How Facebook Gave Birth to an Industry

Scrabulous and the New Social Operating System: How Facebook Gave Birth to an Industry

Published: January 23, 2008 in Knowledge@Wharton

Most industries do not begin on a single day, but it’s easy to see
Facebook CEO Mark Zuckerberg’s presentation on May 24, 2007, as the
starting gun in an entrepreneurial race that some have dubbed "the
Facebook Economy."

On that day in May, Zuckerberg announced that the privately held
social networking site he founded in 2004 would open to third-party
developers, transforming itself from a popular website to a platform on
which other businesses can operate. Eight months later, more than
14,000 applications from third-party developers are live on Facebook,
allowing users to do everything from flirt to browse for books. The
most successful are raking in profits from ad revenues.

Is Facebook becoming the social operating system of the Internet,
poised to support a whole new generation of businesses? Or is this new
industry of applications leaning too heavily on the quixotic popularity
of a single website? Industry leaders and Wharton experts see major
opportunities ahead for those who can manage the risks.

"There’s no question that social networking platforms will be the
basis for a great deal of innovation and business opportunity," says Kevin Werbach,
professor of legal studies and business ethics at Wharton. "What’s not
clear yet is whether there will be one or two dominant players. It’s a
very dynamic environment."

For the moment, however, Facebook is "king of the hill" as a social networking platform and will be for some time, according to Peter Fader,
a Wharton marketing professor. While MySpace is bigger, currently the
third-most-popular site in the U.S., compared to Facebook’s rank of
fifth, it has not yet opened to third-party developers (although owner
Rupert Murdoch has announced intentions to do so). "Facebook is like
the QWERTY keyboard: There’s nothing particularly special about it, but
it came along at the right time and place. At some point that standard
just becomes locked in," says Fader.

What makes Facebook attractive as a platform for businesses is
obvious, says Kendall Whitehouse, senior director of IT for Wharton.
"It brings in this huge audience from the get-go and you have a
built-in infrastructure [for online interactions], so you get the
network effect in spades." The payoff for Facebook? Rich interactive
content that keeps eyeballs on the site, and an entire world of
developers competing with each other to create newer and better
applications, says Whitehouse.  

With the floodgates now open to developers of every stripe, from
Facebook-addicted teenagers to major public companies, Fader says
entrepreneurial excitement is reaching a fever pitch. Judging from
interest among his students, he jokes, Facebook entrepreneurism could
be "a stand-alone major" at business schools. "Many of them aren’t even
thinking of making money. Facebook is just where they spend so much of
their lives already, and now they have a chance to play on it
themselves."

But such enthusiast-entrepreneurs are just one group climbing onto
the Facebook platform, says Fader. For already established companies,
making a Facebook application is a way to "stand up on a mountaintop
and shout." In that category are applications tied into real-life
products, like the popular game "Parking Wars" created by A&E
Television Networks to advertise a new series about the Philadelphia
Parking Authority. This "advergame" allows Facebook users to "park"
cars on one another’s profiles and earn virtual cash by ticketing
illegally parked vehicles.

There’s no doubt that Facebook’s platform, known as "f8", has
spawned a fledgling industry, says Fader. "I’m only surprised it’s
taken so long." But with many start-ups focused entirely on Facebook,
Fader sees potential downsides. "Being based 100% on Facebook is very
risky, because social networks are inherently unstable. Five years ago,
we would have been talking about Friendster." Still, he says the market
is vibrant enough now to at least "give businesses a start."

Two Brothers and a Board Game

Jayant and Rajat Agarwalla are typical in many ways of Facebook
entrepreneurs. The Kolkata, India-based brothers first created a
website for playing an online version of the word game Scrabble several
years ago "just for the love of the game," says Jayant, 21, who also
runs an offshore web development firm with his brother. The website
attracted about 3,000 regular players. When an American user suggested
the brothers launch a Facebook version of the game, they spent 10 days
cooking up the application and then launched it in July 2007.

With this small investment, the brothers were suddenly owners of one
of Facebook’s biggest hits: Scrabulous. As of late January 2008, more
than half-a-million Facebook users play Scrabulous daily, with four
times that number having added the application to their Facebook
profiles. Because third-party developers can keep all the revenue they
generate, the Agarwallas are currently pulling in about $25,000 a month
from advertising, according to Jayant, resulting in a "decent profit"
after expenses like hosting, labor and server costs. 

