The Update:
Facebook reported Q3 earnings two days ago, with the anticipation a virtual fever pitch as investors and onlookers sought to get insight into the recent controversies as well as the effect that iOS14 had on their advertising business.
Mark Zuckerberg:
‘As expected, we did experience revenue headwinds this quarter, including from Apple's changes that are not only negatively affecting our business, but millions of small businesses and what is already a difficult time for them in the economy.’
Zuckerberg outlined that Facebook was expecting to be able to be able to eventually navigate the changes with investments that were currently being made. In a previous update about Snap’s Q3 earnings I had mentioned that Facebook’s treasure trove of 1st-party data would make it the best placed of the social players to navigate the challenges that Apple had imposed upon them. Ironically, I have been slightly off on this point.
Facebook’s ad business had been interrupted, however this is simply spurring them into new business lines. Zuckerberg had already announced the partnership with Shopify earlier this year before Apple announced its new privacy policies, and Facebook Pay has been making appearances on large scale ecommerce players. All the pieces are lining up for Facebook to be able to facilitate in-app purchases. They have already shown their ability to make meaningful strides here by the success of Marketplace, and Shops.
A shift to commerce, which Zuckerberg has been alluding to for over a year now, will be a powerful shift both for the robustness of Facebook’s business, but also for their Metaverse aspirations. In a future where targeted advertising is much less effective, businesses will look for other ways to directly monetise their ad-spend. These ad-dollars probably will not the leave the Facebook ecosystem, they will be funnelled into a virtual store presence, using Facebook’s enhanced in app advertising offers. This is where Facebook’s investment in recapturing the younger age demo’s will come into play:
Mark Zuckerberg:
‘So we are retooling our teams to make serving young adults their North Star rather than optimizing for the larger number of older people. Like everything, this will involve trade-offs in our products, and it will likely mean that the rest of our community will grow more slowly than it otherwise would have. But it should also mean that our services become stronger for young adults. This shift will take years, not months, to fully execute, and I think it's the right approach to building our community and company for the long term.’
I think this was perhaps the most interesting part of Zuckerberg’s opening remarks. It is no surprise that Facebook specifically, and the family of other apps generally, have been losing appeal to the youngest cohorts of internet users. It was interesting to see the enormous backlash to the announcement earlier this year that Instagram would be rolling out a child-friendly version. In this regard their largest concern is Tik Tok. Tik Tok took an extremely potent version of short form video, and combined it with an algorithm to suggest extremely engaging content to users. The strategy about how they plan to do this is yet to come to light, but I suspect it will have something to do with the re-brand anticipated to be unveiled at Facebook Connect on Thursday. Zuckerberg did leave a clues:
Mark Zuckerberg:
‘…I am optimistic that Reels will be as important for our product as Stories is. We also expect to make significant changes to Instagram and Facebook in the next year to further lean into video and make Reels a more central part of the experience.’
Clearly an enhanced version of the short form video is on the cards, and is really the future for engagement across the Facebook and Instagram platforms.
The other major theme discussed at length was the Metaverse. This was first announced, to considerable fanfare, in the Q2 earnings call. According to Zuckerberg, the Metaverse will be an ecommerce-first medium. The goods sold will be both physical and digital. It’s a very nascent concept but you can see the early underpinnings of what Facebook plan with their current product set:
Essilor Luxottica Smart Glasses,
An enhanced 128-gigabyte Quest 2,
Digital Commerce,
A focus on young adult adoption,
Payments,
Digital Currency,
In this ecosystem you can see Facebook tying together its extremely large network of users, across properties, together with its almost 10 million business customers, in a VR/AR format. As Zuckerberg acknowledges, this vision will take years and a huge outlay of capital:
‘In 2021, we expect these investments to reduce our overall operating profit by approximately $10 billion, and I expect this investment to grow even further for each of the next several years.’
At current levels this is a little less than 1/4th of Facebook’s operating profit.
‘Starting next quarter, we will begin disclosing financial metrics for Facebook Reality Labs separately from our Family of Apps. And this will provide investors with additional visibility into the investments that we're making in augmented and virtual reality.’
Separating out the reporting for these next generation investments will be important for two reasons. Firstly, what gets measured gets done. Investors will expect results when they break out these numbers. Secondly, breaking out this loss making segment will reveal just how profitable the Facebook, Instagram, and to a lesser degree Whatsapp, properties truly are. This could go someway to remedying the perpetually undervalued status of the hold co.