Facebook and its parent company Meta Platforms haven’t lost their mojo. They have simply grown to the point where the advertising cycle dominates the company’s revenue. This is the cause of their recent revenue decline and the likely fate of other tech businesses. Companies that looked great when they were young and growing fast now look like old rust belt companies that move up and down with the business cycle.
Advertising has always been a cyclical industry, at least for as long as data has been collected. Looking back to 1919, inflation-adjusted total advertising grew 5.7% per year outside recessions, but fell 5.6% in recession years.
Although marketing people often say it’s in a recession when a company needs to increase its advertising, the math just doesn’t work that way. But the cold, hard facts of advertising show that actual dollars spent drop in economic downturns.
The larger a company’s market share grows, the more it will be affected by general industry trends and the less important the company’s own sales trajectory. This appears to be the case with Amazon’s online store sales, which fell in the second quarter of 2022. This will also be true for Tesla when (and if) it reaches the market share of General Motors or Toyota- they will drive the automotive industry to cycle instead of continuing to grow market share.
Think of a large, highly cyclical industry, such as steel or automobiles or paper. Now imagine a small company with better management or technology. It starts with just a fraction of one percent of total industry sales, but grows by 50% a year. This company will appear to be non-cyclical. Its sales growth will reflect how well it deals with its growing pains and how it makes strides to win more customers. At first, the industry cycle dictates where a given year’s growth is 55% or only 45%. Even the smallest number is pretty amazing in a mature industry.
Eventually the law of diminishing returns will set in and growth will drop from 50% per year to 30% or 20%. But this early growth has made it a large part of the total industry. Now the industry cycle can limit growth by 25% in good years or 15% in poor years. It’s still not very cyclical, at least compared to legacy companies. As market share growth inevitably declines, however, industry cycles will dominate changes in company sales. And that’s where Meta finds himself.
Being cyclical isn’t terrible, although being down is certainly less fun than being stable. And rapid growth is fine, assuming profits came along with sales growth. The challenge for business leadership is understanding the new problems that need to be addressed.
In the early days of a tech company, achieving growth is key. Whether the economy grows by two or three percent is irrelevant, because a great new product can achieve more sales regardless of the economy.
However, in the cyclical phase, company leadership must think about what business cycles mean. How much will income fall in a recession? Will spending have to be cut? Maybe yes. And how should it be cut? Layoffs, less marketing, slowing capital spending or eliminating goat yoga classes for employees?
Cycles not only decrease, but also increase, and often unexpectedly. Business leaders must consider – when conditions are at their worst – how they will meet increased demand when it arrives. This may require adding employees, equipment, locations, and financing all of this expansion before the bills are paid.
Growth is good, and growth to the point where the business becomes cyclical is what happens when growth continues long enough. New skills are needed. This is true for Meta and all other great companies with great ideas.