NEW YORK (CNNMoney.com) -- In its first full quarter under the direction of new chief executive officer Jerry Yang, Internet media titan Yahoo! reported that sales and profits for the third quarter beat analysts' expectations.

Yang also outlined an updated strategy for Yahoo. He stressed that the company was planning to more effectively integrate its numerous assets more directly into the Yahoo home page, add more online advertising partners and open up applications on Yahoo to outside developers.

Wall Street cheered Yahoo's first full quarter of results under co-founder and new CEO Jerry Yang. Shares of Yahoo surged 10 percent after hours after Yahoo beat sales and earnings estimates.

Video

More video

CNNMoney's Jim Ledbetter and Fortune's David Kirkpatrick discuss the new ad technology deployed on Yahoo! and whether it will dethrone Google. Play video

Shares of Yahoo surged nearly 10 percent in after-hours trading following a more than 4 percent decline in regular trading on the Nasdaq Tuesday.

Yahoo's good news also helped lift shares of Google in after hours trading. Google's stock rose nearly 2 percent after the closing bell.

Yahoo (Charts, Fortune 500) reported sales of $1.77 billion, up 12 percent from a year ago. Excluding advertising sales that Yahoo shares with partners, the company reported revenue of $1.28 billion, an increase of 14 percent. Wall Street had been expecting revenue of $1.24 billion, according to estimates from Thomson First Call.

The company reported net income of $151 million, or 11 cents a share, a slight decrease from the $159 million, or 11 cents per share generated in the third quarter of 2006. But Yahoo's profits came in well ahead of analysts' forecasts of 8 cents per share.

The Sunnyvale, Calif.-based company has been struggling to stay competitive against Google (Charts, Fortune 500), which will report its third quarter results on Thursday. Yahoo also has to contend with challenges from smaller search rivals such as Microsoft's (Charts, Fortune 500) MSN, IAC's (Charts, Fortune 500) Ask.com and Time Warner's (Charts, Fortune 500) AOL. (Time Warner owns CNNMoney.com)

Web research firm Hitwise reported Tuesday that Google accounted for 63.6 percent of all searches in the U.S. in September, up from 60.9 percent a year ago. Yahoo was second with 22.6 percent market share, up only slightly from 22.3 percent in September 2006.

Google has widened its market share lead in search over Yahoo in recent months despite the fact that Yahoo has unveiled a new search advertising platform called Project Panama. Yahoo also recently rolled-out updated consumer features on its search sites.

But one analyst said that since expectations were so low for Yahoo, the fact that Yahoo didn't disappoint was a good sign. In other words, people may have been assuming the worst and were pleasantly surprised.

"Things may be more stabilizing. Advertisers are not defecting. If you read into these numbers it seems that Panama must be doing pretty well," said Martin Pyykkonen, an analyst with Global Crown Capital.

Yahoo also gave guidance for the fourth quarter that was roughly in line with what analysts were expecting, news that also probably soothed the Street. Yahoo said it expected sales for the fourth quarter, excluding revenue shared with affiliates, to be between $1.31 billion and $1.45 billion. The current consensus estimate for the fourth quarter is $1.37 billion.

Nonetheless, Pyykkonen said that Yahoo's 14 percent revenue growth in the third quarter was "nothing to get totally jazzed about," particularly since Google is expected to report a sales increase of 58 percent for the third quarter.

Jeffrey Lindsay, an analyst with Sanford C. Bernstein, also said Yahoo's results were not that inspiring and that the company may have benefited from having a relatively low bar to clear on the expectations front. He pointed out that even though sales were up in the quarter, earnings still decreased.

"Year-over-year, profit margins were down. That's an issue. If there was a definite, clear sign of radical improvement, it would have showed up in both the revenue and profits," he said.

In addition, Wall Street has expressed concerns that Yahoo may be losing ground to companies like News Corp.'s (Charts, Fortune 500) MySpace and privately held Facebook in the burgeoning social networking market.

