Facebook’s Opportunity

Facebook reported earnings for the first quarter of 2016 on Wednesday and they bucked what’s been the trend for most of the other big tech companies so far this earnings season. The company reported phenomenal year on year growth in users, revenues, and profits, and seems to be facing few of the headwinds its competitors and counterparts are facing. Why is Facebook doing so well and where does it go from here?

Note: the charts in this post come from the quarterly deck I do on Facebook (as well as lots of other tech companies) as part of my Quarterly Decks service, which you can read more about here.

User growth multiplied by ARPU growth

Facebook reported yet another quarter of strong user growth, in marked contrast to Twitter, which has been eking out only very modest growth recently. In fact over the past year, Facebook’s monthly active users grew by roughly two-thirds the size of Twitter’s entire base. This wasn’t a one-off – Facebook has grown by over 150 million users year on year for the past four years at least and growth has actually accelerated recently:Facebook y on y MAU growth

Predictably, the strongest growth has been in the least mature markets – Asia and Facebook’s “Rest of World” geographic segments lead the charge, with over 75 million new users each over the past year, while North America and Europe added fewer users (but still grew decently). That reemphasizes the importance of Facebook’s efforts to grow usage in those emerging markets and, hence, projects like Free Basics (recently shut down in India) and its other connectivity projects. So far, though, it seems to be doing just fine in these countries.

Average revenue per user is also growing strongly across the board, led by the US and Canada, where annual ARPU is approaching $50. Other regions have far lower ARPU – the rest of the world combined has an annual ARPU of just $7:

Screenshot 2016-04-27 17.22.34

That overall ARPU growth multiplied by the user growth is driving phenomenal overall revenue growth. And, because that growth requires a much more modest increase in costs, it’s also driving margin expansion. Revenue grew by 52% year on year for the second quarter in a row and operating margin was up 11 points year on year. Just as a reminder, that revenue is almost all coming from ads at this point – the FarmVille era is well and truly over at this point and payments are a tiny fraction of total revenues for Facebook today.

The mysterious role of Instagram

One of the hardest things to get at in Facebook’s results is the role of Instagram. The app has been serving up ads for some time now and management has been talking up the benefits in general terms for several quarters. But it doesn’t break out metrics other than monthly active users (400 million at last count). In addition, Instagram users are excluded from the MAU count Facebook reports and on which it bases its ARPU calculations, even though Instagram revenue is included in ARPU. As such, there’s a little misdirection going on in that Facebook is including Instagram in the numerator but not the denominator here. There is, to be sure, a good chance many Instagram users are also Facebook users and so there’s not too much double counting, but I do wonder how much of the growth in ARPU is from Facebook monetizing Instagram better and how much comes from the core product. It almost certainly has a bigger impact on those rapidly growing (and large) US and Canada numbers than in other regions, but it’s likely being felt in additional markets too.

The Messenger and WhatsApp opportunity

That all brings us to the next point. Facebook hasn’t officially turned on the monetization spigot for Messenger or WhatsApp yet. At the F8 developer conference recently, Facebook outlined its vision for turning these additional products (including Instagram) from products into platforms by opening up functionality to developers. But there’s also an opportunity to turn them into real moneymakers as it already has both the core Facebook experience and Instagram. It’s being very careful about that, as it was with the initial mobile ad experience on Facebook itself. Facebook has the additional challenge of getting around WhatsApp founder Jan Koum’s antipathy to ads, but I’ve no doubt it will find a way in time. I’ve written previously about some of the ways it looks to do this and I think these opportunities have significant additional growth potential if they’re done right. Given how fast Facebook is already growing, once it decides to make the switch on monetizing these products, things might even accelerate, which is an impressive feat given the scale of the business. Those opportunities are largely tied up in increasing the ways in which businesses communicate with their customers, and ultimately building a commerce platform. That could raise ARPU even further, both for the core Facebook experience and for these offshoots and acquired platforms.

