How (not) to calculate your ad revenue

morgan_stanley

We all heard the news that YouTube was starting to put overlay ads on some of its content.

Morgan Stanley’s Internet analyst Mary Meeker presented her calculations of the impact of new revenue source on Google’s bottom line and concluded that the overlay ads could immediately add $4.8 billion of gross revenue and $720 million of net revenue to Google’s annual results.

That is a very high number indeed. Here is her calculation.

you_tube_mary_ad_calculations

Revenue of $400M a month, $4.8B a year. Of course the problem, as pointed out by Silicon Alley Insider and as it is plain to see, Mary forgot that CPM means cost per thousand ; so the total revenue from the ads is not $4.8B but $4.8M, a minuscule amount.

Once the error was identified, Morgan Stanley published a new estimate of revenue for YouTube and in addition to correcting the error, also changed the assumptions, so the numbers came out to be more “reasonable.”

Two observations here. The first one is that this is not the first time I have seen people forgetting to do a “sensibility” check on their ad numbers. I have a distinct recollection of a business plan that I saw where a very smart guy I knew, kept punching numbers in his calculator and came up with revenue of $500M just from putting ads on his site. I continue to come across these fake high numbers all the time. So always have a sanity check applied to any numbers you come up with.

The second observation is regarding the “analyst’s numbers” and how fluid they are. It is not uncommon (and very often it is the norm) that the analyst comes up with an estimation and then massages the numbers so the answer comes to what they want; not the other way around.

As for the ad revenue, one must take in to account the total inventory available, the sell through rate, CPM rate, CPC rates, click through rate, percentage of allocation between CPC and CPM, the market rates, the quality of inventory you have, affiliate links, the scaling issues, equivalent adsense revenue, and the list goes on. The point is that there is a way to reasonably accurately calculate/estimate the ad revenue number. You might have some leeway in some of the assumptions, but don’t let it get away from you. Do a sanity check.

The second observation, about the “analysts numbers” being fluid ones, is actually related to the first observation of making sure that the number pass a sanity check. A lot of these estimations are “blink” reaction by a knowledgeable person in the industry. The blink reaction includes all the computations one would do in an excel sheet. In this particular example, Mary incorporated 1% of the videos as having ads in them. Where does that 1% come from? Why is it not 25%? If it is 25%, does Google have enough advertisers who are willing to spend the card rate for CPM? So what happens here is that one is using the calculator (or Excel sheet) not as a guide but as a cane; it can’t tell you where to go, but if you are in the vicinity, it can tell you if you are at the right place or not, and it can warn you if you are tripping over anything.

The ad revenue can’t exceed the value you can provide to the advertisers. If you generate $1 in ad revenue, the merchant advertising has to generate $5-$10 revenue. Can your user base generate/support that? Compare that number against the number you calculated using various assumptions and if they match, you have done well.

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2 Responses to “How (not) to calculate your ad revenue”

  1. By Sheila on Aug 27, 2021 | Reply

    Talk about creative accounting! And I don’t even trust the CPM numbers ($20-$50) that most people come up with. A lot of companies end up having a “paper” valuation of many time what they are worth.

  2. By diyugg on Feb 5, 2022 | Reply

    Thank you again for all the knowledge you distribute!I am glad to post my views and points in this blog! I will keep visiting this blog very often.

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