For these reasons, investors were eager to hear what strategic plans, including possible acquisitions and asset sales, Yang has to get Yahoo back on track.

When Yang took over for ousted CEO Terry Semel in June, he promised to provide investors with a new road map for Yahoo within 100 days and added that there were no "sacred cows" at the company.

During a conference call with analysts, Yang said that as a result of the company's strategic review, Yahoo plans to do a better job of integrating sites such as its social networking offering Yahoo 360 and photo sharing site Flickr into other Yahoo sites.

He added that the company plans to open up the site to applications from other developers, a strategy that has won raves for Facebook. He also said the company will try and become a premier online destination for advertisers by partnering with more companies.

To that end, Yahoo announced Tuesday that it had signed multi-year advertising agreements with Cars.com, a site targeting car buyers and sellers owned by a consortium of newspaper publishers, Forbes.com, Ziff-Davis Media and WebMD.

These announcements follow a string of deals announced earlier this year by Yahoo, including partnerships with cable company Comcast, media conglomerate Viacom and social networking site Bebo.

"While we still have a lot to do we have made some important steps and some progress," Yang said.

Clayton Moran, an analyst with Stanford Group, said that Yahoo's new plan was not a major departure but that he thought the company did not need to undertake a massive overhaul.

"There is nothing dramatic they can do to turn around the company on a dime. There's a lot at risk if you change things too much too quickly. New partnerships help and that's the path they should take," Moran said.

Yahoo president Susan Decker added during the call that Yahoo saw an acceleration in growth in the third quarter in display advertising, i.e. sales of ads tied to banners, videos and other non-search ads. She said display ad sales were up 20 percent.

The improvement was a relief to some investors who had been worried that turmoil in the mortgage market would hurt Yahoo since lenders such as Countrywide are big online advertising spenders.

Last year, Yahoo disappointed Wall Street due to what it described as weakness in demand for ads from the automotive and financial services sectors.

"I was most encouraged by the strength in display advertising. That's a nice improvement and it's something people weren't expecting Yahoo to be able to turn around so quickly," Moran said.

Decker also noted that Yahoo hopes to take advantage of the fact that online ad networks and exchanges, companies that help advertisers buy ads across a broad array of sites, are growing more rapidly than stand-alone sites like Yahoo.

Yahoo recently completed the acquisition of online ad exchange firm Right Media and online ad network BlueLithium.

Analysts quoted in this story do not own shares of Yahoo and their firms have no investment banking ties with the company. 

SHANGHAI, China, Oct. 1 /Xinhua-PRNewswire/ -- Focus Media Holding Limited , China's largest digital media group, announced that on September 28, 2007, Mr. David Ying Zhang was appointed to its board of directors as an independent director. Mr. Zhang is the managing director and head of the Beijing office of WI Harper, a private equity fund.

Mr. Zhang, 34, has been actively involved in the building, managing, fundraising and institutionalizing of WI Harper's Fund VI and has been responsible for investments in companies including Pollex, Cardiva, Celestry Designs, Focus Media and iKang Healthcare Services. Mr. Zhang joined WI Harper in its San Francisco office in late 2001 and moved back to China in early 2003. Prior to joining WI Harper, Mr. Zhang was a senior venture associate with ABN AMRO Capital and was responsible for developing and executing various acquisition strategies for life sciences, information technology and Internet companies. Before joining ABN AMRO Capital, Mr. Zhang worked at Salomon Smith Barney, where he was responsible for analyzing, structuring and marketing companies in the Internet, software and semiconductor sectors. Mr. Zhang was born in Shanghai, grew up in the United States and holds a M.S. degree in biotechnology and business from Northwestern University and a B.S. degree in biology and chemistry from California State University, San Francisco.

Jason Jiang, Chairman and CEO of Focus Media noted, "David brings significant knowledge and expertise about the media and finance industries in China. He is a valuable addition to our board as an independent director."

