I read an interesting article on the Economist’s website about Facebook. Facebook is a social networking site like the infamous MySpace and Google’s Orkut, and so many others. It’s a pretty classic example of a business model that attempts to exploit ‘network effects’. This is the effect whereby the more people use a good or service, the more valuable it becomes to its users. A traditional example is fax machines — a fax machine is pretty useless by itself, but if other people have machines then it becomes useful. And it becomes more useful the more other people have fax machines, because the bigger the network that you can send faxes to or from.

Facebook and other social networking sites are similar. Their value comes from allowing people to connect and communicate with other people. A social networking site would be pretty useless without many members. Since Facebook has now amassed more than 30 million members, it’s quite a useful service to join. I myself found several long-lost friends on there. The biggest problem for a network business is how to get off the ground in the first place. Somehow, Facebook has achieved this, and is now exhibiting fast growth as it becomes increasingly valuable to its users as its user base increases.

The key issue for Facebook after getting off the ground is how to make money from its service. One obvious way is to put ads on its site, which will probably make them some money. But there seem to be other more interesting strategies. As described in The Economist article that I linked, what Facebook is creating is essentially a social ‘map’ showing who is connected to who. I’m sure studying this map would be highly interesting to sociologists and psychologists. But how can Facebook make money out of it? I’m not exactly sure of the answer to that. One possibility is again marketing. Facebook not only has a map of people’s social connections, but it also gets people to willingly share their preferences about music, movies, products, and so on, for their friends to see. It’s possible that all this information could be valuable for displaying customised advertising on the site and so on.

But just making money out of advertising seems a little mundane, though I’m sure that with an audience of 30 million, Facebook can more than cover its costs by selling advertising on its site. What the Economist article really talks about is Facebook’s recent move to open its platform up to outside software developers. Anyone with some programming skills can now develop Facebook ‘applications’ which run on its site. For example, you can play paper-rock-scissors with your friends via the site, or share lists of things that you like or dislike. Facebook has opened up to applications by providing an API (applications programming interface) which is a set of programming standards through which a customised application can interact with the basic Facebook site.

By allowing third-parties to develop applications, Facebook has added a new dimension to its platform. The existing groups were regular users of its site, and advertisers. Now Facebook has included software developers into the mix. Facebook is a valuable platform for software developers, because it has so many active users. And applications add some value to the experience of using Facebook for the regular users. I’m a bit puzzled by Facebook’s strategy in allowing applications though. Developing applications is time consuming and costly for programmers. Some will do it for fun, but Facebook has given them more incentive by allowing adverts (eg from Google’s adsense) to appear in the applications. Thus application developers can receive revenue from these adverts, if they make a popular application and if people click on the ads.

However, Facebook lets application developers keep all of their advertising revenue, and doesn’t charge the developers anything to use its site. So although Facebook has added a new ’side’ to its platform, it doesn’t seem to be making any money from that side (at the moment). I wonder why it is doing this. Is it just trying to drive more traffic to its site, to sell traditional advertising? Or maybe Facebook is using the applications as a way of outsourcing its R&D. It gets others to do the work of developing new uses for its site, and doesn’t have to bear the cost or risk of that itself. Then if applications become successful, Facebook can buy them out, I suppose.

In any case, it’s still early days, and it will be interesting to see how Facebook makes use of the platform that it has built. The Economist article suggests that the Facebook founder, Mark Zuckerberg, wants to ‘change the world’. So he might have other things on his mind than making money. Which is fine, but I’m sure his investors are most keen about how he can make money. If Facebook can figure out how to extract some of the value that its network has created, and can figure out how to balance sources of revenue across the different groups using its platform, it could become very valuable indeed.