Can digital advertising recover from Apple signal loss? - Transcript

Mark Odendahl: The compute intensity of the Metaverse is going to be extraordinary because again, the key hallmarks of it are that it's not only decentralized. I think people understand that along the lines of blockchain, but it's also what's called semantic. Meta announced their $ 1, 500 headset coming out at some point. Clearly in the early days of smartphones, we needed carriers to subsidize the adoption back when smartphones only cost $200.

Welcome back to the Industries in Motion podcast, brought to you by RBC Capital Markets. My name is Mark Odendahl, and I'm head of US Capital Markets Research here at RBC. Thank you for joining us today. This podcast, just a reminder is where we explore what's new and what's next in today's fast- moving markets and industries to help you stay ahead of the curve.

Today, we're really excited to welcome back Brad Erickson. Brad is BC's Internet Services analyst. He joined in 2021 and he currently covers roughly 25 stocks in the internet sector. Brad has really put a lot of focus on his digital advertising channel check process. That's important for a couple of reasons. It's important because the industry is grappling with the Apple signal loss, and it's also important because the digital advertising industry has seen macro- economic headwinds. So we're bringing Brad on the podcast today to talk about some of his recent checks in the digital media space.

Brad, welcome back to the podcast. We're really excited to dive into some of these topics.

Brad Erickson: Yeah, thanks for having me. And yeah, thanks for that. It's been a good first year and a half and looking forward to more.

Mark Odendahl: So we're going to unpack all of this. First off, Brad, could you give the listeners a little bit on your check methodology of how you keep an eye on digital advertising trends?

Brad Erickson: Yeah, sure. I've been a consumer analyst across a bunch of different verticals, even back to things like just basic consumer electronic products, and from a sell- side research analyst perspective, a lot of people's speculations and stock ratings frequently come from their perception of the product and how they believe that it will be digested by the public or whoever the buyers are. And my philosophy's always been a little bit different in that I don't actually think I'm smart enough to predict those types of things. And so we always just figured it was easier to go out and ask the channel who was in charge of distributing and selling those products, whatever those might be, to get a better sense. And so we've just applied that to every new vertical we try and cover.

And as you said, in this case, with digital ads, there's a lot of very small call them, business consulting, marketing- type agencies in the country that have popped up to try and help small businesses pursue and grow their businesses, particularly in the digital economy. And so obviously, this industry has boomed, especially since the pandemic.

And I think where we sort have differentiated ourselves from maybe some others of our competitors is historically, it's fairly straightforward to reach large agencies. So these are the Omnicoms or the WPPs of the world, and they can speak to billions of dollars of spend in a representative way, meaning are you spending more on Google, are you spending less on Facebook, et cetera. And those are helpful data points to build a mosaic of what's happening. But what we've actually done is we've gone out and we're talking to these smaller agencies who represent a dozen, 30, 50, 100 smaller advertisers. And so while the dollars aren't as important, the statistical relevance of the number of advertisers we've found has been much more instructive to results. And we've been running this process now for just about a year. And I think you look at our track record, I think we're putting up some pretty good numbers in terms of getting some accurate signal of what's coming back and what's happening in terms of spending trends.

Mark Odendahl: That's great. Brad, thanks a lot. Could you help us understand what the Apple signal loss is, and then how has it impacted the industry?

Brad Erickson: Yeah, sure. So maybe go back a little bit of history. So two years ago, Apple announced that it was going to pursue some privacy changes on behalf of the user with the update of what was iOS 14. 0, which released in about June 2021. And everyone kind of knew at the time that it was going to affect certain aspects of how advertisers tracked users, but it wasn't totally clear how impactful that was going to be to the companies. And so as that rolled out, and basically what it was on your iPhone, if you have an iPhone, is that when you downloaded an app, typically, it didn't ask you whether you wanted to be tracked or not, and the default was set to allowing advertisers to track you. What changed with iOS 14 is they changed the default to not being able to track you. And so if you wanted to be tracked, you had to select that, and, of course, 90% of people didn't select that.