With the appointment of Mr. Zhang, Focus Media's board regains a majority of independent directors.

Focus Media also announced today that it received a letter from Nasdaq Listing Qualifications on September 28, 2007 stating that as a result of the appointment of David Zhang to its board of directors, Focus Media had regained compliance with the independent director requirements for continued listing on The Nasdaq Global Market set forth in Marketplace Rule 4350. The letter from Nasdaq noted that the Company's 2006 annual report indicated that the Company had four independent and four non-independent directors, which does not comply with Nasdaq Marketplace Rule 4350. The letter stated that, with the appointment of David Zhang to its board, Focus Media has regained compliance with Rule 4350.

Forward-looking Statements

This press release includes statements that may constitute forward-looking statements made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. This information may involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Although Focus Media believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Potential risks and uncertainties include, but are not limited to, risks outlined in Focus Media's filings with the U.S. Securities and Exchange Commission. Focus Media does not undertake any obligation to update any forward-looking statement, except as required under applicable law.

This release is not an offer of securities for sale in the United States. Securities may not be offered or sold in the United States absent registration or an exemption from registration. Any public offering of securities to be made in the United States will be made by means of a prospectus that may be obtained from the issuer or selling security holder and that will contain detailed information about the company and management, as well as financial statements.

About Focus Media Holding Limited

Focus Media Holding Limited is the largest digital media group in China, leading China's digital out-of-home, mobile advertising and internet advertising markets. Based on the audience-centric approach, Focus Media provides targeted advertising channels, powered by a broad portfolio of LCD, digital frame, wireless, internet and other new media technologies, which cover specific demographic groups and their daily activities, from office buildings to retail chain stores, residential buildings, shopping malls, golf country clubs, airports, and airport transit buses in China. As of June 30, 2007, Focus Media digital out-of-home had approximately 131,000 LCD display units and 161,400 advertising poster frames, installed in over 90 cities throughout China and 200 outdoor LED displays in Shanghai. Over 4,000 international and domestic advertisers have placed advertisements through our digital out-of-home advertising networks as of June 30, 2007. For more information about Focus Media, please visit our website at http://ir.focusmedia.cn .

Business 2.0 Magazine -- The editors have identified the Best business ideas in the world, which will appear here in a series throughout the next month. Check back daily for updates.

Meeyoo Kwon, a 22-year-old college student, starts every morning the same way: "I just wake up, turn on my laptop, and go to Cyworld," she says.

More from Business 2.0 Live chat: your new online salesperson The hijack-proof truck Server farm goes solar Fastest Growing Tech Companies Current Issue Subscribe to Fortune

Cyworld isn't a game, although its cutesy avatars and 3-D rooms may make it look like one. It's a kind of social network - "cy" is Korean for "relationship" - and Kwon uses it the way Americans check for messages: constantly, on multiple devices. During dinner at a traditional sit-on-the-floor restaurant in downtown Seoul, she sneaks regular peeks at her mobile phone to see if one of her 57 Cyworld friends has posted something new.

In South Korea, there's a term for what Kwon is: a Cyholic. It's hardly an unusual affliction. There are 18 million Cyworld members - that's more than a third of the country's entire population. And 90 percent of all Koreans in their 20s, like Kwon, have signed up.

That makes Cyworld's per capita penetration in South Korea greater than that of MySpace in the United States. And its business plan is unique. The bulk of Cyworld revenue comes from the sale of virtual items worth nearly $300,000 a day, or more than $7 per user per year. By comparison, ad-heavy MySpace makes an estimated $2.17 per user per year.

Who would win a straight between Cyworld and MySpace? We're about to find out, as Cyworld is launching a U.S. version in mid-August.

During the past eight months, a team in San Francisco has been feverishly customizing Cyworld to appeal to an American audience, trying to strip away the bubblegum kitsch that works so well in Asia without losing its cool.

