While some users are still unaware of the miracle that is ad blocking, ad-reliant companies like Google (NASDAQ:GOOG) (NASDAQ:GOOGL) are already feeling the pinch of the Internet's power-users filtering out their placements. This had been primarily a desktop problem, but with Apple (NASDAQ:AAPL) announcing it will allow ad block extensions with iOS 9, coming out this fall, it appears mobile ad-revenue will likely be affected too. As ad blocking extensions continue to grow in popularity and become more mainstream, they pose a larger threat to the core businesses of Google and Facebook.

A full transcript follows the video.

 

Sean O'Reilly: Sound the alarms. This is a tech edition of Industry Focus.

[INTRO]

Greetings, Fools! I am Sean O'Reilly joining you from Fool headquarters here in Alexandria, Virginia. I am joined by the incomparable Dylan Lewis to my left. How are you?

Dylan Lewis: I'm actually pretty well rested, considering it's Friday afternoon.

O'Reilly: Yeah. We had a bit of a break. We're recording this a little bit later than usual because we had a bit of a false fire alarm.

Lewis: Yeah. Well, I thought it was a fire drill. It ended up being a fire alarm.

O'Reilly: Yeah. There were about nine fire trucks outside our building checking things out.

Lewis: Yeah. We were hanging out for an hour, hour and a half out there.

O'Reilly: We had ice cream, went to Starbucks.

Lewis: I took a nap in Starbucks.

O'Reilly: You took a nap at Starbucks?

Lewis: So I am chipper, ready to go, ready to do the show.

O'Reilly: This is exactly what those leather chairs are for.

Lewis: Yeah.

O'Reilly: In case you're wondering, nobody's harmed. The building's fine, we're back up and running. It's all good. We were talking about the big news out of Apple this week. They basically announced that the next version of their Internet browser Safari will have ad blocker built in.

Lewis: Yeah.

O'Reilly: Dylan, what is ad blocker, and why should I care?

Lewis: This is a fantastic lead into a show that I think I've wanted to do for about three months.

O'Reilly: He actually won't shut up about it, folks.

Lewis: Ad filtering, ad blocking, is just removing, or altering advertisement that would show up in a webpage. Basically there are these extensions that you can add to a browser and they block HTTP, HTTPS requests based on the sourced address. There's this reference database that they keep of addresses of known advertisers and they reference that list. If anything comes back from that address they just block it so you don't see it when you're browsing.

O'Reilly: I am all about ad blocker.

Lewis: Oh, yeah. I'm a huge ad blocker. It's weird to go back to watching the Internet, or experiencing the Internet on someone's computer that doesn't ad block.

O'Reilly: Right.

Lewis: You're just like "Whoa. This is what you're working with, huh?"

O'Reilly: Stop it! No! Too many ads!

Lewis: Two of the big names in ad blocking, just for context for our listeners, there's AdBlock...

O'Reilly: Which was an open source.

Lewis: Yeah. It's totally free, there's suggested donation to support the developer Michael Gundlach.

O'Reilly: Have you ever donated?

Lewis: I have not. No. I shamelessly downloaded it as a teenager. That was my copout. I was a teenager. I don't need to pay for anything.

O'Reilly: Right.

Lewis: Then there's Adblock Plus, also free, and while their names are extremely similar, they are independently operated; no connection. The big difference is -- as I understand it -- AdBlock is totally ad free, and Adblock Plus has 'white listed' ads, which is something we'll touch on later in the show.

O'Reilly: How many people are we talking about here that have downloaded these ad blocking programs, or ad-ons to their browsers?

Lewis: The best I can get for you in terms of data is from a 2014 study called Adblocking Goes Mainstream. This is coming from PageFair and Adobe as a joint survey. As of Q2>2014 they estimated there's an active, installed user base of roughly 144 million. I think it's probably closer to 200 million now. We can get into the way that growth is projecting out, but I think it's safe to say it's just under 200 million.

O'Reilly: I just assumed you'd throw out a billion something. I thought it would be more.

Lewis: It's one of those things that you forget that most people aren't aware of. It's wild.

