Six years ago tomorrow, in The Reality of Missing Out, I wrote that the digital advertising market was settled, and Google and Facebook won:

I have been arguing for a while that in the aggregate the tech sector is fine, and the state of advertising-based services is a perfect example of what I mean: taken as a basket the six companies in this article (Google, Facebook, Yahoo, Twitter, LinkedIn, and Yelp) are up 19% over the last year, even though the latter four companies are down a collective 53%; the fact that Google and Facebook are up a combined 31% more than makes up for it.

This makes sense: while advertising as a whole is a zero-sum game, there is a secular shift from not just print but also radio and TV to digital, which is why this basket of digital advertising companies is up. Digital, though, is subject to the effects of Aggregation Theory, a key component of which is winner-take-all dynamics, and Facebook and Google are indeed taking it all.

The Article was prescient for a time; Yahoo has been passed around for peanuts, LinkedIn was bought by Microsoft a few months later, and while Yelp and Twitter’s stock have more-or-less doubled since then,¹ that gain pales in comparison to that of Google and Facebook:

That chart, though, only runs through last Wednesday; here is the new chart post-Facebook earnings:

It turns out that, for now anyways, buying $TWTR on the day I wrote that article would have provided a better return than $FB.

Direct Response and the Collapse of the Funnel

In that Article I painted an idealized picture of the traditional marketing funnel and how Google and Facebook’s advertising products mapped onto it:

What Sandberg is detailing here is really quite extraordinary: Facebook helped Shop Direct move customers through every part of the funnel: from awareness through Instagram video ads to consideration through retargeting and finally to conversion with dynamic product ads on Facebook (and, in the not too distant future, a direct customer relationship to build loyalty via Messenger).

Google is promising something similar: awareness via properties like YouTube, consideration via DoubleClick, and conversion via AdSense. Just as importantly, both companies are promising that leveraging their respective platforms will provide benefits on both sides of the ROI equation: the return will be better given the two companies’ superior targeting capabilities and ability to measure conversion, and the investment will be smaller because you can manage your entire funnel from a single ad-buying interface.

Herein lies the first thing that I got wrong: the traditional marketing funnel made sense in a world where different parts of the customer journey happened in different places — literally. You might see an advertisement on TV, then a coupon in the newspaper, and finally the product on an end cap in a store. Every one of those exposures was a discrete advertising event that culminated in the customer picking up the product in question in putting it in their (literal) shopping cart.

On the Internet, though, that journey is increasingly compressed into a single impression: you see an ad on Instagram, you click on it to find out more, you login with Shop Pay, and then you wonder what you were thinking when it shows up at your door a few days later. The loop for apps is even tighter: you see an ad, click an ‘Install’ button, and are playing a level just seconds later. Sure, there are things like re-targeting or list building, but by-and-large Internet advertising, particularly when it comes to Facebook, is almost all direct response.

This can make for an exceptionally resilient business model: because the return-on-investment (ROI) of direct response advertising is measurable to a fantastically greater degree than traditional advertising measurement, advertisers can spend right up to the level they place on a particular customer or transaction’s value; Facebook, of course, is willing to help them do that as easily as possible, squeezing out margin in the process. Moreover, because these ads are sold at auction, the company is insulated from events like COVID or boycotts; I explained in 2020’s Apple and Facebook:

This explains why the news about large CPG companies boycotting Facebook is, from a financial perspective, simply not a big deal. Unilever’s $11.8 million in U.S. ad spend, to take one example, is replaced with the same automated efficiency that Facebook’s timeline ensures you never run out of content. Moreover, while Facebook loses some top-line revenue — in an auction-based system, less demand corresponds to lower prices — the companies that are the most likely to take advantage of those lower prices are those that would not exist without Facebook, like the direct-to-consumer companies trying to steal customers from massive conglomerates like Unilever.

In this way Facebook has a degree of anti-fragility that even Google lacks: so much of its business comes from the long tail of Internet-native companies that are built around Facebook from first principles, that any disruption to traditional advertisers — like the coronavirus crisis or the current boycotts — actually serves to strengthen the Facebook ecosystem at the expense of the TV-centric ecosystem of which these CPG companies are a part.

The problem for Meta is in the title of that article: Apple. The latter’s App Tracking Transparency (ATT) initiative severed the connection amongst e-commerce sellers, app developers, and Facebook by which Facebook achieved that ROI, and while the company is better positioned than anyone else to build a replacement, it is important to note that the impairment entailed in probabilistically measuring ad effectiveness instead of deterministically is a permanent one.

This isn’t just a Facebook problem: Snap said on its earnings call:

Our advertising partners who prefer to leverage lower-funnel goals such as in-app purchases, have been most impacted by [ATT]. We are seeing these advertisers migrate to mid-funnel goals where they have greater visibility such as install or click. Advertisers who optimize via web-based goal-based bids or GBBs have been less impacted, given that many of them have adopted the Snap pixel.

