Google Is Facing A Strong Threat To Its Core Digital Ad Market From Facebook

Google is no stranger to competition as it has faced tremendous competitive threats from much bigger competitors in the past. Microsoft and Yahoo poured billions of dollars into their Internet search, but failed to make a dent into Google’s dominance in this market. Google has used the massive cash flows generated by Internet search to invest money into a wide variety of technology fields. Most of them have failed to become significant cash cows, however some of them have huge monetization capabilities (Google Maps, YouTube etc.). Some of its other initiatives are still in their infancy (Self driving cars, Home energy management, wearables). These spaces are quite huge in terms of potential revenues and if Google succeeds in even one of them, it could lead to a significant upside in the future.

But in the meantime, Google will have to safeguard its dominance of the Internet search and the massive stream of ad dollars that it gets. Facebook is the biggest challenge that the company is facing right now, though there are numerous competitors. Facebook has captured a large slice of the Internet advertisement spending in the last couple of years and that is set to increase over the coming years. Unlike other competitors, Facebook’s origin lies in the Internet domain rather than software or hardware for other major technology companies. Facebook has been effectively monetizing the traffic it gets to its site and is luring major content publishers. Its game changing move of convincing major contract providers like New York Times, BBC etc. to directly publish on its site is a big blow to Google. It will not only get the content, but also provide ad exchange services to these news providers. I think that Google will need to up its game to counter Facebook’s threat to its advertisement dominance.

Google has failed in social media

Google has failed in the social media domain, despite being one of the first large movers into the space with Orkut. The company failed to realize the importance of social media and let Orkut die due to negligence. Google once again tried to re-enter the space with Google +. But Google plus has also failed, as people hardly use the service and nobody spends much time on it. Google tried to use its search dominance to push Google plus but that too did not work out. Facebook on the other hand, has become the uncontested king of the social media sphere. Its Whatsapp acquisition was a masterstroke, though the initial price that FB paid made me cringe. Whatsapp has become the preferred mode of communication for vast sections of people around the globe. It is threatening the traditional modes of communication such as telecom and bulletin boards, as people find Whatsapp much more convenient and cheaper. Facebook’s acquisition of Instagram has further solidified its position. The company now has billions of users actively engaging with its social media sites, giving it an unparalleled database of users and their behavior. Google used to be the master of Internet data as most traffic used to go through its search services. However, Facebook has changed the paradigm and nearly 25% of the global internet traffic is now controlled by Facebook. Google has almost no visibility on that 25%. Facebook on the other hand has a very granular understanding of the traffic, while Google still cannot identify the true users of its search that accurately.

Facebook is becoming a powerful mobile force

Facebook has managed to increase the time that people spend on its sites to such a level that almost 25% of all Internet traffic is now being monopolized by Facebook. The company is getting 37% of the mobile share display ads and its mobile ad revenues have doubled to ~$2.5 billion a quarter, as compared to last year. Facebook has managed to increase the price of the ad it displays, because of deep knowledge of the consumer it is serving. Advertisers are paying for the targeting value that Facebook brings to the table. Facebook is also copying Google by opening a mobile ad network. The company’s marketshare of desktop has declined, but it is not a concern as the general move towards spending more time on smartphones and tablets is irreversible. PCs have become less relevant in consuming digital content. Facebook is becoming the gateway to Internet to a lot of people displacing Google. Consumers are using Facebook as the principal delivery mechanism for news, communication (Whatsapp, Facebook Messenger) and product reviews. This is an alarming thing for Google which used to be the principal Internet entry point for consumers. While a lot of people still use Google to get product reviews, information and news, Facebook is definitely threatening Google. Facebook is also threatening Google’s dominance in the Internet video category, with a lot the people watching videos through Facebook.

Thanks, Douglas. So with mobile phones really becoming such a primary way people search the net. Our goal is really to help people search, find the content that’s not just relevant and timely but also really easy to read and interact with on these smaller devices and smaller screens. And it’s important to note that this is just one of over 200 signals we use to evaluate the best results.

Source – Google transcript

What Google can do to stave off this threat

Google does not have the social media skills as repeated failures have shown. Google is using Internet search to provide more information and services to consumers. It is starting to give real time flight information and phone numbers of merchants. It is even planning to allow users to directly buy from its internet search results. But I think that these incremental changes will not help. The company needs to acquire social media skills. Buying other major social media players such as Twitter or LinkedIn is one option. These companies have the skills that Google lacks and will help in creating a social media presence, which can leverage its other services such as email, search and video.

Google’s Stock Price Performance and Valuation

Google’s stock price has stagnated over the last one year and it has underperformed the broader market. The company’s revenue and earnings growth has not been that good and its new initiatives such as Google Glass, Driverless cars etc. have not positively impacted the bottom-line. With tepid growth expectations the valuation has also come down substantially and is becoming more in line with large technology companies such as Microsoft, Apple and others. The company’s forward P/E is 16.5x while its 5 year growth expectations is at 14.5%, which gives it a PEG ratio of ~1.1x.

Summary

Google is no stranger to competition, given that in its short operating history it has succeeded in driving off major technology companies like Microsoft through the sheer superiority of its products. However, Google has remained a one trick pony with Internet search continuing to drive most of its products and revenues. Internet search is becoming less relevant with the increasing popularity of smartphones and apps. A lot of consumers are skipping Google to directly interact with other company’s apps. Facebook has become a dominant Internet force, with American consumers spending almost 42 minutes daily on Facebook using their smartphones. As a result, Facebook is capturing an increasing share of digital ad dollars. It is being able to serve much deeper insights into consumer behavior, as compared to other publishers. Google is facing a threat to its core business segment. I think Google needs to react quickly to stave off this threat. The stock valuation is not expensive, but the growth is tapering down.