'CHANGE OR DIE': Why Federated Media Has To Reinvent Online Advertising All Over Again

Federated Media Publishing was once a game-changing startup poised to shake up the digital advertising world.

Now, it's the one that's been shaken by a fast-moving industry, with layoffs and turnover in its executive ranks.

In its heyday, the groundbreaking startup sold ads for some of the fastest-growing websites, including Mashable, TechCrunch, and Business Insider. It raised a $50 million venture-capital round in 2008 after walking away from a $100 million buy-out offer.

But for the past few years, it has drifted from its original vision of upending the established advertising order, getting into the very business of commodity ad sales that it hoped to replace.

While the company says its revenues have doubled in the past three years, it's not clear if that's fast enough to meet the expectations of growth-hungry investors. And its not clear if its now-muddied vision can keep the talent it needs to execute its plan.

The business model that gave Federated its edge over the competition—direct sales of ads, with humans talking to both ad buyers and publishers—is now seen as a hindrance. FM recently laid off 24 employees, mostly in sales, and said it would stop pursuing banner-ad business except through automated sales. Even before that, employees were leaving in droves. One former employee called it a "mass exodus."

What's going on? And what will happen to FM?

We spoke with a number of people familiar with the company, as well as its founder John Battelle and CEO Deanna Brown, about what's going on at FM.

It's a tale with lessons for any startup leader who must wrestle with sticking to an original vision, versus listening to customers and adapting to the market's demands. As FM, Zynga, and many other Web 2.0 companies are finding, you need to change with the markets if you want to survive.

When FM was founded, things were different

When Federated Media launched in 2005, it was an easy way for advertisers to reach smaller, quality sites in one fell swoop.

It also pioneered what Battelle dubbed "conversational marketing"—highly customized advertising adapted to the format and audience of the websites it represented. Its innovations, particularly with the social news site Digg, presaged what's now called "native advertising," like Twitter's Promoted Tweets and Facebook's Sponsored Stories. These formats replace standardized banner ads with specialized units which fit naturally in the services where they appear.

FM's early business was tough from a revenue standpoint, though, because virtually all of the inventory Federated Media sold to advertisers came from sites it didn't own. Federated Media had to give a large portion of its sales—about 60%—to the sites it represented. (Later deals were less generous to publishers.)

But there wasn't another solution like it. Advertisers could either buy dirt-cheap, leftover advertising inventory from networks like Google's AdSense, Casale Media, or Collective, with no say in placement or timing—a business known as remnant advertising—or they could pay high prices and buy from each site directly, which wasn't efficient. In most cases, FM's sites were small Web-publishing shops without their own business staff.

As a result, Federated Media became both media buyers' and small publishers' first choice. And while it kept offering conversational marketing programs, more often than not, customers wanted banners, which were simpler to buy and sell.

As an industry, Battelle says, "we messed up when we decided banner ads would be how we make money on the Web."

As for Federated, Brown says that brokering banner-ad deals, especially in the period after the 2008 financial crisis, was a way to make money for its publishers, "which is what we're all about."

Since then, the digital-advertising landscape has changed significantly. Now when advertisers buy conventional banners, they're increasingly making decisions based on real-time audience data rather than the site's content. That data is most easily surfaced by technology and trading desks, not salespeople.

While FM still has a direct sales business, the company has become much more like an ad network than John Battelle anticipated when he created the company.

"The company has changed," he acknowledged. "Because if you don't change, you die."

Sites outgrew FM, because FM never wanted to be 'The Man'

One problem with Federated Media's initial model was that publishers could leave as soon as they got big enough to hire their own sales teams and avoid giving FM its cut.

Mashable, TechCrunch, GigaOm, and Business Insider left. Wired Digital bought Ars Technica, taking over ad sales. In September, VentureBeat, one of Federated's earliest clients, hired a chief revenue officer, in what looked like a step towards independence from FM. 

The departures of some of those bread-and-butter sites led to more employee turnover, and it contributed to the decline of direct banner sales within FM.

"The business model [of being a site's extended sales arm] didn't work beyond a certain point," one source says.

