Facebook Inc (ticker: FB) doesn’t have a user growth problem … yet.
Unlike its much smaller and more financially challenged rival Twitter (TWTR), Facebook has been able to consistently grow its user base by healthy margins each year. In the most recent quarter, Facebook’s monthly active users (MAUs) increased by 15 percent to 1.71 billion. Twitter MAUs, by contrast, increased by just 3 percent to 313 million last quarter.
So why’s Facebook the one with the problem?
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The issue is that, simply due to its massive size, user growth can’t continue to hum along at a 15 percent growth rate forever. There simply aren’t enough internet users in the world; as time goes on, Facebook’s user growth will more closely approximate the growth of internet users, which is currently about 7.5 percent and falling, according to internetlivestats.com.
It’s a concept known as the law of large numbers, and it’s something that Berkshire Hathaway (BRK.A, BRK.B) shareholders are intricately familiar with. Warren Buffett has been warning shareholders for years that as Berkshire gets larger, it’s harder for him to earn a market-beating average. The days of 50 percent annual returns are long gone.
The fact that FB is growing at twice the rate of the internet is miraculous. But while 15 percent growth is impressive, we can already see how its girth has gotten in the way of its growth: Four years ago, when FB stock went public, Facebook was growing users at roughly twice its current pace — 29 percent annually.
In another four years, don’t be surprised if Facebook’s user growth is cut in half again.
All things being equal, this trend is an obvious negative for Facebook stock, which is priced like a growth stock at about 60 times earnings. The only way for FB to combat this trend is to focus on another area where it actually can grow: average revenue per user (ARPU).
ARPU is where the growth is. Greg Portell, partner at A.T. Kearney, sees Facebook doubling down on ARPU growth in a few ways.
“First, they are acquiring companies that also compete or will compete for consumer attention. By doing so, they not only take a piece off the competitive chess board, but they also enhance the functionality of their platform,” he says.
Instagram is a great example. In 2012, Facebook bought Instagram for $1 billion. At the time, the photo-sharing service had about 30 million users. Today, Instagram has about 500 million users, and if it weren’t owned by Facebook, it would legitimately be viewed as one of Facebook’s largest competitors.
The second way Facebook’s focusing on ARPU growth is by experimenting with new ad units.
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“In the beginning, Facebook ad sales were a bit like a gangly teenager who hadn’t built up trust among the adults in the advertising world,” Portell says. “Now, the sales teams have professionalized their offering and can credibly go to any advertiser with a ‘we will build it for you’ promise.”
That level of customization makes Facebook ads more effective — and therefore more expensive.
Beth Monaghan, CEO of InkHouse, a public relations company focused on creating brand awareness, says Facebook has created entirely new ad types in order to drum up more revenue from ad buyers.
“In February of this year, Facebook released Canvas ads, a full-screen advertising experience to tell a brand’s story,” Monaghan says. She expects that future innovations in ad formatting may venture into the realm of virtual reality, a space where Facebook’s Oculus is sure to be one of the first movers.
Those should bring higher rates still, as brands and advertisers pay up for increasingly immersive ads.
Even without new formats like virtual reality, Facebook has been aggressively growing ARPU, especially in the U.S. and Canada. In the fourth quarter of 2015, ARPU in that region was $13.54, up from $9 a year before and more than eight times higher than the ARPU in the Asia-Pacific region, which came in at $1.59 in the fourth quarter.
ARPU on a worldwide basis in the fourth quarter was $3.73, up 33 percent from $2.81 in the year-before quarter. Back in the fourth quarter of 2010 — before FB was even public — Facebook’s ARPU was just $1.26. In five years, the company has learned how to squeeze three times more revenue from each user, all while the user base itself has been consistently growing.
It’s no wonder FB stock has soared in recent years — and no wonder some investors think it can continue to go even higher.
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If Facebook can triple ARPU again in the next five years — while at the same time steadily (but more slowly) increasing users — then Facebook shareholders will still have quite a lot to “like” in the years ahead.
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Facebook Inc’s User Growth Set to Slow Down Soon (FB) originally appeared on usnews.com
