Can High Flying NetGravity Maintain Its Position?

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Vendor Genesis

NetGravity was founded in 1995 by Chairman John Danner as the first commercial provider of online advertising solutions. NetGravity had $11.6 million in revenues in 1998, with an 81.2% increase over 1997's $6.2 million. Revenues for the six months ending June 1999 were $10.5 million, a 136% increase over the same two quarters in 1998. The company lost $11.3 million in 1998, compared with a $6.9 million loss in 1997. The Q2 1999 loss was $2.1 million ($0.12 per share), an improvement over the Q1 loss of $3.7 million ($0.28 per share). Revenue growth from 1997 to 1998 was heavier in Service and Maintenance ($5M, representing growth of $2.8M or 220%) than in software licenses ($6.5M, representing growth of $2.5M or 163%). Both cost of sales and R&D have decreased as a percentage of revenues, the former from 97% in 1997 to 90% in 1998, and the latter from 47% to 40%. The company went public (NETG; NASDAQ) in June of 1998, and had a second public offering in April 1999. Recent prices have been in the high twenties to low thirties, with earnings per share of -$1.28. The number of NetGravity's customers increased from approximately 250 at June 30, 1998 to approximately 380 at June 30, 1999.

The company's initial and still core product (AdServer 3.5) is software that serves ads to website pages. The AdServer product is licensed to a company and runs on the licensing company's own servers. Ad serving to a web page is triggered by special tags that the web page designer inserts into the page. The tags describe characteristics of the ad to be served to that position. These characteristics correspond to the model against which ads are sold. Characteristics can take into account the page on which the ad appears, the time of day and other environmental factors, demographic information such as the user's zip code or company, search terms entered by a user, or information about the user that might have been previously captured by the website. (See TEC Technology Research Note: "How to Serve an Ad" October 23rd, 1999) Advertisers can view reports detailing the numbers of impressions and clickthroughs. Ad reports are accessed over the Internet.

The entire suite of NetGravity products includes:

  • AdServer 3.5: this is the core product. It is licensed in two varieties: The Enterprise model supports a single webserver; the Network model can support many servers. The two varieties have slightly different features and a site can run both simultaneously to take advantage of all the features, although few sites need to do this. (See Last Page: Two Models) AdServer runs on machines owned by the website publisher.

  • AdCenter for Publishers: A transaction-based version of AdServer in which servers that run the NetGravity software are hosted by NetGravity.

  • AdCenter for Agencies: A version of AdCenter for Publishers designed for advertising agencies, which sometimes wish to host their clients' ads themselves to get better control. The ad agency will buy space on various web sites and provide each with a pointer to the agency's AdCenter server. (The websites on which ads are purchased need not be using NetGravity ad servers.)

  • Targeting solutions: The key product is GPS which allows websites to target ads by users' zip codes or by characteristics of the organization from which they are surfing. GPS is sold according to a transactional model.

  • Professional Services: This group assists customers with installation and upgrades, with evaluating their successes using NetGravity products, and with developing custom solutions to particular ad serving problems.

  • Education: NetGravity offers courses regularly on both coasts. Courses cover basic operations and custom tailoring of the reports or of the functionality of the AdServer itself.

On July 13, 1999 NetGravity announced a planned merger with DoubleClick Inc. (NASDAQ: DCLK). DoubleClick is an outsourcing service which differs from NetGravity's AdCenter in that DoubleClick accumulates information about ads served to particular users, regardless of which site the user had visited, and uses that information to target ads to users based on their past history. Under the terms of the merger, DoubleClick will issue 0.28 shares of DoubleClick common stock for each share of NetGravity common stock. DoubleClick stock hovered around 100 during the end of the summer and has been generally much more volatile that NetGravity's. The merger is expected to close during Q4 1999.

Vendor Strategy and Trajectory

Although estimates of the amount that advertisers will spend on the Internet, and the value that they get from advertising, fluctuate weekly there is no doubt that advertising will continue on the Internet, and that it will continue to become more complex. We believe that there are two areas in which companies involved with ad serving must evolve technologically. First, the technologies that are used to capture surfer attention (so called "rich media ads") will continue to evolve. Whereas most ads today are static images or contain simple animation, we expect to see banner positions becoming mini-entertainment centers, serving up sound, full-scale animation, and video. NetGravity expects that its customers will soon be able to offer their advertisers "transaction-enabled" banners, which will make it possible for users to complete transactions through the banner. Nothing that happens here should be a key differentiator between different products. Whatever capability one company announces another company should - and must - be able to announce soon after.

