cognant, especially around real-time brand management (e.g., seeing the impact of localized Facebook ads for McDonald’s garlic fries on purchases at local outlets in real-time) would certainly be a threat to an earlier generation of cloud-based CRM, like salesforce.com and Oracle, that draws on dated information.
MZ’s DSP very likely has benefited from face-to-face meetings with the Facebook team located in Menlo Park not more than a 20 minute drive from the MZ’s headquarters in Palo Alto. Indeed, MZ’s current HQ in Palo Alto on Page Mill Road across from Stanford was the former HQ of Facebook.
It should be noted that MZ is also located close to Google’s HQ in Mountain View. It will be interesting to see if Google might offer similar assistance.
We would expect Google to lag behind Facebook as Google’s supply of ad impressions is more elastic. Google can increase revenue via increasing the supply of impressions especially on its YouTube subsidiary.
Facebook has no room in its “wall-garden” for more ad impressions. It will be interesting to see how much Facebook derives revenue from its retargeting business outside its “walled garden.” Otherwise, the only way Facebook can increase revenue is by working to improve ROI on the demand side and “shift up the demand curve.”
The question is can MZ’s DSP Cognant and maybe a few other DSPs scale sufficiently and demonstrate enough independence to be called true countervailing powers to the Facebook – Google duopoly?
Or will Cognant become a “front” of independence “playing nice” with Facebook? Will Cognant become some fake sign of competition to be trotted out by Facebook lawyers in some antitrust lawsuit down the road?
Such an antitrust lawsuit will inevitably dwell on ad price trends as measured by cost-per-click (CPC). Consider the following graph showing that Facebook’s CPC rose 136% in the first six months of 2017.
How much of the above trend was due to Facebook asserting it’s pricing power and how much of that trend was due to other factors?
For example, the upward trend could be due in part to a secular improvement in ad ROI delivered by independent DSPs with help of Facebook supplied application programming interfaces (APIs), thus reducing information asymmetry on the part of buyers.
Of course, it takes more than API hooks for a DSP to deliver significant improvements in ad ROI. It takes a DSP that can build a sophisticated real-time programmatic bid engine and a real-time predictive analytics platform that feeds off Facebook-supplied user data and spits out bids with improved click-through rates.
Right now, we believe that the only independent DSP that has this capability is MZ ‘s Cognant.
In sum, Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.
Edge Computing Use Cases for MZ’s (Machine Zone) Platform
This is an expanded answer to a Quora question that I posted on August 6, 2017
I wrote a blogpost about 1 1/2 year ago valuing MZ. At the end, I suggested a few use cases that would benefit from the low latency of their platform. With the passage of time, there is a lot of talk about how the IoT requires a new computing paradigm called edge computing. I now am thinking about how MZ’s publish-subscribe, many-to-many platform could be used as a “first alert” messaging platform at the edge. Servers would be called only in cases of a need for higher order compute functions and storage.
The obvious use case for MZ’s platform would be v2x middleware for the era of autonomous cars. Another use case would be a IoT to IoT “first alert” message of a computer virus akin to what Tanium has developed.
Also, moving 400 billion or so daily events connected with RTB ad exchanges to the edge by conducting individual ad impression auctions within a Docker located on the device.
Also, many-to-many AR games placed via Bluetooth at the edge without calls to the server.
MZ’s has contracted with Switch, an innovative data center provider based in Las Vegas, to house thousands of MZ -owned servers with FPGA’s optimized for its Erlang-written publish-subscribe platforms.
Switch has recently announced “The MOD 100…for a rapidly deployable, single user environment that can be extended to nearly any location around the globe. The MOD 100 data center can be customized to fit on premise, at the edge or in a dense urban environment on a parcel as small as 400 feet by 400 feet.”
MZ has recently entered the AdTech business with an omnichannel, demand-side stack featuring RTB for display ad impressions. We could see them leverage their relation with Switch and growing expertise in rapid-response, FPGA servers. One way would be to enter AdTech from the supply-side via an edge CDN featuring 1,000 of MOD 100’s full of video ads and connected to auctions via MZ’s publish-subscribe platform.
Below is a picture of Switch’s SUPERNAP 8 data center outside Las Vegas:
Machine Zone (MZ): A $10 Billion Dollar Unicorn in the Making
(Original publication date: 6/7/16)
(Our suggested “moonshot” for MZ: ending urban traffic congestion via a real-time pricing platform + “connected car”)
(Our suggested new tagline for MZ: “put a price on it.” Shoutout to Portlandia for its “put a bird on it” tagline for a hand-crafted gift store capturing its big picture strategy)
Short Postscript (12/15/17)
Google Trends confirms that the term “moonshot” peaked one week after writing this article in June 2016. Moonshot is so 2016 we guess.
