iVillage Inc.: A Price Optimization Primer

William S. Morrison | JMP Securities

September 28, 2005

Investment Highlights:

We are reiterating our Market Outperform rating on iVillage.
Following our note out this morning regarding iVillage’s deal with Rapt Technologies and the revenue uplift we expect the deal to produce for iVillage, we thought it might be instructive to describe Rapt’s price optimization technology in greater detail and how Rapt is helping online media companies to improve their pricing models. Our $8 target price places iVIllage at a 17.5x multiple of our 2006E EBITDA, generally in line with its peer group median and historical valuation benchmarks for online media publishers.

Price optimization: an old technology applied to new industries.
Price optimization technologies are not new. They have been used for years in the airline industry, for instance, to determine the optimal prices for seat inventories on planes. Rapt was founded in 1998 by computer scientists at Stanford, venture backed by Accel Partners, with the purpose of bringing traditional price optimization technologies to new industries. The first few industries that Rapt targeted were high technology, life sciences, and financial services. In the 2002 to 2003 time frame, Rapt discovered that it could apply its technology to online media companies and set about targeting companies within the online media space. Yahoo! was its first client in the media space and continues to be a marquee client reference for the company.

Rapt has a history of helping online media companies price their branded/display inventory more effectively and increase their revenue.
Rapt is the only company that we are aware of that has developed and implemented successful price optimization solutions within the Internet media space. We believe Rapt has been a key ingredient in Yahoo! and MSN’s ability to outgrow most of their online media competitors in the branded/display advertising market over the past two years. Our research suggests that other companies in the online media space that have worked with Rapt saw their revenue increase by 5-10% as a result of deploying Rapt’s optimization products. With most of the major portals under its belt, Rapt is now bringing its optimization technology to smaller media companies. According to our research, iVillage is the first company outside the major portals to sign a deal with Rapt. We believe that price optimization solutions like Rapt are going to be one of a handful of factors to support rising online media prices at iVillage and across the industry for the next three to five years.

Why it works in online media.
Few industries offer more pricing challenges than traditional CPM based online media. Remember, search pricing is determined by a relatively efficient auction driven model. Historically, branded CPM based online media has been priced via relatively unsophisticated processes – think spreadsheets generated by sales management. Demand varies and is often complicated by the uncertain availability of inventory supply. Online media is also an extremely perishable, time sensitive product that co-exists with different sales models (auction, rate card, performance based, etc.) and different customer goals (brand building, generating leads, etc.). All of these factors make pricing online media an extremely complicated task. Rapt’s technology brings a more scientific approach to pricing branded/display online media using proprietary algorithms that determine price elasticities and cross elasticities of demand for specific inventory segments and categories. Rapt takes historical demand data from the companies it works with and their projections of future supply to determine the optimal prices for various classes of ad inventory.

Price optimization software is but one tool in a media company’s pricing toolbox.
Our research suggests that price optimization technologies are one analytical tool that companies like Yahoo!, MSN, and iVillage can use to determine the appropriate price points for their ad inventory. We are not suggesting that price optimization is the “be all, end all” solution for online media companies to close the CPM gap with traditional media formats. However, we do believe it is a big first step and is likely to be a major contributor towards more efficient pricing of CPM based inventory. Nor are we suggesting that by raising our estimates on iVillage’s CPM based revenue by 5% that iVillage is going to implement Rapt’s software and suddenly and magically see a 5% increase in its prices. What we are saying is that our research suggests that other companies that have implemented and used Rapt in the past two years have seen an uplift in their revenue in the 5-10% range. We assume some of that uplift comes from the software, but it also comes from sales process re-engineering and management commitment to the new price points. Lastly, of course, it comes down to the sales force’s ability to execute and sell the new price points.

Price optimization can supercharge growth in a rising price environment.
Our research suggests that most online media companies typically change their rate cards for CPM based ad inventory on a quarterly basis. Rapt’s price optimization technology and software, however, enable media companies to develop more dynamic and more immediate changes to their pricing models. We believe Rapt has enabled Yahoo! and MSN, for instance, to go from quarterly rate cards to monthly rate cards. In a rising price environment, this enables companies to raise prices faster, capture more value from media buyers, and supercharge revenue growth.

We remain in the midst of a large secular shift in offline ad dollars to the Internet.
In our opinion, this shift is likely to help fuel a rising price environment in online media for another three to five years. According to a recent report by Forrester Research, consumers are spending 34% of their (at home and work) media time on the Internet while our research suggests that 5% to 6% of the total advertising market is allocated to online media today. If history is any guide, that gap should close dramatically over the next few years, producing a large secular shift of ad dollars from traditional media formats – television, radio, and direct mail – to the Internet. Our research suggests that large budget advertisers are going to embrace Internet branded and display advertising formats, including rich media and broadband video advertising, in the same way that small advertisers flocked to paid search in 2003 to 2004. As they do, we believe companies like iVillage are going to use price optimization and other technologies, such as behavioral marketing systems, to price their inventory more efficiently and on a par with traditional media formats.

Disclosure: In accordance with U.S. Securities laws please note:
1. Rapt and JMP securities are not affiliated;
2. The report has been re-published with explicit consent from JMP Securities;
3. The information posted here is for informational purposes only and is not an attempt to solicit orders. 

 

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