It’s too bad I find Facebook and its various platforms toxic and untrustworthy. I won’t touch the stock, but it’s going to make anyone smart enough to buy and hold a lot of money over the next few years. As Ranjan Roy explains in his newsletter, the cost per ad on Facebook is “skyrocketing.”
More importantly there is no way to significantly increase supply. Network effect, combined with basic supply and demand fundamentals, resulted in a second quarter profit of US$10.2-billion with more to come for the foreseeable future.
Facebook only delivered a total of 6% more ads in Q2 while prices went up 47%. When the majority of people in the world already use your products, there are only so many more ads you can cram into user feeds without completely destroying the experience (the technical term for that challenge is ‘ad load’).
But we also have a situation where digital ad spending is rapidly growing and there’s no end in sight. Even in 2020, with a severe economic contraction, digital ad spend grew 12%. In the last two quarters, brands that had cut budgets are back with a vengeance. Travel, leisure, and every service benefiting from the economy’s re-opening is back spending. The rise in online commerce has also meant brands who traditionally spent big on analog media are shifting more towards digital platforms.
There’s more and more money chasing a relatively stable supply of goods. Prices are increasing but no one is going to leave Facebook.
Ranjan Roy, Margins Newsletter
For value investors that can parrot Warren Buffett aphorisms without truly understanding them – this is the moat you’re looking for.
When you make US$10.2-billion per quarter, regulatory risks that can’t be watered down or eliminated are probably overstated. That same cash flow also buys a lot of R&D capacity to increase engagement through moonshots like virtual reality, augmented reality and Diem. However as Microsoft has proven for the last 30 years, (WordPerfect vs Word, Netscape Navigator vs Internet Explorer, Slack vs Teams) when you own the market you really don’t have to be original, first to market, or even have the best offering. It’s enough to be a good fast follower and let your market share close the gap. Facebook Marketplace is a viable competitor to eBay because it’s combined with the existing user base. Instagram stories may have started life as a Snapchat ripoff but that hardly matter now. Five years later the war is over and Instagram stories on its own is worth more than all of Snapchat.
Unlike Snapchat, which always felt more intimate — private photo and video messaging is still its top use case — Instagram Stories took advantage of the fact that hundreds of millions of people had already created an enjoyable Instagram feed, following friends, family, local businesses, celebrities and influencers. So there was a built-in audience from day one, and a healthy supply of Stories to watch.
Instagram also put Stories right at the top of its app, making it the first thing everyone saw when they opened Instagram. It remains there.
One thing missing from Instagram Stories was a re-posting feature — it was hard for something to go viral in Stories. But users quickly improvised, re-posting screenshots from others’ Stories on their own, often with annotations or comments.
Recode, ‘Stories’ was Instagram’s smartest move yet
Complaints that Facebook has stopped growing its user base in developed markets miss the point that nobody is coming along to displace them. Owning 100% of the most lucrative ad market in history is a good thing. Owning 100% of the most lucrative ad market in history and forcing advertisers to bid against each other for access is even better. Leveraging that market dominance to launch new businesses and kneecap social media innovators is just gravy.
My other takeaway is that Facebook is no longer in competition with Google and Amazon, if it ever was. Instagram and the core Facebook experience are pure pay-to-play ad platforms where the most effective ads keep people inside the environment and there’s no way to surface organic content to new customers at scale without paid promotion. Google and Amazon are fighting for customers showing buying intent. To digital marketers those are distinct markets requiring different lead funnels.
Disclosure: No position in Facebook, because I’m either stupid or a hypocrite. I’d rather bet on a supply/demand imbalance in copper, oil or uranium than an undersupply in digital ad inventory.
