It seems like after the first quarter of 2020. We had discussions about strategies and the future of businesses that didn't happen for years. That is understandable because of the COVID-19 pandemic, lockdown, and the expected economic effects. Many people started to look with more focus than usual into what big companies had to present in the first quarter earning calls.
What I want to explore here is the discussions around online ads, what does big companies earnings are telling us about the current online ads situation. And what does it mean for the future of online ads?
Let's start with this bold statement:
Morgan Stanley analysts project that online advertising will suffer more this year than during the 2008 financial crisis.
Are we in an online ads bubble that about to burst?
Let's investigate first the big companies earning reports.
Google’s revenue has risen in every quarter of its history.
Alphabet reported total revenue of $41.2 billion for the first quarter, up 13% compared with a year earlier. [...] this was a particularly well-timed reveal for a company that has been a model of growth during its 22 years of existence.
I was wondering how many companies can claim this fantastic continuous growth for such a long period of time. Man, we are talking about 22 years! But let's postpone our remonetize talk about google history into another essay. And let's focus on the main topic of today.
The company makes most of its money from online advertising in areas such as search, where many major customers are pulling back sharply in industries including travel and retail. The YouTube unit, on the other hand, has an opportunity to grab eyeballs, and associated advertising, from homebound users, turning to the video platform in lockdown.
Obviously, with more people staying home, the usage of Google services has increased, especially Youtube, but that didn't increase revenue from ads as one might expect because advertisers are trying to be more conservative with spending on marketing (More about that in a minute). And companies in other sectors like tourism, hotels, airlines, etc. had a significant cut in the marketing budget due to lockdown.
And during the second quarter, it's expected to see the real negative effect from online ads spending cut down.
Facebook noted that ad revenue in the first three weeks of April looked flat versus year-ago levels, showing stabilization after sharp declines in March. [...] But for a company so dependent upon small businesses, investors’ optimism could be overblown. Morgan Stanley’s Brian Nowak estimates small businesses comprise 30% to 40% of Facebook’s overall advertising base. He forecasts their ad spending will fall 50% from a year earlier in the second quarter.
Well, there is no easy way to say that, but 98% of Facebook revenue is coming from online ads. So it's not a big surprise that they are one of the most affected companies by both surges of usage as people are using Facebook, Instagram, Whatsapp more heavily, and decrease of marketing spend on ads on its platform. So ads for Facebook are basically a matter of existence.
Earlier this month, Pivotal Research Group’s Michael Levine said he expects any rebound in paid advertising to significantly lag actual economic recovery, particularly by small businesses. His March survey of advertisers showed spending continuing to decelerate. In other words, the worst may be yet to come. For Facebook, higher usage alone doesn’t pay the bills.
Facebook tried a quick solution as a temporary pain killer by offering 100 million dollars in cash grants and ad credit to small businesses. But the smart move for them is actually by looking into diversifying income resources in the near future (More about that in next essays).
By now you shouldn't be surprised when you read Twitter earning report, as its only revenue stream is online ads:
Twitter warned its financial performance would fall short this quarter as the coronavirus pandemic depresses advertising spending, an indicator social-media platforms may not be able to quickly translate increased user engagement during the global health crisis into financial gain. [...] Twitter on Monday said it would post an operating loss in the first quarter and that sales would decline “slightly” compared with the year-ago quarter when it posted about $787 million in revenue.
Just a side question. Twitter, isn't this the time to start thinking about testing different income models, you know, to diversify your revenue sources? Or you know what, let's talk about this in more detail in future essays. I will not forget.
On the more stable side of things, Amazon has a different situation. As a consumer-facing platform, Amazon is conducting different businesses for different types of users. And each of them has different challenges.
1- Selling products: At this line of business, Amazon didn't suffer from a lack of demand. But the issue was to meet that demand. As Ben Thompson explained it:
This, needless to say, falls in the “good problems to have” category. The signaled preference of consumers is that they want more Amazon than Amazon is able to deliver. Theoretically, of course, this also leaves an opening to competitors: what is meaningful about Amazon’s intent on spending whatever is necessary this quarter to meet that demand is it signals the company’s intent to slam that window shut.
2- AWS: In the last essay, I wrote about the power of platforms, and cloud computing is the best example of that. If other companies might lose money due to decreased spending on marketing spending. Cloud services in general and AWS in particular - as the leading player in the cloud service arena - benefited from the surge of internet usage no matter what, due to the pay-per-use model.
"During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents, and blue-jeans made a nice profit. — Peter Lynch"
3- Ads: Usually, we wouldn't consider Amazon at the online ads category, but it seems like Amazon wants to get more into the online ads business! As a way of income diversification - which gives them a much stronger position in comparison with Facebook and Google, who do mostly depending on ads.
As explained in a report from Business Insider Intelligence:-
Amazon's ad strength will continue to come from its unique ability to target millions of consumers with purchase data from the e-commerce platform, but it will increasingly do so across its variety of popular platforms (Amazon.com, mobile app, Twitch, IMDb TV, and devices (Fire TV, Echo). [...] Amazon will eat into Google's and Facebook's share of the digital ad pie in the coming years, but it won't overtake either player in the near to medium term. By 2023, Amazon could take as much as 14% of total US digital ad sales, up from 9% in 2019, per Business Insider Intelligence estimates, based on eMarketer data.
Microsoft is a perfect example of how a very well-diversified company earning should look. We shouldn't also forget about Microsoft government contracts, which provide them with a stable income source, besides its investments in almost every technology sector. Let's read this carefully:
Microsoft reported strong growth in quarterly sales and profit and said the shift of more activities online amid the coronavirus pandemic is helping propel growth in areas from cloud-computing to videogames. [...] Microsoft said sales rose 15% in the first three months of the year to $35 billion, and it generated a net profit of $10.75 billion. [...] The company said the PC group generated sales of $11 billion, as demand to support remote work and teaching offset some of the supply chain issues. The gaming business benefited from people staying at home, with Xbox sales increasing 2% in the quarter, an improvement from the 11% drop in the previous three-month period. Surface laptop sales rose 1% as demand from people rushing to buy devices to work remotely outpaced supply chain issues. [...] Microsoft’s business social-media network LinkedIn also felt the effect toward the end of the quarter, with reduced advertising spending, the company said, though revenue over the full quarter rose 21% from a year earlier.
In the last part of the report, the ads revenue from LinkedIn rose 21% from a year earlier. The same expectations for the business social network will be affected by decreased marketing spending in the second quarter.
So, it seems like many are pessimistic about the near future of online ads. However, others take it further to be pessimistic about the future of online ads in general and started to say that online ads are a bubble, and it's currently bursting. Maybe because nobody likes ads experience - including me - but let's not mix wishful thinking with reality.
It doesn't make sense that companies will stop depending on online ads as a business model any time soon. As long as companies exist, especially small companies with unknown brands, The demand for online ads will continue.
On the other side, companies that create digital products (apps, games, online content, etc.). On the contrary, They will invest more in online ads. E-commerce, especially small and medium companies, would also need to push more online marketing investment to share a piece of the increasing online shopping market.
Nevertheless, diversify the income sources for companies is always useful. The best example of this is the rise of the subscription-based model that many media companies and newspapers started to adapt. As a result, we are having better content and cleaner user experience. That could work well besides the online ads model, not instead of it.
Because currently, online ads are the only way for companies to provide their platform for free for users who can't afford to pay subscription fees in different areas in the world. Yes, we shouldn't forget about that.