Sectornomics: Technology

An inside look at Facebook's controversial ad strategy

Perhaps the most important stat from Facebook's last earnings report—even more so than the 1.39 billion monthly active users on the social network—was this one: Of the company's $3-billion-plus in advertising revenue, 69 percent came from mobile ads, double the previous year.

While Google looks for ways to grow beyond the desktop search ads that made it one of the world's most profitable companies, the advertising fault line for Facebook CEO Mark Zuckerberg may be the better indicator of where the ad world is going or, more precisely, where the evolution of mobile advertising could go wrong.

That's why Zuckerberg told Wall Street last quarter that the way the company generates profits from mobile ads is "a pretty controversial strategy internally."

For Facebook, the boom in mobile advertising is a good problem—and it's set to capitalize better than any company on a huge shift. Money spent on mobile advertising was about $7 billion globally in 2013, compared to about $100 billion globally on the desktop in 2013, revealed a 2014 report from venture capital firm Kleiner Perkins.

By next year, the global mobile advertising market will surpass $100 billion in spending and account for more than 50 percent of all digital ad spend for the first time, according to a report from eMarketer.

"Our strategy is much less [about] increasing the volume of ads and much more about increasing the quality of the content and the quality of the targeting to get the right content to the right people," said Zuckerberg. "And this is a pretty controversial strategy internally, and we will ensure that [it] is going to work out."

This strategy will continue to be a focal point for Facebook when it reports earnings on April 22—as well as a barometer for how other tech companies should tackle the mobile ad riddle. Facebook shares are up 6 percent this year, while Google shares and the S&P tech-sector index are barely holding on to a 1 percent gain.

"Your sales force is typically paid on commission, and a lot of advertisers want maximum reach," said Laura Martin, an entertainment and Internet analyst at Needham & Co. "Mark is basically saying … he wants to have higher-priced ads to more targeted segments so that he can both grow his top line, or even keep it the same, but have fewer ads served."

In other words, irritating an advertising client that might want its ad appearing everywhere isn't much of a concern.

Very few companies have the ability to target user demographics with the accuracy that Facebook has. I think that they are just going to be ahead of the pack for a long time.
James Curran
CEO of advertising technology company STAQ

Limiting the reach of advertisers on Facebook fits in with the business model. Of the approximate 12 million active ads daily on Facebook—a number provided to BuzzFeed last September—the number of ads relevant to a particular user hovers around 6,000, a number the company gets to by culling targeting data provided by users in the form of their likes, comments, biographical information and more. In other words, Facebook has been careful about sacrificing user experience for the sake of having an ad unit show up.

"They're focused on quality and user experience more than anything else," said Heather Bellini, Goldman Sachs analyst.

Read MoreApple's next big blowout surprise could be its dividend

Getting it right is a sensitive issue for Facebook because it made the decision to move away from selling more display ads on desktop to focus more on comprehensive ads in a user's News Feed that can be used in desktop and mobile.

"They've been de-emphasizing right-rail ads for a while now," said Paul Vogel, the head of the Internet and media research team at Barclays. When Facebook redesigned right-hand-column ads last April, it also made sure they appeared less frequently for desktop users. "They want to have sort of more native advertising—ads that look like they sit more seamlessly in your feed. This is more based on your life and interests and targeting ads about stuff that's about you—tailoring ads to your likes," Vogel said.

The internal debate at Facebook over the company's advertising strategy—fewer, more tailored, higher-quality ads versus more ads in general—is a debate about the nature and economics of mobile advertising itself. What ads should a mobile user see that don't agitate the user while they scroll through a small screen but also ensure impressions for the advertiser?

"There is an inherent problem with being able to target on mobile. It's very hard to do, because you can't 'cookie' the user through their mobile device," said James Curran, CEO of advertising technology company STAQ. "The big thing is targeting. It all goes down to targeting. That is the big, big, big thing."

And that's why Facebook is the one to watch, maybe even more so than Google. Which Internet firm has the ability to target advertising best? The way Facebook has its advertising arranged now, it's entirely likely that as people scroll through more content on Facebook, the "organic content" that people end up seeing on the News Feed is more ads. That advertising strategy on the whole has "really fueled [Facebook's] growth in a good way, and we feel very confident that this is the right path going forward," Zuckerberg told analysts last quarter.

"Very few companies have the ability to target user demographics with the accuracy that Facebook has," Curran said. "I think that they are just going to be ahead of the pack for a long time."

Facebook is still popular among teens
Facebook is still popular among teens