The Facebook economy

The Facebook economy

The
No. 2 social network is fast evolving into a new kind of software
platform – and the race is on to figure out how to turn users’ every
move into dollars for enterprising developers.

By Lindsay Blakely and Michael V. Copeland, Business 2.0 Magazine



(Business
2.0 Magazine) — Talk about a killer app. Two years ago Jia Shen and
Lance Tokuda wrote, just for fun, a goofy Web application for MySpace
that could turn anyone’s photos into live-action slide shows. It
succeeded – horribly. Within days of its launch, hordes of users at the
then-superhot social network discovered the app, added it to their
profiles, and communicated it to their friends. It spread like a case
of Ebola at the Super Bowl. Within a month Shen and Tokuda had 100,000
users, and traffic was doubling every 24 hours.

The servers –
those digital canaries in the mine shaft – crashed, and crashed again.
"It was crazy," Shen says. "We were down 17 of the first 30 days." Then
it got worse. With traffic peaking at 1.5 million users, server costs
topped $20,000 a month. And there was no way to monetize their
creation.

facebook_morin.03.jpg
The gatekeeper: Facebook platform manager Morin is busy keeping tabs on more than 2,500 applications.

graffiti.03.jpg
Drawing power: Kantor (center) and brothers Tim and Ted Suzman turned to advertising to monetize Graffiti’s 5.9 million users.

food_fight.03.jpg
Mini moguls: Goldstein and partner David Gentzel run SocialMedia, one of the biggest startups dedicated to Facebook apps.

Still,
they soldiered on for more than a year, keeping afloat with tens of
thousands of dollars in loans while hoping to figure out a way to turn
their enormous fan base into a brilliant business. It never happened –
at least not on MySpace.

This spring, however, Shen and Tokuda
spent a few days porting their MySpace hit over to Facebook. The
upstart social network began as a hangout for high school and college
students and last September allowed anyone to join.

Eight
months later, Facebook did something MySpace still hasn’t done: It
opened up its network to developers and made it easy for them to make
money from their applications. Which is exactly what Shen and Tokuda
did when they rewrote their app and let it loose on Facebook.

Two
months later, the duo had generated more than $200,000 in ad revenue.
By late July they had 14 other apps up and running, with more than 22
million users. "When we started, we had no idea what we were doing,"
Shen says. "Now we have a whole suite of applications, and that’s where
our power is."

It’s an increasingly common tale as the Facebook
economy picks up steam. In just 10 weeks, hundreds of developers
launched more than 2,500 new applications, triggering 139 million
downloads. While a possible Facebook IPO or acquisition could change
things overnight, for the moment it’s a free-for-all.

The apps
have names like FoodFight, Zombies, (fluff)Friends, and Fortune Cookie,
and they let users indulge in everything from scrawling graffiti and
sending virtual cocktails to buying music, brokering loans, and joining
charitable causes – usually without leaving their Facebook homepages.
Some apps have attracted hundreds of thousands of users, and a select
few have pulled in millions.

One venture capital firm, Sand
Hill Road-based Bay Partners, has set aside more than $12 million to
bootstrap 50 new Facebook applications. "The current apps only scratch
the surface of what is possible," says Salil Deshpande, a partner at
the firm. "We’re looking for much more sophisticated applications that
can make money."


Developers like Shen have
already proven how to use Facebook – and other social networks – to
pull in a mass audience. But figuring out how to profit from those
viral applications is another matter. So far, most of the revenue from
Facebook apps comes from fairly primitive forms of advertising, such as
Google (Charts, Fortune 500)
AdSense. Yet a few developers are building applications to sell real
and virtual goods. And others think they’ll be able to charge major
brands for access to the highly targeted Facebook crowds they’ve
started to assemble. "We intend to build a giant company on top of
these social operating systems," says Slide CEO Max Levchin, who’s
already made one fortune as a co-founder of PayPal. His startup
specializes in photo slide shows that pull in more than 129 million
users a month. "It’s an opportunity for all of us to build the next
Electronic Arts, Intuit, or Adobe."

The Facebook economy was
born one afternoon in May, when the insouciant boy hero of social
networking, Facebook CEO Mark Zuckerberg, told a crowd of developers in
San Francisco what they had been dying to hear: that hackers deserve a
real piece of the action in a market with ad revenue alone approaching
$1 billion.

