The digital advertising landscape in 2022 (Part 1)

Judging from the revenue situation, the pattern of the digital advertising market seems to have been settled long ago: Google and Facebook are competing for supremacy and forming a duopoly. But in this world, the only constant is change itself. Last year, Apple introduced the App Tracking Transparency (ATT) policy aimed at strengthening user privacy. The launch of ATT quickly had an impact on the digital advertising landscape, with Facebook expected to lose $10 billion in advertising revenue this year, while the beneficiaries included Amazon, Google and even Apple itself. This article analyses how the digital advertising landscape will change in 2022. The article is compiled and published in two parts due to length constraints. This is the first part.

Key points:

In the past few years, the digital advertising market has been dominated by Google and Facebook.

Apple's AT&T policy has caused the direct response advertising funnel model to collapse, and Facebook is the most affected

Amazon's advertising business has taken advantage of this opportunity to emerge as a new force, and the digital advertising market has formed a three-legged race

Six years ago, I wrote that the digital advertising market had been settled, and the winners were Google and Facebook:

I’ve always said that the tech sector is doing fine overall, and the ad-based services sector is a perfect example: the six companies covered in this article (Google, Facebook, Yahoo, Twitter, LinkedIn, Yelp) grew 19% overall last year, and while the bottom four dropped 53% combined, Google and Facebook’s 31% share more than made up for the bottom four’s decline.

The implications of this are significant: advertising as a whole is a zero-sum game, and a long-term trend in the industry is toward digitalization, which is reflected not only in newspapers but also in radio and television, hence the overall rise in digital advertising. But digitization itself is also subject to the Aggregation Theory effect, which is a key part of the winner-takes-all phenomenon, and Facebook and Google are indeed taking share.

For a while, the article was prescient; Yahoo had already become insignificant, LinkedIn was acquired by Microsoft a few months later, and while Yelp and Twitter stocks have roughly doubled since then, those gains pale in comparison to Google and Facebook:

Comparison of market revenue of Google, Facebook, Twitter and Yelp over the past six years

However, that picture is from before. Here’s the latest update after Facebook released its earnings report:

Google, Facebook, Twitter and Yelp's market revenue over the past six years, including Facebook's recent revenue

It turns out that buying $TWTR was a better return than buying $FB on the day I wrote that article anyway.

Direct Marketing and the Collapse of the Funnel

In that post, I created an idealized picture of the traditional marketing funnel and compared where Google and Facebook’s ad products fit within it:

The details Sandberg revealed are actually pretty special: Facebook helps Shop Direct move customers from the top of the funnel to the bottom: using Instagram video ads to drive awareness, then retargeting ads to drive consideration, and finally converting through dynamic product ads on Facebook (and soon, direct customer relationships on Messenger to foster customer loyalty).

Google is trying to do something similar: using assets like YouTube to create awareness, using DoubleClick to drive consideration, and finally completing conversions through AdSense. Just as importantly, both companies are expected to leverage their respective platforms to bring benefits to both ends of the ROI equation: the return on advertising will be better given both companies' superior targeting and conversion measurement capabilities, and the investment will be much smaller because you can manage the entire funnel through a single ad buying interface.

Here’s the first point I got wrong: In a world where different parts of the customer journey happen in different places, the traditional marketing funnel works—it really does. You may have seen an ad on TV, then a coupon in the newspaper, and finally the product on the corner of the store. Each of these impressions is a discrete advertising event, the end result of which is a customer picking up said product and placing it in their (literal) shopping cart.

On the internet, though, that journey has been increasingly compressed into a single impression: you see an ad on Instagram, click on it to learn more, log in with Shop Pay, and then wonder what you were thinking when it shows up on your doorstep a few days later. The app cycle is even more compact: you see an ad, click the “install” button, and a few seconds later you’re playing the first level. Sure, there are things like retargeting or list building, but in general, internet advertising, especially when it comes to Facebook, is almost all direct response.

This can make for a very resilient business model: because the return on investment (ROI) of direct response advertising is much more measurable than with traditional advertising, advertisers can determine their spending based on how much they value a particular customer or transaction; and of course, Facebook is willing to help them do this as easily as possible and take a cut of the profits in the process. Additionally, because these ads are sold using an auction, the company is not impacted by events like COVID or boycotts; as I explained in Apple vs. Facebook in 2020:

This explains why, from a financial perspective, the news that big consumer companies are boycotting Facebook isn’t a big deal at all. For example, Unilever’s $11.8 million ad spend in the US was replaced by the automated efficiency of Facebook’s timeline that ensures you never run out of content. Moreover, while Facebook loses some top-line revenue — in an auction-based system, reduced demand corresponds to lower prices — the companies most likely to take advantage of those lower prices are those that wouldn’t exist without Facebook, such as direct-to-consumer companies trying to steal customers from large conglomerates like Unilever.

This explains why the news of the big CPG companies boycotting Facebook is not a big deal at all from a financial perspective. Take Unilever's $11.8 million advertising spending in the United States, for example, which is nothing for Facebook. Moreover, while Facebook loses some revenue, in a system based on ad auctions, reduced demand leads to lower prices, but the companies most likely to take advantage of those lower prices are those that can’t live without Facebook, such as direct-to-consumer companies trying to snatch customers from giant conglomerates like Unilever.

