Advertisers are starting to demand more from Facebook (NASDAQ:FB). They want guaranteed results. Video advertisers want to be sure their videos are seen. App advertisers only want to pay when their apps are installed. And retailers only want to pay when a user clicks through to view more info about their products.
And Facebook has answered their demands. After announcing that it won't count video ad views until a video plays for at least 10 seconds, Facebook redefined a "click," removing likes, shares, and comments from its definition and thus removing them from the "cost" equation. The new definition is more aligned with most businesses' objectives with Facebook ads.
Twitter (NYSE:TWTR) made a similar switch last year, allowing customers to specify the goal of their ads on Twitter. That change had management overestimating how well their ads would perform, and the company missed its revenue outlook for the first quarter. Will Facebook suffer a similar fate?
The key to success with direct response ads
These types of ads, referred to as direct response, rely heavily on targeting to produce conversions. Facebook, arguably, has some of the best targeting data on its users of any company.
I've argued in the past that Twitter has excellent potential when it comes to targeting ads and getting users to respond. A well put together Twitter timeline sends a better interest signal than Facebook's social graph. Nonetheless, Twitter has struggled to get many users to the level where they follow the users they're most interested in. That makes it harder to target and convert ads.
Facebook, meanwhile, has loads of data on its users' likes, the brands they follow, and other demographic data such as age and gender, which Twitter doesn't. Facebook has also been noting how much attention its users pay to each item in their news feeds, regardless of whether it's an ad. Being selective about which ads it places in front of users will maintain the user experience and prevent Facebook from wasting its ad space.
Ad space, by the way, is diminishing
Last year, Facebook made a change to its desktop ads by increasing the size of the right-hand column units. That resulted in fewer ads displayed to users on desktop. Additionally, as more users shift more of their time to mobile, the right-hand column disappears altogether, and Facebook relies entirely on ads in the news feed.
At the same time, the number of advertisers on Facebook continues to increase. The company surpassed 2 million advertisers in February. Twitter, by comparison, had just 60,000 advertisers as of its last update in November.
In other words, Facebook is in a position where it's looking to increase ad prices, where Twitter should be looking to increase total advertisers. Trying to do both at the same time is a bit tricky, and it leads to problems like we saw in Twitter's first quarter.
Facebook, meanwhile, has continued increasing prices as more bidders bid on fewer ads. However, Facebook will start to come up against tougher comparables this quarter, and it needs a catalyst to continue improving ad prices as ad inventory stabilizes. The switch to direct response ads may perform better for Facebook in its current position than it did for Twitter.
Still, there's some risk involved for Facebook. How will businesses adjust to the new definitions of clicks and views? Will they be willing to spend enough per click to make up for lost revenue from likes, shares, and comments? These are things that are outside Facebook's control.
Considering Facebook's current position with its ability to target users, the number of advertisers it works with, and the number of ads it's currently showing per user, the company looks poised to make the shift more successfully than Twitter.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of 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.