Internet Marketing’s Growth Story Is Still Strong
Last week we commented on some of the social and political pressure that has recently been building against the giants of U.S. internet tech: primarily Amazon [NASDAQ: AMZN], Facebook [NASDAQ: FB], and Alphabet [NASDAQ: GOOG]. Regulators are accusing them of using opaque financial engineering to avoid taxes; politicians and pundits are accusing them of being poor corporate citizens by destroying jobs; and the public is wondering about their role in creating an increasingly polarized electorate.
Add in concerns about election advertising paid for by foreign interests, and you have a potentially toxic brew for sentiment about their stocks. As we noted last week, that building sentiment could be part of the reason why their year-to-date appreciation stalled in late July.
Besides all the factors we’ve mentioned, though, another one is in the minds particularly of investors: advertising. FB and GOOG, their grand ambitions for technological and social transformation notwithstanding, are advertising companies. In their last annual reports, advertising comprised 90.7% of GOOG’s revenues and 97.3% of FB’s revenues. Particularly with GOOG, the dominance of advertising in their revenue mix can be easy to forget because of the frequent media attention to the company’s “other bets” such as self-driving cars. (One might describe GOOG as “an advertising company with attention deficit disorder.”)
Why has the nature of these firms as advertising companies suddenly become a headwind for investor sentiment? Mainly because of two comments from prominent C-suite executives over the summer. On Procter & Gamble’s [NYSE: PG] July earnings conference call, chief financial officer Jon Moeller commented on the firm’s digital advertising strategy. (Note that PG is the biggest advertising spender in the world.) In the quarter ending in June, the firm cut $100 million in digital marketing — and said that the cuts seemed to have had no impact on its business. Moeller said: “We didn’t see a reduction in the growth rate. What that tells me is that the spending we cut was largely ineffective.”
Then in September came some more flamboyant comments from a more flamboyant executive, Gary Friedman — the CEO of Restoration Hardware [NYSE: RH]. At a retail conference hosted by Goldman Sachs [NYSE: GS] in September, Friedman told the following anecdote directly addressed to his company’s GOOG ad spending:
“We had our marketing meeting… and the online marketing team was pitching to double their budget… I said, well, how many words do you buy? …[They said] 3,200 words… And I said, well, what are the top 10 words? And they didn’t have the information. I said, why don’t we cancel the meeting and come back next week when you have the data? …and they came back the next week… And they said, well, we’ve found out that 98% of our business was coming from 22 words. So, wait, we’re buying 3,200 words and 98% of the business is coming from 22 words. What are the 22 words? And they said, well, it’s the word ‘Restoration Hardware’ and the 21 ways to spell it wrong, okay? Immediately the next day, we cancelled all the words, including our own name. I mean, I can’t believe how many companies buy their own name and they’re paying Google millions of dollars a year for their own name…”
Not exactly a stellar endorsement of the effectiveness of online advertising.
Are These Anecdotes Accurate… or Relevant?
Various media and market commentators had a field day with these remarks, of course. The basic questions for investors are: “Are these anecdotes accurate?” and “Do they signal a major negative shift for the ad-based tech giants?”
Very likely, the answer to both questions is “no.”
The “fine print” of PG’s comments suggested much more of an adjustment to digital ad spend, rather than a radical change. For example, although the company decided that ultra-niche targeting in FB advertising was ineffective, it indicated that it would not be reducing its overall FB advertising spending. And its adjustment of search spending was mainly dedicated to reducing improper ad placement and the registering of “clicks” from bots rather than from human consumers. Online advertisers have been working on and talking about dealing with these problems for some time.
Likewise, although the RH CEO’s comments were colorful, we simply that the company is very small, with its sales representing about 0.05% of total U.S. retail spending. Therefore his comments on the perceived efficacy of a single product on a single platform may be entertaining, but they are probably not representative of the trend.
We recently reviewed a research piece which surveyed more than 1,300 marketing professionals, almost half of whom manage marketing budgets in excess of a million dollars. Some 70 of them manage marketing budgets in excess of $100 million.
Here’s a summary of the findings:
• 69% of marketers allocate more than 20% of their budgets to online channels — a record high proportion in the survey’s history.
• 78% of respondents expect online ad spending to increase in the next year; only 3% expect it to decrease.
• Most marketers will draw the funds for their additional online spend from print advertising; secondly from TV advertising; and thirdly from newly allocated marketing funds.
• Record low numbers of marketers spend less than 10% of their online budget on search; record high numbers spend more than 40% of their online budget on search.
• Social and mobile show the same trend, and the growth standout is video, where a record 91% of marketers are allocating at least a portion of their online budget. Video advertising is clearly the cutting edge of online marketing.
• Marketers see the best return on their investment firmly with GOOG and FB (with their associated YouTube and Instagram products). This is a long-standing trend, with GOOG and FB continuing to pull ahead of the pack. Snapchat [NASDAQ: SNAP] and Twitter [NASDAQ: TWTR] lagged.
• Amazon [NASDQ: AMZN] made a strong showing for its initial inclusion in the survey. It is likely to be an increasingly important destination for online marketing dollars.
The bottom line is that according to a substantial survey of marketing professionals who control large marketing budgets, spending on online marketing is planned to increase; the share of GOOG and FB in that spend is increasing; and the perception of positive “return on investment” from online marketing programs is high and strengthening, not weakening. In a continuation of the long-established trend, the funding for this increased online ad spend is coming from legacy channels — especially print and TV.
In short, we think that the current buzz about the ineffectiveness of online advertising is more smoke than fire. The story remains the same; the migration to online marketing will continue to be relentless, although all participants will be honing, tweaking, developing, and replacing specific products and strategies. (The rise of video’s significance is an example.) GOOG and FB remain in powerfully dominant positions to benefit from this ongoing trend. FB in particular now boasts two of the premier platforms, the Facebook homepage and Instagram, and is only beginning to develop the revenue potential of WhatsApp.
The place to reach the consumer, more than ever, is online; and those best positioned to put brands and products in front of the consumer online, especially in a social, mobile, and online video context, will continue to experience robust growth.
Investment implications: We believe the media narrative about the inefficacy of online advertising, and the growing skepticism of big online marketing spenders, is overdone. In reality, the marketing trend remains firmly towards increased online spending, with some new funding, but a lot of funds continuing to come out of print and TV marketing budgets. Several trends of public opinion, analyst opinion, and political pressure have been converging against the big, ad-dependent U.S. tech firms since the summer. While those sentiments predominate, their stocks will continue to be under pressure; but we believe they will lift over the coming months. We are still fundamentally bullish on the biggest ad tech companies, FB and GOOG, and would regard any significant correction as an opportunity to add to existing positions. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s principals and clients own AMZN, FB, and GOOG. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.