Pando

Momentum is shifting from ad revenue to subscription revenue, and that's not good for Facebook

By Kevin Kelleher , written on April 2, 2018

From The Money Desk

If there is one beneficiary emerging from the crisis of conscience engulfing Facebook right now, it's the subscription-based business model. 

For the first two decades after the Netscape browser began ushering consumers onto the Internet, information wanted to be free. Not just free as in unfettered and decentralized, but free as in at no cost. Publishers who charged subscriptions were sidelined as readers became accustomed to getting content at the alluring price of zero cents.

In the past few years, top media brands as well as smaller publishers with specialized content have, after painful rounds of trial and error, learned to offer subscription-based models that are starting to resonate with readers. The risk of that approach was that subscriptions quickly become a zero-sum proposition as consumers are only willing to spend so much of their budgets on content.

But in the past year, something more dramatic has started to happen: Consumers are realizing the cost of no cost is more than many are willing to pay. All along, the users of search engines, social networks and free mobile apps were the product. But a plague of data breaches and the role of user data in the 2016 election has started to make people wary, if not angry, about how their personal data is being abused. And now many people are unhappy being the product.

In the same way that Uber became the crisis point for a startup culture that tolerated rule breaking in the name of hypergrowth, Facebook has found its brand appended to a #delete trend protesting its cavalier business practices. The breaking point was the revelation that Cambridge Analytica used data from 50 million of Facebook users for political campaigns.

Like Uber, Facebook is asking forgiveness for having bent rules it knew it was bending. Like Uber, Facebook has made similar apologies in the past without ever addressing the core of the problem. And like Uber, Facebook has hit a crisis that, unlike previous ones, isn't dying down quietly. The longer the controversy continues, the more the screws tighten around the company.

What started out as self-reflection has turned into public displays of self-excoriation by Mark Zuckerberg, who is likely to face more heat if as expected he testifies before Congress. Here is Zuckerberg when Recode asked him how Facebook has been hurt by the Cambridge Analytica scandal.

I think it's been a pretty big deal. The No. 1 thing that people care about is privacy and the handling of their data. You know, if you think about it, the most fundamental thing that our services are, whether it’s Facebook or Whatsapp or Instagram, is this question of, “Can I put content into it?” Right? Whether it’s a photo or a video or a text message. And will that go to the people I want to send it to and only those people? And whenever there is a breach of that, that undermines the fundamental point of these services.

In this and other interviews, Zuckerberg talked about how bad he felt for letting his users down. Before Congress, the expressions of remorse are likely to grow even more dramatic. But in some ways, Facebook apologizing for being Facebook is like a scorpion apologizing for being a scorpion. It's just a matter of an organism's DNA expressing itself. And Facebook's DNA was written years ago. Here's Zuckerberg in another, more notorious interview back in 2010:

People have really gotten comfortable not only sharing more information and different kinds, but more openly and with more people. That social norm is just something that has evolved over time...When I got started in my dorm room at Harvard, the question a lot of people asked was, “why would I want to put any information on the internet at all? Why would I want to have a website? Then in the last 5 or 6 years, blogging has taken off in a huge way, and just all these different services that have people sharing all this information.”

So Facebook will tweak (and tweak) its privacy settings, clamp down on some of its partnerships, and hire thousands to play whack-a-mole with disinformation. All of this will help some. But it will never stop being digital-ad company, even as the worst aspects of digital advertising – increasing engagement at the risk of addiction, tolerating “the ugly” in the name of growth – tarnish its brand.

And besides, why would Facebook, or Google for that matter, want to quit playing a game that they are winning? The two have dominated digital-ad growth for years. And while YouTube, Google Play and G Suite may rely at least in part on subscriptions, the core business of selling ads alongside its free properties will remain the heart of both Google and Facebook – and a highly profitable one.

That offers another big advantage for companies with a subscription-based model: It lshelders them from direct competition from two of the consumer Internet's giants. But it also points to what may be the Achilles heel of both Facebook and Google: Their own subscribers, so to speak, are the advertisers they are dependent on for revenue.

If Facebook ever makes more than cosmetic change to its privacy practices, it won't so much be #deletefacebook that drives it, or even regulators (with the possible exception of those in Europe). It's unlikely to be shareholders, because even after Facebook's 16% drop in the past two months, all it will take to make Facebook investors forget about privacy controversies is a single quarter of stronger-than-expected earnings.

This is why April will be an interesting time for Facebook in particular, but also Google to some extent. It will give a peek into the impact that recent scandals have had on ad spending. Sonos, Commerzbank and a handful of other advertisers have pulled ads from Facebook in the past two weeks, while Musk removed Tesla's and SpaceX's pages from the site. That's a small fraction of companies, so we don't know yet how many have trimmed or stopped growing their digital ad budgets.

Small businesses, as Sarah Lacy pointed out this week, are unlikely to bolt, but bigger ad companies are showing a willingness to flex their muscles. If nothing else, the scandals offer big advertisers and ad firms more leverage against the company. WPP said its clients are talking about the scandal. Unilever last month said the digital ad supply chain was “little better than a swamp.” 

The pushback matters, because it's only been in the past few years that bid advertisers have finally embraced digital ads in favor of print and TV. In some ways, it's still unproven. Procter and Gamble has been publicly disparaging what it sees as disappointing returns from Facebook ads, with mobile ads appearing for an average of only 1.7 seconds.

Facebook ads are expensive because the demand is high relative to the ads allowed in its news feed. But if those high costs aren't warranted, advertisers will complain or pull back. The scandals surrounding Facebook, and also the problematic ad placements that has afflicted YouTube, may cause some large advertisers to pause before spending more on the platforms.

Even with apologies and expressions of regret, these pressures aren't likely to alleviate any time soon. Every new problem that emerges serves to perpetuate and even amplify the weakness at the core of the digital-ad tradeoff. Targeted ads work because precisely because they put a target on consumers.

Companies that rely on subscriptions, meanwhile, face no such quandaries. And some are doing remarkably well. Consider that, while Facebook has risen 12% and Alphabet 24% in the past year, Netflix and Amazon have performed much better. Amazon has gained 65% in the past year, while Netflix shares are up 99%.