It'll be a hellish battle for the hearts and minds of teenage girls - Cyworld's target audience. And it's not as if MySpace (which declined to comment for this article) is the only competition. Facebook, Friendster, Hi5, MSN Spaces, Multiply, TagWorld, Tribe.net, and Yahoo (Charts) 360, to name just a few, are all jostling for population growth.

Still, there's a huge amount at stake for anyone who can tame this fickle market - and Cyworld's fearless leaders think their site offers a unique proposition that could quickly establish the Korean company's world dominance.

The outfit SK Communications snapped up Cyworld for a mere $8.5 million in 2003. It was good timing. Cyworld had introduced the mini-homepage to its users two years earlier and had been steadily adding features. By 2003 the user could use them to upload photos, write a blog, and create digital sketches.

As Cyworld gathered a critical mass of users, it discovered a new business model. Using the site was free; personalizing it was not. If you wanted to decorate your mini-homepage, you could choose from tens of thousands of digital items - homepage skins, background music, pixelated furniture, virtual appliances. But you had to pay for them with "dotori," or acorns, and you had to buy the acorns with real money.

The virtual goods were cheap - typically less than $1 apiece - and consumers had no problem paying for them. A well-appointed mini-homepage reflected your social standing, and users who did not decorate were considered boring.

This year Cyworld expects to make $140 million in sales, with acorns accounting for 70 percent of that. That means Korean consumers will shell out more than $100 million this year for Cyworld's virtual inventory. Most of the rest its sales comes from mobile services, where customers pay to upload photos (90 percent of all images uploaded in Korea go to Cyworld).

Cyworld is exporting its service to the U.S. through a barebones office above a Quizno's in San Francisco and $10 million in funding, part of which is going to adapt Cyworld's sensibility to the United States. Cyworld U.S. CEO Henry Chon is the first to admit that the Korean site is "a little too cutesy" for American tastes.

"The thing we'd like to retain is how the service is based on your real identity," he says. By linking the identities of new members to their mobile-phone numbers at sign-up, Chon hopes to keep a lid on anonymous accounts - and the exhibitionism that can scare advertisers away.

The U.S. version will launch in mid-August with mini-homepages and a digital store. Where MySpace is as chaotic as a million teenage bedrooms, Cyworld's U.S. version is organized but customizable. Each mini-homepage offers the same tabs (profile, mini-homepage, photos, journal, guest book, sketches, and bookmarks).

Although the store will open with more than 5,000 virtual items for sale, Chon expects to make more money in the United States from advertising than from acorns. The pay-to-decorate model is appealing - it's why venture capitalists are calling every other week to ask if they can invest. (The answer is no.)

But that doesn't change the fact that Cyworld is entering the U.S. market at a time of social-networking saturation. MySpace and Facebook are already well entrenched. But two-thirds of U.S. youths have profiles on multiple networks - and 53 percent would join another if it were compelling enough. On MySpace, they can be glamorous party creatures. On Facebook, they can be students. And on Cyworld, the bet goes, they can be themselves.

Cyworld will by no means be the most advanced social network out there. It offers no video hosting, no podcasting tools, and limited content search. But if the Koreans have done their homework right, such bells and whistles don't matter. Rather, the market turns on creating an emotional connection with young consumers by letting them express themselves in an environment they control.

This is an excerpt from a longer story in Business 2.0's August issue. Click here to read the complete version.

NEW YORK (CNNMoney.com) -- Viacom sued Google and its online video subsidiary YouTube for $1 billion Tuesday, the first big lawsuit against the online video site and its parent for copyright infringement.

Experts predict more lawsuits to come.

YouTube co-founders Steven Chen and Chad Hurley have to deal with their first major lawsuit for copyright infringement. Viacom is suing YouTube and its parent company Google for more than $1 billion.

Google CEO Eric Schmidt defended his firm's purchase of YouTube and said it was eager to partner with media firms at two investment conferences earlier this month.