"Right now, social networks are closed platforms,"
Zuckerberg told the assembled entrepreneurs. "Today we are going to end
that." That day Facebook began allowing programmers like Shen to build
as many apps for Facebook’s 32 million users as they could dream up –
and to pocket whatever money they made doing it, with Facebook
providing access to both the audience and the programming tools needed
to draw them in.

Programmers talk about Zuckerberg and Facebook in the same terms they once used to describe Bill Gates and Microsoft (Charts, Fortune 500),
so great are the power that social networks wield and the perceived
stranglehold Facebook has on its growing audience. MySpace, by far the
largest of these networks, with more than 100 million users, was the
first to see them as software platforms, allowing users to customize
their profiles by adding simple apps. But when it came to sharing
revenue, MySpace held its cards close to its chest: it would quietly
permit developers to make money only when their users left the MySpace
network.

Zuckerberg has turned the MySpace business model upside
down: Not only is he giving developers their own real estate within
Facebook – both inside users’ profile pages and on piggybacked
application pages – but he’s allowing them to make money from their
apps any way they can, from ad sales to direct purchases of services
and merchandise. For example, download iLike, an app that lets you
sample and purchase music, and the developer gets a 5 percent kickback
if you end up buying songs from iTunes or Amazon.com (Charts, Fortune 500).

To
incentivize developers, Facebook is also breaking ranks with rivals by
sharing crucial data – such as a user’s age, interests, and friends –
that enables more sophisticated applications. Zuckerberg also set up a
speedy approval process that allows most programmers to load their apps
into the network in a matter of days.

Josh Kopelman, a
Philadelphia-based venture capitalist and investor in such startups as
LinkedIn and Yapta, sees more users coming Facebook’s way (ComScore
reports Facebook grew 270 percent last year, while MySpace grew 72
percent) – and even more developers. "If you were a venture-backed Web
startup," Kopelman says, "and had to decide whether to focus on a site
that welcomed you in and let you keep 100 percent of the revenue you
generate, vs. a site with a vague policy that doesn’t let you generate
any revenue, it’s not even a decision. It’s an IQ test."


The real IQ test, of
course, is figuring out how to create an app that takes off and makes
money. So what defines a killer Facebook app? Senior platform manager
Dave Morin says the stickiest applications are those that tap into the
"social graph." That’s Zuckerberg’s oft-quoted term for the web of
connections between users and their friends. "Most apps are only
interesting if there is much more content below that widget," Morin
says. "It needs to take you someplace different, do something more."

Morin’s
favorite example is (fluff)Friends, which lets the user place a cartoon
image of a penguin, pig, squirrel, radish, or other cute object on his
or her profile page. People can pet it, buy a habitat for it (with fake
dollars), even buy a real T-shirt (with real dollars) bearing the
virtual pet’s image. That’s all pretty standard stuff these days.

But
this app’s clever twist, Morin says, is the way it gets you to reach
out to your friends. First you adopt a pet and invite your friends to
pet or feed it. Then you pet their pets, or see all the pets that your
friends have adopted within Facebook – all while racking up virtual
currency to engage in more (fluff)Friend silliness. "I call it
interaction capital," Morin says. "The more users interact with the
application, the more virtual credit they get." And if they sell a lot
of T-shirts or advertising, that’s more cash in the (fluff)Friends
creators’ pockets. The app cleared 1 million downloads after just seven
weeks and now adds more than 10,000 new users a day.

There’s a
science to achieving perfect viral alchemy, and it’s getting more
sophisticated by the day. One place every Facebook developer frequents
is Appaholic.com. Created by San Francisco-based programmer Jesse
Farmer, Appaholic breaks down Facebook applications by popularity,
growth rate, and even "virality," as measured by growth in a single
day. On a recent day, Farmer ticked off the leading app in each
category: Top Friends, a Slide application that lets you rank your
friends; Griddle, a word game; and What’s My Chinese Name?

Appaholic
has developers glued to the site’s analytic tools, looking for secrets
that reveal what makes one app soar and another tank. When a new
feature suddenly boosts an application’s number of users, "you quickly
see other developers rolling out similar features," says Paul McKellar,
the San Francisco-based programmer behind the hit app SocialMoth, with
more than 400,000 users. "You have to, if you want to keep up."

