Good morning,
Charles Arthur noted that my confusion about who might have gained PC share between Microsoft and Apple came from my forgetting an important variable: Chromebooks. Indeed, PCs are now a three-way competition.
On to the update:
Meta’s Earnings
From the Wall Street Journal:
Facebook parent Meta Platforms Inc. startled investors with a sharper-than-expected decline in profits and a gloomy outlook in its first earnings report since Chief Executive Mark Zuckerberg outlined a pivot to the metaverse. Meta shares plunged after the results were announced, dropping more than 20%. If shares dropped that much when trading opens on Thursday, it would wipe more than $175 billion from the tech giant’s market capitalization.
The company said it expected revenue growth to slow because users were spending less time on its more lucrative services. Meta cited inflation as a weight on advertiser spending and estimated that ad-tracking changes introduced by Apple Inc. last year would cost Meta some $10 billion this year. Meta also lost about a million daily users globally and stagnated in the U.S. and Canada, two of the company’s most profitable markets, the results show.
This last bit about users is drawing a lot of headlines and consternation, but I tend to think it is the least of Meta’s problems; the company has 2.91 billion MAUs, and was bound to hit a saturation point eventually. Moreover, that saturation had already happened in North America; the slowdown in growth, which Meta attributed in part to more expensive mobile plans in India, is to a part of the user base that, at least at this point in time, has minimal impact to the top-or-bottom lines.
Facebook’s Three Challenges
What matters more are three challenges hitting the company all at once: competition, particularly from TikTok; a product shift, which is self-inflicted; and a decrease in advertising effectiveness, which is a result of Apple’s App Tracking Transparency (ATT) changes. The relative impact of these challenges depends on your frame of reference.
Competition From TikTok
The first mention of TikTok on a Meta (then-Facebook) earnings call was Q1 2021, and it came in an analyst question; no Meta executive mentioned the short-form video service until Q3 2021, when Zuckerberg acknowledged in his prepared remarks that TikTok was “one of the most effective competitors that we have ever faced.” Then came yesterday’s earnings call, where Zuckerberg brought TikTok up five times, although it felt like 500.
The threat is certainly real: TikTok, predicated as it is on public content across the service, isn’t really a social network at all, which meant it exploded in Meta’s blind spot. The problem for Meta is that its business isn’t based on surfacing content from your friends; it’s based on engagement and serving ads, which means any service that occupies your time and attention — and TikTok occupies a lot of it — is a fundamental threat.
Understanding Meta and TikTok’s plane of competition does, as I have repeatedly noted, including in last fall’s Regulators and Reality, call into question the FTC’s antitrust lawsuit against Meta, which dismissed TikTok as a competitor. To that end, I can’t help but wonder to what extent the emphasis on TikTok on this call was driven by the fact that said lawsuit was allowed to move forward last month.
Meta’s Product Shift
This observation may come across as cynical, but it’s really the opposite: Meta is fundamentally changing its products in response to TikTok; the company is showing by its actions that short form video is a threat.
First, Meta actually announced last quarter that it was changing its internal targets away from total users to a specific focus on young adults. Zuckerberg said:
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. One aspect of this is given all our apps, the goal of being the best services for young adults, which we defined as ages 18 to 29. Historically, young adults have been a strong base and that’s important because they are the future. But over the last decade, as the audience that uses our apps has expanded so much and we focused on serving everyone, our services have gotten dialed to be the best for most people who use them, rather than, specifically, for young adults.
As a quick aside, this is a fascinating object lesson in how KPIs that make perfect sense at one particular junction in a company’s history — growth at all costs — can cause problems at another.
And during this period, competition has also gotten a lot more intense, especially with Apple’s iMessage growing in popularity, and more recently, the rise of TikTok, which is one of the most effective competitors that we have ever faced. Though 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.
What this means in practice is sacrificing Facebook’s most important foundational invention: the Feed. I already wrote about how this was happening to Instagram last summer:
This is where the shift to Stories created an opportunity: if you look at the Instagram home screen, the vast majority of time is spent in a relatively small amount of space:
While Reels did recently get its own tab at the bottom, I suspect that Instagram’s plan is to push Reels content into that main feed, and as Mosseri noted, that includes content from creators “you may not be following yet.” In other words, Instagram, having shifted the primary use case of the app from the Feed to Stories, is going to transform said feed to address its two remaining shortcomings relative to TikTok: a new consumption experience, and content from anywhere.