Snap’s direct response business is not nearly as good as Facebook’s, and is a much smaller business both overall and in terms of the overall company’s revenue; that left a lot more cushion to absorb ATT, both because Snap’s performance had less to lose, and also because the company’s brand-business could help pick up the slack. This, paradoxically, led many investors to overfit Facebook’s disappointing forecast to Snap’s outlook; the reality is that advertising dollars will find a way to be spent, and the alternatives to direct response on Snap were more impactful to the bottom line than they are on Facebook, in part because the latter was so dominant in direct response until now.

The Amazon Advertising IPO

What made the Facebook model tick was the way in which the company could convert conversion tracking to targeting: because Facebook knew a lot about someone who saw an ad and then converted, they could easily find other people who were similar — lookalike audiences — and show them similar ads, continually optimizing their targeting and increasing their understanding along the way.

Google Search, though, has a built-in advantage: Google doesn’t have to figure out what you are interested in because you do the company the favor of telling it by searching for it. The odds that you want a hotel in San Francisco are rather high if you search for “San Francisco hotels”; it’s the same thing with life insurance or car mechanics or e-commerce.

Google is not the only search engine that monetizes e-commerce effectively. Back in 2015 I described the breakout of Amazon Web Services’ financials as The AWS IPO:

This is why Amazon’s latest earnings were such a big deal: for the first time the company broke out AWS into its own line item, revealing not just its revenue (which could be teased out previously) but also its profitability. And, to many people’s surprise, and despite all the price cuts, AWS is very profitable: $265 million in profit on $1.57 billion in sales last quarter alone, for an impressive (for Amazon!) 17% net margin.

Those numbers pale in comparison to what I guess we might call the Amazon Advertising IPO, given that the company broke out its advertising for the first time this quarter, revealing $9.7 billion in revenue, a 32% increase year-over-year (Amazon did not break out the unit’s profitability). While that is still a fraction of Google’s $61.2 billion last quarter, or Facebook’s $32.6 billion, it is a larger fraction than you might expect, and several multiples of Snap’s $1.3 billion in revenue. Indeed, given the fact that Amazon is closer in revenue to Facebook than Facebook is to Google it seems fair to characterize the advertising market as dominated not by a big two but a big three.

Amazon’s advertising business has three big advantages relative to Facebook’s.

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 advertising to a receptive customer, the more advertisers are willing to bid for that ad slot, and text in a search box will always be more accurate than the best targeting.</p>

2. Amazon faces no data restrictions. That noted, Amazon also has data on its users, and it is free to collect as much of it as it likes, and leverage it however it wishes when it comes to selling ads. This is because all of Amazon’s data collection, ad targeting, and conversion happen on the same platform — Amazon.com, or the Amazon app. ATT only restricts third party data sharing, which means it doesn’t affect Amazon at all.

3. Amazon benefits from ATT spillover. That is not to say that ATT didn’t have an effect on Amazon: I noted above that Snap’s business did better than expected in part because its business wasn’t dominated by direct advertising to the extent that Facebook’s was, and that more advertising money flowed into other types of advertising. This almost certainly made a difference for Amazon as well: one of the most affected areas of Facebook advertising was e-commerce; if you are an e-commerce seller whose Shopify store powered-by Facebook ads was suddenly under-performing thanks to ATT, then the natural response is to shift products and advertising spend to Amazon.

All of these advantages will persist: search advertising will always be effective, and Amazon can always leverage data, and while some degree of ATT-related pullback was likely due to both uncertainty and the fact that Facebook hasn’t built back its advertising stack for a post-ATT world, the fact that said future stack will never be quite as good as the old one means that there is more e-commerce share to be grabbed then there might have been otherwise.

Google’s Dominance

Of course you could just as easily make an argument that when it comes to digital advertising there is Google and everyone else. Google clearly faces competition from Amazon for e-commerce search advertising — the European Commission’s Google Shopping case is only surpassed by the FTC’s Facebook lawsuit when it comes to overly narrow market definitions that ignore reality — but is dominant in terms of nearly every other vertical. Moreover, that dominance is shored up by the same factors favoring Amazon, at least in part.

The first one is obvious: search advertising works great, and Google is the best at it.

The second one, about data collection, is more interesting, particularly in the context of ATT. Facebook CFO Dave Wehner groused on the company’s recent earnings call:

We believe the impact of iOS overall as a headwind on our business in 2022 is on the order of $10 billion, so it’s a pretty significant headwind for our business. And we’re seeing that impact in a number of verticals. E-commerce was an area where we saw a meaningful slowdown in growth in Q4. And similarly, we’ve seen other areas like gaming be challenged. But on e-commerce, it’s quite notable that Google called out, seeing strength in that very same vertical. And so given that we know that e-commerce is one of the most impacted verticals from iOS restrictions, it makes sense that those restrictions are probably part of the explanation for the difference between what they were seeing and what we were seeing.