While our suggested moonshot for MZ of pricing congestion seemed reasonable back when we first wrote the article, it seems (sadly) downright heretical today given the current chill against open discussion of controversial tech solutions that Y Combinator head Sam Altman has blogged about recently.
“Put a price on it” is a controversial idea for solving problems. We hope that folks will not be deterred by the chill and and continue to stick with it.
Back to original article written 6/7/16)
In a year when valuations of so-called Unicorns — startups valued at $1+ Billion — are being marked down by investors, we will present the case that Machine Zone, recently rebranded as MZ, is a $10 Billion Unicorn in the making.
This is an audacious claim. A January 2016 Unicorn list compiled by Fortune Magazine assigned a $3 Billion valuation to Machine Zone based on a WSJ report in June 2014 of a funding round of $250 Million led by JPMorgan Chase. There was second hand confirmation of this in Pitchbook.
Machine Zone was not even listed on any Unicorn list a year ago simply because such lists required that valuations be based on reported equity financing with implied valuations of $1+ Billion. Machine Zone’s last reported funding round listed in Crunchbase was a Series B done a full four years ago when Machine Zone was just beginning.
We found Machine Zone’s absence from 2014 Unicorn lists both perverse and ironic. It was perverse in that Machine Zone didn’t need financing so it was excluded from successful startup lists. It was ironic because, unlike most other Unicorns, Machine Zone’s revenue levels and revenue trends are observable daily via app store data reported by analytics companies such as App Annie or Thinkgaming.
On July 15, 2015, Bloomberg reported that the company was in discussions with investors for an additional $200 Million in funding at an implied valuation of $6 Billion. Dean Takahashi of VentureBeat also reported rumours of this new funding round. But, he reported that Machine Zone was seeking $500 Million at an unstated valuation — not the Bloomberg figures. Takahashi’s source also said that “the pitch has met with skepticism.”
Machine Zone has refused to comment on any venture capital interest or funding. As we blogged at the time, compared to most startups who would relish disclosing funding rounds that would confer Unicorn status, Machine Zone “walks the walk, not talks the talk”.
The Evolution of Machine Zone’s Identity
Until this year, Machine Zone’s CEO Gabe Leydon averaged about two interviews a year and never talked about revenue, valuation or IPO plans. He never talked about the state of the mobile game industry. In fact, he rarely talked about Machine Zone’s two hit successes Game of War: Fire Age or Mobile Strike.
Instead, he used rare interviews to advance the theme that Machine Zone was a technology company with software platforms whose applicability and marketability extended beyond games.
In a 2013 interview, Leydon said that Machine Zone had developed a “game engine” that could be “re-skinned” to create other genres of games with the same underlying play and communications innovations. This comment was designed to counter the perception that Machine Zone was a one-hit wonder deserving less of a valuation than mobile game rival Kabam with multiple Top 10 hits at the time.
In 2016, Machine Zone has done just what Leydon predicted in 2013. It had “re-skinned” their top revenue rank Game of War: Fire Age to release another Top 5 revenue rank game Mobile Strike, published by their downtown Palo Alto studio Epic War LLC. What is remarkable to us is that there does not seem to be much cannibalization going on between the two games.
In 2014, Leydon talked about Machine Zone’s real time, crowd-sourced chat translation engine. We wrote several papers speculating that this chat translator would be a valuable addition to Slack as it would open doors to large multi-national corporations.
In a March 2015 interview with Bloomberg’s Robert Kolker, Leydon identified what he thought was the “Wow” factor of its hit game Game of War: Fire Age — the low latency of the game play.
“…Game of War accommodates about 3 million users in simultaneous play, with what the company clocked as a 0.2-second response time…. This is the largest real-time concurrent interactive application ever built. There’s nothing even close to it.”
He also hinted at the marketability of this technology outside of gaming.
An additional signal of Machine Zone’s intent on being a fundamental technology company was a report in the Las Vegas Sun that the data center builder Switch would be expanding its Southern Nevada facility to house 4,000 dedicated servers owned and managed by MZ. These servers likely feature FPGAs that optimize the speed of MZ’s Erlang-written, publish-subscribe messaging platforms.
On February 18, 2016, Machine Zone and CEO Leydon had a “coming out party”. He broke out of his pattern of infrequent print interviews to give a full blown 39 minute video interview at the important Code/Media 2016 Conference.
In our opinion, it was here that Leydon first demonstrated his charm and ease at speaking as he mixed in fond memories of 90s skateboard videos with big picture views of the state of ad-tech. The interview was convincing evidence to us that Leydon was capable of leading an IPO and being the spokesperson for a publicly-held company.