In
the short time since the new Facebook platform went live, Farmer has
already spotted a few telltale patterns. One attribute that’s death to
an app, he says, is complexity. Facebook and all its homegrown
applications are relatively simple; those who create something that
requires too much thought or explanation quickly run into trouble.

Farmer
learned the hard way: Bookshelf, an application he helped develop, lets
you list, share, and search your books, movies, music, and games. It
went nowhere. "We were decimated by applications that didn’t do nearly
as much, that were far simpler, like iRead," Farmer says. "Within a
week they were 10 times our size. Any application that is more
complicated than the most complicated feature in the core of Facebook
will be penalized."

Applications that augment or mimic existing
features on Facebook – such as the wall (a space for writing messages)
or a poke (a way for friends to say a quick hello) – are also more
likely to take off. And those that stumble on even the smallest bug are
likely to become roadkill. Matches, a flirting application, fell into a
hole when a time-out bug, a Facebook glitch, stopped the app in its
tracks. In the week it took to fix it, Matches lost about 100,000 users
and ceded the category to a rival called Crushes. The lesson, Farmer
says, is "users don’t care why it doesn’t work or whose fault it is.
They will leave and probably not come back."


Armed with those sorts of
insights, some startups are positioning themselves as Facebook app
factories. "Netscape browsed the Web, Yahoo organized it, Google
searched it, and now Facebook has made it social," says Seth Goldstein,
co-founder of SocialMedia, a small shop in Mill Valley, Calif., that’s
already turned out such Facebook hits as FoodFight (throw a virtual
lobster at your buddy) and Happyhour (send that buddy a cocktail). How
does he plan to cash in on all those widgets?

At the moment,
advertising opportunities are unproven – which is why Goldstein is
leaning toward sponsorship as a simpler path to profits. FoodFight,
Goldstein says, is an ideal mechanism for food companies to market
themselves. Instead of throwing a chicken drumstick at a friend, a user
could throw, say, a drumstick sponsored by Tyson Foods. "I had an ad
agency representing a buffalo wings chain approach us with an $80,000
ad buy," Goldstein says. "It’s starting to happen."

Shen and
Tokuda’s outfit, meanwhile, has become a lot more than a slide show.
The company, now called RockYou, has more than $10 million in venture
funding, more than a dozen developers, and one of the largest
portfolios of applications. Its 15 apps include Horoscopes, Emote
(icons for your status box), and Glitter Text (sparkly fonts). This
time around, the revenue model is getting as much attention as the
code. In late July the startup launched its own advertising network:
RockYou is offering its user base and Facebook pages as a way for
advertisers and other developers to reach more users. "We don’t know
which approach is going to work best yet," Shen says, "so we’re trying
them all."

So is San Francisco-based Slide, which has 12
Facebook apps and a growing audience to offer advertisers. Slide is
also launching an ad network that will let advertisers brand its apps.
CEO Levchin thinks that because users volunteer their ages, interests,
locations, and other specific personal information, Facebook has the
potential to be the best ad platform on the Web. "Until recently,
Facebook had all of this ad inventory to itself," Levchin says. "Now
it’s saying, ‘Go nuts. Sell it any way you want.’"

Not everyone
is drinking the Kool-Aid. Andrew Chen, an entrepreneur-in-residence at
Mohr Davidow Ventures, thinks the revenue opportunity is still
unproven. "The question is whether large-brand advertisers will feel
like it’s a good idea to buy space on still relatively small pieces of
real estate," Chen says. "I would imagine they’d want to deal directly
with Facebook." The company, after all, already generates an estimated
$150 million in ad revenue on its own.

Developers face other
risks: Should Facebook go public or get acquired – as has been widely
rumored – new circumstances could force Zuckerberg to give up his
share-the-love revenue model and keep more of it in-house. The company
might also rip a page from the Gates playbook and launch its own
versions of the most popular applications. Or Zuckerberg could kick
everyone out and go home.

