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Are Facebook and Google Running Out of Room to Grow?

By Adam Levy - Dec 26, 2017 at 3:40PM

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U.S. digital ad spending is nearing saturation.

Facebook (META 1.70%) and Alphabet's (GOOG 2.36%) (GOOGL 2.39%) Google are the two biggest forces in digital advertising, particularly in the United States. Combined, they take 83% of the growth in digital ad spending, according Brian Wieser of Pivotal Research Group. His estimate is actually lower than others', which put Facebook and Google's combined share of digital ad growth closer to 100%.

But Wieser calls into question whether the growth in digital advertising is sustainable. After growing 23% year over year in the first half of 2017, digital has easily surpassed TV ad spending in the U.S. Growing at a more modest 15% rate would have digital consuming the entire ad market by 2025, according to Wieser's estimates.

There's no doubt Facebook and Google's growth has been fueled by the secular shift in ad budgets to digital. If digital advertising is nearing saturation, investors may be disappointed by the future growth of the companies.

Mark Zuckerberg holding a microphone

Facebook CEO Mark Zuckerberg. Image source: Facebook.

Ad budgets don't care about return on investment

Google and Facebook ads provide the benefit of more precise targeting, which in turn produces higher return on investment for ad buyers. That's why social media and search ads are extremely attractive to direct response marketers (advertisers that are seeking a specific action from people that see the ad, like an app download or a retail purchase).

Targeting has enabled both Google and Facebook to attract a huge number of advertisers to their respective platforms, as they can help maximize relatively small ad budgets. Even larger advertisers can get more from Google and Facebook, since they have such a broad reach. Facebook COO Sheryl Sandberg is fond of saying, "We have a Super Bowl on mobile every day."

Ultimately, however, total ad spending is limited by consumer spending. At some point, consumers run out of money to spend on the things advertised to them. For free things, like apps, they run out of time in the day (another type of capital) to use them. It's pointless to advertise to consumers that don't have any more money to spend. Therefore, Wieser concludes, growth in ad spending will be closely tied to growth in consumer spending.

Cannibalizing television advertising

There's still plenty of opportunity for both Google and Facebook to capture more of the second-largest ad platform: television. Google's YouTube boasts over 1.5 billion logged-in users global (millions more without an account) that spend an average of over 1 hour per day on its mobile app alone. Facebook, meanwhile, recently launched its own YouTube-like platform, Watch.

The opportunity is for Google and Facebook to win over television ad dollars. While digital has seen fantastic growth over the past decade, television has been able to largely sustain the amount of ad dollars it brings in. That could change in the future as more people cut the cord and opt to stream more entertainment. Even if Google and Facebook aren't providing that streaming entertainment, they stand to benefit from fewer hours spent watching television.

Going global

While Google and Facebook may soon face saturation in digital ad spending in the United States, both have significant presences outside of their home country where advertising and consumer spending could grow much faster.

Both platforms are practically ubiquitous anywhere outside of China, which means as the digital economies of the world grow, so will the top lines at Facebook and Google. More and more people are gaining internet access every year on top of the fact that the global economy continues to expand.

Facebook, for example, generated nearly 10 times the revenue per user in the U.S. and Canada last quarter compared to users in Asia-Pacific. Likewise, Alphabet generated three times the revenue of its operation in Asia-Pacific in the United States alone. Over time, that gap ought to narrow as the U.S. digital ad market saturates but markets in Asia continue to grow relatively quickly.

As long as Google and Facebook continue to dominate all over the world, investors don't have much to worry about with regard to their future growth. Both companies have billions of users outside of the United States with a significant runway for monetization growth.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. The Motley Fool has a disclosure policy.

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