And if you look at it, we believe those restrictions from Apple are designed in a way that carves out browsers from the tracking prompts Apple requires for apps. And so what that means is that search ads could have access to far more third-party data for measurement and optimization purposes than app-based ad platforms like ours. So when it comes to using data, that it’s not really apples-to-apples for us. And as a result, we believe Google’s search ads business could have benefited relative to services like ours that face a different set of restrictions from Apple. And given that Apple continues to take billions of dollars a year from Google Search ads, the incentive clearly exists for this policy discrepancy to continue.

Apple, it should be noted, has always treated the browser as a carve-out from its App Store restrictions (not that it has any choice: Apple, in contrast to the App Store, doesn’t have any points of leverage over the open web), so it is fair to dismiss Wehner’s conspirational musings about the iPhone maker’s motivations.

At the same time, the broader observation is a smart one: Google, thanks to the combination of being the default browser on Safari and having a business built on the web, basically has first-party privileges on the iPhone when it comes to data. It can show ads to iPhone users on the default browser and track how those ads perform on third-party websites to a much greater extent than an app like Facebook directing users to the exact same third-party websites can.

In terms of ATT, it is notable that the only part of Google’s business that fell short of Wall Street expectations was YouTube; I suspect it is not a coincidence that YouTube has a significant app-install business of its own, and ATT’s restrictions on what those installed apps can report back to Google may have hurt business a bit. At the same time, the same dynamics that drove advertising to other parts of Snap’s business and to Amazon advertising likely benefited Google as well, including Android.

Facebook Risk

There is no question that Facebook has been significantly impaired, but the company is by no means doomed, in large part because while search is very effective at finding what you want, there remains the need to make you aware of what you didn’t know existed. This is what Facebook excels at more than any other platform: by knowing who you are and what you have liked or purchased in the past, Facebook can place ads for products or apps you have never heard of in the Feed, in Stories, or, going forward in Reels.

This, in my opinion, is actually a far more important form of advertising than search ads: yes, there are scenarios where a firm can surface something that fits exactly what you are searching for, but oftentimes search ads feel like a rake on organic results that would have given you what you were looking for anyways. Facebook-style display advertising, on the other hand, is the foundation upon which an entirely new host of Internet-only businesses are built. These niche-focused companies are only possible when the entire world is your market, but they would founder without a way to find the customers who are looking for exactly what they have to offer; Facebook ads solve that problem.

That discovery mechanism, though, doesn’t just depend on data; it also depends on attention. This is where the TikTok challenge looms large: Apple and ATT may have had the largest financial impact on Facebook, but TikTok and the loss of attention are the more existential risk.

Illustrating the Ad Market

Still, Facebook’s forecast, disappointing as they were to investors, was for $27-29 billion in revenue this quarter; this is still a major player in an advertising market dominated by the three companies mentioned in this article, with one looming dark horse. To illustrate the market — and with the caveat that this is a massive oversimplification of what is a large and varied opportunity — consider a two-by-two defined by apps and commerce (both physical and digital) on one axis, and search and display on the other:

This is what that market looked like back in 2016:

This is what the market looks like in 2022:

First off, note that this illustration doesn’t include a huge part of Google’s market, which is basically search for anything other than e-commerce. It also doesn’t include the still substantial market for brand advertising. Direct response advertising, though, is the truly Internet-native advertising form, and while Google and Facebook are important, note the two new entrants who have substantial advantages:

Amazon:

Amazon has the best fulfillment and logistics operation in e-commerce,² which it uses to not only drive its own first-party retail but also third-party merchant services. Indeed, this is another way to think about how Amazon is insulated from ATT: it’s not that the company doesn’t have a multitude of third-party merchants on its platform, it is that by taking on the role of an Aggregator instead of a platform it gets to fold all of those third party merchants into its app and website, beyond the limitations enforceable by Apple. Then it effectively gives those third party merchants no choice but to buy ads if they want to be noticed by customers.

Apple:

Apple launched its App Store advertising business in the fall of 2016, starting with the most obvious place: search. Apple hasn’t disclosed how much it makes in advertising, but there are analyst estimates of $5 billion annually. Not all of this is search — Apple has since added inventory in the App Store’s “Suggested” section as well as owned-and-operated apps like Apple News — but most of it is; Apple is confined to the top right corner…for now.