Within the first minute of the interview, Leydon articulated a more focused view of Machine Zone as “real time” technology company. However, because the audience were media and ad-tech people, Leydon did not talk about the software technology at all.
Instead Leydon startled the crowd with sharp criticism of 3rd party buy-side ad-tech platforms and the state of ad-tech in general. He casually revealed that Machine Zone had developed it own ad-buy platform specifically tailored to the acquisition and retention of freemium game players aka “whale targeting and retention”.
This platform was an alternative to relying on outside platforms like Chartboost and Tapjoy, used by Machine Zone’s rival Supercell and other top mobile game companies. According to Crunchbase, Tapjoy has received a total of $2.47 Billion in VC funding over the years.
Once again, by building its own buy-side ad-tech platform, Machine Zone has set itself apart from other mobile app Unicorns. Supercell, its chief rival in the mobile game industry, uses Amazon AWS for infrastructure and Tapjoy for ad-tech. Supercell does not have any internal chat function for players to communicate.
On April 4, 2016, Machine Zone issued a press release stating that it had changed its name from Machine Zone to MZ to underscore its new identity as a “real time” technology company. It also announced that it would begin licensing its real time publish-subscribe messaging platform, branded as RTplatform™. Leyton suggested in a follow-up conversation with Venturebeat that RTplatform ™ had wide-spread applicability ”from financial service companies to connected car companies to government institutions”
Valuing MZ’s Mobile Game Business
What follows is an estimate of MZ’s current valuation based solely on its mobile game business. There are three pieces of data required: (1) App Annie revenue ranks for MZ’s games; (2) an estimate of a power function relation between annualized revenue run rate (ARR) and app store revenue rank; and (3) “market-derived” valuations of pure play mobile game companies as a multiple their ARR.
For example, Activision Blizzard recently bought King Digital for 3.08 times ARR. Using that as a comparable and an estimate of MZ’s mobile game ARR of $2.0 Billion, we would arrive at a valuation for MZ of 3.08 * $2.0 Billion = $6 Billion.
We have used this methodology to value MZ over the past 2 years: Machine Zone: The $4 Billion Unicorn that Walks the Walk ; Machine Zone and the Perversity of Unicorn Lists and Machine Zone: IPO or What? (for Seeking Alpha).
We used the same methodology in articles to value other publicly-held mobile game companies — King Digital, Zynga and GLU Mobile — and the start-up Kabam. Finally, we have used the methodology to make prescient buy recommendations for two undervalued Japanese mobile game companies — Mixi and KLAB.
Below are two “market-derived” valuations of pure play mobile game companies as a multiple of ARR. The first is a valuation of 3.08 * ARR that Activision Blizzard paid to acquire publicly-held King Digital in late 2015. Using King’s ARR, as reported in 10-Qs to the SEC as a checksum, we present below an estimate of the distribution of King’s ARR by individual game revenue and associated revenue rank as reported by App Appie.
The second is a market-derived valuation for Finland-based Supercell. While the company is not listed on a stock exchange, it is required by Finnish law to report financials once a year. In 2015, Supercell reported revenue of $2.326 Billion. We coupled that with a reported $5.5 Billion valuation that Softbank placed on Supercell when it bought an additional 22 percent stake in Supercell (bringing its ownership to 73 percent) in mid-2015.
As with the King valuation, we use Supercell’s reported 2015 revenue as a checksum when estimating the distribution of Supercell’s ARR by individual game revenue and related revenue rank.
For our valuation of MZ here, we chose the lower, more conservative, Supercell valuation of 2.36 * ARR. The higher 3.08 * ARR that Activision-Blizzard paid for King Digital was 20% higher that the market value of King at the time. Plus, most financial pundits felt that Activision-Blizzard paid too much for King.
In past valuation of MZ, we chose 2.5 * ARR based on market-derived valuations of publicly-held Japanese gaming companies. Given, the general downward drift in Unicorn valuations, the use of the lowest multiple of 2.36 * ARR seems appropriate today.
Based on the estimates above of individual game revenue associated with various iOS Apple USA revenue rank as reported by App Annie, we derive an estimate below of a 2016 power function of global ARR vs iOS USA revenue rank.
We now present a current valuation of MZ based on its two hit games alone which rank #2 and #3 on the App Annie iOS USA revenue charts.
