source: techstory.in

source: techstory.in

A lot of chatter has come about from the contrarian viewpoint of one analyst that continues to hit on the thesis Facebook (F) is facing some serious headwinds because of market saturation of the digital ad market.

Pivotal Research analyst Brian Wieser wrote in a note to clients, reaffirming his position that the digital advertising market is approaching a point of saturation.

If that’s true, it would be detrimental to Facebook because it relies almost solely on advertising as its source of revenue.

One example he used concerning reaching a digital ad spend plateau was Procter & Gamble (PG), which he said recently slashed $140 million from its digital advertising budget with no effect on its revenue. If that were to extend to a lot of large brands, it would have a significant impact on Facebook’s revenue and earnings, as they account for about 30 percent of its overall business.

The point he’s making is if other companies do the same with no negative consequences on their revenue, it would suggest digital advertising may not be providing the type of return brands are looking for.

It think there isn’t enough data to support that idea at this time, but it’s something I’m sure a lot of companies will look at when determining where to allocate their marketing capital, and whether or not to keep it at existing levels.

The ad industry in general

One thing to take into account concerning the ad industry is it’s going through a period of transition in how to allocate their capital and generate the best results.

Part of that is going to where the eyeballs are going, and that means looking to the Internet. That’s why traditional media companies are suffering on their existing platforms. Appointment TV is diminishing in attraction, and Craigslist long ago disrupted the classified ad market with newspapers.

How to view this is it’s possible digital ad revenue is approaching a saturation point, and if it is, the thesis of Wieser would be worth seriously considering. One reason I’m not convinced yet is even if there are some companies cutting back on digital ad spend, a lot of that would be replaced by spend that had been placed against content on traditional media outlets.

Something I’ve thought about for awhile, and where this gets interesting is what happens when digital ads do hit a ceiling. Just like there is a rearranging of the chairs in overall ad spend from traditional to digital platforms, when the ceiling hits there will be a rearranging of ads among the major players.

Those that can prove they deliver the best results will attract more advertising dollars at that time, at the expense of those that don’t. In the near future AI will play a big part in confirming the companies that deliver the best results.

The point in all of this is there is a limit on how much brands allocate to their marketing efforts, and even though advertising dollars are gravitating from traditional to digital properties, there is still only so much companies will or are able to spend.

Facebook’s strength

Going forward, how Facebook chooses to use its platform to encourage ongoing engagement will be a key to how it performs over the long term. Eventually it will bump up against the ceiling on ad spend, and it will have to prove it has alternative revenue streams to make up for the eventual decline in momentum.

One thing bantered around and which has potential is the inclusion of premium video content it can offer a subscription service with. With the user base it has, it could generate a huge revenue stream that could be relied upon for many years if it gets the content right. This could be augmented with live sports.

The strength of Facebook is it has a platform it can insert a variety of types of content or apps into in order to generate revenue; this could be done without increasing ads to the point of interfering with users’ experience, which could lower engagement.

Facebook, with its user base, can try a lot of different things to see what works, and it can do so at relatively low costs in many cases. Premium content would be an exception, but there are a lot of less expensive ways it can provide improvement in user experience. I’m thinking here of low-cost apps users could buy. There are of course a lot of free apps already on the platform, but it could position some apps as premium apps; something users wouldn’t mind paying for.

These are just ideas and examples of Facebook having the ability to experiment and throw things out to see if they work. It has an unprecedented number of users it can do it with.

And with the rapidly improving quality of AI, the things that are tried are based upon much better data than in the past, which is improving the chances of success.

Risk of one revenue stream

For a long time investors and pundits have pointed to the risk Google (GOOG) (NASDAQ:GOOGL) faced by being so reliant on advertising as its primary revenue stream. To this day that remains true.

While one revenue stream can be a risk, it’s not as much of a risk as some may think when considering momentum and whether or not the market is still growing.

The only way Facebook would be at risk is if digital advertising has reached a ceiling. I don’t think it has reached that point yet, even though some individual companies may be moving in that direction.

After all, who is Facebook really competing against? I don’t see Google as being a direct competitor, although it would be a competitor in the sense of battling for who gets the digital ad dollars. But as far as taking users away from Facebook, it has no leverage there. Facebook will continue to grow for now, with the caveat concerning advertising that it will be in markets that aren’t as valuable to advertisers, and wouldn’t command premium ad prices.

As far as one revenue stream, I don’t see that being a problem for Facebook in the near term. It still has momentum on its side, and is unlikely to find advertisers pulling back. That will happen when the next recession hits, but we’re not there yet.

Conclusion

The thesis that Facebook is at risk from digital advertising hitting a ceiling has merit, but I think it’s one that is premature. It’s obvious that some day ad spend allocated to digital platforms will level off. It’s an irrefutable reality.

What isn’t obvious is how long it’ll take. In the meantime, I expect Facebook will start to think in terms of alternative revenue streams without taking its eye off of what is driving revenue and earnings at this time.

The only risk to one revenue stream is if the revenue dries up. That’s not going to happen quickly. Recent performance may have generated too much optimism which may end up in some disappointment for some investors, but I don’t see Facebook having a sudden disruption in its revenue from a quick cut in spend from major brands at this time.

If some do cut back some, it will be offset by advertising dollars being reallocated from TV and newspapers to digital. The rearranging of the advertising chairs isn’t close to being finished.

I don’t see a problem in the short term. As for the thesis digital ad spend will eventually bump up against a ceiling, as I said, that’s obvious. It’s a matter of when, not if, it’s going to happen.

How investors view that will determine their outlook for Facebook in the near term. In that regard I don’t see it being something to be overly concerned about for now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Google News

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