Business is booming at Facebook (META -10.56%). The company's revenue grew by 58% in 2014 to $12.5 billion. Advertising climbed to 92% of total revenue, up from 84% in 2012. Indeed, average ad prices have been the driving factor for Facebook's revenue growth over the past year, and nowhere is it more pronounced than in its home continent.
The United States and Canada was Facebook's fastest-growing advertising market last quarter, growing 25% sequentially despite active user growth of less than 1%. Europe performed comparatively well, despite headwinds from the strengthening dollar: ad revenue grew 23% on user growth of less than 2%. In Asia and the rest of the world -- which are typically considered the fastest-growing markets -- ad revenue increased just 14% despite over 5% user growth in Asia.
Despite the excellent results last quarter, Facebook investors need to ask whether the company can extend its success in North America and Europe to the developing markets in Asia, South America, and Africa.
Source: Facebook's Fourth Quarter 2014 Earnings Slides.
What's driving success in the United States?
The main driver of ad revenue growth in the U.S., Canada, and Europe, according to Facebook COO Sheryl Sandberg, is measurement. That is, the ability for businesses to measure their ad performances.
Over the last 18 months, Facebook has taken several steps to help its customers better track the effectiveness of their ad spending with the social media giant. Most notably, the company last fall relaunched Atlas, which helps advertisers track users across multiple devices and track conversions of sales, both online and in-store.
It has also established small test cases for brands that tracks an ad campaign's efficacy with Facebook ads and without them. Sandberg said Facebook ads show a very strong return on investment in those cases, but did not provide exact figures. She did say, however, that the next step for Facebook is to prove to advertisers that the results are repeatable in larger campaigns, in more brands, and in more countries.
It would appear, then, that Facebook just needs a bit of time and a few willing participants to run test cases in India, Brazil, or other emerging markets where its user base is climbing. Once it does that, showing the value of its advertising in test markets compared to other channels, Facebook should be able to increase ad prices in those areas just as quickly as it has in Europe and North America.
Another positive driver for U.S. and European markets
Facebook CFO David Wehner also chimed in on Facebook's fourth-quarter earnings call to note one other important reason the U.S. and Europe grew so well last quarter. He said the U.S. is Facebook's most advanced market, so the base of advertisers is significantly larger per user in North America compared to the emerging markets.
This is important because Facebook's ad prices are based on a bidding system, so more advertisers bidding on fewer ads will drive prices higher. The impact of the bidding system is seen quite clearly in Facebook's decision to reduce the number of ads in the right-hand column, as well as the shift of users to mobile -- both of which decreased ad impressions. Facebook increased its average ad price 335% last quarter due to those changes.
The path to solving this problem, however, is the same as the path described above, in which Facebook runs more advertising tests in emerging markets. Positive return on investment results should drive stronger demand for Facebook advertising in emerging markets.
Further growth in 2015
Facebook expects future user growth to be concentrated in the Asia-Pacific and the "Rest of the World" regions. Considering that average revenue per user is lower in those regions, a lot of weight is resting on Facebook continuing to increase its ad pricing in North America and Europe.
Last quarter, the two regions combined provided 74% of Facebook's ad revenue. While that number should decline as user growth in the rest of the world outpaces the U.S. and Europe, these markets remain key to sustaining growth. Analysts project Facebook to grow revenue by 37.2% in 2015. To achieve that number, the United States and Europe will likely need to remain Facebook's fastest-growing ad markets.