Headwinds

As I mentioned, Facebook’s competitors and counterparts among big tech companies seem to be facing a variety of headwinds – Apple, the increasing maturity of its three major product lines; Google, the shift to mobile ads (where Facebook is a much bigger force); Microsoft, the decline of the PC and traditional productivity software; Amazon, the challenge of competing in new markets like China and India where local competitors are much stronger, and so on. All of the above are also dealing with currency movements which devalue the contributions of their non-US businesses. What headwinds does Facebook face? The recent stories about a decline in the more personal sort of content sharing and the more persistent stories about teenagers moving to other platforms are certainly candidates. Neither of these appears to be denting Facebook’s growth so far – engagement seems to be rising, not falling and, though users may be sharing less personal material, they’re sharing more of other types of content including video and news articles, which make for better ad material anyway. But these are perennial threats and can’t be entirely dismissed.

From a perspective of internal threats to success, Facebook is placing some biggish bets on future projects like virtual reality (through Oculus) and research and development into new forms of connectivity, both projects outside its core business and therefore both potential distractions and financial sinkholes. But the scope of these efforts seems to be modest in the context of Facebook’s overall business and its margins aren’t suffering yet. Government action on Free Basics, as we’ve already seen in India, is another possible threat, but a modest one at this point and one few other governments seem willing to take on for now.

Perhaps the biggest threat of all is that platform owners like Apple and Google end up owning the next round of devices and platforms in the same way they have smartphones despite Facebook’s VR investments, and steadily squeeze out third parties they perceive as a threat. Facebook seems aware of this possibility and has invested not just in VR as a potential future interface but also an increasingly OS-like presence on smartphones but, so far, this is a theoretical threat at most and Facebook continues to dominate the time people actually spend on their phones. For now at least, Facebook looks set to continue to buck the market trend.

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Jan Dawson

Jan Dawson is Founder and Chief Analyst at Jackdaw Research, a technology research and consulting firm focused on consumer technology. During his sixteen years as a technology analyst, Jan has covered everything from DSL to LTE, and from policy and regulation to smartphones and tablets. As such, he brings a unique perspective to the consumer technology space, pulling together insights on communications and content services, device hardware and software, and online services to provide big-picture market analysis and strategic advice to his clients. Jan has worked with many of the world’s largest operators, device and infrastructure vendors, online service providers and others to shape their strategies and help them understand the market. Prior to founding Jackdaw, Jan worked at Ovum for a number of years, most recently as Chief Telecoms Analyst, responsible for Ovum’s telecoms research agenda globally.

39 thoughts on “Facebook’s Opportunity”

  1. Predictions of future growth should be tempered by an awareness that there is a limit to the size of the ad market, and Google and Facebook are so dominant in the online sector already that soon they will hit a ceiling unless they either convince companies to advertise a lot more (unlikely to work), or broaden their buisness model beyond ads.

    1. Of course, one could make a few counter arguments to that.

      1. Digital ad spend still has room to grow and is doing quite fine. Could level off at double the current total if we just guess from the charts. http://www.emarketer.com/m/Article/Total-Media-Ad-Spending-Growth-Slows-Worldwide/1012981

      2. Google and Facebook ads are more effective and faster growing than most other online ads (search/native vs. banner ads). Their ads will likely hugely outpace the others.

      1. 1 There is already too much digital advertising in terms of what people find tolerable – ad blocking is growing rapidly. Doubling the amount of advertising will just drive people to install ad blockers even faster. Right now digital advertising is in a bubble, and sooner or later it will pop.

        2 even if google and Facebook gobble up 100% of digital ad competition, that still isn’t a lot of growth because they already have most of the market sewn up between them.

        1. Your argument for item 1 is certainly true for display ads distributed through ad networks. However, the type of ads that are driving Google’s and Facebook’s growth, search ads and native ads are a) generally immune to ad-blockers, b) not the type of ads that are driving people crazy. That is why you will probably find Google and Facebook vastly outpacing the growth of online advertising in general.