Quick Vote

How do you feel about Viacom's $1 billion lawsuit against YouTube?

• Media companies need to protect their rights
• YouTube and media companies should negotiate a deal
• YouTube shouldn't be liable at all
• Not sure

or View results

In the lawsuit filed Tuesday in the U.S. District Court for the Southern District of New York, Viacom (Charts), owner of MTV and Comedy Central, said that "almost 160,000 unauthorized clips of Viacom's programming have been available on YouTube and that these clips had been viewed more than 1.5 billion times."

In addition to damages, Viacom said it wants an injunction prohibiting Google and YouTube from further copyright infringement.

Google said that it and YouTube had yet to see the lawsuit but added they feel "confident that YouTube has respected the legal rights of copyright holders and believe the courts will agree."

Viacom first demanded that YouTube take down videos from shows on Viacom-owned networks that were posted on the site without Viacom's consent. Google (Charts) bought YouTube for nearly $1.7 billion last year.

Viacom is the first major media firm to sue Google and YouTube for copyright infringement. Other media companies, including GE (Charts)-owned NBC Universal, CBS (Charts), and Universal Music Group, have decided to partner with YouTube, the world's most popular online video site. But Viacom said that it decided to sue Google and YouTube "after a great deal of unproductive negotiation."

"Obviously, they couldn't come to an agreement. Viacom must have felt its back was against the wall and had to pull the trigger and file a lawsuit," said Barry Cohen, partner in the intellectual property practice with Thorp Reed & Armstrong LLP, a law firm based in Pittsburgh.

While other media firms, notably CBS, say they see promotional value in having snippets of their programs posted on YouTube, Viacom has led the charge against YouTube since it feels entitled to advertising revenues tied to viewing of its programming. YouTube typically serves more than 100 million video streams a day.

"Their business model, which is based on building traffic and selling advertising off of unlicensed content, is clearly illegal and is in obvious conflict with copyright laws," Viacom said in a statement Tuesday.

Viacom CEO Philippe Dauman told investors at an industry conference last week that traffic to Viacom-owned sites has surged since the company asked YouTube to remove its content.

Industry experts predict that other media companies might also decide to sue Google and YouTube.

"Every copyright holder has to be seen to defend their rights or otherwise they risk surrendering them altogether," said Brian Wieser, senior vice president at Magna Global, a media buying firm based in New York. "So even where there are minor infractions, if you are not defending a trademark or other copyrighted content, you risk losing those rights. It's too important."

Since Google currently has more than $11 billion in cash on its balance sheet, that also makes it a bigger target for media companies.

"If Google and YouTube don't demonstrate that (they're) taking concerns that media companies like Viacom have by implementing filtering technology and being willing to negotiate fair pricing for distribution and ad revenue sharing, then other media companies will pile on with lawsuits," said James McQuivey, principal analyst for television and media technology with Forrester Research.

One lawyer said the case hinges on who should be responsible for keeping watch over copyrighted content on the Web. Is it the responsibility of sites like Google and YouTube to proactively remove pirated videos or should the onus be on media companies to ask online video sites to take down illegal videos after they've been posted.

"The real question is going to be who needs to do the policing on the Internet. That's what this is a battle of," said Mark Litvack, a partner in the intellectual property practice of Los Angeles-based law firm Manatt, Phelps & Phillips "Do I think this is the last lawsuit? Probably not. Not until the rules are firmly set."

But intellectual property lawyer Cohen said he wasn't sure if other media companies would be eager to sue Google and YouTube, which some jokingly refer to as "GooTube." He pointed out that since several media firms have already partnered with Google and YouTube, they may find that it is wiser to embrace "GooTube" rather than take an antagonistic stance against the online video kingpin.

"You're not going to stop technology. You're not going to stop advancement," Cohen said. "Everyone will keep an intense eye on this case, but you still have to do business with Google and YouTube since they are the 800 pound gorilla."

