Is he ready for the mobile future? Photographer: David Ramos/Getty Images
Is he ready for the mobile future? Photographer: David Ramos/Getty Images

Facebook has once again crushed its quarterly earnings report, primarily on the back of mobile advertising. While overall user growth is slowing, thanks to market saturation, Facebook increased both engagement and revenue per user, with mobile revenue surpassing non-mobile revenue for the first time.

Part of this growth is due to the attractiveness of the Facebook mobile ad unit: Unlike most other mobile ads, which sit in a small bar at the top or bottom of the screen, Facebook’s mobile ads are directly in your timeline. Thus, as you scroll, each ad has an opportunity to fill the entire screen with an attention-grabbing image that is eminently clickable. It’s arguably the best display unit in digital advertising today.

Significantly, the largest driver of Facebook’s mobile revenue is app-install ads -- that is, ads that encourage users to download an application rather than simply promote a product. According to AdKnowledge chief executive officer Ben Legg, whose company handles about 2 percent of Facebook’s ad sales, app-install ads make up well over half of Facebook’s mobile revenue. These ad units are largely purchased by free-to-play game publishers such as King (maker of Candy Crush Saga) and Big Fish Games (the Bejeweled series), which leverage Facebook’s incredible demographic data to target the small percentage of players who will spend hundreds of dollars on in-app purchases.

The cycle goes something like this:

  • Publisher launches a free-to-play game, usually on the back of previous hits
  • Some fraction of players become “digital whales,” repeatedly spending real money on in-game upgrades
  • The publisher figures out the demographic profile of these profitable players, and uses Facebook mobile ads to reach potential players with the same profile

The technique is so effective that there is actually a shortage of these ad slots, leading to extremely high prices. It's a reason to be bullish about Facebook’s alleged plans for a new mobile ad network.

So, what's the problem? Actually, Facebook’s dependence on app-install ads primarily driven by free-to-play games leaves the company exposed to both Apple and Google, albeit in two different ways.

On the Apple side, Facebook should be wary of Apple making significant changes to App Store policies around free-to-play games. There are many people in the broader Apple ecosystem who strongly disapprove of free-to-play, and the slight whiff of scamminess surrounding an industry predicated on using psychological tricks to separate people from their money could easily lead to a clampdown, especially if Apple’s management becomes concerned that having such apps is degrading their brand.

How likely is this? Well, Apple itself is addicted to the revenue numbers generated by free-to-play games, and nearly every announcement from Cupertino is led with an update on the app store, with developer payments being front-and-center. In addition, if Apple were to re-jigger the formula for its "top" lists away from the focus on upfront costs and gross sales that favors free-to-play -- as many developers are pressing it to do -- alternative means of reaching customers, such as Facebook’s ad units, would become even more valuable.

Google is a bigger threat; last week it announced its own app-install ad units for both search-result pages and its YouTube subsidiary. Those two locations may not be as good as Facebook’s timeline for surfacing games you didn’t know you wanted, but Google will have the best possible data driving those units: app usage. In the blog post announcing the initiative, Google explicitly called out the ability to "reach people who are your most likely customers, based on the apps they use, the frequency of use and the types of in-app purchases they make.”

That type of data is even more valuable to free-to-play publishers than demographic data, and Facebook runs the risk of becoming the second option for the sorts of advertisers that are currently its best customers. Facebook has made several acquisitions that will help them gain more insight into in-app behavior, most notably Parse, and is restarting its F8 developer conference to encourage app developers to incorporate Facebook, but will always be at a disadvantage to the app-platform owners when it comes to understanding actual app usage.

Ultimately, Facebook is doing far better on mobile than most predicted just a couple of years ago, given that it doesn't actually own the underlying platforms. Yet that doesn’t mean concerns about its future in a mobile-driven world were unfounded. Apple and Google will always know the most about consumer behavior relative to apps, and Google, in particular, won’t hesitate to use it.

To reach the writer of this article: Ben Thompson at benthompson@stratechery.com.

To reach the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.