O'Reilly: I'm picturing my grandma clicking on ads and stuff.

Lewis: Yeah. Here in the U.S. it's surprisingly not as big as I thought it would be.

O'Reilly: So all these people are in Europe or something?

Lewis: Yeah. Perhaps not surprisingly, some of the Scandinavian countries where a lot of the...

O'Reilly: "We don't believe in your ads."

Lewis: Where a lot of nefarious Internet activity started with music streaming and music downloading. I think Kazaa was Swedish, right?

O'Reilly: Yeah.

Lewis: Sweden's third on the list in terms of 21.6% of Internet users using ad blocking. First is Poland at about 29%. U.S. isn't even in the top 10.

O'Reilly: Wow.

Lewis: That's kind of interesting. So when we're talking about ads not being served up to users, this obviously impacts very ad reliant businesses like Google, and Facebook.

O'Reilly: Certain people have been freaking out about this.

Lewis: This is something that has been on the radar for a while. This isn't something that came out of nowhere. They've known about this. I will say, given what the average revenue per user is for most of these major tech players, the fact that U.S. is not in the top 10 is a nice thing. U.S. ads are by far the most sensitive and most valuable.

O'Reilly: It's super important to Google as far as the bottom line.

Lewis: Yeah. That's 99% of their revenue.

O'Reilly: Yeah.

Lewis: They're almost entirely ad dependent. Facebook has about 45%, 47% of its revenue coming from the U.S. So the fact that there's a low installed base of ad block users is generally a good thing for them, but I think you're going to start to see that shift a little bit. If you want to look at it demographically -- again, this is coming from that PageFair survey -- the age group of 18 to 29 year olds represent the highest proportion that are using various ad blocking softwares. That's about 41%. It drops off dramatically when you go to 30 to 44, to 26%. Then 45 to 60 is 21%.

O'Reilly: It's not a completely straight line, but -- yeah. I'm looking at this and as it goes up in age, the usage of ad blocking goes down.

Lewis: As soon as you get outside of that millennial group the drop off is pretty steep.

O'Reilly: Game over.

Lewis: Yeah.

O'Reilly: What if Google's in trouble when we're all 50?

Lewis: Yeah. One of my college professors -- Rick Swasey, at Northeastern University -- said "Demographic shifts are like glaciers; they're visible and slow moving, but they'll sink a lot of ships."

O'Reilly: Yeah. That's a good quote.

Lewis: Right?

O'Reilly: That's good.

Lewis: He's a smart dude. I can't help but look at this breakdown here and say "Well, these major Internet players aren't in trouble right now."

O'Reilly: Right.

Lewis: "But, five, ten years from now this is something that needs to be addressed. They need to work something out. Either a way that's more of a partnership with the ad blockers, or eliminate them somehow." If you're reliant on serving up ads to people and 40% of the people that are most actively browsing are blocking those ads then your business is in trouble.

O'Reilly: So Apple's announcement is really related to mobile Safari. Does it matter? As I understand it, a lot of mobile ads outside of Facebook aren't that big of a deal to Google and stuff.

Lewis: Yeah. The impact isn't quite as big just because the ROI on mobile is a little different. I think people were more surprised with that Safari announcement. Just some background here; Apple announced when iOS 9 launches in the fall you'll be able to go to The App Store and download an extension that can block most new sites and some of the other content providers out there.

Obviously, the desktop version of Safari currently allows something like that. Just to give you an idea; it's roughly a 10%, or 12% installed base for desktop Safari users. The reason this was such a big deal is because before that, there weren't a lot of mobile options for ad blocking. I think Firefox and Opera were really the only two.

O'Reilly: Yeah. I've got Chrome on my phone and now that I think about it, it isn't there. It isn't an option.

Lewis: Yeah. You think of some of the big browsers out there -- Chrome, Firefox, and Safari -- those are the ones that immediately pop into mind.

O'Reilly: The biggest one is obviously Safari. It's got 60% or more for mobile.

Lewis: For mobile.

O'Reilly: In the United states. Yeah.