YouTube's massive reach, particularly with younger consumers, presents a unique problem for media firms. Even though media giants obviously would like to receive revenue from videos posted on video-sharing sites, such as YouTube, getting a video seen on YouTube can lead to increased exposure.

For example, many credit YouTube with the recent resurgence in popularity of NBC's "Saturday Night Live" since the SNL skit "Lazy Sunday" from 2005 became a smash hit on YouTube after it was posted there.

"Marketing people love YouTube and legal people hate it and inside media companies marketing people are actively working with them while legal companies are actively thinking of suing," said Magna's Wieser.

Still, the big media companies are also investing heavily in their own online video sites and are partnering with other video upstarts. Viacom, for example, has purchased iFilm and Atom Entertainment in the past two years and earlier this month announced a deal to allow YouTube competitor Joost to host videos from Viacom-owned networks.

To that end, Forrester's McQuivey said that the lawsuit against Google and YouTube could benefit other smaller online video firms. But it was a shame that Viacom and Google couldn't agree on a deal without litigation, he added.

"Now everybody is going to suffer. We are going to tie up the exciting revolution of consumer video in the courts," he said.

Google said, however, that it did not expect the lawsuit to affect YouTube's business. "We will certainly not let this suit become a distraction to the continuing growth and strong performance of YouTube and its ability to attract more users, more traffic and build a stronger community," the company said in its statement.

One lawyer suggested that Viacom's suit is just a tough negotiating tactic and that ultimately, Viacom, Google and YouTube would resolve their issues out of court.

"Part of Viacom's plan is to send a message that content is extraordinarily valuable. You can't simply take it for free," said David Gurwin, chair of the entertainment and media practice at Buchanan Ingersoll & Rooney, a law firm based in Pittsburgh.

"But both sides have things to gain and things to lose out of a lawsuit. It's always risky and at the very least it would be time-consuming and expensive. My guess is that they probably will settle out of court," Gurwin added.

Google stock sank 2 percent on Nasdaq while Viacom gained about 0.6 percent on the New York Stock Exchange, both in afternoon trading.

NEW YORK (Fortune) -- As we celebrated the nation's birthday, I asked myself a patriotic question: Does the United States still lead in tech? As an American myself, my lens is inevitably distorted. Even so, the answer is hardly an unqualified yes.

On the positive side, this is the country where some of the most important breakthrough products are still being created. The iPhone came out of Cupertino. As the packages say: "Designed by Apple in California." And here some of the most revolutionary new Internet businesses are still being incubated - including Facebook of Palo Alto, Second Life (created by San Francisco's Linden Lab), and Salesforce.com (Charts), also of San Francisco. Each is pointing the way to whole new ways of doing things online.

More from FORTUNE

Junk mortgages under the microscope The consumer buying binge is over Starbucks founder bites into Pinkberry

FORTUNE 500 Current Issue Subscribe to Fortune

How the iPhone will change computing This is a computer, not a phone, says Fortune's David Kirkpatrick. Finally, we'll be able to surf the Web anywhere we want. (Read the column.)

But the equally-disruptive Skype came out of Europe, and Joost, launched by the same visionaries, seems a truly international company. Nokia (Charts) of Finland continues to be the world's largest cellphone-maker by revenues, and Samsung of Korea is close behind. SAP (Charts) of Germany, of course, still dominates the enterprise software business that Salesforce.com is unsettling. (Though much of SAP's engineering is done from its tech center in Palo Alto.)

No other country can duplicate the American environment of tech creativity, which arises from a unique stew of entrepreneurs, academics, engineers, imaginative marketers and savvy financiers packed together in an atmosphere of risk-taking and plentiful capital. There is nowhere outside the United States remotely like the three places where this formula is most clearly at work - Silicon Valley of course, plus Austin and Boston.