But the Agarwalla brothers may become victims of their own success:
In mid-January, Pawtucket, Rhode Island-based Hasbro, which holds the
Scrabble trademark in the U.S. and Canada, asked Facebook to remove
Scrabulous because of copyright infringement. "We have spent many years
building the Scrabble brand, and what Scrabulous is doing is piracy,"
reads an official Hasbro statement. "We … hope to find an amicable
solution. If we cannot come to one quickly, we will be forced to close
down the illegal online game."

The Agarwallas’ entrée into viral superstardom demonstrates the
business opportunities inherent in the Facebook platform, according to
Wharton’s Whitehouse. Launching an online application is "not like
cranking up a manufacturing plant," he says. "The barriers to entry,
while not trivial, are relatively low — basically the cost of a clever
programmer’s time." The Agarwallas’ seemingly accidental success is
actually a common pattern, he adds. "Often developers create their
first application without any immediate plans for revenue generation.
If it doesn’t take off, it doesn’t matter, because they didn’t expect
to make any money. If it does take off, they can then figure out how to
generate revenue." Such a nothing-to-lose strategy is less appealing
for major businesses. "The lone programmer has a different set of
incentives for making his work available for free. An established
company, with a responsibility to its shareholders, will probably take
a more measured path."

In August 2007, Hasbro sold the digital rights to Scrabble and other
games to the Redwood City, Calif.-based online gaming giant Electronic
Arts (EA). The following month, EA launched a version of Scrabble for
mobile phones. Technology reviewers gave the game a thumbs-up except
for one potentially fatal flaw: Users can only play with one another by
physically passing the phone back and forth between them.

Hasbro does have online multiplayer games. Users can download
Monopoly, another Hasbro board game, for $19.95, but playing with
friends is only possible if they buy the game as well.

Both attempts at digital board-gaming demonstrate how Scrabulous
filled a niche by drawing on Facebook’s greatest asset, what Zuckerberg
calls "the social graph," the links between users and their friends.
Scrabulous makes it possible, for example, to recreate a big family
game of Scrabble, even when family members are scattered around the
world (assuming, of course, that all family members are tech-savvy
enough to maintain a Facebook account). Because Scrabulous games can be
saved and played out over weeks or months, they allow for what
new-media entrepreneur Rodney Rumford calls "short bursts of
interaction."

"I know so many venture capitalists and CEOs who play Scrabulous.
It’s a new form of golf. Maybe you don’t have time to play nine holes,
but you can socially interact and challenge one another via
Scrabulous," says Rumford, CEO of the Solana Beach, Calif.-based
Gravitational Media and publisher of Facereviews.com, a review site for
Facebook applications.  

"Scrabulous has created value for the product in a way Hasbro would
have never thought of doing," says Wharton’s Fader. "Hasbro’s challenge
is to call off the lawyers, do better business development and come up
with an online version of the game people will like even better. If
people are playing more Scrabble, they should figure out how to tap
into that."  

Karl Savage, whose Facebook photo describes him as "the unelected,
unofficial radio spokesperson for the Save Scrabulous Campaign," was
asked during a BBC radio interview last week whether he would play a
Hasbro-created online Scrabble game if Scrabulous were shut down.  "The
main selling feature of Scrabulous for me is the fact I can play it
within Facebook. If it was on an external site, I would have to search
for my friends all over again, and I don’t think that would work, and I
don’t think people would sign up for it." 

Online Dating and Greeting Cards

Because the majority of Facebook application developers are
individuals or small companies, major companies "who are used to hiring
ad agencies with $100 million budgets are only now just beginning to
work with microdevelopers," says Rumford. A few major brands have made
it big on Facebook, like Red Bull, the energy drink produced by
Austria-based Red Bull GmbH, whose Facebook application "Roshambull"
offers an online version of the classic children’s game
"Rock-Scissors-Paper."

But many more major brands may be falling behind. Rumford’s
Gravitational Media launched a greeting card application on Facebook as
a lab experiment, to give its programmers a chance to play around with
the f8 platform. "We didn’t intend to make any money on it, but now
we’re beating out Hallmark’s application by 10 to one," says Rumford.
On a recent day, Gravitational Media’s "Cool Greeting Cards" had 2,015
active daily users compared to 205 at "Hallmark eCards."