Note: during the writing of this paper in April 2016, Supercell’s Clash Royale and MZ’s Game of War have traded #1 and #2 positions multiple times. We are being conservative in our valuation here by using the lower #2 ranking for Game of War. Had we chosen #1 for Game of War with an associated ARR of $2.1 Billion, our valuation for MZ’s game business would have come in at $7.3 Billion instead of $5.7 Billion
Use Cases for RTplatform™
We place the MZ’s valuation today at $9.1 Billion as a fundamental technology company. We think the valuation for its ad-tech platform is fair at $1.0 Billion, give that VC’s have poured over $2.7 Billion so far into Tapjoy, a comparable platform. We think the licensing value of its chat translator is fair at $400 Million, given the doors it might open for Slack. There might even be interest in the chat translator from Facebook or Microsoft, given the current interest in text messaging as a replacement for apps and mobile OS.
Addendum 3/8/18: Here is an article of ours on MZ’s newly branded demand side platform (DSP): “Lemons” And Antitrust: Two Forces Driving Facebook’s Work WIth MZ’s DSP Cognant
Addendum 6/13/18: Here are several more articles of ours on the division of MZ into a game company — MZ – and a real-time crypto-economic platform called Satori® with Gabe Leydon as CEO.
Toward a P2P Market Design for a Crypto-Economy (6/10/18)
Satori: Toward a True P2P (Post-Walrasian) Crypto-Economic Platform (6/3/18)
Admittedly, our $2.0 Billion valuation for RTplatform™ is the most speculative component as no comparable market-derived valuations are offered. One factor that caused us to value it so highly was the very fact that MZ hyped it. Here was a Unicorn company and CEO who had “walked the walk” for years and never made comparisons. Suddenly, it started “talking the talk.” as in “our specs crush your specs” and “ our new specs crush our old specs.” We believe the company can make good on the hype, given their amazing string of accomplishments.
According to the Venturebeat interview on the day of the launch, the company said its platform was “much more scalable than what is currently available in the market from rivals like Amazon or Google…” Leydon said PTplatform™ was “100 times bigger” than its current platform running Game of War.
The other factor underlying our high valuation was the use cases and market potential we were envisioning for a platform described by the company as a
- “massive platform for doing high-fanout data processing,”
- “many-to-many applications”
- “an infrastructure that allows you to do some extremely large things in real time at scale.”
- “unique ability to interconnect ‘billions’ of endpoints worldwide and transmit data at low latency”
In the Venturebeat interview, the company hinted at use cases “from financial service companies to connected car companies to government institutions”. In earlier interviews, Leydon hinted that its game engine was transactional with ultra low latency. He compared it to platforms required for high frequency trading.
We present the following broad use cases for a real-time pricing or auction platform coupled with the “connected self” or the “connected car”:
- eliminate information asymmetry and “moral hazard” between insurers and customers;
- eliminate the “tragedy of the commons” like urban traffic congestion or overfishing;
- eliminate transactions costs causing “sticky prices” for services whose performance over time is uncertain;
A specific use case for (1) would be real time auto insurance pricing. In 2014, consumer auto insurance had been estimated to be a $190 Billion market. MZ should be targeting one of the top 4 auto insurers — State Farm, Geico, Allstate, and Progressive — as an exclusive licensee. They should aim for an announcement within the next three months, with a roll-out and initial monetization within a year.
This “early win” will shock the auto insurance industry, impress the VC investment community, and finally clue tech writers that MZ should listed along with handful of unicorns — Uber, Airbnb, WeWork, Palantir and Slack — as having the greatest upside potential.
A specific use case for (2) would be a real-time auction for peak commute time on urban freeways. There is an article in Forbes citing a report which estimated the direct and indirect costs of traffic congestion at $124 Billion in 2013.
There was also something called the Millennium Project out of UC-Berkeley in the mid-2000 which used (then novel) mobile phones to gather data on drive times and traffic congestion in the Bay Area. In 2011, there was a report which presented in detail the problems in ”scaling up the Mobile Millennium traffic information system using cloud computing and the Spark cluster computing framework”.
Surely, the 2016 RTplatform™ would be a prime candidate to underpin any solution to urban traffic congestion. Needless to say, solving this problem would require government sponsorship so monetization by MZ for this use case might be a 5+ years off. But, announcing that it would be involved in a project to end urban traffic congestion would place MZ alongside only a handful of companies undertaking a “moonshot” and “make a difference in the world” type of project.
A specific use case for (3) would be dynamic pricing for sporting and entertainment events. Many Major League Baseball team are setting aside bleacher sections with individual game day tickets that vary by day of week, opponent, and weather. The National Football League is also starting to set aside individual game day tickets that vary over the course of the season by attractiveness of the matchup.
We could envision MZ’s platform taking this dynamic pricing of sporting events to a “real time” level by allowing both baseball and football fans to bid on game day seats inning by inning or quarter by quarter. Obviously, this use case seems ludicrous, but it does emphasize widespread instances of “sticky prices” due to transaction costs for a steam of services with uncertain, highly variable quality.