A development that may go down as a defining moment in eBay's (NASDAQ:EBAY) evolution slipped by virtually unnoticed last month when the company introduced "Keywords on eBay." Reminiscent of the successful pay-per-click services offered by new Yahoo! (NASDAQ:YHOO) bride Overture (NASDAQ:OVER) and privately held Google, the new program opens up a largely untapped pool of revenue.
Advertising on eBay
I've been an eBay shareholder for over four years now. Almost from day one, I saw the company losing out on some significant revenue because it never accepted more than a modicum of advertising on the site. Remember, these were the heady days before the bubble popped and it wasn't unusual to see CPM rates (cost per thousand ad impressions) in the $40 to $50 range.
There were reasons eBay didn't accept advertising, even as others with heavy traffic -- Yahoo!, AOL (NYSE:AOL), etc. -- raked in millions. For one thing, by plastering ad banners all over its site, eBay ran the risk of alienating its sellers. If you're a user running an auction, the last thing you want to see is an ad banner inviting potential buyers to leave either your page or a listing of your auctions.
Moreover, eBay not only makes money on listing fees, but each time an item is sold. Every customer clicking on an ad, therefore, could potentially be a lost sale. Management had no desire to cannibalize its own auction revenue.
Also remember that back then eBay faced significant competition from Yahoo! and Amazon.com (NASDAQ:AMZN) auctions, not to mention the threat that AOL or Microsoft's (NASDAQ:MSFT) MSN would jump into the fray. Had eBay lost disgruntled revenue-generating sellers to these competitors, the landscape might look far different today.
And while eBay did accept advertising on a limited basis, language like this was common in the quarterly and annual reports:
We continue to view our business as primarily transaction driven and we expect third-party advertising net revenues in future periods to continue to decrease as a percentage of total net revenues and in absolute dollars.
A commanding performance
CEO Meg Whitman and her management team deserve a ton of credit for several things, including:
- Realizing the importance of keeping the sellers happy.
- Realizing that the threat of competition and the lack of a critical mass in the number of users meant all efforts had to be focused on building the auction business.
- Sacrificing a few dollars of extra profit in the short term in order to build a rock-solid long-term business.
Management's competence shone most brightly when the bubble popped and eBay's business didn't miss a beat. Even as CPM rates plummeted and many advertising-dependent companies went under, eBay kept rolling along, nearly unscathed.
Even so, the lure of ad revenue persisted (at least in my mind). What could be more desirable to advertisers than 20 million people with money to spend, actively searching for things to buy? Factor in the ability to target just the right slice of that 20 million (people searching on the words "camera" and "film," for example), and it's easy to see why advertisers would pay a premium, and why this nagged me for four years.
But the problem remained: Just how do you get at this ad revenue without hacking away at your huge seller base? The answer, it turns out, was simple: include the sellers in the program.
By the sellers, for the sellers
"Keywords on eBay" was designed mainly as a way for eBay's users to advertise on the site. Developed with heavy input from its "power sellers," the program closely resembles Overture's pay-per-click model, where advertisers bid for prominent placement and pay only when users click on their ads. Higher-bidding sellers will see their ads appear more frequently.
But while eBay may generate decent revenue from its own sellers, they're not the only targets here. The company says the program is also open to outside "selected partners," which opens up possibilities for significant revenue generation.
For example, I typed the word "camera" into eBay's search box and got the usual listing of auctions. At the top of the page was a banner ad for a Polaroid camera being auctioned on the site. Another search on the same term, however, brought up an ad for Netflix (NASDAQ:NFLX), the DVD-rental-by-mail service. Subsequent searches on "camera" produced ads for concert tickets on eBay, an external student loan consolidation service, and IBM (NYSE:IBM) authorized auctions.
The strategy, apparently, is to allow ads that are directly related to the search term to point only to a seller's internal auction or eBay store. Non-related advertising can link to third parties, however. Thus, you might see Netflix when searching for cameras, but not if you're hunting for DVDs or DVD players. This is a logical means of avoiding cannibalization and keeping sellers happy.
Implications
eBay won't comment about its revenue expectations for the program. Looking at its past track record in this area, I expect management to proceed with caution. (The program has already been tested by a select number of users, and one restaurant equipment seller reported a 35% jump in revenue and increased traffic to his eBay store.) Once eBay is convinced there will be no serious negative implications, we'll likely see a rollout on a grander scale.
What kind of revenue might we see? Perhaps not much early on, but I think it will be significant in the years to come. Given the constraints of not displaying ads that compete with its eBay sellers, I wouldn't expect Yahoo!-type numbers anytime soon ($988 million, $571 million, and $652 million in "marketing services" revenue in 2000, 2001, and 2002, respectively).
But that leaves a lot of room for growth. After all, eBay recorded just $61 million in ad sales in 2002, or 5% of its $1.2 billion total. Forget those old disclaimers: I fully expect these sales to increase as a percentage of total net revenue and in absolute dollars.
We'll track this closely in the quarters and years to come.
Rex Moore isn't the only fan of eBay at Fool HQ. The stock is one of David Gardner's top picks in Motley Fool Stock Advisor.
Rex Moore's last purchase on eBay was a packet of de-worming medicine for his amazing Sea-Monkeys® -- the true miracles of nature. At press time he owned shares of eBay and Microsoft. Visit his profile page to view the rest of his holdings, and the Fool's disclosure page to view the, um, Fool's disclosure policy.