One of the biggest questions about the advertising landscape going forward is if Apple is going to move down to the “Apps + Discovery” quadrant that remains Facebook’s purview. If the company did they would have an unbeatable advantage: remember, Apple has made clear through its App Store policies and testimony in the Epic case that it views apps on the App Store as first party for Apple (this is how the company justifies its anti-steering provisions, likening links to websites to putting up signs in its own store for another, even though the signs in question are in the app and not the App Store). It follows, then, that Apple would see no inconsistency in denying Facebook the ability to have knowledge about installation and conversions derived from a Facebook ad, even as Apple has perfect knowledge of those installations and conversions from its own ads.

This isn’t a hypothetical! Apple’s Advertising & Privacy page states:

We may use information such as the following to assign you to segments:

• Account Information: Your name, address, age, gender, and devices registered to your Apple ID account. Information such as your first name in your Apple ID registration page or salutation in your Apple ID account may be used to derive your gender. You can update your account information on the Apple ID website.
• Downloads, Purchases & Subscriptions: The music, movies, books, TV shows, and apps you download, as well as any in-app purchases and subscriptions. We don’t allow targeting based on downloads of a specific app or purchases within a specific app (including subscriptions) from the App Store, unless the targeting is done by that app’s developer.
• Apple News and Stocks: The topics and categories of the stories you read and the publications you follow, subscribe to, or enable notifications from.
• Advertising: Your interactions with ads delivered by Apple’s advertising platform.

When selecting which ad to display from multiple ads for which you are eligible, we may use some of the above-mentioned information, as well as your App Store searches and browsing activity, to determine which ad is likely to be most relevant to you. App Store browsing activity includes the content and apps you tap and view while browsing the App Store. This information is aggregated across users so that it does not identify you. We may also use local, on-device processing to select which ad to display, using information stored on your device, such as the apps you frequently open.

As you can see, Apple does not currently allow developers to target downloads or purchases from within a specific app the developer does not own,³ but that doesn’t mean Apple cannot; again, the company has made clear it sees every app on the iPhone — especially their purchases — as Apple data, and this document makes very clear that Apple only sees data collection as problematic when it involves third parties. To that end, Apple could set up an auction-based advertising network that monetized on a per-install basis and run those ads within an Apple-controlled network that is available to third-party apps. It would basically be a better version of Facebook — well, in theory, Apple has admittedly never been really good at this sort of thing — but since only Apple sees the data (just as only Facebook sees the data from third-party apps), Apple gets to pat itself on the back all of the way to the bank.

This would, needless to say, be a breathtaking example of anti-competitive behavior; kneecapping your competitor via platform control and then taking over their business is what one would think antitrust law would be designed to stop. But then you look up and Apple has gotten away with its App Store policies for years, and Facebook is getting sued for limiting competition even as it faces an existential threat from TikTok, and who knows, maybe it would work.

I hinted at one of the objections to this happening above: Apple has tried to do advertising before, and failed miserably. As any Apple aficionado will tell you, ads aren’t in their nature, products are. But then again, had you told those same aficionados that Apple would be facing developer ire, antitrust lawsuits, and regulatory obstacles all over the world because of its insistence that it is owed 15-30% of all digital content consumed on the iPhone, they probably would have said that was impossible too. What is clear is that the $10 billion in revenue that Facebook won’t see this year will go somewhere, and Apple’s Services Narrative has never felt like a bigger opportunity.

There is a broader takeaway to this discussion; I wrote in the conclusion of 2020’s The End of the Beginning:

In other words, today’s cloud and mobile companies — Amazon, Microsoft, Apple, and Google — may very well be the GM, Ford, and Chrysler of the 21st century. The beginning era of technology, where new challengers were started every year, has come to an end; however, that does not mean the impact of technology is somehow diminished: it in fact means the impact is only getting started.

There was one company conspicuous in its absence, and that was Facebook. Real power in technology comes from rooting the digital in something physical: for Amazon that is its fulfillment centers and logistics on the e-commerce side, and its data centers on the cloud side. For Microsoft it is its data centers and its global sales organization and multi-year relationships with basically every enterprise on earth. For Apple it is the iPhone, and for Google is is Android and its mutually beneficial relationship with Apple (this is less secure than Android, but that is why Google is paying an estimated $15 billion annually — and growing — to keep its position). Facebook benefited tremendously from being just an app, but the freedom of movement that entailed meant taking a dependency on iOS and Android, and Apple has exploited that dependency in part, if not yet in full.

This, more than anything, is the way to understand the Meta bet, and why it matters so much to CEO Mark Zuckerberg. Investors may want the company to focus on what it is best at; Zuckerberg wants to build a company that is truly independent of anyone.

1. Twitter did have a large run-up a year ago that has since disappeared ↩

2. ex-China, anyways ↩

3. This is why I have been intrigued by AppLovin’s approach. ↩