So basically, if you were an advertiser, you suddenly lost the ability to track. And maybe just a quick sec on what that means. Basically, let's say you're scrolling through your Instagram newsfeed and obviously, Meta knows what adds they're showing you. Well, you go out onto other parts of your phone in apps where they can track you, they can then attribute a sale or a conversion or providing an email address, some level of engagement, they can attribute that to the campaign that that was run on their app. And it gave them an extraordinary ability to not only build the social graph of what you liked, what your behaviors looked like, what you were into product- wise, service- wise, et cetera, but then it also gave them incredible reporting capabilities so they could go back to the advertiser and say, look at all this value we drove. And of course, that drove a ton of spending.

And all the social media companies utilized, it was called IDFA, so it stands for Identification for Advertisers. All of the social media companies leveraged this, so YouTube, Snap, Pinterest, Meta TikTok, et cetera. So everyone lost the signal. But the key thing was that because Facebook blew the core brand, no, they just have more social graph. They know more about you because you tend to input more data there. And there's the way that people utilize the newsfeed on Facebook actually just provides 10, 20, 30 more data points about you than a Snap would know or a TikTok would know.

This change was especially impactful to Meta's business, and it took 10% of the revenue out of their business. It ripped, we think about 15 billion out of the model. And some of those dollars got redistributed, a lot of them to Google, we think. And then some of them may have just disappeared because they couldn't find productive turn on ads.

That's kind of what happened, if it's helpful.

Mark Odendahl: That's very helpful. Thanks, Brad. So now talk to us about what this has meant to meta and help us understand what is Meta's response to the Apple signal loss.

Brad Erickson: Yeah, sure. And this is something that the industry is doing, not just Meta. It's interesting. There's a whole new sub- pocket of the ad industry called mobile measurement providers, MMPs, that are popping up. As we do our channel work, we're stumbling on them more and more because in this post Apple signal loss world, everybody needs help to try and build a better mosaic. The question we get frequently is, what do they have to do to restore the signal? Well, the answer is easy. And we've heard this from dozens of agencies. It's never coming back. We're done. It's over. We got to give up on that part of it.

 But there are a ton of efforts and a lot of dollars being spent both by Facebook as well as third parties to try and build alternatives. And the key term in all of this is deterministic data. So IDFA provided deterministic data. It allowed Facebook and ultimately the advertisers to say no, that I, Brad Erickson had done whatever on my iPhone, and that was reflective of what I saw on my Instagram account. That is gone forever. The world we've moved to is called probabilistic, basically cohort- based targeting where they no longer know it's Brad Erickson, but they know that I exhibit a lot of characteristics like a group of people that they can target. And so if they can match that up theoretically, they can get targeting that maybe approaches the deterministic level that we used to before the signal loss.

Mark Odendahl: Okay, that's a very good update, Brad. Thank you. Recently you've been writing about Meta's response and their new Advantage Plus algorithm, which is somewhat of a solution for Apple signal loss. Could you help us understand Advantage Plus and is it working?

Brad Erickson: Yeah. SO, we picked up on this about two months ago. They had Buried Advantage Plus, which is basically an algorithm update to be able to target and hopefully measure better... They've been bearing this in blogs for the last six or eight months. But essentially, what this is one of the key alternative, I should say, to the new world of targeting, which is really around connecting advertiser platforms like Facebook back to the advertiser's data. Some refer to it as server- side attribution, but essentially what it is two things really. It's getting advertisers to provide Facebook dynamic data so that Facebook can analyze the effectiveness of campaigns in real time and allow its AI to continually optimize the campaign to be able to target better.

And then secondarily, agencies and advertisers frequently would apply manual changes, if you will, to how they wanted to target because of what their beliefs were on who would make sense as likely audiences for their product that is no longer. Part of the reason Facebook's spending so much money on AI is that they are starting to leverage AI to take over for that human component because they're finding that it does actually improve targeting and they're working on the measurement of that.

