For a long time, social media was overlooked by advertisers as it was considered a highly inefficient medium for targeting - a very important criteria from an advertiser’s point of view - resulting in very low advertising rates and very little user engagement. But Facebook (FB, Financial) has turned that ideology on its head and made social media extremely attractive to the advertising community. It is not without reason that advertisers are flocking to be on Facebook’s platform, pushing the world's largest social media site’s annual revenues from a mere $1.97 billion in 2010, to an eye-popping $17.9 billion in 2015.
On the Average Revenue per User Front
As a natural process of evolution, Facebook first increased its penetration in developed markets and then started expanding into emerging/developing markets. But there was a major problem, as user base numbers started to get skewed in favor of emerging economies - where the number of users added in those regions was far higher than what they can add in developed countries - the natural direction for Average Revenue Per User (ARPU) was downwards.
Though one could argue that emerging markets may lack the dollar’s appeal but make that up with numbers, in reality when you convert revenues into the dollar equivalent, the gap is considerable.
For example, Facebook’s ARPU for the U.S. and Canada during the second quarter of the current fiscal was $14.34, nearly 8 times more than the ARPU of $1.77 in the Asia Pacific region. To achieve parity in revenues between those regions, Facebook needs 8 times its U.S. user base in APAC. It is not impossible, but considering that North America has 226 million users, getting 8 times that - or close to 2 billion - is going to take a while.
But the puzzle here is that instead of showing a slow decline in ARPU as the number of users in APAC and Rest of the World grew, Facebook has done the exact opposite - made its ARPU grow. And the key point to note here is their ARPU is growing across all regions, a clear indication that the value of Facebook as an advertising platform has grown in the eyes of advertisers. So naturally, they are willing to pay more and more for the kind of returns they have been getting.
Of note here is the fact that their Facebook Audience Network recently got a fillip from Instagram users being added to it. Now, instead of just the 1.3 million users on Facebook, advertisers can hit another 400 million on Instagram using the very same ad network. And that is another reason for ARPU growth.
What Next, You Ask
The truth is, Facebook has always been relentless in its pursuit to keep on expanding, whether its user base or advertisers. Now, video seems to be the next area of attack and there are three main reasons why they would want to do this.
As an aside, this is also why Twitter (TWTR, Financial) is going after live streaming video as a way to increase engagement, something I have written about in detail in Is This Twitter’s Last Lifeline? so these three reasons below apply to Twitter as much as to Facebook.
Reason #1: Mobile consumption is growing
The first trend that we must take note of is the rate at which data consumption via mobile devices is growing. Desktops are practically dead for social media. This is borne out by the fact that Facebook derived nearly 84% of its advertising revenue from mobile during the second quarter. In fact, that number has been steadily growing for Facebook over a period of time.
As data consumption via mobile rose, it helped video consumption rates go up as well. As your screen size gets smaller, it is far easier to watch something than read it, so the shift is natural and not something that will go way in the future.
Here is a look at how people are spending their time on digital content. Look specifically at the numbers for digital video and you will see what I mean.
So people are spending more time on their mobiles and more time watching videos. And that brings about an increase in another important metric.
Reason #2: User Engagement is Higher with Video Content
As you saw in the table above, user engagement on video is extremely high, especially on social networks. For the moment, that only includes YouTube, but Facebook wants to be where YouTube is right now.
As engagement increases, it also increases the stickiness of the site, pushing viewers to spend more time on the site. And the more time they spend on a site, the higher the value of the site for advertisers.
“Using videos we uploaded to Facebook during Fashion Week in February, we saw an 85X lift in view rates versus our previous Fashion Week campaign, which linked to videos from other players. This fall we will begin tapping into the new video views objective, and our ads are now eligible to automatically play in News Feed. Facebook is and will continue to be a key part of our video marketing strategy going forward.”
— Jen Daly, Senior Brand Building Manager, TRESemmé & Nexxus, Unilever via Facebook
So the first reason Facebook is going the video way is because of the shift towards mobile and the resulting increase in video engagement. The final reason is actually where the real motivation is for Facebook.
Reason #3: Higher Advertising Rates
The last, but most important, thing to remember is that video ads pay more than their display counter parts. The higher the video consumption, therefore, the higher the number of videos ads viewed and higher the advertising revenues they generate.
As we saw earlier, engagement is higher with a video. When engagement goes up, click through rates (the percentage of ad viewers who click on the ad) are also typically higher. Video CTR rates, for example, were nearly 7.5 times higher than their display cousins. So that means Facebook as a platform will be getting nearly 7.5 times more revenue from video compared to display. And that is on a per advertisement basis.
Moreover, video also has higher CPM rates (cost per mille, or cost per thousand), which means Facebook makes 10X more money from a video ad than a display ad.
What are the Implications for Facebook?
The combination of an increasingly mobile world that is consuming more video and the resulting ad rates are exactly the situation Facebook wants to be in. Not right now, but well into the future. Mark Zuckerberg has already voiced his views on video being the future of the company and the social media juggernaut is already being tugged in that direction.
As Facebook reaches peak penetration around the world (which it has not done yet, in my opinion) it will need additional revenue drivers to keep it going forward. Notwithstanding the fact that WhatsApp is still sitting outside their revenue fence, this is just one more pillar of support that the company is adding in order to “grow into” its current high valuation.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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