(FORTUNE Magazine) – Viral marketing: It sounds like a disease, but FORTUNE 500 companies are beginning to believe this Internet strategy could be the cure for their banner-ad woes. It's inexpensive and potent, and marketers are now using it to sell everything from shampoo to phone services. Ideally it works like this: Marketing messages spread like the flu, passed by word of mouth from one friend to another to five more, until there's a full-blown epidemic and products are flying off the shelves.

Netheads and dot-coms have been viral-marketing believers for years. Consider the well-documented success of free e-mail service Hotmail. When its creators approached venture capitalist Tim Draper in 1996, he suggested a way to advertise the service cheaply: "I said, Why not put a message at the bottom of each e-mail that says, GET YOUR FREE E-MAIL AT HOTMAIL.COM?" Draper recalls. "It spread to 11 million users in 18 months--with no other advertising."

Strong--not to mention virtually free--stuff. "If you do this right, it can really work," says Seth Godin, author of the viral-marketing manifesto Unleashing the Ideavirus. That's especially true for a service like Hotmail, which is predicated on information's passing from one user to the next. A viral component is built into its DNA. Mainstream companies have to work harder to make viral marketing work for them. They have to get the execution down cold, and they must do more to persuade their perhaps stodgier consumers to do their marketing for them. Most FORTUNE 500 companies working on viral campaigns say their efforts are still in the laboratory stage. But they have learned one basic principle: They must give people an incentive to pass their message on. Here's what the early adapters are giving away to get their word out.

DISCOUNTS. "Gentle, subtle bribery can accelerate an idea virus," says Godin. That's what AT&T Wireless San Francisco figured when it sent e-mail to college students. The company offered them a discounted cell phone, a calling plan with many free features, and a $25 credit on their bill for each referral who signs up with AT&T Wireless (up to a limit of five). Their friends get the same offer. Julie Anderson, who managed the campaign for AT&T Wireless, likes the tool because it allows her to track results. "If I put an ad on the television, I couldn't tell you exactly who saw it and responded," she says. "With e-mail you can. It enables you to spend your marketing dollars more effectively." The tracking showed that the campaign didn't work as well as the company had hoped. Students did pass on the message, but not enough of their friends actually registered for the phone service. But Anderson hasn't lost faith in the method: The company is now using that information to hone the technique.

FREE MERCHANDISE. Refer ten friends to the Website for Procter & Gamble's new Physique shampoo, and you'll get a free, travel-sized styling spray and be entered in a sweepstakes to win a year's supply of the shampoo. "This has generated two million referrals," says Tom Millikin, a P&G spokesman. And the shampoo is selling: In terms of revenue, P&G says Physique is the most successful shampoo ever launched in the U.S.

THE CACHET OF BEING A TREND SPOTTER. Part of the appeal of the Internet is all the outrageous stuff out there. When you find something really cool, you want to share it with your friends. Lee tapped into that impulse to generate buzz for its jeans. Lee built a promotion around its mascot, Buddy Lee, who looks like a kewpie doll in blue jeans. There were Buddy Lee for President Websites that looked as if they had been built by amateur kooks. There were fake home pages for Buddy's foes, including a cheesy racecar driver called Curry, with photos, testimonials, and a video of Curry seductively rubbing his chest hair. Lee's target audience, 17- to 24-year-olds, was supposed to stumble across the Websites and pass them on to friends. "At that age they don't trust advertising; they like to think they've discovered something for themselves," says Nancy McDonald, who manages interactive communications for Lee. At least one indicator shows that the creative deception worked: During the Buddy Lee for President campaign, sales of Lee jeans at Sears jumped 125%.

Not every company is so gung-ho about viral marketing. The strategy can backfire, particularly if customers think their privacy is threatened. Last March the Swedish furniture chain IKEA canceled a viral campaign that offered customers discount coupons if they passed on e-mail postcards announcing the opening of a new store in Emeryville, Calif. "In a naive, simple way, we thought, Wouldn't it be nice to use old-fashioned word of mouth, where I send it to you, and you send it to friends?" says Rich D'Amico, manager for new-business development at IKEA. "Most people loved it. But some contacted us and said, This is like spamming." IKEA had no intention of adding the addresses to its database, D'Amico says, but the fear was out there, and that was enough to make him abort the campaign. He's not eager to try viral marketing again.

Consumers also may rebel once they wise up to the origins of a fake Website. Lee's McDonald insists that her young audience didn't mind when it discovered that Curry was a corporate plant, not a real, live self-promoting sleazeball. "Once they realize they've been had," McDonald says, "they love you for it." Perhaps, but there is certainly the danger that the technique will lose its novelty, like forwarding too many e-mail jokes. (How many chest-rubbing racecar drivers do you really want to see?)

Even if a brick-and-mortar outfit gets all the details right, it may find that viral marketing is just too off-point to deliver the customers. Viral guru Godin is skeptical that mainstream companies can succeed the same way Hotmail did: "You have to build a business around this idea instead of using it as an afterthought," he says. "Maybe some people will pull it off and prove me wrong, but I think products that aren't engineered at the genetic level to be a virus will have disappointing results with viral marketing."

For now, big-company marketers, who are looking for any good alternative to Web-page banner ads, are paying little heed to such words of caution. Certainly, adopting the method with great abandon will cause some spectacular flameouts (and some really irritating e-mails). But the few who manage to pull it off will tap into the most promising Internet marketing strategy discovered so far.

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