The Next Billion Mobile Users May Be Invisible To Advertisers

Summary

• The use of ad blocking browsers in mobile devices almost doubled in 2015.
• New ad blocking technologies can also intercept in-app advertising.
• Ad blocking is disrupting the traditional Web advertising model, and investors should be cautious about companies dependent on advertising.

A new report on mobile ad blocking by PageFair suggests that the next billion of mobile users in emerging markets will be mostly invisible to advertisers. PageFair has found that use of ad blocking technology has skyrocketed in emerging markets. This calls into question the long-term growth strategies of companies such as Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (FB) that are actively seeking the "next billion(s)" of mobile device users in emerging markets.

Source: PageFair

Where the Action Is

Following the development of extensions for Apple's (AAPL) iOS browser, Safari, that enable ad blocking, I wrote some articles about the technology with a focus on iOS and the possible impact to Google. What's interesting about the PageFair report is that iOS devices don't seem to be where the real growth is in ad blocking. The report indicates that about 20% of the estimated 1.9 billion mobile device users employ some form of ad blocking tech, but the vast majority are concentrated in emerging markets, where iOS has fairly low usage share.

PageFair also points out that about 36% of users in the Asia-Pacific region now employ an ad-blocking browser. In contrast, there have only been about 4.5 million downloads of ad blocking apps for iOS through March 2016.

In my article, I had pointed out that with the growth of ad-blockers, as well as ways to defeat ad blockers, the Internet was being turned into a two tier medium. In the upper tier, subscription based ad-free services would appeal to more developed and affluent regions. Users of subscription services wouldn't need ad blockers.

The lower tier would be advertising based and "free to all". The growth of ad-blocking usage in the developing world seems to confirm this stratification of Internet usage.

In the past year, there have also been technology developments that not only threaten Web page advertising, but also in-app advertising. If the assumption was that in-app advertising would be safe from ad-blocking, this assumption is proving wrong. There are now apps available for both Android and iOS that can block the ads served by other apps. These apps work by intercepting the Web connections that are used to serve ads within the apps. Since so many companies, such as Facebook and Google have turned to in-app advertising as a source of revenue growth, this new technology development could pose a threat.

In addition to apps that can block ads in other apps, the iOS world saw the development of Friendly Social, a third party app that can connect to Facebook and Instagram. Friendly Social filters out all the ads that would normally be served in the FB and Instagram feeds.

The PageFair report identifies the high cost of mobile data in emerging markets as the principal driver for ad blocker usage. Advertising, whether in Web pages or apps, consists of a lot of data, which is charged at the same rate as content by the mobile carrier. Ad blocking is a simple and effective expedient for cutting data usage.

Invisible Billions

The relatively low uptake of ad blocking tech in developed markets, and in iOS in particular, came as somewhat of a surprise. It's not that people are relying exclusively on subscription content in these markets. It's a combination of lower cost for data plans and the greater disposable income of users. With extra money to spend, there's probably less objection to seeing ads suggesting how to spend it.

This probably explains why there has been so little apparent impact of ad blockers to the revenues of companies such as Alphabet and Facebook. Google revenue for 2016 Q1 was up 17% y/y. Facebook revenue was up 52% y/y. Both companies attributed much of their growth to mobile advertising.

In the near term, ad blocking in developing markets doesn't seem to be costing the companies a lot of money, but this could change as the emerging markets become more mature and their middle classes expand.

It's likely that most of the "next billion(s)" of mobile device users will adopt ad blockers. These are effective enough to render users invisible to mobile advertisers and the companies such as Google and Facebook that sell advertising.

Even though wealth can be expected to increase in these markets, users are unlikely to stop using ad blocking technology once they start. In addition to this impact, it's also likely that ad blockers will be increasingly adopted by users in developed countries, just for convenience.

Web developers and browser developers are abandoning Adobe's (ADBE) Flash based advertising, but this doesn't seem to have helped at all. HTML5 appears to offer more than enough opportunity for Web pages to get in your face with pop-ups that block the content, as well as plenty of video advertising that can't be turned off. As Web advertising becomes less effective, it only seems to become more obnoxious.

Back in October, during Google's Q3 conference call, CEO Sundar Pichai had this to say about ad blocking:

On the ad blocker stuff, it's not a new phenomenon. I think it's important to understand that ads today fund almost all the services which people use, including products like Google Search, Google Maps many, many third-party products. For publishers, it represents the majority of the revenue and I think users are okay with the contract and we need to make sure it works well. It's also clear that that are areas where the ad experience is getting in the way, it affects performance, and so we as industry need to collectively do all that better. And so we are going to work hard to do that.

I wonder if Pichai still feels the same way, especially since the contract he refers to seems to be breaking down.

Investor Takeaway

I've long regarded ad blockers as a disruptive technology, and it's clear that it is beginning to disrupt the traditional Web and app advertising models. Ad blockers don't make advertising ineffective, but they do make them less effective.

Ultimately, the best tool that ad supported content providers (Web or app based) have in defeating ad blockers is to simply refuse to serve content to users who employ them. In the traditional advertising model, this is somewhat self defeating, since it means turning away potential customers.

Eventually, I see content delivery over the Web becoming mostly subscription based. The subscription model is the best option for monetization without relying on ads. This move will tend to bifurcate the "premium Web" from the ad supported Web. This evolutionary trend will be a years-long, perhaps decades-long process.

Up until the PageFair report, I've viewed Alphabet and Facebook as strong buys. But the growth of ad blockers has made me a little more cautious about companies so dependent on advertising. Facebook is still a buy, but Alphabet has dropped back to being a hold.

Apple I still consider a buy, partly by virtue of its lack of dependence on advertising, for those investors with a 3-5 year investment horizon.

Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.