As a hedge, developers aren’t
limiting themselves to one platform. Bebo, LinkedIn, MySpace, and
several other large social networks have signaled in recent months that
they will likely follow Zuckerberg’s footsteps. "They will all open
up," says Charlene Li, a marketing analyst at Forrester Research. "It’s
inevitable." MySpace, for its part, is said to be working on
substantial changes to its platform. While company officials declined
to respond to specific questions about its plans, they did say their
goal is to work more closely with outside developers.

Anticipating
that day, Palo Alto-based Box.net, which sells online storage and
sharing, recently created a Facebook app for its service and a
subscription package for Facebook users. But that doesn’t mean the
startup won’t be showing up on other networks when their doors open.
While the networks all have different software protocols, the apps are
small, and the time and effort required to retool one for, say,
LinkedIn or MySpace doesn’t scare developers. "Facebook has done the
best job opening up," says Box.net CEO Aaron Levie. "But we are not
about building a business on any particular platform."

For
folks like McKellar, though, simply owning a few Facebook apps is just
fine. He has yet to make any real money from SocialMoth, but he’s
willing to fork out $500 a month in server costs just to hold on to his
audience in the hope that he’ll figure out a revenue model soon enough.
"I go where the users are, and where they make it easy for me,"
McKellar says. "Right now, that’s Facebook."

Four ways to make money

1: Sell ads

The play

Just
about any Facebook app can get into the ad game, but only those with
the biggest audiences will earn serious money. Several easy-to-use ad
networks are already delivering the ads for a cut of overall sales.(See
"Tools," below.)

The front-runners

Graffiti (5.9 million users). This highly viral drawing tool spread quickly because of its simplicity and originality.

iLike (5.4 million users). Users can set up their music and video libraries in mere minutes.

The Simpsons Photos, Quotes, and Trivia (60,000 users). Pearls of wisdom from the first family of Springfield.

The payoff

Apps
currently generate less than $1 for every 1,000 pageviews. But that
amount will likely increase as demographic targeting becomes more
refined and the ad models move from simply racking up pageviews to
measuring users’ engagement.

Tricks of the trade

1.
Establish your base. Hold off on serving ads until you have at least
10,000 users. Bombarding users with too much advertising can scare them
away and hurt your growth in the long run.

2. Test different ad
networks. Putting up ads is a simple cut-and-paste operation, so you
can afford to be choosy and pick the network that gives you the best
deal.

3. Don’t clutter up app pages. "This is definitely a
challenge for developers," says Mark Kantor, one of three developers
behind Graffiti. "The most important thing is to preserve user
experience."

4. Renegotiate as you grow. Demand a bigger cut of
the revenue share as your traffic jumps. Says Kantor, "It might be
better to go with a small ad network if you think you’ll stand out."

Tools

Dozens of ad networks are cropping up to serve the Facebook developers. Here are a few.

1.
Lookery (lookery.com). This new Facebook-specific ad network aims to
offer developers demographic profiles of their user bases. More
targeted advertising could soon fetch a higher price.

2.
Userplane (userplane.com). AOL-owned Userplane pays per minute of
exposure rather than just per pageview, so it’s good for applications
like games that keep users highly engaged.

3. Google AdSense. Not new, but many developers consider it the best means of supplying relevant ads.

2: Attract sponsors

The play

Advertisers
are already sponsoring apps. Besides being widely used, your
application needs to offer companies a natural way to interact with
their customers.

The front-runners

Likeness (2.9
million users). Offers quizzes that generate top-10 lists – an ideal
branding vehicle – and matches them with those of friends with similar
preferences.

FoodFight (2 million users). Virtual lunch money
buys you food to throw at friends. Next up on its menu: chicken wings
from a major food chain.

HotLists (1.6 million users). This app
lets users define their personas by posting brands’ logos, cleverly
dubbed "stylepix," on their profiles.

The payoff

Building
direct relationships with brands takes more time and effort, but it
means higher-quality advertising and more control over how your users
interact with it. Expect to earn multiple-dollar CPMs instead of the
pocket change you’d get from the ad networks.

Tricks of the trade

1.
Don’t pitch big brands without big numbers. You’ll need a large traffic
base – at least a few million users – before top brands will pay
attention.

2. Know who’s looking at your pages and why. Analyze
your user demographics so you can pitch your audience effectively to
sponsors.(See "Tools," below.)