          Regarding item 2, the article that I linked to shows online advertising growing double digits. The online advertising pie is still growing fast and all that Google and Facebook need to do is to grow with the pie. Online advertising is growing because people are spending more and more time online. Importantly, the total size of the advertising market is probably determined not by the number of eyeballs, but more by the marketing budget of companies, which is likely to be a relatively fixed percentage of revenue. Hence the shift towards apps and away from Google Search for example may not significantly decrease total ad spend. Advertisers will simply spend their marketing dollars elsewhere, but probably still on the Internet (because that’s where people spend their time). They may spend it on YouTube or Facebook for example.

          To understand the future of online advertising, you have to understand what drives so many companies to spend so many dollars on advertising in the first place, and how their marketing budgets are determined. I don’t claim to have expert knowledge of the subject, but my impression is that it tends to be more a function of the financial health of the whole company, and where the customers spend their time. It is less a function of the ad technology, or whether ads are annoying or not.

          1. When I install an ad blocker, by default it blocks google ads, facebook ads, and all other ads. Once someone gets pushed over the edge by over-intrusive advertising, their eyeballs become worthless across all sites.

            This is why I am ultra skeptical of claims of unlimited growth potential for digital advertising based businesses. On the one hand, the companies with products to sell have a limited ad budget, and they aren’t going to increase that. On the other hand, there is a saturation point for seeing ads, past which they become noise, or become blocked.

            It’s like how facebook’s user base is now at the point where they can’t add significantly more users without adding more people to the population who have access to the internet. When you acquire a significant portion of the world’s total marketshare of ad spending, predictions that you will be able to continue to grow like gangbusters for the foreseeable future don’t hold water.

          2. Ad blockers typically work by blocking what is called “3rd party content”. For example, in http://daringfireball.net , the ads are loaded from http://connect.decknetwork.net (an ad network). This is what ad blockers actually block. They have a database of ad network URLs and block these unless they come from the domain that you have in your browser location bar.

            If you are doing a search on Google.com however, the ads do not come from an ad network. They come embedded in the HTML that you download from https://google.com. They are not 3rd party, and hence cannot be blocked. Some desktop ad blockers may do funky things to erase this, but iOS ad blockers simply are not capable of doing this. This is why ads that show up on a Google Search are not blocked (I have tested with Ghostery). The same is true for Facebook native ads.

            The thing is that ad blockers will block some type of ads, but not all. They will typically only block ads that are shown via a 3rd party ad network. These are typically the display ads like the ones that you see on Daring Fireball.

            Online advertising has already captured a significant part of ad spending. The article that I linked to in my original comment suggests that it is still about 30%. Although it obviously cannot grow indefinitely, I would say that it could plausibly double to 60% of total ad spending. My guesstimate is that since Google and Facebook, etc. have the better ad formats, they could still easily grow to double their current ad revenues.

          3. “They are not 3rd party, and hence cannot be blocked.”

            You are simply wrong. It sounds like you have never actually used a modern ad blocker. Sure, back in the stone age of the Internet, people pasted a giant list of ad domains into their hosts file… and before IOS 9, blockers like Weblock, using the same approach, were the best you could get on mobile. And with that approach, you do see Google ads in search results, and ads before videos on youtube, and sidebar ads on Facebook. Like I said, that’s the stone age.

            Nowadays, the most commonly used blocking scripts are giant lists of regular expressions. They block not just domains, but also material that matches a recognized formula in the HTML of the web page. On desktop, with easylist installed, I never see any ads on Google. Nor do I see ads on Facebook. Nor do I see the video ads that precede content on Youtube. Ditto goes for mobile Safari with 1blocker installed.

            The only ads I do see are those from obscure, often shady ad companies on small or obscure sites that have not yet been studied and had a blocking script written for them by the list maintainers. I suspect I’d see fewer of those if I bothered to install some region specific ad blocking scripts, but so far all I’ve bothered with are the basic North American based ad, tracking, and social tracking blockers.

          4. The ad blocking mechanism you describe is not possible with the iOS content blocking extension mechanism.

            Not all popular desktop ad blockers do that either. The one that I use, Ghostery, does not do that, at least not by default.

          5. “The ad blocking mechanism you describe is not possible with the iOS content blocking extension mechanism.”