But while Silicon Valley retains its unrivaled vitality, the rest of the world is now paying close attention and is never far behind. Every innovation is mimicked elsewhere. For instance, there is a German clone of Facebook, called StudiVZ.

My own best guess is that the next great hotbed for tech innovation will be China. It is steadily tightening the rules for software intellectual property protection. And a raft of amazingly fast-growing Internet businesses have already arisen, including portals Sina.net and Sohu (Charts), search engine Baidu (Charts), game company Shanda (Charts), auctioneer Alibaba, and communications and gaming pioneer Tencent. Some number their customers in the hundreds of millions.

The United States for much of the 20th century had the natural competitive advantage of the most developed and largest domestic market. If you could make it here, in effect, you could make it anywhere. Now the numbers are starting to favor China, which will eventually have the world's largest domestic market in all parts of tech. It is already the world's second-largest PC market, with 120 million installed PCs, and another 21 million expected to be sold this year, according to Microsoft (Charts, Fortune 500). And in China there are an astonishing 460 million cellphone subscribers, by far the biggest such market anywhere. Tech innovation in China will garner customers and become fine-tuned, then begin penetrating markets elsewhere.

It's been sad to see post-9/11 immigration paranoia inhibit the free movement to the United States of creative engineers from around the world. We have survived, sure, and it's not so bad that many of those smart people have stayed in their own countries. But it's telling that a new survey of recent graduates from the Indian Institutes of Technology - that group of schools that offer superb engineering training - shows that for the first time IIT graduates are more interested in working in China or India itself than in coming to the United States. In the past, they have helped start many of the United States' most aggressive and creative tech firms.

Of course the lure of India, China and other developing markets is powerful regardless of what is happening in the United States. That's where the growth is.

Which leads to perhaps my ultimate patriotic thought - it's great for the United States when formerly poor countries get wealthier and stronger. As the gap between our own wealth and that of the rest of the world diminishes, we will be more secure and less the subject of jealousy and hatred. And who doesn't want the most people possible to thrive?

So let's keep leading the world in tech, if we can. But as people around the world take advantage of great U.S. innovations like the PC and the Internet, I'm happy to see them adding further innovation no matter where they come from.

(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.

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

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

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

More from Business 2.0

Live chat: your new online salesperson The hijack-proof truck Server farm goes solar

Fastest Growing Tech Companies Current Issue Subscribe to Fortune

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."

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.  

NEW YORK (CNNMoney.com) -- Civil rights and privacy rights groups have opposed radio frequency identification, or RFID, for years. But now, researchers in the field and some lawmakers are beginning to voice concerns about the security of the technology.

In the past year, twenty-two states have introduced legislation regarding RFID technology, which uses tiny radio transmitter chips, or "tags," that can be inserted in a pallet full of goods, a pair of jeans, or a passport.

The technology boosts companies' ability to keep track of inventory and equipment - a prospect that's been embraced by the likes of Wal-Mart (Charts, Fortune 500), Best Buy (Charts, Fortune 500), Kimberly-Clark (Charts, Fortune 500), maker of Scott tissues and Huggies diapers, and others. A host of tech companies are behind it as well.

However, a small but growing number of tech security experts and some state lawmakers fear RFID's unchecked deployment will lead not only to eavesdropping, forgery and hacking but also to a society in which an individual's privacy is compromised at every turn by the remotely readable objects they carry.

For these reasons, the California state Senate is mulling legislation that would prevent the use of RFID in drivers' licenses and public schools, and tighten security standards on state-issued documents that carry RFID, as well as outlawing surreptitious access.

"There is a backlash," said California State Sen. Joe Simitian, a Democrat and sponsor of some of the legislation. "Public concern will grow until there is a sensible set of privacy protections."

Simitian, who represents a Silicon Valley district and calls himself an avowed "booster of tech innovation," called RFID technology "great." But he readily admits to concerns about its uses. Simitian said he has pressed the issue with RFID industry leaders, telling them it's "in the industry's long-term interest" to address security concerns.

