March 03, 2005

Arbitrageurs vs. Prequalifiers

Regular readers know my disdain for using the terms "price comparison" and "shopping comparison" as if they were synonymous. Today, I have a new pet peeve, courtesy of Bambi Francisco at MartketWatch. (see: The arbitrageurs.com: VCs may fuel a future paid-search bubble)

"These startups call themselves niche or vertical search engines, comparison-shopping engines, or next-generation search engines. I call them middlemen, the pre-qualifiers or arbitrageurs. Whatever moniker today's startups are using..." (emphasis mine)

Arrgghh!

Let's nip this in the bud, because it devalues the work of everyone who is adding real value in the shopping comparison space.

ar·bi·trage (n.) - the purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy. American Heritage Dictionary

two key differences:
immediate resale - what about the repeat visitors?
price discrepancy - what about the service offered?

A company that is in the business of adding value can also take advantage of pricing discrepancies, but that does not mean the two concepts are synonymous.

If You Want To Look At Real Paid Search Arbitrage...

...look no further than "AdWords affiliates" who are selling traffic direct-to-merchant.

Immediate resale? Yes
Repeat Visitors? No
Price Discrepancy? Yes
Services Offered? No

These are the clear-cut arbitrageurs, and their revenue-per-visitor is the arbitrage baseline. Anything about that baseline, long-term, will be won by the middlemen who provide above-average value.

In Defense of Middlemen Who Earn Their Keep

I know pundits like to predict the demise of middlemen, but I'm partial to this quote from Kevin Kelly in New Rules for the New Economy:

"Everything about the web ...suggests that the expectation that the network economy favors disintermediation is exactly wrong. It is quite the opposite. Network technologies do not eliminate intermediaries. They spawn them. Networks are a cradle for intermediaries."

Shopping Comparison and Merit-Based Advertising

Adding another wrinkle to this topic is the AdWords ranking formula that uses click-through rate (CTR) in addition to maximum bid.* That means there is always a human element, and this is never strictly a financial proposition. You can work all you want to identify undervalued keywords, but if you do not click with the customer, you do not get access to the market. (calculation explained: post #11)

Luckily for the comparison shopping sites, they have plenty to offer in exchange for a user's click: feature finders, feature comparisons, user product reviews, user merchant reviews, price comparison price alerts, the list goes on. This does not always sit well with retailers, who get tired of seeing the same comparison sites in the paid and organic search results. Still, in my experience, "killer shopping apps" are more commonly found at aggregators, not retailers. In merit-based advertising, if you offer a useful service and can convery it in a short text ad, that can be a very real form of pricing power.

I have tried to illustrate this "comparison dynamic" with the following made-up text ads:

Conclusion

I agree with the basic math of overcapitalization + overbidding = distaster for companies that focus on the filthy lucre of arbitrage more than the real job of prequalifying. However, I think a paid search bubble due to shopping-search restructuring would be a mini-bubble with a short lifespan. I certainly would not mention these sites in the same breath as boo.com.

If we look past the investment fads, there is a big-picture trend here. The shopping engines are creating more value than ever, and there is plenty of opportunity for improvement. And I'm not just talking about the obvious shortcomings of Froogle. I'm talking about all kinds of synergies between services and technologies. What if every product category was served as well as digital cameras?

Arbitrageurs vs. Prequalifiers (1) (2)
Posted by Sean O'Rourke on March 3, 2005 at 6:45 PM
Archived at Shopping Search Industry

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» re: Niki Scevak Bursts the Bubble on Search Arbitrage from SearchViews
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Tracked on March 4, 2005 07:27 PM

» Arbitrage, schmarbitrage from Greg Yardley's Internet Blog
There's been a lot of discussion lately about arbitrage - the practice of buying something for a low price and then quickly reselling it for more than you paid. Arbitrage takes into advantage of inefficiencies between markets - nice work if you can ge... [Read More]

Tracked on March 8, 2005 10:22 AM

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Posted by Andrew at July 31, 2005 01:23 AM

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