What is notable is that Zuckerberg is now clear that this change is coming to Facebook as well, despite (or, per the KPI point above, because) the dominance of older users. Facebook is, radical though this may sound, leaving the social part of social media behind, at least as far as the feed is concerned; this, though, is also following the younger generation, which has moved those sorts of interactions to messaging. Zuckerberg noted:
A lot of people now are taking a lot of the content that they may have previously shared in a Feed and sending it to friends over chats, whether it’s one-on-one or through group chats. And this is one of the reasons why I called out community messaging as one of the major priorities for us. Because if you look at the overall constellation of services, a lot of the kind of personal sharing is sort of shifting towards messaging. And a lot of what we’re seeing in Feeds is just basically this content consumption and a lot of just really highly engaging content that forms the basis for conversations, whether it’s in chat or in common trends in those Feed apps.
The challenge for Meta is the same challenge they faced with the shift to Stories: a new format, at least in the beginning, monetizes much more poorly than an established one; user time shifts before advertising spend does. This reality is why I remained bullish on Meta the last time they had disastrous earnings; from 2018’s Facebook’s Story Problem — and Opportunity:
That’s the thing about Stories, though: while more people may use Instagram because of Stories, some significant number of people view Stories instead of the Instagram News Feed, or both in place of the Facebook News Feed. In the long run that is fine by Facebook — better to have users on your properties than not — but the very same user not viewing the News Feed, particularly the Facebook News Feed, may simply not be as valuable, at least for now.
The shift clearly worked; here is that previous record drop:
The problem this time, though, is that TikTok is a much stronger competitor than Snap was; what is even more pressing, though, is Apple.
ATT’s Impact
Meta (and Stratechery) has been giving warnings about the impact of Apple’s ATT changes for two years; the company didn’t fully specify the scale of the impact until yesterday though, and it’s massive: approximately $10 billion in 2022. That is 8.5% of Meta’s 2021 revenue; worse, because that impact is primarily felt through lower prices, that is money straight off of the bottom line as well, and $10 billion is 25% of the company’s 2021 profit. This, more than anything else, is what is driving Meta’s disappointing outlook.
Moreover, while Meta is piecing together ways to improve conversion tracking, the lack of precision and longevity in those signals means that it is much more difficult to leverage conversions for targeting. Meta will figure this out, in part by making massive investments in machine learning to improve its targeting; that, though, entails a big increase in capital investment, which hurts profitability even more (this does, though, increase Meta’s relative moat in the long run).
Financial Versus Existential Risks
I ranked the financial impact of these challenges from least to most; what is interesting is that the ranking of the existential risk of these challenges goes in the opposite direction. Working through ATT is going to be painful and take years, but Meta is better equipped to figure it out than anyone else in the 3rd-party advertising space (Meta did note on the earnings call that Google doesn’t face the same headwinds because Safari isn’t covered by ATT).
This format shift, meanwhile, is riskier than the addition of Stories: that prior shift moved engagement and temporarily reduced monetization, but Stories were additive to the Feed. Replacing the feed means not only shifting engagement but also reducing very valuable inventory. Moreover, the older users that Facebook is de-prioritizing are also likely to have more disposable income and may be more valuable to advertisers.
The true risk to Meta, though, is (and always has been) a loss of engagement to other companies. Winning users back is much more challenging than figuring out how to shift advertisers to another spot on your own properties. This battle matters more than anything for Meta’s long-term value.
To that end, just as Facebook’s product changes are evidence that TikTok is real competition, today’s stock price drop is also evidence of the benefit of founder control. Meta could have delayed its response to TikTok until ATT worked its way through the system, but instead the company is fundamentally changing its products at the very moment its results are the most impacted by Apple’s changes. The easier decision, particularly for a manager, would have been to wait a quarter or two, when the comps would have been easier, and the excuses clearer, but founders have the freedom to prioritize existential risks over financial ones.
Of course they also have the freedom to spend $10 billion on a speculative bet like the Metaverse, an amount that will “increase meaningfully” in 2022; Meta continues to be first and foremost a bet on Zuckerberg.
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