It should have been a great moment of triumph for Facebook. Instead, the social network's stock took a precipitous nosedive.
Facebook released its third-quarter results on Wednesday, showing spectacular year-on-year revenue growth of 56 percent, arriving at $7 billion. Facebook's third-quarter profits, meanwhile, grew almost 300 percent, to hit $2.3 billion.
Overall, the company has been on a tear. Revenue grew 59 percent in the second quarter, and has been pretty amazing all year. Not surprisingly, Facebook's stock price has been on a tear too, rising 30 percent in the last year, and 230 percent since May 2012.
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And yet, shortly after those third-quarter results came out, Facebook's stock tanked by 7 percent. By Thursday, it had settled at a loss of around 5.5 percent.
What gives?
It boils down to the distinction between making money on volume and making it on price. In 2016, 57 percent of Facebook's revenue growth came from new users or from established users spending more time on the platform — more eyeballs looking at ads for longer. Another 32 percent of that growth came from Facebook showing each of its users more ads.
Meanwhile, growth in the price advertisers have to pay Facebook to feature each ad accounted for a measly 11 percent of the increase in revenue this year. In other words, 2016's gangbusters revenue increase has largely been about jacking up the volume of ads, not the price advertisers are willing to pay for them.
There's an obvious natural limit to this dynamic. Facebook can only cram so many ads into your Newsfeed before you get mad. And when it released its third-quarter results, Facebook admitted this can't continue: "Ad load will play a less significant factor driving revenue growth after mid-2017," David Wehner, the company's CFO, told analysts on a conference call. As a result, advertising growth will "come down meaningfully." Hence the investor whiplash.
To keep Wall Street happy, Facebook needs to transition its strategy from volume to price. The social network must start making more money by charging advertisers more to feature ads on the platform. By 2018, growth in the price Facebook charges per ad is projected to account for 40 percent of revenue growth, while growth in ads per user will fall to just 8 percent.
Going forward, instead of worrying about scaring off users with too many ads, Facebook has to worry about scaring off advertisers by charging too much. But the company has a plan: video.
TV stations have traditionally been able to charge a premium for advertisements because of the value brands place on getting themselves in front of TV viewers across the nation. Particularly for appointment viewing that people must watch live (you've gotta love sports!), advertisers are downright eager to pony up for the chance to get a vanishingly rare shot at viewers' undivided attention. A Bloomberg Intelligence analysis found that reaching 1,000 people on prime time television cost advertisers $50 in 2015, while accomplishing the same thing on Facebook cost just $5. Of the $500 billion spent on all forms of advertising in America each year, $200 billion still goes to TV.
Now, the social network wants to make video on Facebook the new television. "We see a world that is video first, with video at the heart of all of our apps and services," Facebook CEO Mark Zuckerberg has said.
The company has deployed Facebook Live, which allows users to shoot video on their mobile devices and stream it live on the social media platform. And Facebook is already dropping $50 million to encourage major media companies and public personalities to make use of the feature. They're also building video capabilities into Facebook Messenger and WhatsApp.
The explosion of high-quality mobile devices with good video capability has made this possible, opening up video content to be both watched and created by anyone, pretty much anywhere, pretty much anytime. Ads sold to run on mobile devices specifically already make up 84 percent of Facebook's overall revenue stream. Ninety-three percent of its 1.79 billion monthly users sign on with mobile devices.
Of course, replicating the television market on a billion smartphones will be far easier said than done. Facebook's users are so fractured among so many niche subcultures it's hard to see how the platform could deliver the same audiences at scale that brands can get from events like the Super Bowl, the World Series, the CMAs, or the most popular cable shows.
But Facebook clearly intends to try. The holy grail would be to combine the prestige of television ads with the kind of targeted data-heavy advertising Facebook and Google are perfecting, all offered up primarily through everyone's smartphones; Facebook as a TV channel, not just for celebrities, major content producers, or big events, but for everyone.
And yet... ads on mobile video specifically are still a small slice of the ad market, at just $4.5 billion this year. By 2018, they're expected to hit $7.1 billion, or roughly 10 percent of the mobile ad market. And all by themselves, Facebook and Google account for 68 percent of all spending on online advertisements. So Facebook — along with Google — will largely be making up the world of mobile video advertising as it goes along.
