This story was written by Keith Dawson for UBM DeusM’s community Web site Business Agility, sponsored by IBM. It is archived here for informational purposes only because the Business Agility site is no more. This material is Copyright 2012 by UBM DeusM.

Facebook Agrees to 'Sponsored Stories' Climbdown

The social network will let users choose not to be featured in advertising, pay $20 million, and forego at least $103 million in revenue.

Facebook's proposed settlement of a class-action privacy lawsuit will cost it at least $123 million, and could end up jeopardizing its program to monetize mobile traffic.

The case contains object lessons for any company pressing hard on the boundary between user privacy and user monetization.

In 2011, five California residents filed a class-action lawsuit against Facebook over its Sponsored Stories advertising program. Under Sponsored Stories, when a user "Likes" a business or brand on the social network, Facebook has the option of displaying that user's brand approval to his or her friends -- a form of endorsement that Mark Zuckerberg has called the "Holy Grail" of advertising. (TechCrunch's coverage of the settlement has some details of the relative effectiveness of three types of Facebook advertising.)

The basis of the lawsuit was a California law forbidding a commercial entity from profiting from any California resident's name or likeness without that person's permission and without compensation. The law was originally written with celebrities in mind, but it applies to any California citizen. (In fact one of Facebook's initial arguments was that the plaintiffs were not celebrities; the judge dismissed this line of defense.)

Facebook initially gave users no effective way to opt out of having their name and likeness appear in Sponsored Stories.

The proposed settlement agreed to by Facebook (which must still be approved by the judge) stipulates that the company will pay $10 million into a fund to be used for charities of the plaintiffs' choosing, and another $10 million for legal fees. In addition Facebook will implement a user opt-out from Sponsored Stories, which the settlement estimates will cost the company a further $103 million in foregone advertising revenue. (That figure was redacted from the settlement when Reuters broke news of its filing late last week; Reuters attributed the number to plaintiffs' attorneys.)

The opt-out that Facebook agreed to still gives the company a lot of wiggle room. Facebook must allow users to discover which of their Likes have already been used in a Sponsored Story and opt out of future uses of any of those Likes for advertising. The way this opt-out is structured, Facebook gets at least one bite on each Like before the user can see it to opt out of future use. And there is no general opt-out from all future use of Sponsored Stories.

Now how do we monetize mobile?
One of the controversial issues involved in Facebook's controversial IPO was the question of how the company could justify its monumental valuation. Analysts agreed that Facebook needs to develop and demonstrate a rock-solid strategy to monetize the users visiting the site in increasing numbers from mobile devices. Facebook's mobile advertising is just getting off the ground. The company was surely counting on Sponsored Stories to contribute significantly to mobile advertising revenues. Such stories, appearing in the mobile user's timeline, are less intrusive, more natural, and far more persuasive than display advertising.

Facebook will obviously try to make the Sponsored Stories opt-out as obscure and hard to find as it possibly can within the confines of the settlement, which stipulates an easily accessible mechanism (emphasis in the filing). Their hope is that not many users will opt out.

But the judge may decide that the interests of the lawsuit's plaintiff class are not sufficiently protected by such a Facebook-friendly opt-out. If the final settlement stipulates that Facebook must provide users a way to opt out of all future Sponsored Stories, the company's mobile monetization plans could take a major hit.

In a poll, a live chat, and a blog, members of this community have weighed in on the question of what steps Facebook needs to take to justify its outsized valuation. Mobile monetization figured large in these discussions. Mark Zuckerberg and co. have to hope that the judge approves the settlement they have negotiated.