Everyone wants to talk metaverse, but what about advertising?
Though I began this blog many weeks ago, the timing of its publication is quite apt. On Tuesday, The Verge reported that Facebook plans to change their company name as part of a rebrand to focus on the metaverse. As Zuckerberg told The Verge in July, Facebook "will effectively transition from people seeing us as primarily being a social media company to being a metaverse company.”
The rebrand seems at once both reactionary and proactive. While Facebook has signaled an overall commitment to the metaverse and business segments outside of its core social media platforms (they now have more than 10,000 employees solely building consumer hardware products like AR glasses), the exact definition, let alone future state, of the 'metaverse' is still widely unknown.
At the same time, there are a number of reasons why Facebook would want to move public discourse away from the present. For one, Facebook is under intense scrutiny after a former employee-turned-whistleblower testified before Congress regarding the company’s misleading of the public about the platform’s impact on children safety and mental health. Additionally, Facebook seems to be embattled in an endless Antitrust lawsuit with US (and international) regulators regarding it’s social media network. Plus, the platform continues to see eroding consumer trust from its users.
But, for the most part, this seems rather par for the course for Facebook. Scandals, lawsuits and discontent is nothing new for the social media giant (see Winkelvoss twins, Eduardo Saverin, etc.), nor has it seemed to phase them in the past. So perhaps there is something else at play, rather than PR jockeying, that has Facebook unnerved enough to play their ‘rebrand’ card and distract Wall Street and users from what’s going on under the hood?
This post will focus on the reactionary causes of the rebrand rather than the proactive. Specifically, let's unpack the current state of Facebook's advertisement business, and how certain fundamental drivers are leading Facebook to project a very different future state of this core business line. We can save metaverse for another day 😁.
A New World
COVID-19's impact on eCommerce adoption has become a common hor d'oeuvres amongst media consumption, with '10 years growth in a span of months' perhaps the favorite accoutrement for many of these food for thought. And while a tad hyperbolic, the premise is directionally valid: ecommerce will continue to eat into consumer spending over time.
In parallel to this, off the shelf software solutions have digitized the value chain and drastically lowered the barrier to entry. Companies like Shopify, Stripe, ShipBob, Klayvio and thousands of others have democratized the ability to sell online directly to consumers.
Consequently, low barriers to entry leads to more competition, and as much of the value chain has been modularized, the battle has increasingly concentrated on the final frontier: marketing. Data from WARC revealed global ad spend rose by 23.6% year-on-year in Q2 2021 to $157.6 billion, setting a new record high for a second quarter period and marking the strongest rate of growth in this metric for more than a decade.
The consequence of these two rather congruent inflections to supply and demand would appear to be a golden goose for the social media toll keeper: Facebook.
And it has. Facebook's advertising revenue increased 56% year-on-year in Q2 2021.
But Facebook's gilded moniker appears to be cracking for a few reasons. First, Facebook's user growth in the US and Europe is stagnant.
Yet at the same time, Facebook continues to see an increase in demand (active advertisers).
Consequently, Facebook is earning more revenue per user. Facebook’s ARPU for US & Canada users increased 45% YoY in Q2 2021 to a whopping $53.01, driven by increase in advertisement prices rather than ads delivered.
"Advertising revenue growth in the second quarter of 2021 was driven by a 47% year-over-year increase in the average price per ad and a 6% increase in the number of ads delivered. Similar to the second quarter, we expect that advertising revenue growth will be driven primarily by year-over-year advertising price increases during the rest of 2021."
- Facebook Q2 2021 Earnings Call
The increase in ARPU should not be surprising to any basic student of Macroeconomics that understands the law of supply and demand. Without additional user growth, Facebook cannot increase it's supply (ads delivered) as it would decrease utility on the platform. As such, additional competition (increase number of advertisers) bids up a flat supply, raising prices.
In isolation, this alone would not cause much alarm to Facebook's advertisement partners or companies that rely on the platform for customer acquisition. As long as they have positive Return on Ad Spend (ROAS), or the amount of revenue you earn for each dollar of ad spend, advertisers will bite their lip and write it off as cost of doing business.
But, something else happened in Q2 that has fundamentally affected the economics of the advertising platform. Apple, in an epic move of corporate strategy, enacted new privacy changes via iOS 14.5 updates that allowed users to opt out Apple's Identifier For Advertiser (IDFA) tracking tool. The response from iPhone users was overwhelming. According to Flurry Analytics, 96% of US users have opted out of app tracking in iOS 14.5.
Specifically, Apple's privacy changes had three direct consequences on Facebook's advertisement business.
1. Disrupting view-through conversions.
View-through conversion is a metric used to measure how many users saw an ad, did not immediately click on it, but later made a purchase related to that ad. This allows Facebook to directly attribute indirect revenue from advertisements, thereby effectively bolstering revenue earned from ad spend and permitting them to charge more for ads.
Here's an example of how it works. A user scrolls on Instagram and sees an ad for a razor. The user doesn't engage with the ad and decides to continue to scroll or check a story. A few days later, the user searches Google for the razor he/she saw on Instagram and buys it. After purchase, the razor company records the IDFA of the user who bought the item and shares it with Facebook. Facebook then shows this as a converted user, bolstering the ROAS of the ad campaign and proving to the advertiser/retailer that the campaign worked. Without the ability to map view-through conversion, Facebook can no longer directly attribute such indirect revenue to their digital advertisement products. As such, advertiser's ROAS immediately takes a hit, and the razor company has less ROAS cushion to compensate for increasing ad prices.