FM became like a parent. If its sales team did a good job nurturing and selling young brands in its network, eventually they'd grow up and leave it. It could be a tireless and thankless job, and it's easy to see why a more automated approach began to tug at Brown.

Still, FM held on to its direct sales foundation. It tried to fill the void big brands left in their wakes and soak up more direct sales revenue by creating original content. It even bought up a few sites.

But most attempts, sources say, failed.

Some placed the blame on Brown and suggested she didn't put enough resources into making sure the new brands thrive.  "There were definitely other roads that could have been taken," one said.

One road that seems to be working is the path pursued by Say Media, a company born out of the combination of VideoEgg, an ad network, and Six Apart, the maker of online blogging tools.  Since the acquisition, Say has acquired sites like Dogster and ReadWriteWeb. The latter was a Federated client before Say took it over.

"Say took FM's model and did it the right way," an ex-Federated Media employee says. "It's the company FM should have been."

Say purchased more of the sites it was selling inventory for and began buffing up its video-ad products, which advertisers seem more eager to buy than banner placements.

But Battelle says it was never his goal to acquire the publishers FM represented. He considered sites outgrowing FM a natural and good part of his business's cycle.

"We got compared to companies like [magazine publisher] Condé Nast because we had—and still have—a lot of great brands in our network," he says. "But I never wanted to buy and control our partners. I'm a content creator, I created The Industry Standard and Wired. And I always felt content creators did so because they wanted to be in business for themselves. I never wanted to be 'The Man.'"

A controversial CEO and a "mass employee exodus"

While FM is blaming the current shift in its business model on changes that have transpired in the advertising industry, others have pointed fingers at Brown. They feel a few leadership missteps led FM to this "change or die" moment.

Battelle had hired Brown, a former Yahoo and AOL media executive who rose to become president at Scripps Interactive, as COO in 2009. She was brought in to turn the startup into a real, buttoned-up company. As the company's operator, Brown did a good job.

In 2011, Federated named her CEO, replacing Battelle, who's now the company's chairman.

"I'm a big softie," Battelle tells Business Insider. "I like to write books and look at where things are headed. I'm good at starting things, but I needed someone to come in and make the tough decisions and execute. And Deanna has been great at that."

But others don't feel the same way. When it came to executing a roadmap to the future for Federated Media, some feel Brown stumbled.

"Federated and its bombastic founder John Battelle have always had a bigger profile on conference stages and inside the boardrooms of Sand Hill Road and Silicon Alley than they have in the daily give and take of the media and advertising world," Doug Weaver recently wrote on The Drift, his influential online-advertising blog. Weaver had worked with Battelle at Wired, whose online arm actually invented the banner ad.

Employees had mixed feelings about Brown.

"I loved Deanna Brown and I thought she was wonderful," said one source who previously worked for Federated Media. "But a lot of people didn't agree with the way I felt or [where] she was taking the company. John stepped down and Deanna took over, and a lot of people were thinking, 'Deanna is screwing us all.'"

The "screwing us all" sentiment stemmed from watching the company try and fail to retain strong brands. It also came from watching the foundation of the company, which was built on business relationships instead of technology, slip away.

The final straw for some employees came last November, when FM acquired a Colorado-based, automated ad bidding company, Lijit Networks.

For those who thought FM was still a prestigious sales organization, the move made little sense.

"That’s when I really sensed a decline and things changing; Deanna was making decisions I didn't agree with," says a former employee.

Indeed, from the months leading up to the Lijit acquisition until now, many FMers departed. Amy Yeh, FM's chief product officer, left in the summer of 2011. Former senior vice president James Gross founded a company, Percolate, and two more FMers joined him. Former CTO Emanuel Puentes recently joined LinkSmart. Two more executives, Business Insider has learned, are looking for ways out.

Battelle acknowledges the company could have done a better job explaining its new, more technology-driven roadmap to now-departed employees.

"I think [their confusion] is fair," he said. "As for current employees, we have a plan to communicate with all of them and that plan is being executed as we speak. There's always confusion the week that something like [this restructuring] happens.”

But Battelle says he still has no regrets about choosing Brown to replace him as the company's CEO. "I still completely support Deanna," Battelle says. "She's done everything the board has asked her to do."

