The increased adoption of smartphones is making location-based business ideas very popular right now. One player in the space — Foursquare — has gotten attention this week for its ability to help advertisers turn location data into dollars.

Foursquare is a location-based social networking app. I’m a user — and friend of the creators Dennis Crowley and Naveen Selvadurai. This week I found myself in the middle of Foursquare’s business potential after I had dinner at Supper with my friend Michael Galpert.

We “checked in” on Foursquare and an hour later, his friend Charlie asked what he should order there. We recommended the spinach gnocchi.* Charlie took our advice. And then wrote about the potential of Foursquare for advertisers on his blog.

Charlie O’Donnell is also the CEO of Path101, an advice service that helps people figure out what’s next in their careers. His post, “Why Yelp (…and Every Single Retail Establishment) Should Support Foursquare,” caught the eye of TechCrunch and Fred Wilson of Union Square Ventures.

Foursquare currently doesn’t have any ads, but I caught up with O’Donnell to see why he thinks the app has so much potential for advertisers and why Yelp should be all over it right now.

Why didn’t you like Foursquare when it launched?
At first, I thought of Foursquare as this neat mobile app that was all about a social competition — something I was totally uninterested in. I didn’t feel the need to win anything or go out the most. But what I realized is that it’s got both a mobile specific use for the consumer and a use for the retailer that really brings  alot of value to both sides.

A bunch of people have attempted stuff like that. The Socialite guys did place tagging and it was about leaving messages for other people. But one of the hard things about mobile when you tie things together and make them social. When you’re doing things in real time — geolocation and stuff — you need critical mass. 

But people haven’t really been able to figure out what the selfish use of this stuff that an individual could use. You could be the only user on foursquare. And it still works.

How is Foursquare different than its precursor Dodgeball?
Dodgeball relied too heavily on needing that critical mass of users. Nothing hapened on Dodgeball unless someone was also out using it. There are two things being solved here. One is they figured out how the service can give you benefits if you’re just checking in on your own. Two, now you have all these other social networks to leverage. Now I’m not just telling my Dodgeball friends, but I’m telling my Twitter and Facebook friends using Foursquare.

How important are location sensitive mobile apps going to be for advertising?

A lot of the mobile apps out there are just kind of extensions of the web product. They’re not there yet. They’re enthralled with the idea of where you are, but they’re not feeding the real time data back into the application. If you’re using your Yelp app, there’s useful data. You are somewhere right at that moment. Yelp should be building a whole advertising play around that. Stores should get areal time notification or have some automatic setting to give coupons.

If i’m Yelp, I would buy Foursquare yesterday. I don’t think Yelp would do that, or that they would sell. I think they want to let this thing ride and actually build the company.

How are ads going to go mobile? What about mobile couponing?
I think it would be annoying if in the process of taking a six block walk I got six new text messages. The thing I think will matter is building relationships about stores and places you really have an affinity for.  The biggest opportunity in mobile for apps is not necessarily to bringing a new cusomter in, but in continuing to engage the most loyal customers. For a retailer, if you can get your most loyal customer base coming in one extra time a week, there’s positive ROI on that.

Why do you think a company like Foursquare captures “the holy grail of the advertising world”?
It’s the missing piece of the offline puzzle. It’s much more clear for ecommerce retailers — how to get traffic. You buy keywords. Some of them convert, some don’t. You can literally buy traffic and bring people in. If you’re an offline store, how the hell do you buy traffic? You can place things in papers and get them online, but at the end of the day, you never know whether someone came in the door because of your ad.

I don’t know whether Foursquare will do their own advertising, where you’re buying traffic on Foursquare. But I think there’s a business in providing the data to other people.

After you wrote your post, Fred Wilson wrote about Foursquare and started using it. Is that how venture capitalists get involved in projects?

Venture capitalists are hilarious, and very frustrating for startups. They are momentum players and pattern matchers. If something is generating a buzz, they want to know about it. Fred’s actually written about this before: ‘If I hear something once, maybe I’ll pay attention. If I hear it three times, clearly I should take a meeting.’

It really is hard to figure out where a business is going. What you invest in compared to what a company is when you exit is like a looking at a sonogram and trying to pick out what color hair the kid’s going to have.

So, how was the spinach gnocchi?
We wound up sharing. We got the spinach gnocci and a seafood plate special, sort of a pasta fra diablo. It was definitely pretty good.

*It’s amazing. And due to a lapse in Supper’s liquor license, it’s easier to get a table at the restaurant through the end of July.