Not actually futures

by greg on February 22, 2010

Andy Atherton’s recent post in AdExchanger about a futures market for advertising is interesting but flawed, primarily because of problems with the terminology.

Let’s start with forward contracts. A forward contract is just a contract for the future sale of something. Guaranteed advertising buys are forward contracts, for example. A forward contract doesn’t imply that you can go and trade that contract with anybody else – you can’t promise to buy 10MM impressions from Yahoo in March for $1.00 CPM and then sell your right to those impressions to a third-party for a $2.00 CPM. The same is true for offline advertising. When Andy writes that “Futures market buying (e.g., the TV “upfronts”) is the standard practice offline for Brand advertisers”, he should be saying that “Forward contracts are the standard practice offline for Brand advertisers.”

Now, a futures contract. A futures contract is just a standardized forward contract that’s guaranteed by a clearinghouse. So we now need to understand both standardization and clearinghouses.

First, standardization – that means that the contracts being traded are identical in every aspect, and the underlying good is a commodity. You could create a futures contract for (say) new iPhone 3G S phones with 16GB of RAM, but you couldn’t create a futures contract for ‘iPhones’ – the latter’s too vague to be a commodity. You could create a futures contract for delivery of a good on the first business day in March, but you couldn’t create one for delivery in ‘March’ – the latter’s too vague to be a standard contract term.

Next, the clearinghouse. This is a financial institution that acts to guarantee the future transaction will occur, by acting as the buyer to every seller and the seller to every buyer. The clearinghouse reduces friction in the market by eliminating the need for you to care who the particular buyer and seller is – their creditworthiness isn’t your problem, it’s the clearinghouse’s problem. (The clearinghouses themselves keep those not creditworthy from trading and mitigate their risk by collecting collateral – the ‘margin’.)

A true futures market exists when the only thing you have to care about is the price of the contract. You don’t care about the terms of the contract because they’re standard. You don’t care about the good underlying the contract because it’s a commodity – everything’s the same as everything else. You don’t care who’s selling to you and they don’t care who’se buying from them, because the clearinghouse takes care of all that. And because no one cares who the buyers and sellers are, there’s no need to take delivery of the good – you can buy the contract and then resell it.

Now that our terminology’s clear – what Andy’s arguing for sounds a whole lot less like a futures market and a whole lot more like expanding the use of forward contracts by helping publishers sell more guaranteed inventory, which is how brand advertisers and agencies traditionally have liked to buy. Which makes a lot of sense, when it’s put plainly. No need to mention futures or forwards at all.

The online advertising industry has made a lot of analogies between it and financial institutions in the past, and they’ve been useful for relaying high-level concepts quickly. But we shouldn’t overextend them to the point where the analogies break down, or try to claim we’re doing things the government highly regulates when we’re not. There’s enough regulation already without asking for more by claiming you’re selling a financial instrument.

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