Google and Facebook are among the most valuable companies in the world thanks to their grip on the advertising market. The big question is whether investors are overestimating the companies' ability to keep expanding their dominance.
The Alphabet Inc. unit and Facebook Inc. pulled in a combined $114 billion in revenue from advertisements in 2017, excluding the money that Google turns over to partners such as Apple. That means more than one out of every five dollars in the $500 billion global advertising market goes to Google and Facebook, based on Magna Global estimates of worldwide ad spending. Excluding advertising sales in China, where neither company has made much headway, Google and Facebook are responsible for about 25 percent of annual advertising revenue.
That's impressive, right? The companies grew into beasts because they changed how businesses from Ford to the corner coffee shop pitched to their customers. The local Yellow Pages, newspapers and magazines all lost advertising sales to varying degrees to Google and Facebook, which offered businesses a more efficient and effective way to persuade people to buy pickup trucks or drop by the store. In 2017, about 40 percent of all global advertising revenue was spent online, up from 20 percent six years earlier, the Magna estimates show. Google and Facebook led that shift and benefited from it more than any other companies.
But it gets harder for Google and Facebook from here, and it's not clear that the companies' stock market values reflect the difficulties of their mission. Both companies need to continue to grab advertising from television, radio and other places where businesses try to reach customers and expand into areas other than what is considered conventional consumer advertising. I'm more sanguine about the former than the latter.
First, I'll tackle the companies' market share task. The Magna data show that global advertising spending has increased an average of less than 5 percent annually since 2011, a bit faster than the expansion of the global economy over that period. Google and Facebook ad revenue has grown much faster -- 18 percent and 49 percent in 2017, respectively. In other words, the growth of Google and Facebook hasn't come so much from an increase in the total advertising pie but from grabbing bigger slices from other media.
To keep growing, Google and Facebook need to continue to expand their market share of the advertising pie. That's one reason why Google and Facebook are each trying to encroach on the turf of television, the source of $175 billion in annual advertising spending worldwide. But increasing their ad market share isn't enough.
Let's assume Google and Facebook expand their share of global advertising revenue excluding China to 40 percent in 2022 from the current 25 percent. That would work out to an estimated $216 billion in combined advertising revenue for Google and Facebook, based on Magna's ad market forecasts. That's a 14 percent compound annual growth rate for the companies, which would be a significant deceleration. Google and Facebook's combined advertising sales have grown 22 percent to 28 percent a year since 2014.
To grow at the rate investors expect, then, Google and Facebook need "moonshots." I'm not necessarily talking about autonomous cars, technology to let people hear through their skin and other projects the companies are cooking up in their science labs. Google and Facebook need moonshots in their primary business of advertising, too.
That could mean expanding into what is thought of as marketing, such as the email messages and coupons that companies pay to send to their customers. It could be selling software used by marketing departments, as Adobe and Salesforce provide now. Or Google and Facebook could find ways to take a slice of revenue when they refer people to buy from local merchants. Those are all ways Google and Facebook could tap large pools of revenue outside of but adjacent to their core advertising businesses.
It's possible each company could continue to thrive just by sticking to advertising. The companies have grabbed more ad market share than many people expected, and that could continue. Both companies are also trying to diversify into non-ad areas such as virtual reality and cloud computing.
For the foreseeable future, though, Google and Facebook are reliant on advertising. Alphabet generates 86 percent of its revenue from advertising; at Facebook the figure is 98 percent. The companies may be running out of room to grow before they hit a ceiling in advertising. And that may flip their iron grip on advertising from a strength to a vulnerability.