Facebook (NASDAQ:FB) took another step into social commerce last week with the introduction of Facebook Shops. The feature gives small and medium-sized businesses the ability to upload their catalog to Facebook and Instagram, providing shoppers with another way to buy online.

The service is free to use, and Facebook will only collect a fee from small businesses that use the Checkout feature it introduced on Instagram last year. But analysts still see Shops as a massive opportunity for the social networking titan. Deutsche Bank's Lloyd Walmsley, for example, thinks Shops could drive as much as $30 billion in incremental revenue.

And just like practically everything Facebook does, the bulk of the opportunity is in advertising.

Four smartphones showing examples of the Facebook Shops interface

Image source: Facebook.

Fighting back against one of its biggest challengers

One of the biggest threats to Facebook's dominance in the digital advertising market over the last few years is Amazon (NASDAQ:AMZN). Amazon has quickly grown its digital advertising business, from practically nothing to nearly $13 billion in ad spend last year. That number could double by 2022, according to estimates from eMarketer.

Amazon's advantages are huge amounts of shopper data and its position as the top destination for online product searches. Both feed into its ability to target ads on its Fire TV and Kindle products or on its main website in search results pages. Additionally, Amazon is able to accurately attribute ad impressions directly to customer purchases, since the transactions take place within the same ecosystem. That provides excellent insight for ad buyers to determine the value of their campaigns.

Shops is an opportunity for Facebook to emulate Amazon's strengths. It can collect more shopper data and more accurately attribute ad impressions to conversions with its Checkout feature. Direct checkout through Facebook should also increase the conversion rate for ads, as it reduces the friction between discovery and checkout.

As Facebook users start adopting the feature, storing their credit card information with Facebook, it could create a virtuous cycle -- a network effect -- increasing the ease of conversion within Facebook versus navigating away to to retailer's website. That will lead to more shopper data for Facebook to target ads and recommend products, just like Amazon does.

Can Facebook really take on Amazon?

Amazon has been able to build up its advertising business so quickly because it's the premier destination for online shopping. Facebook isn't going to usurp Amazon as a place to go for when shoppers are seeking out something specific. At least not anytime soon.

That said, Facebook's Marketplace feature is already used by "hundreds of millions" of people around the world. It hasn't updated the number since early 2018, when it reported 800 million monthly users. Meanwhile, an increasingly large percentage of Instagram users see the app as a place for virtual window shopping. Instagram has leaned into it with the new Shop section in Discover, among other features.

In other words, consumers have already shown a willingness to shop on Facebook's apps. Shops just makes it easier for retailers to get their products in front of users and convert shoppers into purchasers. And advertising will play a key role in the process for retailers, just as it's become a key part of any third-party retailer's strategy on Amazon. The benefit with Facebook is that merchants don't have to worry about competing directly with the company they're doing business with.

Facebook's opportunity with Shops is to develop its e-commerce advertising capabilities to the point where they're on par with Amazon's. If it can do that, it should be able to produce incremental ad revenue in the vertical that's already one of its most important. Even a slight increase in average ad price for e-commerce ads will translate into billions in additional revenue.