Instagram's new ad units appeal to a wider range of businesses. Source: Instagram

Since introducing sponsored posts more than a year and a half ago, Instagram has run fewer than 500 campaigns featuring big brands. The results of those campaigns have been good, with Nielsen Brand Effect metrics showing ad recall 2.9 times higher than normal online ads. However, if Instagram is going to become a real revenue stream for parent company Facebook (NASDAQ:FB), it needs to open up to more advertisers.

Last week, Instagram announced its plans for new ad formats, targeting capabilities, and broader availability to businesses. These steps will enable Instagram to generate meaningful revenue from its rapidly expanding audience.

Calls to action now allowed
Instagram does a very good job keeping users in its app. Last year, Facebook said the average Instagram user spent 21 minutes in the app per day. One of the ways it keeps people in the app is by not allowing users to post links in photo comments. When it introduced advertisements, it kept the same restrictions on sponsored posts.

Instagram is ready to lift those restrictions with its newly announced direct-response advertisements. These posts include a button with a specific call to action, which will attract a group of businesses outside of brand advertisers.

At a recent JPMorgan conference, Facebook exec Carolyn Everson noted that the line between brand advertisers and direct-response advertisers is blurring. After all, big brands want to drive direct responses just the same as a small online business. Investors should expect big brands to adopt these direct-response ads, and it's likely they'll pay a premium for that little call-to-action button.

Targeting those most primed to buy
Introducing advertisements with a specific call to action is one thing, but getting those posts in front of the audience most likely to respond to those calls is another. By leaning on Facebook, Instagram will enable businesses to target users beyond the basic gender and location data it previously limited businesses to.

Many Instagram users are also on Facebook, where the social network is able to gather lots of demographic details. Facebook has some of the best targeting capabilities of any online ad platform due to the amount of time users spend on the platform feeding it information.

Meanwhile, Instagram's interest graph remains an untapped treasure trove of data. Unlike Facebook, where the social graph is made up of personal connections, Instagram's social graph is based largely on passions and interests. Those data make for a much stronger signal for targeting advertisements.

If Instagram is going to grow direct-response advertising, it wants to show those ads to the users most likely to respond well to those ads. Comparatively, brand advertising requires much less targeting.

Scaling the ad business
With those two advertising features in place, Instagram needs a path to scale its ad business. For the first 500 campaigns or so, CEO Kevin Systrom checked every post before sending it out into the wild. It doesn't take a genius to know that system doesn't scale.

To fix that, Instagram is developing an API to make it easy for businesses to purchase ads. Facebook will also integrate Instagram advertisements into its ad buying interface. That means the 2 million businesses advertising on Facebook may soon have access to ad inventory on Instagram.

With access to that huge base of advertisers, providing familiar ad units and targeting capabilities means Instagram users should see a lot more ads in the near future. The good news is that Facebook's and Instagram's targeting data should make them at least somewhat appealing. Oh, and if you invest in Facebook, the sight of an ad in Instagram should make you smile, because you get a share of every dollar the company makes.