Facebook and its parent company Meta Platforms (META) have not lost their mojo. They have simply grown to the point where the advertising cycle dominates company revenues. That’s the cause of their recent revenue decline and the likely fate of other tech businesses. The companies that appeared brilliant when young and growing rapidly now look like old rust-belt companies moving up and down with the business cycle.
Advertising has always been a cyclical industry, at least as long as data has been collected. Looking as far back as 1919, total advertising adjusted for inflation grew 5.7% per year outside of recessions but fell 5.6% in recession years.
Although marketing people often say that it’s in recessions when a company should ramp up its advertising, the math just doesn’t work out that way. But the cold, hard facts of advertising show that actual dollars spent decline in economic downturns.
The larger a company’s market share grows, the more it will be influenced by overall industry trends and the less that the company’s own trajectory matters to sales. That seems to be the case with Amazon’s (AMZN) online store sales, which dropped in the second quarter of 2022. That will also be true of Tesla (TSLA) when (and if) it achieves the market share of General Motors (GM) or Toyota (TM) – they will ride the auto industry cycle rather than continue growing market share.
Think of a large and very cyclical industry, such as steel or automobiles or paper. Now imagine a small company with better management or technology. It begins with just a small fraction of one percent of total industry sales, but it grows by 50% a year. This company will appear to be non-cyclical. Its sales growth will reflect how well it deals with its own growing pains and how it makes breakthroughs to win more customers. At first, the industry cycle dictates where a particular year’s growth is 55% or just 45%. Even the smaller number is pretty amazing in a mature industry.
Eventually, the law of diminishing returns will set in, and growth will drop from 50% a year to 30% or 20%. But that early growth has made it a large part of the total industry. Now, the industry cycle may peg growth at 25% in good years or 15% in poor years. It’s still not very cyclical, at least compared to the legacy companies. As market share growth inevitably declines, though, industry cycles come to dominate changes in company sales. And that’s where Meta finds himself.
Being cyclical is not awful, although in downturns it’s certainly less fun than being stable. And having grown rapidly is good, assuming profits came along with the sales growth. The challenge for business leadership is understanding the new problems to be dealt with.
In the early days of the tech company, achieving growth is the key. Whether the economy grows by two percent or three percent is irrelevant, because a great new product can achieve more sales regardless of the economy.
In the cyclical stage, though, company leadership must think through what business cycles mean. By how much will revenues drop in a recession? Will spending have to be cut? Probably yes. And how should it be cut? Staff layoffs, less marketing, slow down capital spending or eliminate goat yoga classes for employees?
Cycles don’t only go down, they also go up, and often unexpectedly. Business leaders must consider – when conditions are at their worst – how they will meet increased demand when it comes. That could require adding employees, equipment, locations, and financing all of this expansion before invoices are paid.
Growing is good, and growing to the point that the business becomes cyclical is what happens when growth continues long enough. New skills are needed. That’s true of Meta and all the other great companies with great ideas.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.