Meta's Moment of Truth (Facebook's Ad Problem Explained)

Mark Zuckerberg is dark in the door of Capitol Hill. Facebook is scrambling to contain the fallout; it's facing a real threat to its cultural relevance. Do you think, in the wake of all these revelations, Facebook's gonna make any changes?

It is an extraordinary moment as he greets... I now turn to you. Welcome to the committee. Proceed, sir. Before I talk about the steps we're taking to address them, I want to talk about how we got here. Love it or hate it, Meta is by far the world's largest and most successful social media company and is also one of the world's most profitable businesses.

In 2021, Meta boasted 3.59 billion monthly active users across their platforms, which helped them generate record-free cash flow of 39 billion dollars, the vast majority of which came from selling ads. Back on the 6th of November 2007, Mark Zuckerberg introduced to the world Facebook ads, a system designed to use Facebook to connect businesses with consumers through a tailored targeted ads experience.

The concept was simple: learn about your users—who they are, what they like, what they search for—and then, from that information, place highly relevant ads from highly relevant advertisers right in the middle of their news feed and make a lot of money. This extremely effective, data-driven approach to advertising helped set Meta's business apart from traditional advertising sources such as billboards or TV or radio, and it single-handedly fueled the company's monstrous revenue growth in the 2010s.

But as we all know, Facebook's focus on personal data collection would eventually lead them right into the middle of the Cambridge Analytica scandal. What happened? What went wrong? Facebook was officially fined five billion dollars by the FTC. This was business as usual; we didn't think we were doing anything wrong. All of these industries are actually built on harvesting data. The cynical manipulation of American citizens for the purpose of influencing an election is deeply offensive, and I'm really sorry that this happened.

In 2014, Alexander Kogan developed an app called "This Is Your Digital Life," which paid 270,000 Facebook users to take a personality survey supposedly for academic use. The problem was this app was not just able to collect the data of the survey's respondents; it also collected the data from all of their Facebook friends too without their knowledge. This enabled Cambridge Analytica to harvest information from approximately 87 million people, the majority of which had never even heard of Cambridge Analytica or "This Is Your Digital Life."

Now, while Facebook was just the app where all of this deceptive behavior occurred, questions were still asked of how Facebook could let a third party harvest so much user data without the person actually agreeing to or even knowing that this was occurring. It seems to be part of a pattern of lax data practices by the company going back years. Actually, at the first line of our terms of service say that you control and own the information and content that you put on Facebook. At least from when I was there, that's just fundamentally not true.

Those profiles were used as the basis of the algorithms that became the foundation of Cambridge Analytica itself. The company itself was founded on using Facebook data. This event marked a significant turning point for the online advertising industry, and since 2018, people, companies, and legislators have been increasingly alert to data collection and usage on social media platforms.

Today, nearly every part of your life can be digitized, tracked, and logged. Cookies actually make our online world possible, and they've become the center of a war for our personal data. Here in the States, we saw officials taking aim at big tech companies. They not only wield tremendous power, but they also abuse it. It's being described as the biggest shakeup of data protection laws in a generation, giving ordinary people unprecedented control over the information companies hold on us.

This obviously poses a very serious threat to Meta's business. In 2021, Meta generated 115 billion of their 118 billion dollars of revenue from selling ads and enjoyed a very nice 24 year-over-year rise in price per ad thanks to the effectiveness of their data-driven ad targeting system. But now, in 2022, Meta faces a major problem, and no, it's not just a little FTC fine that Meta can subsidize by showing you a few more ads from the Dollar Shave Club. It's an issue that attacks the very way they operate their business.

We take privacy extremely seriously. It's the new App Tracking Transparency prompt. All that's changing is that Apple wants Facebook to ask our permission before they track us. Let them know precisely what you're gonna do with their data. That's it. And Facebook seems intent on seeing it as an existential threat.

It wasn't surprising to us to hear that some people were going to push back on this, but I think when it comes down fundamentally for Facebook, we increasingly see Apple as one of our biggest competitors. Only about 15 to 20 percent of users are opting in. It's really the gut punch tracking transparency—a simple new feature that puts your data back in your control.

In April 2021, Apple took a major step in limiting Meta's ability to track what you're up to on your phone with the release of iOS 14.5. Apps would no longer have default access to your IDFA, your identification number for advertisers. Instead, users would have to opt in for advertiser tracking for each and every app that used it. Without this tracker enabled, Facebook or Instagram can't see the full picture of how you use your iPhone, and with less personal usage data to draw from, their ads become less targeted.

This is clearly a major problem for Meta, so much so that during a Meta earnings call in January last year, CFO Dave Weiner said, "We continue to believe that that will be a headwind in the ads business. We're going to have to be providing a prompt asking people for permission to use third-party data to deliver personalized ads, and we do expect there to be high opt-out rates related to that."

