Memo: A is for Ads

Apple’s advertising business strategy is becoming clearer after a string of announcements, confirming what’s been suspected by many analysts over the past year. The company is tipping the scales in favor of its own ad products, looking to cut competitors Meta and Google off at the knees. At the same time, Apple’s advertising products are expanding beyond the app store.

Apple is planning on aggressively expanding its ad business, with the goal of increasing annual ad revenue from $4 billion today into the double-digit billions, according to Bloomberg. That means iOS users can expect to find more Apple ad products across Apple’s native platforms. As of now: News, Stocks and the App Store have potential ad positions. Those will become areas that are increasingly monetized.

It’s something Apple will have to navigate carefully, meeting its own revenue goals without alienating the user and diluting the performance of its native apps. The company has already supercharged its ad business in the last five years, which 2PM reported on in March, growing the ad business from $300 million to $4 billion. To triple that will mean unlocking ad experiences that were previously off limits, and this could become a nuisance even to Apple loyalists. As Bloomberg’s Mark Gurman puts it: “Some people may resent Apple putting ads in the News and Stocks apps. After all, the iPhone is supposed to be a premium device. Let’s say you shelled out $1,000 or more to buy one, do you want to feel like Apple is squeezing more money out of you just to use its standard features?”

Apple’s ad strategy may carry risks, but it’s full of intention. The foundation of this strategy is that Apple limited the efficacy of third-party advertisers. The App Tracking Transparency (ATT) feature launched last year, a blow to performance marketers. By making it more difficult for ads to follow customers around multiple apps and sites, performance marketing has become less relevant and the data around what’s working and what’s not has become less clear. It’s something that has directly impacted Facebook’s performance marketing, with Facebook, Google, and Snapchat advertisers reporting that campaigns have become less effective.

Apple is simply exercising control over its walled gardens, and making it easier for users to opt out of tracking. That’s the noble angle shared by Apple’s public relations teams: it doesn’t want its ads to track people around the internet. As a result, any of Apple’s advertising business development will be framed in the context of its preceding privacy initiatives. The same initiatives that have impacted a number of social media companies that rely on advertising revenue to support its global audiences. The less-than-noble angle that could be attributed to Apple is that it has successfully torpedoed the advertising businesses of its competitors to fortify its own.

The key function of data collected by mobile app publishers via iOS for third-party advertising is no longer the priority for developers, an indicator that advertisers are looking for new sources of consumer data.

One of the workarounds that Meta was using to address Apple’s ATT changes has likely seen further disruption by Apple’s second wave of privacy initiatives. From Apple’s Privacy Tax, we cited Apple’s private relay:

Private Relay has the potential to have a major impact on the advertising industry. As The Information explains, the feature was released in September to Apple iCloud+ customers who could elect to turn the feature on for Safari browsing and a small percentage of “insecure app traffic over port 80.” For now, users can still use Chrome or any other non-native browser. Additionally, platforms that have you logged in: Gmail, Youtube, Facebook, TikTok can track your movements through the first-party data that the platforms collect.

It’s part of a bigger strategic shift for Apple to rely less on hardware sales and see more revenue coming from existing users in the form of ads and other subscriptions and features. It’s also likely to trigger responsive features from companies like Google that are building out their own privacy features. There’s more to come, and this development is only the latest. In March’s report on Apple and performance marketing, we explained:

Apple will need to continue growing its content marketplace; Tim Cook’s digital fiefdom will require greater (user-generated) content engagement. As such, it’s not a leap in logic that Apple will build a platform for user-generated content (UGC). Don’t be surprised if Apple acquires one in the process. Twitter, anyone? Without greater advertising opportunity within the Apple ecosystem, digitally-native businesses will suffer from the collateral damage. Apple has become the solution for handheld consumer privacy; business owners deserve a capable alternative to the services that Apple is crushing with its new practices.

I’ll admit that the prospect of becoming a platform for user-generated content may be too forward-thinking for Apple. Bloomberg’s Gurman predicts that the ads will soon spread to other apps including Maps, Books and Podcasts. Each of these have a tremendous audience that may eventually be repurposed for the sake of advertising revenue. And self-serve advertising is set to become easier for businesses looking to benefit from Apple’s now-superior first-party data, according to 9-to-5 Mac:

In addition to bringing ads to other stock apps, Apple has already announced that customers will start seeing more ads in the App Store. New ad units in iOS 16 will allow advertisers to place ads on the Today tab in the App Store, and at the bottom of product pages for other apps.