We've heard evidence of Advantage Plus just in the last month that it's really, really starting to work. And I think what we were looking for was evidence that maybe advertisers were using it, seeing improved conversion and then potentially spending more. We'll see what happens there, but I think we're pretty optimistic that that is going to happen at some point.

Mark Odendahl: Okay, that's great, Brad. So what happens if the economy weakens and we just see general digital advertising start to weaken?

Brad Erickson: Yeah, so certainly, advertising is a more discreet part of any business's P& L and would certainly be one of the first things to get clipped. And I think we heard this back as far as January, and really it picked up steam in April where a large portion of the advertisers we were speaking with were cutting budgets. In retrospect, I mean there were kind of two real drivers that stuck out. One was, it sounds a little crass, but a lot of small and medium- sized businesses who are not necessarily making data- driven decisions, but they wake up, they read their Google News and they get scared about the future and they say, " Hey, I want to cut costs, not because my business is seeing any issue, but just because I feel like the economy's about to get a lot worse." I think we found evidence that a lot of small businesses made those moves back in the Q2 timeframe, so spring and early summer.

And in fact, what happened later in the summer particularly is gas prices came down, we actually saw that improve a little bit. And so that combined with higher input costs, particularly supply chain, you think about product companies that are shipping stuff in from China, those costs obviously spiked through that early spring period, and then those costs have actually come back. So, I think there's been some easing on the budgets. I think for larger organizations, interestingly, they were maybe a little bit slower to move, and so actually their spending was a little bit better through that part of it. Facebook actually comments on this at some level of granularity. Large enterprises was the sort of source of any weakness during the quarter, and it actually called out that small and medium- sized businesses were actually stronger into the holiday on this last report.

So I think if we continue to deteriorate into next year, for sure, there's risk here. And could we be facing say, a down's five or 10% type of scenario next year? It's certainly on the table. I think from my seat covering solely the digital guys, which tend to outgrow the market, down five to 10 would seem like a pretty draconian outcome. And at this point, I think the industry's probably more in the camp of a zero to 5% growth- type expectation for next year. And things are looking stable, I would say at this point. So we'll see what plays out.

Mark Odendahl: Okay, Brad, so what wins out the benefits of Advantage Plus starting to work or the slowing macro that could impact overall advertising trends?

Brad Erickson: Google picked up a lot of that 15 billion hole that I mentioned earlier that Meta lost. We don't know exactly how much, whether it was eight or 10 or 12, but probably something in that neighborhood. And if Advantage Plus is successful, and if any other workarounds are successful, clearly, there's an opportunity for some of that share to potentially revert, and that would be well into 2023 that you would see that impact the model.

And at this point, I think it's too soon to say whether that's, in fact, happening, but I think there's absolutely potential there. And so for Meta where they've got all these other, we'll call them headaches going on right now around Mark Zuckerberg's desire to spend lots of money into the metaverse, but setting that aside, it certainly sets up as Meta maybe potentially having a better opportunity to gain share as we think about any presumptive downturn we may head into in 2023.

Mark Odendahl: That's great, Brad. And that's just a wonderful snapshot of what's going on in the digital advertising sector right now. Now let's turn to another topic in the internet space, and that is the metaverse. Could you help us understand what the Metaverse is and some of your opinions around it?

Brad Erickson: What is the metaverse? This has become the most interesting question at conferences where the Apples of the world to say it's a word they'll never use, it's interesting. To us, the metaverse is effectively like the next generation of the worldwide web and a browser, if you will. So today, if you're a business, and even if you're not an e- commerce business, let's just say you're a brick- and- mortar business of some kind, you're going to have a website. It's table stakes, maybe it's not that critical to your business, but you're definitely going to have it. And then obviously, if you're in any sort of an e- commerce vending online- type business, you absolutely have a website and it's critical to the operations and revenue generation of your business.

