Although Facebook's (NASDAQ:FB) 2013 revenue growth can thus far be attributed to an increase in News Feed ads, growth in mobile ad revenues, and growing user engagement, growth in 2014 could prove to be more challenging. Facebook recently set expectations that News Feed ads will play a smaller role in contributing to overall revenue growth in 2014. Essentially, Facebook has capped the frequency of ads displayed within in a user's News Feed to around 5% of total stories -- right where it stands today.
In order to justify its roughly $120 billion market valuation, Facebook is expected to grow its 2014 revenues by 36% over 2013 results to $10.4 billion. With a major revenue growth driver effectively out of the picture, how will Facebook achieve stellar revenue growth in 2014?
The law of addiction
At the most basic level, the more time users spend on Facebook, the more revenue-generating opportunities for Facebook. The good news is that overall engagement continues to rise, and the better news is that Facebook commands a greater share of mobile usage than it does on the desktop, a great position to be in today's increasingly mobile world.
According to Facebook, one out of every eight minutes spent on the desktop in the U.S. is spent using Facebook and Instagram, but on mobile it improves to one in five. What's more, Facebook and Instagram together command a greater share of U.S. mobile time spent than nine of its largest competitors combined, including YouTube, LinkedIn, Twitter, and Snapchat.
But to get the full engagement story, investors should also track the ratio of Facebook's daily active users, or DAUs, to the number of monthly active users, or MAUs, to see if Facebook's platform is converting occasional users into daily users. Over time, investors want to see the number of DAUs relative to MAUs increasing, because it indicates that Facebook's careful approach to building its ads business isn't getting in the way of growing user engagement.
Facebook may not be planning on increasing the quantity of News Feed ads, but it's certainly planning to increase the quality and scope of ads found within the News Feed. Over the long term, ad quality improvements have the potential to drive meaningful revenue growth because it makes the experience more valuable for users and marketers alike. For the foreseeable future, Facebook will continue investing in increasing ad quality because every stakeholder involved benefits from a more engaging advertising experience.
Additionally, once the user experience is improved, video ads are expected to make their way to the News Feed, which could mean upwards of $2.5 billion a year in new revenue. Facebook is currently testing a new ad format to see how users react to other user uploaded videos that automatically begin playing within their mobile News Feed. The catch is that they play without sound until the video is clicked on. Taking into account both of these growth drivers, I'm confident that Facebook has the ability to grow its News Feed ad revenue in the short and long term without having to increase ad frequency.
Now that Instagram has officially entered the advertising age with magazine-style ads, it can start benefiting Facebook's business. By applying the same run rate of Facebook's mobile ad business, investors could deduce that Instagram's 150 million MAUs will ultimately bring in about $606 million a year, or about 6% of Facebook's 2014 expected revenue. While this may sound insignificant to Facebook's overall results, Instagram's true worth could be how it provides Facebook with better insights among younger users, which recently started giving investors grief. If Instagram can improve Facebook's adaptability by even just a little bit, it could potentially be worth much more than $606 million a year.
Staying true to its roots
Without increasing the frequency of News Feed ads, there are still plenty of opportunities for Facebook to continue growing its revenue in 2014 and beyond. But investors shouldn't take this to mean that Facebook has reached the point of existence where it only caters to shareholders and making money.
Let's not lose sight of the fact that Facebook doesn't build services to make money; Facebook makes money so that it can build better services that allow the world to be more open and connected -- the company's primary purpose of existence. Should Facebook's ad business ever detract too greatly from its purpose, I fully expect management will take the necessary actions to put users back above everything else. Not only does this management approach emphasize longer-term goals and the user experience, a longer-term focus is often a key differentiator between mediocre and excellent businesses -- a difference that can mean everything for investors.