            So I am to believe your superior knowledge instead of my own lying eyes, am I? With 1blocker installed, in mobile Safari, there are no sponsored ads in Google search results, and no ads preceding videos on youtube.

            “The one that I use, Ghostery, does not do that, at least not by default.”

            Which is one of several reasons why I switched back to a non-dark side fork of adblock plus after trying ghostery.

          6. I think I’ve addressed this in my update that I added to my previous comment. Some modern adblockers do use the CSS-filter feature provided for Safari content blocking extensions. However, possibly because it is inconsequential to privacy and tracking, many (including some popular ones) don’t seem to bother.

          7. I think Naofumi’s point is still a valid one. Even with ad blocking, companies need and will pay to advertise. How does that adjust what type of ads are worth more? And what is it worth to the company to get on Adblock Plus’s default “white list”?

            Joe

        2. % GDP spent on ads is fairly stable. How big a slice Google and FB take is mostly a function of the time people spend looking at their content instead of magazines, TV, …
          Also because of that constant share, ad-blocking will just make ads that do go through more valuable, not sure it will have much of an impact on overall IT-ads revenues ?

          1. Yes, it is also my hypothesis that ad-blocking will actually drive up the cost of ad impressions. In fact, the algorithms on AdSense for example use classical supply-demand equations to determine price, so if supply (ad slots) become scarcer through the rampant use of ad-blockers, and at the same time the demand stays the same, then the algorithms should increase the unit price of ads. Similarly, the move away from Google Search on mobile could increase the cost-per-click of Adwords.

            Unfortunately I don’t have any data directly showing this as a macro trend. I would love to.

          2. You can be pretty sure use of ad-blockers will increase. The advertisers have practically guaranteed it.

          3. Yes, I agree. However, the use of ad blockers does not guarantee that ads will decrease nor that ads will become less valuable. Just like PC antivirus software did not kill off all viruses but caused exploits to mutate, evolve and become more sophisticated, we can expect online ads to do the same.

            The reason they do not die is because there is a financial motive to exploit PCs, and a financial motive to distract consumers with ads.

            The best we can hope for is ads that are useful. This is why Google Search ads are doing so well. They are actually relevant to the task that the user is engaging in.

        3. I really agree there’s too much advertising. A 1 hour show on CBS will have 18 minutes of ads and only 42 minutes of content. I’d rather pay for Prime on Amazon and watch shows ad-free.

          1. Yes, I’m sure that many people will do that. The question is, if car companies for example decide that advertising on CBS is no longer working, then what will they do with their left-over marketing dollars? Most likely, they would use it on other ads like Facebook ads, or (gasp) tele-marketing. Unfortunately, they will not save that money or use it on R&D or decrease the price of their cars. Ads as a whole will not decrease. That is how the modern free economy works.

          2. In a free economy, “too much advertising” is determined by the balance between demand and supply. I imagine the level of advertising seen in the US reflects that. In Japan at least, there is a self imposed limit by the broadcasting industry to cal it at 18% of total viewing time average, and 10% during prime time.

            Similarly, I would imagine that you would need some form of regulation to keep online advertising under control.

            This is a case where regulation is in the public interest and free markets are not. However, given Google’s lobbying efforts, I doubt that it regulations will be imposed in the US. In other countries though, it could happen.

        1. Yes. That is included in #1 of my previous comment. Ultimately though, I think it’s a bit more interesting to try to understand why TV ad spending is as large as it is.

          The thing is, companies are willing to spend huge chunks of money to gain new customers and to retain interest of their old. Advertising (and sales) is a huge and essential part of the free economy, annoying or not. Ad blockers will only cause ad money to move to somewhere else. If one totally hates ads, maybe they should go to North Korea, one of the last communism holdouts.

          https://vtldesign.com/inbound-marketing/content-marketing-strategy/percent-of-revenue-spent-on-marketing-sales/

    2. their ceiling are far fetch because of all the Advertising money that will move from TV to mobile platform

  2. It makes sense to block ad-blocking, but I am not sure… Do ads leave some kind of cookies for the browser?

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