When asked about her perceived missteps, Brown replied, "I have no comment because I'll let the numbers speak for themselves."

Federated's revenue, she says, has grown an average of 33% per year.

Some turnover is normal in the fast-moving worlds of technology and advertising. Employees don't tend to leave strong companies, though.

"It seems like FM lost a lot of good people," says a former employee. "All the best salespeople just left. And sales dropped."

We made that observation to Brown.

"The two executives who turned over were acquired," she replied. "They both served us well over the transitional year, and in one case two years. Whenever you acquire employees who are great entrepreneurs, it doesn’t surprise me that they’d be off to do another startup. And I can't speak to the other two executives who might be leaving because I don't know who they are."

Lijit Networks started crushing goals

As controversial as Lijit was internally, it has had a positive effect on Federated's finances. 

After FM bought Lijit, Lijit produced amazingly well. Meanwhile, FM's banner business continued to dwindle.

Last year, direct sales made up nearly 100% of Federated Media's revenue, with banner direct sales accounting for 15% of the total and conversational direct sales about 85%. This year, Brown says revenue is still increasing, but Lijit has taken a large chunk of the pie. It's now responsible for 40% of FM's total revenue, up from 0 the year prior.

FM provided the following breakdown of estimated revenues by ad category for 2012, which fueled the decision to restructure the company:

• Direct-sold (banners): 11% (down from 15% the year prior)

• Conversational/native: 49%

• Programmatic media (Lijit): 40%

While Brown declined to project future revenue percentages for FM, she cited an IDG report which suggests advertising spending on real-time bidding platforms like Lijit Networks will grow from $1.4 billion in 2011 to $13.9 billion in 2016.

"When you’ve got an independent company like ours that’s venture-funded, we need to make bets that we know will [see] return,” Brown recently told AdWeek.

So what's happening at FM right now?

AdWeek recently reported that FM had "shuttered its standard direct sales business."

But Brown disputes the idea that FM has "shuttered" anything.

"'Shutter' makes it sound like we closed something," Brown says. "We still sell media and conversational marketing like we sold before, we just did some restructuring around two businesses that are successful.”

Now, if an advertiser comes to FM with a request for proposal that only contains banner ad placements, they'll be directed to Lijit Networks. If an advertiser wants something more customized, Brown says her team will be happy to help.

FM's business model is in the middle of a painful, industry-induced transition. Its most important people used to be its sales staff, who could wrangle requests for proposals from ad buyers and command high CPMs on behalf of its publishers. Now many of those people who were core to its business are being cast aside as an inefficiency in the business model, and technology is becoming the darling of FM.

What will FM become?

Whether FM stumbled into a big win with Lijit or not, programmatic sales seem to be the shining new business model. Brown and her board are prepared to run with it. They're betting the entire advertising industry will, once again, follow suit.

"I see a lot of people refusing to acknowledge the trend lines here and are clinging stubbornly to direct sales model," says an industry source. "2012 is really the defining year in death of the banner ad. Other people are refusing to believe it because then they don't have a clear revenue path."

With that in mind, Federated Media says it's just listening to that industry demand; it's innovating to survive.

"We probably chased too many standard media RFPs for too long," Brown says. "The company needed to refocus around the things we do best."

As for its new direction, she says, "We’ve scaled and grown. No one has both premium sales and programmatic media.”

And those premium sales efforts—the human-sold campaigns—are based around Battelle's original vision of conversational marketing, a trend which is rising in the industry with Facebook, Twitter, LinkedIn and others building their own forms of integrated advertising.

Whether Brown's plan to revamp FM will work remains to be seen.

"There's still a lot of smart work being done there," says a source. "But I don't know what their future wil be. They have to reinvent themselves."

Battelle is still bullish on FM's future and its new direction. He's also proud of the company's founding work.

"If all that FM ever becomes is a company that helped big sites get to the next level and be self-sustaining, like TechCrunch and Business Insider, I'll still be happy," he said.

Disclosure: The author of this post used to work directly with Federated Media as Business Insider's sales planner. She has also helped another startup she advises implement ads sold by Federated Media, Lijit Networks, and Say Media.

Please follow SAI on Twitter and Facebook.

Join the conversation about this story »