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Facebook’s Stock Shock Foreshadows a Less Profitable Future for the Social Network

These days, everything seems to be going wrong for Facebook. The social networking giant is still reeling from the aftermath of the Cambridge Analytica privacy scandal. Its content moderation guidelines are under scrutiny over decisions to keep Infowars content, as well as Holocaust denial, on its platform. And on Wednesday, investors reacted with shock after Facebook delivered lower-than-expected earnings, growth metrics, and financial forecasts.

However, the resulting stock sell-off, which resulted in the evaporation of $120 billion of the company’s market capitalization, can’t just be explained with Facebook missing Wall Street’s revenue estimates. Instead, investors are waking up to a key realization that Facebook executives have been frank about for some time: The ways consumers interact with social media are changing, and as Facebook is adapting, its profit margins are bound to get smaller.

Facebook’s growth problem

One of the key take-aways from Wednesday’s earnings report is that Facebook’s growth is slowing. The company had been delivering solid double-digit growth every single quarter, but in Q2, its year-over-year growth slowed down to 11%. What’s more, quarter-over-quarter, growth in the U.S. and Canada was flat, and user numbers in Europe even declined.

This shouldn’t come as a surprise: Facebook is now being used by 2.23 billion users around the world every month. That’s already close a third of the world’s total population, and an estimated 62% of the world’s internet users. Facebook has been investing into helping to expand internet usage around the world to grow its potential audience, but ultimately, the company is set to hit a ceiling.

That kind of saturation can already be seen in the U.S., where the social network has been hovering at around 185 million daily active users for a year now. Facebook is addressing this with a bigger focus on some of its other apps that still have more of a growth potential, including Instagram, and the company is likely going to put a bigger emphasis on those numbers going forward. CEO Mark Zuckerberg already set off a trial balloon for this approach during Wednesday’s earnings call, revealing that 2.5 billion people used one of Facebook’s apps every month.

Stories and Watch have fewer ads

Facebook’s growth slow-down alarmed investors. But what really sent them over the edge Wednesday was Facebook CFO David Wehner’s forecast that the company’s revenue growth would decelerate over the coming quarters, and his warning that Facebook’s operating margin would sink from its current level of 44% to the mid-thirties over the coming quarters. Wehner attributed part of this with a bigger investment in security and content moderation, which executives have flagged for some time as something that could negatively impact profitability.

But Wehner also singled out Stories, which have been extremely popular on WhatsApp and Instagram. Facebook started to add Stories to many of its apps two years ago after the format proved popular on Snapchat. This successfully stopped Snapchat’s growth, to the point where now twice as many people use Stories on Instagram as Snapchat.

However, Stories have a lighter ad load, and as such, don’t make Facebook as much money as its traditional newsfeed. Facebook COO Sheryl Sandberg wasn’t able to promise investors Wednesday that they ever would, telling investors: “We honestly don’t know.”

Investors seemed unnerved by these revelations, but executives had been warning about the issue for some time. In fact, Zuckerberg had talked in frank terms about a need to evolve Facebook’s business almost exactly a year ago, when the company was reporting its Q2 2017 earnings. Back then, Zuckerberg warned investors that the company’s embrace of video could lead to some significant changes. “The economics are quite different from the current feed-based businesses that we have today,” he said.

“The margin structure will be different,” Zuckerberg explained. “This business will likely be — not likely I think, almost certainly will be — a lower margin source of revenue than the current thing that we do.” At the time, Wehner also warned that Facebook’s embrace of video would likely mean that people would spend less time in the company’s highly-profitable newsfeed. “There is, in that sense, a cannibalistic effect of sort happening there,” Wehner said.

Say good-bye to the cash machine

Zuckerberg and Wehner made those remarks just before Facebook launched Facebook Watch, a dedicated, YouTube-like video destination seeded with original content from partners like BuzzFeed, Tastemade, and Cheddar. But the same is true for similar media-centric initiatives, including Stories and Instagram’s newly-launched IGTV.

Ultimately, Facebook has to evolve to stay relevant to its user base and not lose out to competitors like Snapchat. Those changes can impact the company’s profitability in the short run, but it’s also likely that some of these new media formats will never be as profitable as Facebook’s newsfeed.

To be clear: Facebook is still poised to make billions every quarter for the foreseeable future. But as the company embraces a changing online media landscape, investors may have to cope with the fact that the days of the newsfeed cash machine may not last forever.

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