The second and more critical area of technology evolution is to serve the growing requirements from advertisers for micro-targeting of ads. Advertisers are coming to expect ever more sophisticated abilities for targeting those surfers who are most likely to convert from ad viewers to buyers. NetGravity sees targeting as a major piece of their future, and is preparing for it in two ways. The next version of the Ad Server (AdServer 4.0), announced for release in October 1999, allows the system to collect information about target audience segments to be used as the basis for daily forecasts into the future. Meanwhile, NetGravity maintains flexibility by allowing customers to choose any provider of targeting software and integrate it with the ad server. NetGravity has partnerships with vendors like Net.Genesis and Net Perceptions, both of which have capabilities for collecting, reporting on, and using information about the behavior of users.

There are two big questions about NetGravity's future. One is the effect of the merger into DoubleClick. We do not believe that DoubleClick will interfere with NetGravity's core software licensing business. The merger was made, at least in part, to give DoubleClick access to NetGravity's technology, so interference with the AdServer product would be self-defeating. The AdCenter product is more vulnerable. AdCenter could be seen as competing with DoubleClick; both serve customers who want ad serving capabilities but do not want to host their own servers. However, there are other ways in which the products differ. DoubleClick positions its DoubleClick Dart service as a network. For the purposes of comparison with AdCenter the salient difference is that DoubleClick merges information about user behavior across all the sites it serves. Thus if website A wants to serve car ads only to surfers who have previously shown interest by clicking through on car ads, website A will have access to information about whether a surfer has clicked through on car ads on any of the sites served by DoubleClick. This is a powerful capability for a website to be able to offer to an advertiser, but there are many website publishers who are unwilling to share their user data with other sites. Although DoubleClick Dart does offer its customers the opportunity to opt out of data sharing, the physical ownership of user behavior data resides with DoubleClick, and this had been unappealing to some publishers.

Logically, therefore, the merger should not affect the AdCenter product. However, the business story has some other considerations. Revenues from AdCenter were $1.1 million for the six months ending in June of 1999. The cost of providing transactional services (including GPS) was $2.2 million for the same period. This is hardly out of line for a new product line. However, given that additional expenses are expected for equipment and personnel, and that NetGravity will have to duplicate DoubleClick's expertise in managing outsourced services, we think it is quite likely (probability 85%) that AdCenter will be merged into DoubleClick Dart. We suspect that DoubleClick is prepared to make this move fairly swiftly, but think that reports from the field about customer concerns with both data privacy and performance may delay any announcement until DoubleClick has introduced NetGravity's technology into its Dart service.

Vendor Strengths

NetGravity is above average for both its features (including the ability to target ads, the administrative capabilities provided to the website managers, reporting and support for adding custom features) and, especially, its scalability. The software is fast and generally reliable: One of their major customers serves one billion ad impressions each month. It is easy and relatively inexpensive to scale up as the number of ad impressions grows, so a NetGravity customer can handle almost any imaginable volume of ad impressions. The software runs on both Unix and NT servers, and with the Netscape and Apache webservers. Version 3.5 does not work with the Microsoft Internet Information Server, a weakness that is expected to be repaired in AdServer 4.0. Users provide their own databases, which can be Oracle, SQL Server, or any ODBC compliant database. Operationally the software is relatively easy to use, although the basic Ad Master training is strongly recommended for new users. Bringing up a new ad is relatively easy, as is generating an ad hoc report. However, the standard reports are not presented in real time, and a site with many hundreds of advertisers (a rarity) can expect report generation to take up to a day The reporting package offers a number of different options and a customer can develop custom reports if needed. The courses presented in their education centers are useful, and on-site consultants are knowledgeable and helpful. All consulting engagements are documented carefully, and the company builds the cost of post-installation reviews into the license cost, ensuring customers that they will be set off on a strong footing. Post-installation customer service gets generally acceptable marks.