In this sense, Facebook has an antifragility that even Google doesn’t have: a lot of its business comes from the long tail of internet-native companies that were built around Facebook from the beginning, so any disruption to traditional advertisers, like the coronavirus crisis or the current boycott, actually strengthens Facebook’s ecosystem at the expense of the TV-centric ecosystem that these CPG companies operate in.

The problem with Meta is the title of that article: Apple. The latter’s App Tracking Transparency (ATT) policy cuts off the ties between e-commerce sellers and app developers and Facebook, through which Facebook’s ROI is realized, and while the company is better positioned than anyone else to create a replacement, it’s important to note that the damage done by measuring ad effectiveness with probability rather than certainty is permanent.

This isn’t just a Facebook problem: Snap also said in its own earnings call:

Our advertising partners who prefer to leverage lower-funnel objectives, like in-app purchases, are the ones that are most impacted by [ATT]. We’re seeing these advertisers migrate to middle of the funnel, towards higher viewability objectives like installs or clicks. Advertisers optimizing through web-based and goal-based bidding, or GBB, were less impacted because many of them have adopted the Snap pixel.

Snap's direct-response business isn't as big as Facebook's, and it's a much smaller piece of the pie both overall and in terms of the company's overall revenue; that leaves AT&T with more of a cushion, both because Snap's earnings losses are smaller and because the company's brand business can help make up for it. The paradox is that this has led many investors to overfit Facebook’s disappointing forecasts to Snap’s prospects; the reality is that ad dollars will find a way to be spent, and adopting alternatives to direct response advertising on Snap would have a greater financial impact than finding corresponding alternatives on Facebook, in part because the latter has so dominated the direct response advertising business to date.

Amazon Advertising IPO

The Facebook model worked because the company could turn conversion tracking into targeted advertising: Because Facebook knew a lot about who saw an ad and then converted, they could easily find other similar people — lookalike audiences — and show them similar ads, continually optimizing the accuracy of their targeting and deepening their understanding in the process.

However, Google search has a built-in advantage: Google doesn't have to figure out what you're interested in, because you've already told it what you like through your searches. If you search for “San Francisco hotels,” chances are high that you’re looking for hotels in San Francisco; the same goes for life insurance, auto mechanics, or e-commerce.

Google isn’t the only search engine that can effectively monetize e-commerce. Back in 2015, I described Amazon Web Services’ financial breakthrough as the AWS IPO:

Here’s why Amazon’s latest earnings report is so important: For the first time, the company broke out AWS as a standalone product segment, which sheds light not only on AWS’ revenue (which could have been teased out before) but also on its profitability. And, to the surprise of many, AWS remains extremely profitable despite the price cuts: $265 million in profit on $1.57 billion in sales last quarter alone, a whopping 17% net profit margin (for Amazon!).

Those numbers pale in comparison to what I guess you could call the Amazon Advertising IPO, as Amazon disclosed advertising financials for the first time this quarter, reporting $9.7 billion in revenue, up 32% year over year (Amazon doesn’t break out earnings). While that's still small compared to Google's $61.2 billion or Facebook's $32.6 billion last quarter, it's bigger than you might expect and several times larger than Snap's $1.3 billion in revenue. Indeed, given that Amazon’s revenue gap with Facebook is smaller than Facebook’s with Google, it seems fair to describe the advertising market as a three-way battle rather than a two-horse race.

Amazon's advertising business has three major advantages over Facebook.

1. Search advertising is the best and most profitable form of advertising. This goes back to the point I made above: the more certain you are that you are showing your ads to customers who are inclined to receptive, the more willing advertisers will be to bid on that ad space, and the text in the search box will always be better than the best targeting.
2. Amazon faces no data restrictions. It’s worth noting that Amazon also has control over its own user data, and it is free to collect as much data as it can and use it at will when selling ads. That’s because all of Amazon’s data collection, targeted advertising, and conversions occur on the same platform — Amazon.com or the Amazon app. ATT only restricts data sharing to third parties, which means it doesn’t affect Amazon at all.
3. Amazon also benefits from the spillover effects of AT&T. This isn’t to say that AT&T doesn’t have an impact on Amazon: I mentioned above that Snap’s business is performing better than expected in part because its business is not dominated by direct response advertising like Facebook’s, and more ad dollars are flowing to other types of advertising. This will almost certainly have an impact on Amazon as well: one of the areas where Facebook’s advertising business is most affected is e-commerce. If you’re an e-commerce seller and your Shopify store is powered by Facebook ads and it’s suddenly underperforming due to the ATT impact, the natural reaction would be to move your products and ad spend to Amazon.

All of these advantages will always be there: search ads will always work, Amazon will always have data to leverage, and some of the revenue reduction associated with ATT will likely be due to uncertainty and the fact that Facebook hasn’t yet built out its tech stack for ads. In a post-ATT world, future technology stacks will never be as good as past technology stacks, which means more e-commerce share can be captured than before.

Translator: boxi

Source: 36Kr