How Facebook fixed the social advertising problem

November 22, 2010: 3:39 PM ET

MySpace was once the big kid on the social networking block, but Facebook beat it in part by improving on its social advertising strategy, or lack thereof.

By Kevin Kelleher, contributor

So much of the discussion around Facebook centers on the way it's shaping our social interactions with others that it's easy to overlook how profoundly the company is rewriting the rules of online advertising. When Facebook's revenue is mentioned, it's usually in the aggregate: The six-year-old company will bring in as much as $2 billion this year and close to twice that next year.

The bulk of that figure will come from selling ads on its social-network platform – a web technology that was seen as barren soil for ad revenue until a year or so ago. Facebook made social ads pay through a number of tricks. One of the most important innovations was to reach out to the smallest advertisers with self-serve ads on its social-networking site.

Setting up a Facebook ad is simpler than using Google AdWords. To test the idiot-proof concept, I set up a page for my work as a freelance writer. It wasn't terribly elegant but it did take less than two minutes. In another five minutes, I had created an ad targeted at my own demographic – male, 40s, college grad, living in the San Francisco Bay Area and interested in business or technology journalism.

Facebook instantly narrowed it down to 4,220 members who might see the ad and recommended I bid between 30 and 45 cents per impression, or between 72 cents and $1.05 per click. Granted, it must have been one of the most thoughtless and ineffective ads in Facebook's history, with no hope for a return on the 30 cents I bid. But it illustrated an important point: In less than ten minutes, any business can not only hang up a virtual shingle on Facebook, it can also became an advertiser.

Basic tutorials on the site help advertisers design more effective ads.  Once they are live, they can receive customizable, granular data on its performance in a simple format that encourages them to experiment with different kinds of ads. Tweaking the location or demographics of users or trying out different text, images and keywords is aided by data comparing the response to alternate ads.

Facebook benefits from the experimentation too. The company doesn't charge for the data, but the experiments of its legion of advertisers offers the company an unprecedented insight into what makes people click on ads on its site.

Understanding the behavior of its members on the site is central Facebook's goal of building a robust ad business. Advertisers and consumers interact differently on Facebook than they do in other media: Here, they become friends. MySpace had some limited success in getting its members to be online buddies with bands like My Chemical Romance and TV shows like The Office. But persuading people to connect with a corporation on a social site was a whole new game.

It works better for some companies than others. Only 3,600 of Facebook's 500 million members "like" Goldman Sachs (GS).  But 17.5 million like Starbucks, making it more popular than South Park and the Twilight Saga. And 18 million like Coca-Cola, putting it behind Lady Gaga but ahead of Megan Fox on the list of Facebook's most popular pages. On Starbucks' wall, people write declarations of love to brewed beverages that many lonelyhearts can only dream of.

Starbucks (SBUX) lets its customers reload their Starbucks cards on Facebook, and when they do a notice appears on their wall and in their friends' news feeds. Facebook has found that people are much more likely to click on a company's page if it appears to be endorsed by their friends.

Such engagement has driven up Facebook's click through rates. Back in 2007, Facebook was called the "worst-performing site" for ads, with click-through rates of 0.04 percent, or 4 clicks per 10,000 page views. But that started to change last year. Companies that could entice users to their wall pages started to see click-through rates of 6.5 percent.  According to Facebook, Japanese airline ANA targeted its ads to travelers who liked Japanese culture and saw click-through rates of 25 percent.

Facebook knew there was no magic formula for an advertiser to connect with its users. It encouraged companies to experiment. Clorox marketed its new line of Green Works cleaners by asking Facebook members to nominate and vote on "green heroes" in their community who would receive grants.  The campaign drew 400 entries and 20,000 votes. A campaign by Levi's offering a 40 percent discount on a new line of clothes brought a 35-percent increase in Facebook members who liked Levi's page, many of whom are still connected.

Some critics might argue, with good reason, that Facebook's efforts to study its members behavior, to entice them into online relationships with brands and to share that information in their friends' feeds benefit advertisers at the expense of personal privacy. In fact, the closer you look at how Facebook is turning its site into a vibrant ad market, the easier it is to understand why the company has pushed so hard against reforming its controversial privacy policies.

On the other hand, a lot of people – starting with the 18 million who like Coca-Cola (KO) – have no such qualms. And the revenue that Facebook is expected to bring in this year also suggests the company's approach is working well enough. The world Facebook is creating – a place where individuals sacrifice their privacy in exchange for a friendship with a brand – may not be a utopia, but it is going to be highly profitable.

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