Facebook, Google, and, now, even Amazon make oodles of cash from advertising. This is not a secret. For decades now, these companies have built and optimised their online ability to serve you relevant ads. The scalability of these business models means incredibly high margins for these key players. In other words, they are making mountains of profit.
The mega-cap tech companies continue to make enormous amounts of money and use that money to retain power and influence. They have deep enough pockets to buy out the competition and enough spare cash to risk purchasing “moon shots” — projects that either fail or become dominant in their sector. Although it seems unlikely now, these companies will probably go into decline one day. History is replete with such examples. So how could it happen? Good old commoditisation.
Tell me more about this six-syllable word
All new products or product innovations go through several life stages and usually end up as a “commodity” in the eyes of the buyers. Roughly speaking, the stages are:
- Innovation — an innovative company creates a new product or idea.
- Demand growth — early in the product’s lifecycle, demand is high, providing the retailer pricing power. The product is highly profitable.
- Growing competition — the product’s success and profitability draws competitors into the market. Competitors offer different versions of the product meant to appeal to different demographics, e.g., luxury versions versus cheaper versions. Profit margins begin to drop but remain solid at this stage.
- Approaching market saturation — the majority of potential customers have purchased some version of the product. A large number of competitive firms may exist. Product innovations are incremental and small, and profit margins are declining. Sellers are forced to continually reduce prices to attract new customers.
- Commoditisation of the product (or service) — typically, several companies offer the product or service, and there is little difference between the various vendors. The product has reached the near-perfect competition scenario. It is no longer considered innovative and has become an everyday product. Prices are virtually the same across all sellers.
This process has played out since antiquity. From the first wheat farmer to the smartphone producer — most products go through this cycle. Here are a few other historical examples: automobiles (although EVs have restarted the cycle), personal computers, utilities (gas, electricity), banking, clothing, and Internet access.
The Death of Giants?
Over 85% of the companies that were part of the Fortune 500 in 1955 were gone by 2014. It might seem impossible to fathom that a behemoth like Google may not exist in a few decades, but history is not on its side. Although it is challenging to ascertain an exact number, it is thought that 80% of Google’s revenue comes from online advertising. For Facebook, that number is around 97% (as of 2020).
Online advertising has had incredible tailwinds this past year. Yes, many companies cut their advertising budgets during the lockdowns (for example, travel advertising). Still, there was a significant acceleration of the digitalisation of businesses (as can be seen from Shopify’s growth). Many companies were forced online, and many others were forced to increase their online advertising budgets. Currently, we are seeing the second tailwind for these giants: the world economy is reopening and companies that did not advertise during the lockdown are back in business. Since the economy has not fully reopened, advertising expenditure in physical media remains lower than usual, and at least some of those funds are making their way into online advertising instead. Consequently, Facebook and Google have strong pricing power, and they are sitting well.
But I would argue that these tailwinds have accelerated their march towards commoditisation. The acceleration of business digitisation has brought forward the eventual market saturation point. I don’t think we are there yet, and luckily (for them), there are only a handful of major players for now. But the same could be said for utility providers. And auto manufacturers. And mobile phone makers. You get the picture.
You may disagree, but over the next decade, I think we will see the commoditisation of advertising services like those offered by Facebook and Google. I think these companies know that the writing is on the wall, and that is why they are constantly experimenting with additional products and services. They have to innovate and find a market suitably big to replace their current Golden Geese. If not, they will join those Fortune 500 giants that have ceased to exist.
Wesl3y is a technology consultant and an eToro value investor. He has consulted for major global companies and sold his business to Accenture in 2015. He uses his industry insight to try and beat the market.
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