Lewis: So I think that's why people are really starting to freak out because...

O'Reilly: "This was our last bastion! What are you doing?"

Lewis: Yeah. Something that PageFair notes with their report is that installed bases for ad block services are smaller on pre-installed browsers. You see that on desktop, where Safari generally is around 10% or 11%, whereas Firefox is up around 35%, Chrome is around 31%. I think a part of that is your more savvy Internet users are going to seek out these browsers and install them.

O'Reilly: Right.

Lewis: I think this is really telling that Internet Explorer from Microsoft only has a 2% installed base in terms of ad blocking softwares. That's crazy, but not surprising.

O'Reilly: When Microsoft announced they were getting rid of Internet Explorer I was like "They still had it?"

Lewis: Yeah. I can't think of anyone that I know that uses IE. Again, this is a demographic thing; a lot of older folks use Internet Explorer. I think one of the most interesting things with this in terms of Google's conundrum here is roughly 30% of Chrome users have this extension running, and Chrome is leading the charge in terms of growth among the ad block installed base.

O'Reilly: I've been thinking this whole time: is Google shooting themselves in the foot? What's the game plan here?

Lewis: It's interesting. I think looking into the numbers here, PageFair said roughly 5% of the global Internet population uses ad block. That's not a direct translation to Internet traffic, because those tend to be power users; people that consume a disproportionate amount of the Internet.

O'Reilly: Okay.

Lewis: Realistically that probably counts for about 10% of total traffic. Based on the distribution there are a whole bunch of ad blocks out there. One of the interesting things is that Google has a 'white list agreement' with Adblock Plus and a couple advertisers -- notably Microsoft and Amazon -- have that as well. Adblock Plus has these 'approved' ad providers.

O'Reilly: Okay.

Lewis: They're approved because they're supposedly 'non-intrusive'. They're not as disruptive for your online experience. Adblock Plus reportedly gets a 30% commission on ads served up through its White List Provider program.

O'Reilly: Oh, wow. "We're going to give you ads, but they won't be that bad."

Lewis: Exactly. It's a solution that both sides are kind of comfortable with.

O'Reilly: There's a precarious equilibrium going on.

Lewis: Yeah. It's an interesting dynamic.

O'Reilly: Okay. What's the impact on revenues here?

Lewis: If you want to look at what Google's putting out, that's about $68 billion in trailing 12 month revenue. PageFair estimates about 5% of the global Internet population uses ad block. They probably account for about 10% of traffic usage just because most of the people that are running ad block also tend to be power Internet users. Let's say half of that's lost because it's not part of people that are using Adblock Plus and have the white listed ads.

O'Reilly: Okay.

Lewis: But thanks to that White List Agreement with Adblock Plus, Google recoups about 70% of that other half. The numbers wind up working out to about a 7% revenue impact for Google.

O'Reilly: That's not small.

Lewis: No, that's not small. I think it's something that you're just going to see creep up, and up, and up.

O'Reilly: Slowly, but surely.

Lewis: So, it's something that you have to watch. Like I said, they have a relationship in place with these ad block providers, but is it a sustainable, long term solution? I'm not 100% sure.

O'Reilly: Got it. Thank you for your thoughts, Dylan.

Lewis: Always a pleasure, Sean.

O'Reilly: That is it for us, Fools. If you have any questions, or comments for us we would love to hear from you. Just email us at focus@fool.com. Again, that's focus@fool.com. I did want to make everybody aware of a very special offer for all of Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner. We're offering the lowest price out there for all of our Industry Focus listeners. It is $98 for two a two year subscription to Stock Advisor.

You will get two stock recommendations every month with insight from our team of analysts. Just go to focus.fool.com to take advantage of that deal. Once again that is focus.fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening, and Fool on!

Dylan Lewis owns shares of Apple. Sean O'Reilly owns shares of Facebook. The Motley Fool recommends Adobe Systems, Amazon.com, Apple, Facebook, Google (A shares), Google (C shares), and Starbucks. The Motley Fool owns shares of Amazon.com, Apple, Facebook, Google (A shares), Google (C shares), and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.