Why it's best to be friends with Facebook

It's boom time for the site once considered a fad, as tailored online ads take off

It seems remarkable now. The site had more than 200 million users and an estimated market value of around $10bn; one of Silicon Valley's greats, Sheryl Sandberg, had been lured from Google to be chief operating officer; and a major Hollywood film about its origins that would go on to win Oscars and Golden Globes, The Social Network, was in pre-production.

And yet Facebook, in 2009, was still privately dismissed as a passing wonder by some of the advertising industry's most influential businesspeople. Others were worried about making any financial commitments while the crisis hit advertising spend and, therefore, their profits.

These cynics and fiscally conservative agencies missed out on one of the great opportunities of recent years: developing the technology that would allow clients to customise their advertisements to every single Facebook user. News last week that online advertising spend in the UK, at £2.26bn in the first half of 2011, has overtaken broadcast for the first time, only emphasises the silliness of so many agencies of not participating in a game-changing tender process two years ago.

Facebook invited more than 100 companies to pitch to become one of their "alpha" partners in developing an advertising application programming interface (ad API). That's tech-speak for the software that tailors and distributes advertisements – there are similar APIs for gaming and instant messaging.

It is understood that only 13 of these companies wanted the work. "The response was not too amazing," says a digital advertiser. "It was a huge business, yet advertising agencies were telling me that Facebook was just a fad."

Two small British firms, TBG Digital and Techlightenment, got the contracts. They were selected based on their existing work within Facebook, in which they had built their own basic tools. A third group, the US-based Blinq Media, became an alpha partner shortly after based on its work with a telecommunications client AT&T.

This year $3.8bn (£2.4bn) of Facebook's projected $4.27bn revenue will come from advertising, according to estimates from the market research outfit eMarketer. Facebook's revenue has increased more than five times since that big commercial drive in 2009 – and those three firms have virtually mirrored that incredible growth.

Although this is not the only way Facebook has monetised, and there are other forms of advertising on the site, this smacks of the way Google beefed up its commercial operations. Industry sources say it is no coincidence that Sandberg joined in 2008 and this API followed shortly after.

"Facebook became more com-mercially savvy," says a source, pointing to Sandberg's Google role; she was responsible for online sales of advertising and publishing.

The ads API is extraordinarily sophisticated. A car company will be able to distinguish between a 50-year-old German woman who likes to drive slowly, and an 18-year-old male speedfreak in Birmingham. Different cars, colours, and contexts can then be advertised on each of their pages. "Rather than one TV ad where you hit and hope, you've got a highly optimised and personalised advertising medium," says Ankur Shah, co-founder and co-chief executive of Techlightenment.

Shah's firm was set up in 2007, and big-name clients include the pharmaceuticals giant GlaxoSmithKline and the online dating agency Match.com. Experian, the FTSE 100 market-research company, was so impressed that it snapped up Techlightenment earlier this year.

Facebook then allowed a "beta" selection of 25 agencies to develop online tools and ideas. This has since been opened up so that developers meeting certain minimum thresholds can join.

The services are broadly carved up into two. There are agencies that provide managed services, which would comprehensively run a campaign, and those that just license their API tools. Many do both. The developer will take a proportion of every dollar of advertising spent, in the single digits for licensed and double for managed services, and Facebook takes the rest.

It is generally agreed that the three alpha partners are more likely to win work than their rivals and each has more than 100 clients. They have built up the experience and have the databases and profiles of Facebook users that are so valuable to the advertisers.

"Definitely all three of us have a competitive advantage from coming in first," argues Simon Mansell, founder of TBG Digital, which has an "ad builder" that can automatically create 10,000 advertising variants in just three minutes. "Advertising is a $500bn [global] marketplace and you can assume that there will be a significant move to digital and Facebook. We're disrupting the traditional advertising agencies and we're creating a problem for the likes of WPP as the big advertisers will be looking to digital media experts."

Bold words, but Mansell's business has an impressive array of clients. There are 35 US Fortune 500 companies and names such as Coca-Cola, HSBC, Heineken and Dell. Turnover in the 12 months to July 2011 is thought to be at least five times higher than the previous year's £17.5m, though Mansell will not confirm this.

As exciting as this new world might be, APIs have their problems so soon after launch. Bugs have to be ironed out, coding quirks removed.

"This stuff is still in the very early stages," says Dave Williams, chief executive and co-founder of Blinq, which counts McDonald's and Samsung among its clients. "It's like the wild, wild west out there. Facebook will change and update an API on even a weekly basis – some of the firms without the experience aren't used to that."

For years, there were question-marks over how Facebook would ever make money, but now its more than 750 million users represent billions of dollars-worth of advertising opportunities. When Facebook finally floats in New York, perhaps late next year if the markets settle down, estimates suggest it could be valued at around $100bn. That is not the sort of valuation that suggests a fad. It is the sort of valuation that points to an extraordinarily successful business model.

Unsurprisingly, others are looking to ape Facebook's advertising schemes. Twitter is readying its own API and is expected to announce a list of alpha partners early in the new year. Some of the developers on the alpha and beta lists of Facebook are believed to be in talks with Twitter and they are likely to dominate the final list.

As Twitter is quite news-orientated, advertising could be based around what topics are trending strongly at the time. Next year would mean that political campaigning could be a big revenue earner during the Republican primaries and ahead of November's US general election.

"Ads aren't quite as much front and centre [of the page] as Facebook," says a source. "It's about how best to leverage Twitter, such as developing advertising around trends."

Linkedin is also thought to be giving some early thoughts to an ads API, but the word is that this is quite a bit behind Twitter's plans.

Facebook, then, will not be the last social media site to develop these clever, tailored advertising tools. Arguably, though, it is the most important, and has enabled a handful of small, nimble advertising and media technology firms to steal a march on the world's biggest advertising agencies.

Leading Lady

Sheryl Sandberg has been very much to the fore of Facebook's corporate strategy since she joined from Google in 2008. She oversees sales, marketing and business development, allowing its founder and chief executive Mark Zuckerberg to concentrate on the development of Facebook's technology and infrastructure. Sandberg was recently named by Fortune magazine as one of the 50 most powerful women in business.