Digging into Facebook's ad future

The fireworks have faded, the champagne has been uncorked and drunk, and now it's time to get down to business: Now that Microsoft has acquired a $240 million stake in Facebook to expand its advertising partnership, how is either company going to profit from the deal?

"That's the question that has surrounded social networks for the past few years," said Debbie Williamson, an analyst at eMarketer. "Right now, a lot of (the revenue) is from old-fashioned banner advertising that's not very targeted, it's inexpensive, and very plentiful."

The common wisdom is that social networks inherently have a tough time making money. People don't go to Facebook for Google-like information queries or media consumption; they go there to communicate, leading some to theorize that advertisements on social networking sites simply get ignored.

Michael Cassidy, president and CEO of Undertone Networks, an online ad network, said in an interview that it is a "big waste of money" for advertisers to buy ads on social networks like Facebook and MySpace. Users of those sites "are going there to interact with their friends and play with their profile," he said. "They're not in the frame of mind to respond to an ad."

It's also not helping that Facebook is tight-lipped about its revenues--as a private company, it's afforded that privilege--and most people take that as a sign that it simply isn't raking in a whole lot of profits, even though the Microsoft deal values Facebook at $15 billion.

"They are very, very, very secretive about their numbers," said Alex Kwiatkowski, a London-based analyst for market research firm Datamonitor. "They might talk about subscriber numbers," (which Facebook proudly says are approaching 50 million users, by the way) "but they're incredibly defensive (about revenue). Hence, why this valuation at $15 billion is like, 'Well, what did you base it on?' As part of this discussion, did they open the books to Microsoft?"

But Facebook, like Apple and Google, has so far been successful in crafting its image so that even many industry insiders are continually convinced that something borderline revolutionary is in the works behind closed doors. The $15 billion valuation was, essentially, a sign of confidence in the shaky fact that Facebook's current advertising strategy is that it's developing an advertising strategy.

On November 6, the company will be holding an advertising-related announcement in New York. Ad industry analysts are breathless with enthusiasm even though many admit that they don't have a clue as to what the announcement will actually be. Why? Because the amount of personal information that people spew out onto their Facebook profiles could create an advertiser's paradise. There's no concrete evidence of innovation, but there sure is potential.

"This is an advertising platform that we really haven't seen before," said Jeremiah Owyang, an analyst with Forrester Research. "Users opt in personal information (and then there is) the network information. Who they're connecting with, and what they're doing. These unsaid gestures speak reams about preferences of the individuals."

Forget Facebook's $15 billion price tag, because there doesn't appear to be either an initial public offering or a full-out acquisition in the near future, say some insiders. Forget speculation over whether, in a down-to-the-wire bidding war, rival Google drove up the price of the stake in Facebook so that Microsoft would emerge in a Pyrrhic victory in which it paid a whole lot more than it should have.

"Did Google kind of pump its interest, over-inflate its interest to make Microsoft blink first and put its money down? I'm not sure," Kwiatkowski admitted. "Google doesn't need a social network to make money. It's making money hand over fist." Of course, so is Microsoft in its traditional software sales.

Never mind that fighting over a company still figuring out its plan for long-term profitability could be a warning sign of the feverish and short-sighted nature of the current technology scene. What matters with Facebook is the hottest new social-media catchphrase since "social graph," and that's "targeted advertising."

Targeted advertising is one of the strategies that brought Google to the forefront of the ad industry. On Facebook, or any social-networking site with a solid database behind it, the personal information that a user enters into his or her profile could shape the advertisements that appear throughout the site.

If someone is listed as "engaged," for example, a wedding dress maker might be interested in that user's social-networking habits. Concert promoters might choose to advertise a Killers concert in Chicago to users who are members of area university networks and who list the band among their favorite music picks. And--perhaps most provocatively--if your "status message" says you're craving pizza, imagine what would happen if an advertisement highlighting the phone number for your local Domino's showed up on Facebook.

There's good reason for advertisers to be excited about an opportunity like this. Indeed, the advertising world is just as abuzz over targeted advertising on Facebook as the Web 2.0 crowd was about the site's developer platform, which launched in May.

Of course, much of this is speculation until Facebook unveils what it's working on. Even ad industry experts admit that there are a few potential drawbacks as the company grows. Could Facebook be forced to change its free-for-all model of its developer platform, which currently allows developers to advertise at will on their applications and keep all the revenue? (Facebook has declined to comment on whether it will be changing its developer platform in accordance with its advertising announcement.)

"There's a lot of poking and food-fighting and content being passed along that I think ultimately will all have advertising in it," said Curtis Hougland, co-founder of new-media marketing firm Attention PR. "I think (the original model) is really smart. They wanted the fastest adoption they could possibly get, and so the lowest threshold they could get was 'come in, play, do what you need to do.'" But as the Facebook Platform grows up, the company many need to make some tweaks.

"Think about what would happen if (Facebook) wanted to license out the ability to put a widget on the platform. That's a potentially huge model for them," RBC Capital Markets' David Bank said. "I think the danger in all this is for all these platforms, the widgets start to feel like spam."

That's key. If advertising gets in the way of their poking and photo browsing, Facebook users won't be happy. "It is, if you think about it, a lot more invasive," Curtis Hougland said. "It's not a banner ad that you can tune out. It's an ad within a person-to-person correspondence."

Some pointed to the experience of the advertising-saturated MySpace, once social-networking's hottest topic (and still its biggest site), and have warned that Facebook may suffer the same fate if it isn't careful. "They should continue to be wary of what's happened on MySpace, where the experience is too crowded and cluttered and commercialized," Hougland added.

"When the flood of advertisers comes into any popular area, the cool kids are going to leave, and they're going to take their peers with them," Forrester analyst Jeremiah Owyang said. "A balance has to be struck to not make it an over-branded experience."

CNET News.com's Elinor Mills contributed to this story.