And so to us in the future, I feel like the construct could look largely the same, where every company, every organization that wants to have any sort of a web presence would have a metaverse presence. But similar to the current environment, it's very difficult in many cases for those companies to get customers or users to come directly to their site. And so what do you ultimately need? You need access and the ability to advertise on search and be available on horizontal search, you need to be on social. There's probably an enterprise component.

And so I think that's where, whether it's Meta or Microsoft or some of the gaming companies like Roblox, there's a huge unknown as to what that construct will look like. And I guess in Meta's case, just as an example, because why not, they renamed the company, they're taking a bit more of an over- the- top approach than what they have done in the current web environment, which is they're trying to actually create their own ecosystem alongside hardware. So, they're trying to build a true walled garden, but with tighter software integration, which, of course, has worked out fabulously for Apple over the last 15 years. So, it'll be interesting. And I think this is what was interesting on, as we've learned, how much money Meta's going to spend on all of this stuff, the compute intensity of the Metaverse is going to be extraordinary because again, the key hallmarks of it are that it's not only decentralized.

I think people understand that along the lines of blockchain, but it's also what's called semantic, which means that if you and I go to a website today, that website is sort of set, the experience is set you and I can't control, it doesn't change anything like that. The idea of semantic innovation is it's you and I go onto the metaverse, we do what we do, and the AI actually allows us to affect change within that particular metaverse, say a company's metaverse or a horizon world of Meta. And that's beyond my depth, but that sounds complicated and very compute- intensive.

So I think that's one of the things that needs to be solved. The hardware piece, right, is very challenging. Meta announced their $ 1, 500 headset coming out at some point. Clearly, in the early days of smartphones, we needed carriers to subsidize the adoption back when smartphones only cost $ 200. Clearly, we don't have the same stakeholder buy- in and alignment of incentives to produce that type of arrangement. And so whether it's meta or potentially, Apple or whoever, we're going to have to come up with a method to make the hardware affordable enough to drive real adoption. And then lastly, I think the big question too is, and you'll read this a lot of places, is that people will argue of what's the market opportunity here? And trillions is a number where people like to go. I've even seen somebody argue that it could be bigger than the GDP of the world.

That seems a little aspirational. But nonetheless, I think my question is it a zero- sum game? Are you just shifting people's time from the web to the metaverse and thus, can it really sort of be accretive or incremental versus just replacing? I always think of this. My North Star for this as like, look, there's 24 hours in the day. There's a limit to how much time we can extract from people's lives to participate on these platforms and be valuable to advertisers and brands and companies. And I think there's a lot of question as to whether we've already sort of reached a peak moment in that, and so you'd effectively just be mix- shifting over to the metaverse.

So a lot of questions. Certainly very, very fun to talk about. Very interesting area where a lot of people want, a lot of investors want exposure to this. They're just in the very early innings of trying to figure out how to do that.

Mark Odendahl: Brad, thanks a lot for today. I think you've shown to our listeners the depth of your research, the depth of your knowledge of the digital advertising space. So thank you very much for sharing some of your thoughts today. It's also obvious that you have a very strong intellectual curiosity as it relates to the internet sector, and thank you for your coverage here at RBC.

Brad Erickson: Yeah, this is great. Thanks for having me.

Mark Odendahl: Okay, well, we learned a lot about the digital advertising space today from RBCs expert. It's great to hear about the challenges that these internet platforms is faced with the Apple signal loss, and now Meta, the former Facebook has a new algorithm in the market, Advantage Plus where they're able to potentially start to grow their advertising business again.

What else lies ahead in today's ever- evolving markets and industries? We'll be keeping track right here on Industries in Motion. Until then, thank you for joining us. This episode was recorded November 4th, 2022.

Be sure to subscribe to Industries in Motion wherever you listen to your podcast. If you'd like to continue this conversation and are interested in more information, please contact your RBC representative or visit our website at www. rbcm. com/ industries in motion for further insights.

Narrator: This content is based on information available at the time it was recorded and is for informational purposes only. It's not an author to buy or sell or solicitation, and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives. For disclosures, please visit www. rbccn. com/ disclosure.