Online dating is another area where big players are lagging. Like
the Agarwalla brothers before the f8 launch, Cliff Lerner ran a
website, in his case called Iamfreetonight.com, an online dating site
owned by the Manhattan-based eTwine Holdings. After the Zuckerberg
announcement in May, Lerner recalls, "We decided to stop working on
Iamfreetonight.com for a couple of weeks in order to write a dating
application for Facebook." The result was an application called "Meet
New People." "In no time we had more users on the app than we had on
the website. And we didn’t spend a dime on advertising the app — it
was all viral."

Lerner’s company has since launched an even more popular
application, "Are You Interested?" which allows users to find and
express interest in other available singles. The application recently
had about 600,000 daily active users. Lerner’s company has now changed
its name to SNAP Interactive and is preparing to shut down its
stand-alone dating website and concentrate full-time on developing
Facebook applications.

In comparison, two of the dominant players in online dating —
eHarmony.com and Match.com — had Facebook applications with 48 daily
active users between them on a recent day. And it’s not just on
Facebook where the online-dating incumbents are losing out. According
to comScore, a web analysis firm based in Reston, Va., traffic to
stand-alone sites like eHarmony.com and Match.com fell 21% and 16%,
respectively, between 2006 and 2007. Industry observers partly blame
the allure of dating opportunities on free social networking sites like
Facebook.

Scaling an Industry

Lerner’s SNAP Interactive receives extra attention in the Facebook
business world because it is one of the few publicly held
application-development companies. Its preliminary earnings report for
the final quarter of 2007 showed revenues of $388,000 — a more than
10-fold increase over third-quarter revenues.

In spite of such tremendous growth for application superstars,
including the San Francisco-based Slide and San Mateo-based RockYou,
Wharton’s Werbach asks whether the Facebook economy will remain on a
micro-level for some time to come. "If you are starting a business that
needs only a small revenue stream to support a few people, you can do
that on Facebook, but to build a business that would become a public
company, valuable enough to be a major acquisition — it’s not clear
today there is enough opportunity," says Werbach, founder of the
Supernova technology conference.

Other questions about the relevance of applications come from
Facebook users themselves. Because applications constantly prompt or
even require users to invite others, they can lead to a seemingly
constant stream of requests from Facebook "friends". One wants to
compare movie tastes with you; another challenges you to a game of
Texas Hold’Em; a third invites you and a hundred other people to watch
a random video. Some Facebook users have begun to protest such
"friend-spam."

But Rumford, of Gravitational Media, says he’s confident the free
hand of the Facebook market will separate flash-in-the-pan applications
from the truly useful — and in spite of the proliferation of
applications, he asserts there is plenty of room for more. "The
low-hanging fruit has been picked, but a whole bunch of niches has yet
to be filled."

Those bullish on the Facebook market predict that people will
conduct more and more of their online lives through social networking
venues like Facebook. Styky Phonebook, an application developed by a
Wharton undergraduate, for example, allows users to save and
synchronize cell phone address books on Facebook pages. Other
applications let users import their music libraries or feed in streams
of content from outside blogs. And with Facebook planning to launch its
own payment system, users will soon be able to shop online without ever
leaving the cozy blue-and-white confines of their profile pages.

"The apps currently on Facebook only scratch the surface of what’s
possible," writes Salil Deshpande of the Menlo Park, Calif.-based Bay
Partners venture-capital firm in an e-mail. Deshpande, together with
colleague Angela Strange, created AppFactory, a fast-track venture
capital fund targeted solely at Facebook application developers.
According to Deshpande, the fund has received several hundred
applications and has funded six ventures, all with investments between
$25,000 and $250,000.

Deshpande says it is fair to ask whether a healthy industry can grow
from a single website, but writes that AppFactory’s vision "does not
require Facebook’s dominance. Social platforms are here to stay."

One key to scaling up the industry is "interoperability" among
social platforms, says Wharton’s Werbach. With Facebook taking the
lead, industry participants like Deshpande called on other social
networks to make their platforms compatible with Facebook’s so that
developers can deploy their applications on multiple platforms with a
few clicks.

Deshpande says he sees "momentum" in that direction. In early
December 2007, for example, the popular social network Bebo announced
an open application platform that works easily with Facebook
applications. One month earlier, Google launched OpenSocial, a
standardized applications platform which gained the support of most of
the major social networking sites, except Facebook. Such compatibility
may be essential for application developers to break into non-U.S.
markets where Facebook is a less-known quantity.

For the moment, however, Wharton’s Fader sees Facebook commanding a
mass market in a way traditional forms of media no longer do. "Even TV
does not have the same level of engagement. Right now, Facebook is
unique."

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