2. Facebook Audience Network.
The Facebook Audience Network provides advertisements in non-Facebook apps, and it uses IDFA numbers to determine the best ads to show each user based on Facebook's data. Facebook uses their treasure trove of user data to create personas (age, gender, interests, location) that they share with non-Facebook apps to help identify potential customers. Facebook essentially licenses the FAN to brands (say a protein powder brand) who wants to target a certain customer profile (18-34 year old workout enthusiasts in NYC) to run a promotion to that audience on another app. Facebook then splits the ad revenue with the app that hosts the promotion.
While <10% of ad revenue, the elimination of IDFA tracking will severely impacted this business segment. In August, Facebook acknowledged that Apple’s upcoming iOS 14 could lead to a more than 50% drop in its Audience Network advertising business.
3. Less Effective personalized data.
Without IDFA, Facebook loses access to valuable data about what iPhone users do on their device outside of Facebook-owned apps, which is important to their ability to create personas and improve the algorithm powering their ad targeting business.
Facebook now has a worse idea of who their users are and what they like, making their ad targeting less effective. As a result, this ultimately creates wholes at the top of the funnel where Facebook determines the best users to show an ad to.
These consequences have materialized on the platform.
Data from Skai reveals global social CPM has grown 41% year-on-year in Q2 2021 to an average of $6.37, after an equally large uptick in social advertising spend from brands. This is one of the highest costs per thousand impressions recorded in the last year, second only to 2020’s Q4 which reached $6.77 (election effects).
But as CPMs are increasing (driven by increase in demand), impressions and clicks have declined QoQ and are flat YoY.
This is quite a significant dislocation that reveals the degree to which Facebook's advertisement products have weakened. Although they can charge more to distribute to a thousand users (CPM) because of demand increase, these users are actually less valuable leads (less clicks and impressions) than before. As such, the marginal cost of ad spend is increasing while the marginal return is decreasing.
Given the clear impact on Facebook's performance products, brands are changing how they allocate their social paid spend. Ad spend on campaigns designed to grow brand awareness, traffic and reach increased 114%, driven by a 62% increase in CPM according to Skai, demonstrating a shift away from campaigns that target direct action from consumers.
Both internally and externally, Facebook is well aware of these existential forces.
During their Second Quarter Earnings Call, Sherly Sandberg laid out four areas of product innovation core to Facebook's advertising business over the next 10 years. They are:
Instagram is starting to look more like Tik Tok: with full screen video formats, moving the like and comment bar to the side, and pushing discovery of new content. Facebook hopes that it's ability to gently nudge its users into certain thematic rabbit holes will allow them to use context to make better ad recommendations. For example if they nudge you towards travel videos, they then could show ads for hotels and flights.
Facebook is building what they describe as a modern commerce system across ads, community tools, messaging, Shops and payments. It's their end-to-end answer to Amazon, but which they hope differentiates with its emphasis on social commerce. For example, the platform has been building its shopping capabilities with optional shopping links, not only for Instagram livestreams, but also for posts, Reels, IGTV and Stories. In addition, it has built out its dedicated shopping section with curated shops and a Drops feature.
Facebook is 'collaborating across the industry' to develop new technology to help minimize the amount of personal information they process while not diminishing their ability to show relevant ads and measure their performance. While this is nice in theory, it still seems quite rhetorical and reactionary, and very little tangible guidance has been provided.
Business tools beyond marketing
Lastly, Facebook wants to build tools for SMBs beyond marketing. They've pointed to CRMs, messaging tools and hiring as key services they hope to develop their Business Suite solutions.
Fundamental to Facebook's ability to get away with increased ad prices is an equivalent ability to improve their ad products, and thus ensure a positive ROAS. One such way that they do this is by sophisticating how they measure attribution (like they have historically done with view-through conversion) to claim credit for revenue that indirectly (and sometimes loosely) derives from their platform. In the world of eCommerce where there are so many disparate data sources, indirect customer journeys, and data mapping still remains highly opaque, this has been a valuable tool for Facebook to convince many advertisers of the success of their campaigns. And considering the alternatives — out of home, TV, podcast, influencer — many are happy to gobble up any ability to attribute their spend and prove the ROI of their marketing allocation. Yet this seems less of an emphasis for Facebook in the decade ahead, and instead they view a blend of business suite solutions and social commerce capabilities as the core drivers of innovation for their advertisement business. Interesting…
The Bull opinion from Morningstar says" Facebook's ad revenue per user is growing, demonstrating the value that advertisers see in working with the firm." Hopefully, this blog revealed why this is misleading.
Facebook's hold on digital distribution has allowed them to capture almost the entirety of the increase in demand for social media marketing. Without competition, advertisers/brands/retailers are beholden to Facebook's economics. The price of ads are determined based on the supply (fixed) and demand (increasing) for an ad product. However, the marginal benefit of Facebook’s ads has diminished nearly overnight due to iOS 14.5 changes, yet since it has massive control of supply, price remains the same — if not increasing. Moreover, since Facebook user growth is flat, they cannot decrease prices without decreasing revenue (or increasing ads delivered and most likely losing users).
Facebook’s advertisement business is at a crossroads. For their customers, marginal cost is increasing while marginal benefit is decreasing. Speak to any brand, and they will tell you horror stories about how iOS 14.5 changes led to their CACs rising as much as 300% practically overnight.
Facebook’s rebrand and movement away from being “primarily a social media company” reinforces this conclusion. In order to keep customers from leaving, Facebook will have to reduce prices. As a result, revenue growth will slow down and Wall Street won’t be happy. But if Facebook is no longer “primarily a social media company” but instead a “metaverse company”, the slowdown of their ad business becomes less fatal and a new narrative emerges.
Whether or not the two are mutually exclusive has yet to be seen, its fair to say that there is both a reason why Facebook wants to be a metaverse company, and why they don't want to be a social media company.