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The decline in YouTube advertising revenues, along with weak growth in Search revenues, has investors questioning Alphabet’s (NASDAQ:GOOG) (NASDAQ:GOOGL) safe-haven status. A deteriorating economic outlook and intensifying competition were the main culprits behind YouTube’s advertising woes. Amid these headwinds, YouTube is taking initiatives to maintain its efficacy as an advertising platform.
Tough comps, worsening macro backdrop and intensifying competition
It is understandable why investors would fret over YouTube’s first revenue decline since it started disclosing the numbers in 2019. However, this revenue decline comes on the back of explosive, pandemic-driven revenue growth (when offline advertisers were forced towards digital advertising), hence it is natural to witness advertisers pull back on digital advertising spend in the post-pandemic era.
More importantly however, growing fears of a recession on the horizon have also led to declining advertising spend on YouTube; “there was a further pullback in spend by some advertisers across both brand and direct response”. This is especially concerning given that a rising advertising rival, Amazon (AMZN), saw advertising revenue grow 25% yoy in the same period.
Amazon’s appeal to advertisers as a website able to attract purchase-minded visitors is proving to be a formidable competitive threat to YouTube (and Alphabet in general), and this plight has become more apparent amid the divergence in advertising trends between the two platforms over the last quarter.
While there is indeed potential for further ad revenue declines in YouTube as economic conditions deteriorate and competition intensifies, all hope is not lost for YouTube. E-commerce advertising is used primarily by product retailers, whereas YouTube advertising is used for more than selling products, including promoting services (e.g. educational courses, financial advice, etc.) and awareness campaigns that may continue to do well despite dire economic conditions. YouTube’s more diversified source of advertisers should support the resiliency of its advertising business relative to other advertising platforms.
Furthermore, YouTube has been taking its own initiatives to attract more purchase-minded web visitors, primarily through the launch of YouTube Shopping in 2021, enabling content creators to promote and sell products live-stream. In fact, YouTube doubled down on this initiative earlier this year through a partnership with Shopify (SHOP), a rising e-commerce platform, to more effectively compete against Amazon. According to a company study conducted with Publicis and TalkShoppe, “89% of viewers agree that YouTube creators give recommendations they can trust”. Hence, YouTube certainly has great potential to become an effective challenger to Amazon in attracting purchase-minded web visitors going forward. How successful these initiatives will be at taking advertising revenue from Amazon will be determined overtime, however, the company’s initiatives at challenging TikTok through ‘YouTube Shorts’ is showing signs of success.
YouTube Shorts
Another factor that played a role in YouTube’s advertising decline is the shift in video content consumption trends towards short-form videos. Last year, as part of an endeavour to take on TikTok, YouTube rolled out YouTube Shorts worldwide, as well as a $100 million fund to reward popular Shorts creators (in lieu of advertising revenue sharing). This initiative has been successful at optimizing user engagement, as the company proclaimed “1.5 billion users every month, 30 billion daily views”.
Philipp Schindler (SVP and Chief Business Officer) shared that:
We continued to experience a slight headwind to revenues as Shorts viewership grew as a percentage of total YouTube watch time. And as I alluded to earlier, the initial progress on Shorts monetization has been encouraging. And we’re focused on closing the monetization gap between Shorts and long-form content on YouTube over time.
Hence, weak YouTube advertising revenue performance relating to shifting content consumption trends is not concerning as long as users are still engaging with YouTube content. Importantly, the introduction of Shorts has subdued the risk of content consumption shifting away from YouTube and towards TikTok altogether. They have been successful at promoting user engagement with YouTube Shorts, and now it is a matter of adjusting their advertising model towards more effective short-form video monetization. Alphabet disclosed that they will “introduce revenue sharing on Shorts early next year”, reflecting the fact that YouTube has managed to successfully build a sufficiently strong advertising revenue stream around Shorts after just one year of worldwide rollout, and should offer a more sustainable way to attract more short-form content creators, creating more viewership, and ultimately better advertising potential.
This development is testament to Alphabet’s prowess in countering competitive threats. If it wasn’t for its ability to allocate a $100 million remuneration fund to Shorts creators, the company wouldn’t have been able to build a formidable competing service to TikTok so quickly. Alphabet’s solid balance sheet and robust cash flow allow the company to counter new competitive threats effectively, thereby enhancing the stock’s appeal as exposure to the advertising market over the long-term.
Nonetheless, while YouTube Shorts has been effective at countering TikTok, the rising competition will undermine YouTube’s ad revenue growth going forward, as advertisers now have another alternative channel for running video campaigns, putting downward pressure on auction bids for YouTube’s various advertising solutions. That being said, rising US-China tensions and lingering trust issues could lead to a potential ban on TikTok, which would be a positive for YouTube. Furthermore, rising data privacy concerns could also lead to potential TikTok bans in other major global markets, such as the European Union.
TikTok is already banned in India, a major market for YouTube, undermining TikTok’s ability to continue challenging YouTube in key global markets. In fact, India was the first market where YouTube initially launched its YouTube Shorts beta offering in September 2020, before it launched worldwide, reflecting the importance of the Indian market.
Summary
Over the near-term, YouTube’s advertising challenges will remain a headwind amid a worsening economic outlook inducing advertising budget contractions, and rising competitors penetrating the advertising market. As a result, the stock could continue to be pressured until investors regain confidence in YouTube’s advertising competitiveness. However, YouTube’s recent success in encouraging user engagement with Shorts to competently challenge TikTok instills confidence that YouTube will be able to continue innovating effectively to counter new competitive threats like Amazon advertising, and maintain YouTube’s strong position in the advertising market. Nevertheless, given near-term challenges, Alphabet holds a ‘hold’ rating.
