How Facebook Lost Generation Y

| About: Facebook (FB)
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Summary

Facebook has lost the teenage demographic as many young users spend time on Snapchat or Instagram.

Snapchat has a more functional user interface when interacting with content that's presented in a blog reel.

This puts Facebook in a questionable position as the core design of the news feed doesn't appeal to a key sub segment of users.

The vast majority of the internet population are still on Facebook, so it's not like the loss of a core demographic hurts Facebook's financial prospects by much.

Facebook remains a strong investment, but developments in this space need to be watched closely.

Somehow Facebook (NASDAQ:FB) lost the interest of teens, and I guess after some deep inspection of facts and figures I can come away with an explanation of what's going on here. The biggest reason for the loss of teen mind share is competition, but from there we have to identify what the younger demographic wants in a social application among competing alternatives.

Setting The Stage

Typically, I use comScore (NASDAQ:SCOR) to compare the market share of mobile applications. However, the problem with comScore is that its survey respondents are over the age of 18. Snapchat's user base is skewed to a demographic that's younger than 18 years of age. So, comScore doesn't rank Snapchat that high as the number of users over 18 is small when compared to applications such as Instagram, Twitter (NYSE:TWTR) and YouTube.

According to a recent report in The Wall Street Journal, Snapchat is estimated to have more than 100 million monthly active users. The company has reasonable upside prospects after rolling out advertising and the inclusion of new features, such as daily snap stories and video.

In the beginning of 2014, Facebook saw an outpouring of users in the 13 to 24 age demographic. This didn't negatively impact earnings or sales growth by much, as the number of monthly active users and daily active users increased throughout 2014. So this really doesn't counter the investment thesis of owning Facebook because the core app is still growing.

However, according to CFO David Ebersman on Facebook's Q3 2013 earnings conference call:

Our best synopsis on youth engagement in the U.S. reveals that usage of Facebook among U.S. teens overall was stable from Q2 to Q3. So we did see a decrease in daily users specifically among younger teens. We won't typically call out such granular data, especially when it's of questionable statistical significance given the lack of precision of our age estimates for younger users. But we wanted to share this with you now since we get a lot of questions about teens.

Facebook has a downside hedge through Instagram and WhatsApp. Instagram has proven popular with the teenage demographic and WhatsApp gives people an affordable way to do international chat on tablets and smartphones. Things look good for Facebook's core product, but the loss of the teenage demographic is something that cannot be addressed as easily.

Strategically, Facebook's monetization of the core Facebook app continues to improve as it rolls out better analytics via Atlas (its ad purchasing platform). This platform has better solutions for targeting and tracking conversions than Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) AdSense/DoubleClick. Facebook also has adjacent businesses like Instagram and WhatsApp with significant monetization potential. In the case of WhatsApp, long-term growth prospects seem to be supported by user growth and an annual subscription that can be priced at a higher rate.

How Snapchat Gained The Younger Audience

Snapchat has replicated the news feed and is a messenger at the same time. It rewards interaction with friends by limiting the length of shared videos to 10 seconds and word count to 10 words at most. The application forces you to engage in rapid conversations because not a whole lot can be said. Second, the application deletes messages, so anything said to a person cannot be shared with other people. This creates confidentiality between friends, because almost everyone can't stop gossiping at that age.

Finally, the snap stories are neatly organized. So instead of each status populating a blog reel, it's added to a specific person's mini-blog, which is their story for the day. Your friend's snap story is a combination of multiple updates. Each update is deleted after 24 hours.

In comparison, Facebook has 1,500 status messages that need to be ranked and prioritized in an average user's news feed. The problem is that the 1,500 status messages get trimmed down and the amount of content that's actually shown is significantly reduced.

The way Snapchat counters this is by presenting everyone's story. This reduces the number of slots in a reel by person rather than by post. Even if you had 300 friends who actively added 12 snap stories a day, you could watch all of that in under an hour. Plus you'd have a list of 300 stories, which is much easier to work with. With Facebook you're wading through 1,500 status messages. It's hard to get through it all, so keeping up with friends is actually a little more difficult on Facebook when compared to Snapchat.

On Facebook everyone is a miniature celebrity trying to compete for attention. So when a status messages only attracts five or six likes, whereas your friend gets 60 likes, you feel like a chump. You begin to wonder, why is that person so much more popular than me? Most people don't have a massive network of friends and when you're put alongside people who have that massive network, it tends to invade your feed and make you feel pretty pathetic in comparison.

So what does Snapchat do differently? It doesn't give you the option of liking or commenting. You only get to private message. So in a sense, Snapchat doesn't make you compare your level of celebrity to your friends. Voila! A bit of psychology comes into play here and I think that's what Facebook might be missing. Adults might be more mature about this, but teenagers? They're insecure and anything to curb that sense of insecurity will move youngsters to Snapchat by the truckload.

Also, Snapchat has 100 million active users. Those active users are young, so if you're young, the social network you want to be on is Snapchat because you'll find all your friends blogging on Snapchat rather than Facebook. Plus, you'll probably get a quicker response back when you send a message on Snapchat.

So now Snapchat is unfolding a sort of network effect creating a bit of a moat around its business. It has a pretty massive valuation priced into it because anything that can get a hundred million young eyeballs is worth a pretty decent sum to marketers. It's like a well-performing TV channel that gets great network ratings every single day (if we had to think in terms of a 20th century thought process).

Consider this from the eMarketer Millennials Roundup (registration required to access report):

eMarketer: Are millennials more or less loyal to brands?

Accenture: There's a perception that they're not loyal, that they're always looking for a deal and that they bounce around from retailer to retailer without loyalty, but our study actually found that wasn't necessarily true. We found they are loyal and price sensitive like everyone else. What millennials do want more than other groups is personalization. They definitely index higher there and want to be individuals.

Millennials vote Snapchat over Facebook and find that the experience is perhaps better. Marketers are frothing at the prospect of selling younger kids into houses and cars, as household formation is ten years down the road for generation Y. Snapchat holds captive a pretty valuable demographic. It's like watching the iOS versus Android debate, but substituting in Facebook with numbers and Snapchat with receptive digital ad-viewers.

Conclusion

Going forward, Facebook's business is well positioned strategically, as I believe many of the adjacent business opportunities will offset the loss of the younger demographic. Double-digit revenue growth and better profit margins help support the fundamentals of owning the business. So for those reasons, investors can own Facebook without feeling threatened by Snapchat.

Snapchat is extremely sticky, as it has a functional layout that appeals to a more tech-savvy audience. The product takes into consideration things a younger demographic finds important. And, for those reasons, Facebook's hold over the younger demographics will degrade over time.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.