3. Let your users do the work. Incorporate brands that your users identify with, and they’ll willingly spread the word.

4. Don’t overdo it. Too much brand presence will scare away Facebook’s sometimes advertising-averse audience.

Tools

Where to find help analyzing your traffic and users.

1.
Google Analytics. Embedding Analytics into your apps is easy, and it
churns out useful stats about where users are coming from.

2. Gigya (gigya.com). This startup tracks metrics like app stickiness and user adoption rates.

3.
Appaholic (appaholic.com). This site tracks traffic growth by the hour,
day, or week – critical when launching a new ad campaign.

3: Sell services

The play

As
apps become more about utility and less about fun, opportunities will
arise to sell digital services of lasting value to users. Eventually,
they’ll make purchases without leaving their profiles.

The front-runners

Files
(43,000 users). Offered by Box.net, this online file-storage service
turns a Facebook profile into a repository for members’ digital media.

Picnik
(206,000 users). A Facebook version of Photoshop.(Hello, Adobe?) Basic
tools are free; advanced features are offered for an additional fee.

The payoff

If
you’re selling a real service, then you can have your cake and eat it
too- try selling subscriptions and ads to double-dip on your traffic.

Tricks of the trade

1.
Start with a free version. And make switching to a paid offering an
easy process. Don’t force users to leave Facebook to sign up.

2.
Set logical limits. Decide carefully what you’ll give for free and what
you won’t. And even the freebies must be valuable enough for customers
to be willing to spend their time.

3. Research your price
points. Box.net already had storage plans for businesses and
professionals. But when it moved onto Facebook, the company rethought
its pricing models and created a $25-per-year plan that’s comparable to
the cost of an external flash drive – the way most college students
store important files.

4. Be tactful and timely. Box.net alerts
its users when they’re nearing their file or storage size limits,
politely reminding them about its for-pay premium service.

Tools

Where to find a platform to process payments.

1. PayPal. A starter plan will cost you 2.9 percent plus 30 cents per transaction.

2. Google Checkout. The standard processing fee is 2 percent plus 20 cents per transaction.

3. Facebook. The company is rumored to be launching its own payment platform soon.

4: Sell products

The play

As
Facebook increasingly becomes the center of people’s digital lives,
it’s also becoming a venue for selling things – digital and otherwise –
to its fast-growing audience.

The front-runners

Amazing Giftbox (127,000 users). Sends virtual Amazon merchandise.

Band Tracker (29,000 users). Searches upcoming concerts and links to ticket vendors.

Visual CD Rack (20,000 users). Lets users browse and buy music from a virtual CD rack.

The payoff

Most
developers are going the affiliate route, offering product wish lists
and then sending users to sites like Amazon.com or iTunes. Others,
however, are directly selling such items as ringtones and T-shirts.

Tricks of the trade

1.
Be a middleman. iLike makes its music-sampling apps simple and hands
off sales to iTunes or Amazon via affiliate partnerships. Those
directly selling hard goods need to prepare for the complexity of
payment and delivery.

2. Keep it simple. Facebook has not yet
become a place where people are likely to buy, say, a digital camera.
But users are starting to purchase items that don’t break the bank and
extend Facebook’s utility. XLR8 Mobile, for instance, is looking to
sell ringtones and wallpaper on Facebook via custom storefront widgets.
"We don’t want to bring people to the store," says XLR8 Mobile CEO
Perry Tell. "We prefer to bring the store to the people."

3.
Give it away. Going viral is always the goal. One great way to get
there is by offering free samples. Whether it’s a digital download of a
song or the image of an item, give your customers a taste of what
they’ll get before asking them to commit.

4. Don’t rule out the
odd. "Sometimes wacky, unusual, off-the-beaten-path stuff sells huge,"
Tell says. "Everyone is looking for the next Crazy Frog, so you must be
willing to try lots of things."

Tools

1.
Clearspring Technologies. This analytics service tracks exactly who’s
downloading an app and what they’re buying through it. It also suggests
when to double down on an item or sales approach that is working or,
conversely, kill off those that aren’t.

2. Garage Sale. Developers can use this Facebook shopping cart system run by Buy.com, which takes a 5 percent cut of sales.

3. Facebook Marketplace. The largest classified-ads community on the network, it’s a good place to monitor buying trends.

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