RFID's boosters are backing a $650 million industry that's expected to grow to $2.1 billion within four years, according to ABI Research. The industry has already seen ongoing consumer boycotts of companies such as Tesco and Procter & Gamble (Charts, Fortune 500)-owned Gillette over the use of RFID-chips in packaging, but so far adoption of the technology has been growing steadily and the industry is keen to nurture it.

"We're definitely aware of consumer and privacy concerns," said Jennifer Kerber of the Information Technology Association of America, a trade group. But Kerber said the industry is opposed to any "mandate" that would slow deployment of new generations of RFID. "Technology evolves so quickly these days," she said.

In fact, it's the gap between RFID security and would-be hackers' tools and methods that has Craig Schmugar, a threat researcher at security and anti-virus firm McAfee, so concerned.

"In general, the impression the companies have is slightly skewed to things being more secure than they've been proven to be," said Schmugar. "The emphasis is first on getting the technology widely deployed, and then security is secondary."

Ari Juels, research scientist at business security firm RSA, agreed.

"I don't think that RFID deployers are really coming to grips with the privacy concerns in a practical way, largely because barcode-type RFID tags probably won't reach the hands of consumers in a major way for some time," Juels said.

The technology can reveal what a person is carrying, Juels said, noting the devices are so small that some bearers may be unaware of them. Controlling who has access to RFID information is hard to manage without the right security protections; data can even be accessed by inexpensive readers bought at retail electronics stores, he added.

And it's not just the chips but the information they could contain that can be pulled into huge databases that's causing concern. Consumers already generate reams of such information that ends up in marketing databases.

The implementation of RFID-technology in government documents like passports, which started last August, or in driver's licenses in the future, has fueled calls for better privacy protections.

People in some parts of the country, meanwhile, seem to expect the worst from widespread RFID use. In April, North Dakota outlawed the "required" implantation of RFID chips in humans after Wisconsin passed a similar law in 2006.

RFID industry representatives say such fears, as well as worries about identity theft and fraud, are largely overblown.

There have been no reports of identity theft or fraud associated with the estimated 30 million RFID devices used for car theft prevention, road toll collection or corporate IDs in the United States, according to Mark Roberti of trade publication RFID Journal.

But there were few cases of viruses damaging computers until personal computers had become much more widespread, some experts noted. For this reason, privacy advocates would like to see something done before the technology - and its vulnerabilities - are in everyone's hands.

Bruce Schneier, security expert and author of "Beyond Fear: Thinking Sensibly about Security in an Uncertain World," would like to see the sale of information gleaned from RFID tags outlawed, along with collection of data for any purpose other than its intended use, unless the tag holder gives permission.

The industry continues to oppose legislation.

Dan Mullen of the Association of Automatic Identification and Mobility said, "It's fairly premature to legislate against RFID. Many laws already translate to applications of RFID."

At the federal level, Congress has no legislation addressing RFID privacy and security issues, although an RFID Caucus was formed last July by Sen. Byron Dorgan (D-N.D.) and Sen. John Cornyn (R-Texas).

The caucus is "more educational than anything at this point" according to Dorgan's office, but it supports the use of RFID technology to help "strengthen homeland security and improve supply chains."

New laws or changes calling for privacy and security improvements in the deployed technology would probably bring higher costs as well.

Allowing users to permanently disable an RFID tag after purchasing a product or requiring consumers to activate an RFID tag before it functions, both ideas Schneier suggests, would likely add to a system's expense.

"Security affects price points of the technology," McAfee's Schmugar said. And security for RFID means not just the chips but the readers, and the databases processing and storing the information.

Simitian, the California lawmaker, predicts that it's only a matter of time before people become more knowledgeable about the privacy and security issues of RFID.

"I understand there's a certain amount of hand wringing when breaking new ground," said Simitian. "But I believe there's a long-term advantage to the industry in providing privacy protections."