Why hi5 Might Have an Edge on Facebook

Facebook has been trying hard to find a business model. Their Beacon advertising product is probably the most infamous example. So far they've been left empty handed and have been forced to look outside the company for money, first from MicrosoftMicrosoft acquires equity stake in Facebook, expands ad partnership (cnet) and then from foreign investors.Update On Facebook's Dubai Fundraising Trip (Business Insider)

If Facebook wants to be the internet's cable company what are they going to have to do to turn themselves into a $40Bn company?

Are Virtual Goods the Key?

Not all social networks are struggling to find a great business model. Tencent, a Chinese social networking company, pulled in over $1Bn in revenue last year, primarily through its use of virtual goods.The world’s most lucrative social network? China’s Tencent beats $1 billion revenue mark. (VentureBeat)

But Facebook doesn't need to look overseas to see that virtual goods could work for them. Most of the top Facebook games use virtual currency to make money, powered by leadgen-based ad networks like Offerpal and Gambit. There are reports that some of these apps are pulling in eight figures per year.Developer Analytics: Facebook game Mob Wars making $22,000 a day (VentureBear)

And of course there's Facebook's own gifting service, which has recently moved to a virtual currency system, pricing gifts in "points" that can be bought with real money.Gift Shop Credits Have Arrived (Facebook)

All of this is to say that it appears that virtual goods are a natural business model for social networks and Facebook has enough data to see that. Why isn't Facebook pursuing this strategy more aggressively? Why do they seem dead-set on building advertising technologies like Social Ads and Beacon?

The US Advertising Crutch

In the world of advertising not all countries are equal. US traffic is generally valued the highest, followed by other English-speaking countries, the G20 , and finally the rest of the world.

Until recently Facebook was concentrated in the English-speaking world. It's the second largest social network in the US, after MySpace, and the largest in both Canada and the UK.

Unlike other social networks which don't have a significant presence in the English-speaking world, Facebook can support itself through advertising. This is a crutch that prevents Facebook making bold decisions with their business model. I believe Facebook sees themselves as the next Google, one piece of technology away from changing the world of advertising.

The Demographic Crunch

Not all social networks have Facebook's demographics, of course. hi5, the world's third largest social network after MySpace and Facebook, has an extensive presence throughout Latin America and other countries which advertisers and publishers typically ignore. The same can be said of the advertising market in China, but recall that Tencent pulled in $1Bn last year through virtual goods.

It's little wonder, then, that hi5 is aggressively pursuing a virtual goods strategy.Hi5's virtual entertainment plans could hit a virtual jackpot (VentureBeat) Their demographics makes this strategy much more appealing. Facebook has the money and the audience to waste pursuing a pure-advertising strategy for social networks.

What once seemed like a demographic disadvantage might turn out to be a demographic advantage for hi5. Will they beat Facebook to the business model punch?

And a year from now will we be reading articles about Facebook's virtual goods strategy compares to hi5's, as opposed to articles about how Facebook's new homepage compares to Twitter?

You're crazy. You know that, right?

Obviously hi5 has an uphill battle. Facebook is growing on the order of 500,000 new users per day and shows no signs of slowing. But the same was said of MySpace and Friendster when Facebook launched. I think we still have a few more twists in the story of social networking on the web, and this is just one possible twist among many.