Apple’s ads business is only getting started, and it’s stepping on the competition to get ahead. This is more or less confirmed. Expect its biggest competitors to fight back but that’s an aside; the value of this conversation is that eventually DTC retailers may finally have some relief as the market for performance advertising is currently in contraction.

By Web Smith | Edited by Hilary Milnes with art by Alex Remy and Christina Williams

Part One: Apple and Performance Marketing

Part Two: Apple’s Property Tax

Member Brief: Formula One Revisited

Revisited is a continuation of the 13 month old report – Formula One and America – and the changing dynamics as the Formula One takeover of American sports and business enthusiasts continues.

There are a number of global sports: boxing, soccer, cricket, tennis, and racing. The last category is dominated by a form called Formula One. Though founded in 1950, it’s just now beginning to reach its zenith in perhaps the most important global media market – The United States. And though the sport’s American influence is scant compared to that of Europe, Mexico, Brazil, Japan, China – the potential of the sport is uniquely American.

The “sport” in Formula One lasts for a couple of hours on a Sunday Afternoon. Everything else is business, pure and simple. […] We set out to provide the best platform with the best image and the best environment for companies to maximize the benefits of their investment.

This was a quote by the former head of McLaren, one of several fabled teams, that I found in the 22 year old book by Russell Hotten, Formula 1 – The Business of Winning. Here’s another anecdote on the mainstreaming of Formula One racing. In the long history of Harvard Business case studies, there are only four cases written on the Formula One business or its many components.

This a preview of content designed exclusively for Executive Members

Memo: Middle America Income

Once viewed as “middle-income America,” cities like Nashville, Austin, and Columbus are redefining certain consumer characteristics. Those cities have retailers rethinking how wealth distribution is assessed beyond the top 6-10 major cities. The south and the midwest was long thought to represent a higher concentration of middle income consumers than coastal cities like New York, San Francisco, and Los Angeles. Luxury retailers like Gucci and Prada are looking beyond midwest stereotypes and finding positive results.

There’s opportunity everywhere, even when the might of the American economy seems to be diminishing by the month. At the same time, within the middle-income strata of consumer, inflation is beginning to hit them where it hurts the most. These two ideas appear to be paradoxical at first glance.

Cowen researchers led by Oliver Chen found that 66% of households earning $50,000 to $100,000 expect to slow their spending due to inflation, up from 63% last month. They estimate Kohl’s core customer’s income lands firmly in that range, between $80,000 and $110,000. [1]

The pandemic and post-pandemic correction made “business as usual” impossible to predict for retailers that appeal to middle income Americans. Consumer behavior reverted back to the mean much quicker than anticipated, and it became difficult to forecast around unpredictable demand. This was only exacerbated by the months-long constriction of supply as ports backed up and deliveries slowed to a halt. Retailers with means were able to throw money at the supply chain problem with the employment of creative freight strategies and alternative sourcing but even the deepest pockets couldn’t account for fast-evolving demand.

Now, many of those same retailers are facing an inventory problem exacerbated by knee-jerk reactions to those same pre-holiday supply chain delays. Target, Walmart, Macy’s, Kohl’s and other retailers like Gap and American Eagle all reported higher inventory levels, excess product in categories like furniture and lower operating margin. In a June 2022 inventory report, 2PM expressed concerns about a number of retailers known to appeal to middle-income America: Bath & Body Works, Ross Stores, Carter’s, Target, Walmart, TJX Companies, Foot Locker, and Kohl’s.

Kohl’s was in the most precarious position with the third-highest growth in post-pandemic inventory (behind Target and Ross). Of those three, however, Ross had the steepest fall in sales over Q1 and Q2 (report attached).