Vendor Challenges

Out-of-the box installation is painless, especially since a NetGravity consultant will be on-site to help. However, straying from the simplest case is not as easy as it should be. Customizations tend to be difficult, in part because detailed technical information is not always easily available to the customer or to the support staff. Also, uses that stray from the basic model, that of a site serving consumer ads, have caused difficult integration problems for at least one business-to-business customer.

The control software used by customers is powerful, but does not support the situation where different units within the customer want to handle managing their own ads; this is a promised feature in the next version, however. While reporting facilities are good, generating reports can be slow, and collecting additional data to report on targeting information that might be collected by the customer can strain the database and reports. The product does not offer real-time reporting, although ad hoc reports are fairly easy to generate. As the competition for ad dollars increases and advertisers look to maximize the effectiveness of their online campaigns, the lack of real-time reporting may become a significant issue. It will not be easy to add real-time reporting to the architecture used in AdServer 3.5, and the situation is as yet unknown for the 4.0 release.

NetGravity allows websites to take advantage of information they collect about individual customers, but does not integrate this information into its own database. This makes the process harder than it should be: The customer has to maintain its own database of information and, before a page is served to a known individual, derive from that database a code that will direct NetGravity to serve a particular kind of ad. There will be an explosion of precision targeting of this kind in the next few years, and NetGravity will be pressured to respond by making such targeting part of its basic offering. This will be a challenge to the current architecture.

The merger with DoubleClick should not prove a negative for NetGravity's customers. But NetGravity must be concerned with the response by its main rival, CMGI. (See TEC Technology Research Note: "'Ads Are Us', Boasts CMGI" October 7th, 1999). NetGravity's major weakness against CMGI's Engage subsidiary has been Engage's targeting capabilities. Engage's actual ad server, Accipiter, has not been a serious threat to NetGravity, but the integrated tracking and targeting capabilities of Engage, which were added to Accipiter when the latter was purchased by Engage, are very attractive. NetGravity does not have equivalent features, although it has partnerships with Net.Genesis and Net Perceptions, which fill in the gaps. Still, the capability would look a lot stronger if it were integral to AdServer.

We are concerned about the lack of attention that NetGravity has paid thus far to security issues. An advertiser's ad traffic reports can be important competive information, and in AdServer 3.5 these data, once an advertiser supplies a password, are sent of the Internet with no advanced for of security protection. Security is relatively easy to implement, and should be high on the feature list.

Vendor Predictions

NetGravity is well positioned to survive any shakeouts in this area due to its new relationship with DoubleClick, and will be one of the top two choices for licensed ad serving software for the foreseeable future. With the backing of DoubleClick and the aggressive moves by CMGI, enhancing the capabilities for intelligence gathering, and targeting are imperative. The probability is near 100% that NetGravity will make a significant announcement along these lines by early 2000.

As noted above, we expect (probability 85%) that DoubleClick will eventually phase out the AdCenter product line, hoping to convert most of its customers to DoubleClick's own service or to NetGravity's AdServer product.

Vendor Recommendations

A logical step first step would be acquisition of enhanced user tracking and targeting capabilities, perhaps from one of its current partners. However, NetGravity should also be looking at some of the leading edge work university work on extracting information from unstructured data, which has the potential of providing its customers with data mining capabilities to capture unexpected relationships between surfers, the pages they visit, and the ads that interest them. Any improvements in analysis and targeting would benefit DoubleClick as well as NetGravity.

Although the software's usability is good given the complexity of the task, NetGravity must show continuous improvements to avoid becoming known as a "high-end" company that can be too complex for the "little guy." On the other hand, those high-end customers will increasingly be pushing the edge of the technical envelope. NetGravity will have to improve the tools it provides to its customers to modify the out-of-the-box functionality if those customers are to be able to react swiftly to demands from their advertisers (or their marketing departments).

NetGravity's support staff and consultants are successful because of their intimate knowledge of the product: The difficult problems frequently require understanding of what the customer wants to do, how others have done similar things, and what technical capabilities of the product are being stretched. It is important for the company to preserve its strengths in this area. It would be a natural bottom-line oriented result of the merger for the support functions to be considered as commodities, and combined into a single organization serving both products. We believe that it is in the best interest of NetGravity 's customers that any such action be delayed, or at least driven according to NetGravity's technical and service standards.

