Club Penguin: Is the social networking bubble about to burst?

Thomas Picken is sharing secrets: about the passageway that leads from the nightclub to the boiler room, and where the old newspapers are kept, and how many coins it takes to buy a log cabin, and how to become a secret agent charged with helping out other penguins...

Seven-year-old Thomas is one of 12 million devotees of Club Penguin, a sort of Facebook for six- to 14-year-olds, whose members get to "waddle around and meet new friends", according to this online Antarctic. He was the first person at his school in south-east London to catch on to the website, and now the whole lot is hooked, playing with each other online long after school is out. Thomas explains patiently what his penguin alter ego, Doctor Madman, can get up to: surfing or flying about with a jetpack on, chatting to buddies, foraging for coins and spending them on penguin attire such as the "so awesomely wicked" Hallowe'en capes that are among his favourite items.

The company behind Club Penguin has just been snapped up from its American founders, a trio of dads from Washington state, for ($700m) £345m by Disney, the latest media company to make a land-grab among the internet's burgeoning social networking sites.

Thomas explains how he first learnt about the site two Christmasses ago and has now amassed precisely 16,560 coins and an imprecise number of online buddies ("it's hard to remember"). He explains, too, how his friends will swap passwords in the playground so that the strong players can go coin-hunting for the weak. "My friend is going to give me £3 if I get him 3,200 coins," he says with glee.

So Thomas might make some decent pocket money from Club Penguin. But will Disney? It is a question that is exercising everyone with an interest in the social networking phenomenon – are these sites really worth the money that is being spent on them? Or are we, god forbid, in the midst of another dot.com bubble?

That canniest of businessmen, Rupert Murdoch, made a $580m bet when he bought MySpace two years ago; Facebook's founder, the Harvard drop-out Mark Zuckerman, turned down a reported $1bn from Yahoo! last year, saying that his creation will eventually be worth much, much more. Nearly 200 million MySpace profiles have been created; Facebook is catching up fast, with 30 million active users and more than 100,000 joining every day. In the UK, Bebo has a strong teen audience and other sites have amassed particular geographical followings. Many more, though, have gone off like a rocket then fallen silent (Friendster, a pioneer, is now reduced to a rump of loyal users), and others have failed to ignite.

Wall Street thought that Disney's was a smart acquisition. If Club Penguin can attract 12 million users, 700,000 of whom are paying £30-40 a year for a full membership, with little formal advertising, then think what will be possible when it is pushed through Disney's marketing machine, complete with tie-ins at Disney stores, theme-parks and – who knows – perhaps movies.

The trouble is that not all social networking sites can charge a fee for membership. Our precious penguins and their parents are paying to keep the club free of advertising and safe from online predators. Niche sites such as the UK's gay-themed Gaydar successfully charge for membership, and the social-networking banner might also encompass subscription-based games such as World of Warcraft. But if Facebook introduced subscription fees tomorrow it would be deserted by Friday.

"There could be a cachet and an exclusivity that justifies a monthly fee, but that experience had better be pretty special, because the next hot thing is right around the corner, and you can bet that it will be free," says Mike McGuire, an analyst at the technology consultancy Gartner.

There are other sources of income for some of these social networking sites. Second Life, the virtual world which claims 8.7 million residents – of whom 1.6 million have been on the site in the past two months – takes a cut whenever real money is converted into the virtual world's "Linden dollars" and sells virtual real estate to companies with wares to advertise.

Facebook itself is experimenting with charging for polls, effectively giving market researchers access to its membership, and with $1 (50p) virtual gifts (millions of people apparently want to send virtual champagne, balloons and puppies to each other). But, most likely, the value of the company will ultimately rest on how much it can charge for advertising on the site.

With the aim of becoming "the social operating system for the internet", Facebook has opened up its computer codes to developers, triggering a race to create tools, games and other applications. By allowing developers to keep 100 per cent of any revenue that they generate, rather than forcing them to share some of it, Facebook is giving up a very large potential revenue-stream. But this bold move has speeded up the development of new applications, which in turn has meant that members are spending more time on the site – making them more valuable to advertisers.

Unfortunately, it remains unclear what exactly a company gets for its advertising dollar, even if its ads are supposedly targeted to Facebook members with appropriate interests. The media rating agency Nielsen has just abruptly changed its measure of the most popular websites, ranking them not any longer by page views but by time spent on the site, a supposedly better measure of audience "engagement".

We know that Rupert Murdoch has won back more than the money that he staked on MySpace, because Google is paying him a minimum of $900m over three years in return for taking over the advertising sales operation across the site. What we won't be able to tell, because it will be subsumed into other figures, is whether Google is actually making a profit on its agreement. The internet is awash with rumours that Microsoft is making a loss on a similar deal to provide the adverts for Facebook, although the figures are secret.

For now, though, we can say this: the internet has shifted decisively from its earlier incarnation as a collection of pages to be opened and passively read, to being a much more complex give-and-take experience. Social networking is the bedrock of this new kind of internet, Web 2.0, but users are all still feeling our way around in this new environment. The current crop of social networking sites will be hugely valuable if we stick with them. But will we? And what will they all evolve into?

MySpace is looking more like a traditional media platform, a place to go find new bands and to seek out other fans, in the same vein as Google-owned YouTube. Facebook is a different, possibly "stickier" beast. If it becomes embedded in the way we keep up with friends, there may be too high a "social switching cost", the disruption that would be caused by trying to hitch ourselves over to a rival site. Will the site be tempted to load up too many applications and too much advertising, spoiling the crisp look and feel that has led it to outpace MySpace in terms of growth this year?

"There is a fine line between spicing up your Facebook page with a little bling and turning it into something unappealing," says McGuire. "Consumers are fickle, and the expansion of broadband is increasing the rapidity with which people can create new sites. Facebook can't take the long-term for granted. Its founders know better than most what a couple of kids can do with a modestly powerful computer, a broadband connection and basic programming knowledge."

The structure of the Club Penguin deal shows just how uncertain the situation is at the moment. The headline figure of $700m was split, with Disney willing to pony up just 50 per cent for now, with the second $350m subject to subscriber targets and other performance measures over the next two years. So even Disney has only one flipper in the water.

For his part, Thomas Picken is absolutely certain that Club Penguin is here to stay. Asked how much longer he expects to be using the site, he answers with an enthusiasm unmatched by even the most excitable dot.com entrepreneur: "Oh, I think 95 billion years."

The internet's big deals

December 1997

Microsoft buys the first webmail service, Hotmail, developed by two former Apple employees in 1995, in a deal worth a reported $400m

March 2002

PayPal, which carried transactions worth more than £11bn in the last quarter of 2006, is bought by eBay for $1.5bn

March 2005

IAC/InterActiveCorp, which also owns Ticketmaster, buys the search engine Ask.com (formerly Ask Jeeves) for $1.85bn. The photo-sharing website Flickr is bought for $30m by web giant Yahoo, which this year closed its own images site

July 2005

Fox Interactive Media buys MySpace for $580m

October 2005

eBay buys the online telephone service, Skype, which claims more than two million accounts and made $195m in 2006, for £2.6bn

December 2005

ITV buys Friends Reunited, the British social networking site set up by a Hertfordshire couple in 2000, for £120m

August 2006

Google signs a $900m deal to provide search and advertising space on MySpace

November 2006

Google confirms a deal to acquire the video-sharing site, YouTube, which was founded by a group of PayPal employees in 2005, for $1.65bn in Google stock

May 2007

The US broadcasting network CBS buys the UK-based internet radio and community website Last.fm, which claims more than 15 million users, for $280m