But middle-income America and middle America income are not one and the same. The woes of mass market retailers describe a problem unique to middle-income America. Middle-American income has evolved to mean something different to the analysts and researchers who project the viability of retail expansion into certain regions:

Gucci in Columbus, Ohio. Chanel in Troy, Mich. Hermès in Naples, Fla. [2]

What the analysts who work for these luxury retailers are suggesting is that Middle America income is now viable enough for many of them to invest in real estate and employment in oft-forgotten regions. For these “second-tier cities”, they are no longer emblematic of middle-income America. Analysts have long assumed that regions like the Midwest answer to both descriptions but retailers are suggesting that there is divergence in this long-held interpretation. Retail data tells the tale: they are finding that enough of the top 10% enjoy the mild weather and humility of Ohio, Michigan, and Pennsylvania. Or the low taxes and sweltering heat of places like Austin, Naples, Scottsdale, or Nashville.

The geographic middle of the United States is slowly shedding the perception that it serves as a proxy for a concentrated group of middle-income Americans. There is opportunity to be found for retail brands looking to engage with non-coastal, upper-income consumers. Believe it or not, you can find these consumers anywhere – even in places like Tennessee, Ohio, Pennsylvania, and Michigan. This is what the data continues to show. In September 2021’s New York, Los Angeles, and Columbus I riffed on the idea that eventually, consumers will view America’s second-tier cities as ideal for upper-crust retail endeavors. Columbus served as a stand in for the many forgotten cities:

The consumer mix has reassured a growing number of luxury brands that they are ready for market expansion. Wealth and opportunity are dissipating. I grew up believing I needed to be in New York, Los Angeles, or San Francisco to succeed. If you were a child from the South or the Midwest, unless you were well-traveled, you believed that your success would rely on your proximity to the centers of the world. This is less so the case than it was even a decade before.

There have always been higher-income, luxury consumers outside of the coastal hubs known to the world’s very best retailers, but the pandemic likely accelerated a growing presence of those consumers in and around cities like St. Louis and Austin:

Kering, which also owns Saint Laurent and Bottega Veneta, says it plans to capitalize on fast-rising U.S. demand by opening more than 30 new U.S. stores over the next couple of years, including Gucci boutiques in New Orleans and St. Louis, and a Saint Laurent store in Detroit. A new Gucci store in Columbus—the company’s first stand-alone store in Ohio—opened in July, with another new store in Austin having opened in April.

“These cities have changed structurally, it’s not just a spike,” Francois-Henri Pinault, Kering’s chief executive, told reporters earlier this year when outlining the group’s U.S. growth plans, describing what he saw as a permanent shift that had turned these cities into long-term markets for luxury brands. [2]

The majority of American wealth will always concentrate in places like San Francisco, New York, and Los Angeles but there is something to say for luxury’s finest retailers finally beginning to address their customers where they are. What may appear to be a risky real estate investment may actually serve as a hedge against falling retail numbers. Mainstream retailers like Kohl’s will see a “reduction in spend in the face of surging inflation”, as the WSJ notes. But it’s also an acknowledgment that affluent consumers are more insulated from the effects of inflation.

Luxury consumers are everywhere and there’s no better way to reach them than by erecting a store nearby their neighborhoods. For retailers like Gucci, Hermès, and Prada, stores are less about inventory and more about experience. This de-risks stores in ways that Target and Kohl’s can never duplicate. There’s no substitute for experiential retail.

In Columbus, Ohio, the state’s sole standalone Gucci store sits adjacent to two LVMH darlings: a Tiffany and a Louis Vuitton store. These retailers have seen great success within Easton Town Center, the region’s most visible and successful retail development. It’s a sign that many of the finest brands in the world have the opportunity to expand their reach by identifying new pockets of consumers who crave the depth of relationship that only physical retail can provide. It sounds like a paradox but in cities like Columbus, Nashville, and Austin, physical retail is reaching new consumers in authentic and meaningful ways.

It’s now consensus that Middle-America income and middle-income America are no longer communicating the same idea. Middle-America income is no longer viewed as moderate,  average, or midwestern. And middle-income America is no longer perceived as specific to certain regions. As inflation continues to eat into the discretionary income in every geography and demographic. The finest retailers will work to find more of their target consumers wherever they may.

By Web Smith | Edited by Hilary Milnes with art by Alex Remy and Christina Williams