User Recommendations

The first two questions a prospective user of ad serving software must ask are:

  1. Whether to license the software or to use a transactional model
  2. Whether to be totally responsible for its own ad sales and data collection or to be part of an ad network

If a website wants to be part of an ad network, the details -- such as whether they want to do some of their own ad sales, all of their sales (but use a network like CMGI's newly acquired Flycast subsidiary to handle unsold inventory) or none of their sales - will be a strong driver in a buying decision. The decision to license the software and host servers or to pay by the ad is also one that conditions the decision. However, there are very few combinations of these factors that rule out a NetGravity solution.

Larger websites, any site choosing to license and host the software itself, and those who have requirements that no vendor addresses directly, will definitely have NetGravity on their short list. Unless NetGravity abruptly discontinues sales of version 3.5 when it announces 4.0, users should consider both products, trading the proven reliability of the older product against the new features of 4.0, at least until 4.0 has established its own reputation. Small sites with simple requirements that want to license software will want to consider NetGravity as well, but are safer making their decision based on cost factors alone.

Note that anyone interested in serving their own ads must consider the total cost of ownership, which must include assuring reliability and redundancy for both servers and storage systems. Once a website begins serving ads any loss of uptime has a direct impact on the bottom line - stronger even than the effect of losing revenue from consumer sales because advertisers will expect refunds if their ads are not served as promised. This is not an issue for or against NetGravitry as opposed to any other vendor, but might well tip the decision to an outsourced solution.

Sites that want to use the transactional model and outsource ad serving will weigh the advantages of NetGravity's AdCenter against that of other services where aggregate user data from different sites is pooled in one way or another. If the NetGravity model is the one that fits best, the considerations are cumulative cost of transactions and the performance and uptime of the servers. The quality of NetGravity's technology is likely to make AdCenter an attractive choice for both performance and uptime, but the service is not sufficiently mature for a good prediction. Calling current users for referencs and testing response on sites that use AdCenter will be necessary components of the decision.

Two Models

There are two different models under which a user can license NetGravity's AdServer 3.5 software. In the Enterprise model, the ad server resides on the same machine as the one that serves the web pages. When a surfer's browser loads a page, the HTML code is first sent to the ad server, which replaces ad tags with images and clickthrough addresses. The resulting HTML code is then passed to the web server and sent to the browser.

In the Network model the AdServer 3.5 software resides on a different machine. (Actually, in this model you may have separate machines for serving ads, running the user console, serving advertiser reports, and running your AdServer database. All of these functions can reside on one machine, but performance considerations may make the multi-machine option more attractive). When a surfer's browser loads a page it sees an image reference to a URL on the AdServer machine. This reference contains parameters that specify the characteristics of the ad. The browser sends a request to the AdServer machine for the image; the AdServer chooses an ad that meets the parameters and returns it as an image.

In the Network model the AdServer 3.5 software resides on a different machine. (Actually, in this model you may have separate machines for serving ads, running the user console, serving advertiser reports, and running your AdServer database. All of these functions can reside on one machine, but performance considerations may make the multi-machine option more attractive). When a surfer's browser loads a page it sees an image reference to a URL on the AdServer machine. This reference contains parameters that specify the characteristics of the ad. The browser sends a request to the AdServer machine for the image; the AdServer chooses an ad that meets the parameters and returns it as an image.

The Enterprise model is generally used by organizations that have only one website. Since ad serving is an extra load on the existing web server these tend to be sites with a small number of ad impressions, although a site that serves content from many servers can mount AdServer software on each. The Network model is used by larger organizations and by those that want to serve ads for many different websites from one server.

One difficulty with the Network model is that when there are two ads on one page, each is served independently of the other. This means, in particular, that if there are two positions on a page that can contain ads from the same pool of eligible ads, it may happen that the same ads shows up in both positions. Since the Enterprise AdServer sees the entire page at one time, it can prevent this from happening. Should this be an issue a single website can use both models: in this some ad tags will be interpreted by the Enterprise AdServer while others would be sent to the browser, which would call on the Network AdServer to resolve them.

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