Facebook's Surprise

Next time you sign in to Facebook, take a look at those three or four little ads on the right side of most of the pages. Do they mean something to you?

One might be for a wedding photographer, another from a political candidate, another for a company offering to publish your book or trying to sell you sleeping supplements.

Chances are that at least one or two will be targeted to the activities and interests you post on Facebook, or the city you live in, your gender, or even your relationship status. These little ads are typically purchased through Facebook’s “self service” system, which enables small- and big-time advertisers to create an ad in minutes to lure specific demographic groups with a few lines of text and a graphic or photo.

Rather suddenly, these little come-ons have turned into the leading source of Facebook’s revenue. As an analyst at eMarketer, the New York-based market research firm, I have estimated that self-service ads account for at least half of Facebook’s total ad revenue, projected to be $1.3 billion this year. That’s way more business than anyone could have expected, given that there are no up-front charges for placing these ads and that Facebook earns revenue only when viewers click on them or when a certain threshold of impressions is reached.

Of course, Facebook isn’t the first Internet company to make a bundle selling ads without salespeople. By design, its system is similar to buying paid search advertising through Google’s AdWords or AdSense programs, which combined to bring in north of $20 billion in revenue last year. But this time marketers aren’t targeting ads on the basis of your search terms or what you are currently doing on the Web but on the basis of exactly who you are, as revealed by the information you’ve disclosed to your Facebook friends.

Facebook’s self-serve ad platform raises privacy concerns, given the ongoing scrutiny of how the company’s customer data is used. Facebook already finds itself in hot water over recent reports about personal profile data potentially being misused by some of the most popular third-party games and applications.

But for advertisers, the sense of intimacy is precisely the allure. “Everyone [on Facebook] is volunteering their information,” says Hussein Fazal, CEO of AdParlor, a startup that manages Facebook advertising campaigns for social-application developers. “They’re saying, ‘Here’s my actual age; here’s my actual gender; here are my actual interests.’ To have the ability to advertise and target to these users who have voluntarily given accurate information is very powerful.”

Tim Kendall, director of monetization at Facebook, puts it this way: “It’s a people-targeting ad system, and that just doesn’t really exist anywhere else.”

It’s hard to believe that the social-media advertising revolution, at least thus far, is the work of ads that shout “Have new shoes delivered to you every month!” or “Having trouble sleeping?” But what Facebook has built points directly toward the way much advertising will be bought in the coming years: without any human intervention.

The system launched in 2007 and started building slowly. But this year, tens of thousands of advertisers are on board, from local bakeries and state tourism offices to online game developers and major consumer brand marketers.

“The advertisers who have found success and continue to have sustainable success [on Facebook] think about us fundamentally differently than paid search,” says Kendall. “When people try us, they need to think about [the fact] that we generate demand, as opposed to fulfilling it.”

Advertisers begin by opening an account, identifying their goals, and determining which target audiences they want to see their ad. Then they create the ad and use an auction-based system to set a maximum bid–the highest amount they are willing to pay either each time someone clicks on the ad or each time the ad is displayed 1,000 times. Facebook’s reporting tool lets advertisers track clicks, impressions, and the demographics of people clicking on the ads, among other metrics.

The key difference between these ads and the dozens of other ways to place advertising online is the precision of the targeting. While other systems might guess on the basis of past behavior or inferred connections, Facebook knows.

The second key difference: social context. Facebook has found, through research done with Nielsen, that ads that mention friends (such as “John Doe likes Toyota”) perform better. People are more likely to notice them, remember them, and plan to buy the advertised product.

For example, appliance marketer Subzero/Wolf Appliance delivered ads to the Facebook friends of consumers who had already connected to the brand’s Facebook page. The ads, which led new visitors to that page, resulted in a 500 percent increase in the number of people who volunteered to connect to it by “liking” the brand. As of September, more than 113,000 people had done so.

Among the biggest buyers of Facebook’s self-serve ads are social-game companies such as Zynga, which typically flood the social network with promotions when they launch a new game. A midsize to large game developer will spend an average of $500,000 on Facebook advertising during launch month alone, says AdParlor’s Fazal.

Facebook still has a way to go before truly perfecting its self-service ad system. Sometimes, for instance, married people will see ads for dating services. Even Kendall admits that the targeting could be more accurate. “I think that has improved drastically over time, but it’s not an easy problem and it’s something that we’re still trying to get right,” he says.

Still, these are relatively early days for social-media advertising, and Facebook’s rapid ad-revenue growth attests that its model is certainly working well enough for some companies. The $1.3 billion estimate for ad sales this year is up from an estimated $665 million in 2009. (Facebook also has an additional, but much smaller, revenue stream from commissions on credits spent on social games.)

So far, advertisers can use the self-serve system only to buy ads that appear on Facebook. But as the social-media giant expands its footprint across the Web and into the mobile realm, third-party publishers and businesses will have more ways to link with Facebook, and I believe the ad platform will expand beyond Facebook’s walls as well–just as Google’s AdSense program has.

Meanwhile, the process of planning and buying the advertising is becoming almost completely automated. Algorithms allow buyers to create, test, and launch thousands of iterations of Facebook campaigns on the fly, changing their targeting choices to see what works best. As more marketers get comfortable with using technology to optimize their advertising, the model will spread to other forms of media, says Joe Mele, managing director for media and marketing at the digital agency Razorfish. “Soon,” he says, “we’re going to start seeing remnant [ad] inventory on television and other media being automated, instead of people taking orders.”

Debra Aho Williamson is a senior analyst covering social-media marketing at eMarketer (www.emarketer.com).