And it turned out Dave's predictions were exactly right. A study done by Flurry Analytics found that in the first three weeks of this update going live, only 25% of users allowed app tracking after seeing the prompts. This is clearly a significant issue as at the start of the year, Apple had over 1.8 billion active devices globally, and Meta are already estimating this update will cost them 10 billion dollars—10 billion dollars essentially up in smoke.

This is Tim Cook getting the last laugh over here. Mark is very upset, but unfortunately for Meta, the pain doesn't stop there because Google are now looking to do the exact same thing on Android devices. On the 16th of February, Google published an official blog post titled "Introducing the Privacy Sandbox on Android," and in it they said, "Today we're announcing a multi-year initiative to build the privacy sandbox on Android with the goal of introducing new, more private advertising solutions."

Specifically, these solutions will limit sharing of user data with third parties and operate without cross-app identifiers, including advertising ID. Although this might still be many years away, this arguably poses a bigger threat to Meta's business than the iOS updates, as there are more than 2.5 billion active Android devices around the world today.

Scarily, as of August 2021, nearly 57% of all internet traffic came from mobile devices. So over the next few years, Meta has quite a big problem to work through. Their whole shtick is targeting social media users with incredibly relevant ads based on what they do and what they like. If Facebook and Instagram can no longer access this information, it stands to reason that the effectiveness of their ad targeting will likely drop quite substantially.

As we described last quarter, Apple created two challenges for advertisers. One is that the accuracy of our ads targeting decreased, which increased the cost of driving outcomes. The other is that measuring those outcomes became more difficult. We're working to try and improve things, but we expect the overall targeting and measurement headwinds to moderately increase throughout 2022.

But although this is certainly going to be an ongoing headwind for Meta, I wouldn't say this is the end of the Facebook era of dominance. As it's been discussed at length on recent earnings calls, there are two big strategies that Meta is currently employing to overcome these hurdles. The first, perhaps the most important foundational technology of our time: artificial intelligence.

Advances in AI have enabled us to deliver better ads to people while using less data. It means we improve the relevance of Reels and overall content ranking in general, and it plays a big role in our commerce efforts. We just announced our AI research supercluster, which we think will be the world's fastest supercomputer once it is complete later this year.

This is going to enable new AI models that can learn from trillions of examples and understand hundreds of languages, which will be key for the kinds of experiences that we're building. So step number one, encountering the reduction in available data, is to invest heavily in AI that can best optimize the targeting process to deliver better ads with less information.

Now Mark really hasn't gotten into the specifics of how this will actually work, so the results of these efforts remain to be seen. But beyond AI, there's also a second, much bigger strategy to minimize the impact of data restriction on Meta's business. It's to diversify the company's income stream so that Meta isn't so reliant on generating increasingly larger sums of advertising revenue.

And this is what we're seeing with Meta's development of the metaverse. While this technology is still very much in its infancy, Meta already spent 10 billion in 2021 on AR, VR, and metaverse development and will continue to spend more and more in the coming years. This is very strategic because the biggest lesson that Meta is learning right now is that the most important moat in the technology space isn't the number of users on your app—it's having the users access the app via your proprietary device.

As Apple and now Google are demonstrating, they hold the true power as they make the devices or the operating systems that the internet is accessed through. With the next generation of internet drifting in the direction of some form of augmented or virtual reality experience, Meta has recognized that they need to be at the forefront of hardware development in this space.

And they already are through three different strategies. Number one: they already sell popular VR hardware under the Oculus brand, and in fact, in 2021, Oculus sold more VR headsets than Microsoft did Xboxes. Two: Meta are also currently partnering with companies like Ray-Ban to fit augmented reality hardware into standard sunglasses.

And three: Meta is also working on Project Cambria, which is a high-end VR headset with a focus on research and development to try and push the boundaries of what a VR experience can be. So while the metaverse might seem like a bit of a pipe dream today, if that's seriously where the future of the internet is going, then it is very important for Meta to be right at the forefront of development both in software and in hardware.

And if they get this right, they'll have the ultimate formula: they'll have billions in hardware sales and a Meta-controlled platform for their ad business to flourish unimpeded. However, if they are wrong, they'll continue to be at the mercy of those that control the hardware and operating systems, and with the ongoing trend towards less and less data tracking, that's not a place Facebook wants to be.

So let me know your opinion down in the comments section below. You know who wins the battle 10 years from now: Facebook, Google, Apple, maybe another company that doesn't even exist yet. As always, guys, leave a like if you enjoyed the video, subscribe to see more, and I'll see you guys in the next one.

This video is brought to you by Sharesight. Seek to track your performance manually, track capital gains, dividends, and currency fluctuations easily; and when it comes to tax time, have everything you need ready to go with just a click of a button. Try Sharesight for free or use the referral link in the description to get four months free when you sign up to an annual plan.

Oh, what the hell? What? What? Where am I? Where's my...?

"You were just playing a game. It's called Roy. Snap out of it! Come on!"