Farhad Manjoo of Slate explains why Facebook's ad business is huge if they can keep engagement high:

How does Facebook expect to become a huge business if most people you know never click on ads?

The answer is surprisingly obvious. It’s a fact well-known to advertisers, though it’s not always appreciated by people who use Facebook or even by folks in the Web ad business: Clicks don’t matter. Whether you know it or not—even if you consider yourself skeptical of marketing—the ads you see on Facebook are working. Sponsored messages in your feed are changing your behavior—they’re getting you and your friends to buy certain products instead of others, and that’s happening despite the fact that you’re not clicking, and even if you think you’re ignoring the ads.

This isn’t conjecture. It’s science. It’s based on a remarkable set of in-depth studies that Facebook has conducted to show whether and how its users respond to ads on the site. The studies demonstrate that Facebook ads influence purchases and that clicks don’t matter. They also shed light on Facebook’s long-term business strategy. The tech world is consumed by the war between Facebook and Google—two huge sites that are constantly battling one another for users, engineers, and advertising clients. Yet Facebook’s studies suggest that its advertising fortune won’t necessarily come at the expense of Google. Instead, the findings show that people react to ads on Facebook in the same way they respond to ads on television. If Facebook’s ad business takes off, it might be at the expense of the biggest ad-supported medium in the world.

Last year, Facebook partnered with Datalogix, a firm that records the purchasing patterns of more than 100 million American households. When you stop by the supermarket to buy Tide, Rice-A-Roni, and Mountain Dew this evening, there’s a good chance you’ll hand the cashier a loyalty card to get a discount on your items. That card ties your identity to your purchases—it puts a name on your Tide, Rice-A-Roni, and Mountain Dew. After you leave the store, your sales data is sent over to a server maintained by Datalogix, which has agreements with hundreds of major retailers to procure such data.

Over the past few months, Facebook and Datalogix figured out a way to match their respective data sets in a manner that maintains people’s privacy (more on that below). In other words, Facebook can now tie its users to the stuff they buy at supermarkets. Armed with this data, Facebook began running a series of analyses into the effects of advertising campaigns on its site. If, say, Procter & Gamble ran a Facebook ad for Tide, Facebook could look at Datalogix’s data to see whether people who were exposed to the ad tended to purchase more Tide in the weeks after the campaign. (Tide is just an example here; Facebook has conducted more than 60 such studies for major advertisers, and while it was willing to give me general insights about its findings, it wouldn’t discuss specific advertisers.)

These general insights make a strong case for Facebook ads. First, according to the study, Facebook ads work. “Of the first 60 campaigns we looked at, 70 percent had a 3X or better return-on-investment—that means that 70 percent of advertisers got back three times as many dollars in purchases as they spent on ads,” says Sean Bruich, Facebook’s head of measurement platforms and standards. What’s more, half of the campaigns showed a 5X return—advertisers got back five times what they spent on Facebook ads.

But the most interesting finding was the total lack of correlation between purchases and clicks. “On average, if you look at people who saw an ad on Facebook and later bought a product, [fewer than] 1 percent had clicked on the ad,” Bruich says. In other words, the click doesn’t matter; people who click on ads aren’t necessarily buying, and people who are buying are almost certainly not clicking.

Advertising works. It influences buy decisions. That's why companies spend so much on it.

Compare the Facebook way with the Google way:

This shouldn’t surprise you, because it’s how most other ads work. There are generally two kinds of marketing messages in the world—“direct-response” and “demand-generation.” Direct ads are those that call on people to take an action more or less immediately—click to visit a site, call an 800 number, order something from a catalog. Google’s Adwords, the little text ads that show up alongside your search results, are a form of direct ads. Adwords are supremely measurable—advertisers pay Google for clicks, and they can track how many of the people who click end up buying from their site. Adwords are also extremely effective; because they’re shown to you when you’re looking to buy something (when you have “high purchase intent,” in the jargon), people who click on them frequently end up buying. Consequently, Adwords have made Google the most successful advertising company in the history of the world.

Yet in the larger advertising industry, direct-response ads like Google’s are something of an anomaly—a way to sell certain products at certain opportune times, but not the way that most marketers approach their jobs. Instead, the vast majority of the advertising world is structured around “demand generation.” These ads aren’t trying to get you to take some action right away. Instead, they’re trying to plant an idea in your head—to introduce you to a new product, to get a name stuck in your head, to improve how you feel about a company. (That’s why demand-generation ads are also known as “brand advertising.”) Other than infomercials, pretty much every ad you see on TV is a demand-generation spot. That’s true of ads in print magazines, on the radio, at bus stops, on billboards and most of the banner ads on your favorite news websites, too. According to some estimates, demand-generation ads account for more than 80 percent of the money spent on ads.

Google is moving in this direction too -- look at the ads on YouTube or anything served by (what used to be) DoubleClick.

Yahoo is the other big player in this space, although there are lots of smaller players, too, as more ad dollars move online.

How is this different from straight-up branding?

It's targeted. In some cases you get bombarded a lot with the same ads.

Straight-up branding has way more guesswork and hope that they're reaching YOU.