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Why Facebook Inc. Is Still Cautious About Serving Advertisements

Source: Facebook

The News Feed ad has been a gold mine for Facebook . The company generated $13.7 billion in advertising revenue over the past four quarters, largely from ads shown in users' News Feeds. But a recent survey from Socialbakers found that just 3% of posts in the average user's News Feed is sponsored content.

That's slightly more than the ad load rival social network Twitter currently sports. And with 2.5 million active advertisers, Facebook almost certainly has enough inventory that it could increase ad loads without diminishing return on investment. So what's keeping Facebook's ad load relatively low?

How it stacks up with Twitter

During Twitter's analyst day in November 2014, CFO Anthony Noto told the audience that the long-term goal for Twitter is to reach 5% ad load. During the company's second quarter earnings call, Noto updated investors, saying it's only about one-third of the way there. That would imply an average ad load of 1.7%.

That ad load might be higher in the United States. A survey from Cowen & Co. found the average ad load in the U.S. to be about 5.4%. Note that the survey was self-reported, not an actual measurement. As Twitter's most developed market, however, it's natural for the U.S. to have more ads than other markets.

Socialbakers' 3% measure for Facebook's ad load puts it at less than twice as dense as Twitter's timeline. But Twitter has just 100,000 active advertisers for its 304 million users that could potentially see ads. Facebook, comparatively, has 2.5 million active advertisers (25 times more) for its 1.49 billion active users (five times more). Facebook could easily support a significantly higher ad load while maintaining ad relevance that's still better than Twitter.

But that's not saying much. That same Cowen & Co. survey found that most Twitter users found ads in their timelines to be largely irrelevant. That speaks to Twitter's poor targeting capabilities in comparison with Facebook, as well as an inefficient ad display system.

Algorithms for the win

Facebook's News Feed is algorithmically sorted based on what Facebook thinks will be most interesting for each user. The ads are weighed against each piece of content based on price, how well a user fits the target audience, and the value it provides over the next piece of organic content.

That ad display mechanism forces advertisers to bid their true value for each ad. It also limits the number of ads Facebook shows to its users to maximize the long-term value a user provides.

The only ways for the ad load to increase is for Facebook to tweak the algorithm -- something it's done quite a few times in the past -- or increase the average bid per ad. The latter has the benefit of increasing average ad prices and ad impressions at the same time (although an increase in average ad prices may compel Facebook to tweak the algorithm to maintain its ad load).

Facebook has seen a huge increase in average ad prices in each of the past four quarters because of its redesign of the right-hand column ads on desktop. Facebook decreased the number of ads in the column, increasing their size and value at the same time. Additionally, the shift to mobile has decreased total ad impressions as more people access Facebook via mobile. As a result, a large part of Facebook's increases in average ad prices have come as a result of declining ad impressions.

But the right-hand column redesign is now over a year old, so investors will get a good look at Facebook's organic growth in ad impressions and ad prices when it reports its third quarter results.

Increasing prices organically

Facebook is doing a lot to increase the value of its advertisements. It's pushing heavily into organic video, which makes promoted videos more approachable for viewers. Video ads generally produce more value for marketers than static ads. Facebook is also testing "Canvas", a new immersive ad experience similar to Instant Articles, where advertisers can essentially make a website contained within Facebook to provide more details on a product. It's also working with retailers to include buy buttons and carousels of related products in ads, both of which increase the value of an ad unit.

Investors should look for Facebook's ad impressions to increase in step with ad prices going forward. But rest assured that if none of Facebook's efforts to increase ad prices work, it still has room to tweak the algorithm to show more ads and keep investors happy.

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The article Why Facebook Inc. Is Still Cautious About Serving Advertisements originally appeared on Fool.com.

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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