By Caroline Waxler, contributor

The annual South By Southwest Interactive conference kicks off Friday and the advance buzz is all about a fierce competition between two location-tagging social networking companies: Foursquare and Gowalla. (Disclosure: I know the Foursquare co-founders.)

These services help you locate where your friends and contacts are at any given moment — perfect for a conference of networking-enthusiasts who all want to connect with the people they know, and the people they only know virtually and want to meet in real life.

Plus, each service offers a competition element. In Foursquare, for example, people can be noteworthy and attain badges within the system for doing such things as being the biggest regular at a certain place (What Norm and Cliff from “Cheers” would do with this…) and going to a venue in which a lot of Foursquare members of the opposite sex are present. Gowalla lets you do such things as get virtual goods, and recognition, when you check in at a particular location, as well as when you reach particular milestones. (Think completing a pub crawl.)

This is so closely watched at South by Southwest not because people feel like they’re witnessing magic but more for two reasons: One, everyone loves a good rivalry and two, South By Southwest attendees by definition love to geek out. (It’s affectionately known as “spring break for nerds.”) And, what better way to do that than to compete over who is the top visitor to the various venues associated with it? Foursquare is even giving out temporary tattoos to commemorate those achievements. (…Hells Angels these are not.)

“The rivalry points to the increasing importance of connecting our online lives to our real world behaviors,” says Deborah Schultz, partner at Altimeter Group consultancy. The services each have a gaming element featuring “check-ins” at different venues from which the users attain status, and also follow where their friends are and what “statuses” they’ve racked up. So far FourSquare has 525,000 users, while Gowalla has over 150,000; but Gowalla has received $10.4 million in investment funds to Foursquare’s $1.35 million. Both launched last year at the conference.

In the arms race run-up to this year’s conference both released new versions of their iPhone apps and Gowalla launched an Android app while Foursquare brushed their existing one up.

At the conference:

•    Both are doing scavenger hunts. Gowalla teamed with partners like Palm and Chevrolet to turn some lucky users’ acquired virtual goods into real world items and services, like a Palm Pre Plus and a Chevy ride from the airport. Foursquare, whose partners include Pepsi and PayPal, is giving out all sorts of real-world goodies for check-ins. Prizes for their musical scavenger hunt with Spin includes concert tickets.

•    Both companies have large, splashy parties on Monday night.

•    PayPal, Microsoft (T), and Porter Novelli are launching a social media marketing campaign “Check-In for Charity” using the Foursquare platform. For every check-in, $0.25 is donated to the nonprofit, Save the Children Haiti Relief Fund, with a goal of  $15,000. At Gowalla’s party for each person who checks in $1 will be donated to the charity LiveStrong on their behalf.

•    Both services are up for the conference’s “People’s Choice” award in the mobile category.

•    People from both companies will be speaking at the conference, but not on the same panel. That’s taking place at another marketing conference in town at the same time, which is already getting buzzed about by SXSWi attendees.

Who will win?

“While this is not a zero-sum game, it will be interesting to see what people gravitate towards at SXSW, a conference full of early adopters,” says Allison Mooney, vice president for emerging trends at MobileBehavior, an Omnicom Group consultancy that studies how consumers use wireless technology.

Says Gowalla founder Josh Williams: “We need to remember that this space is very young. The real test for a service like ours is when it starts to reach out to everyone beyond the just the tech-friendly crowd of SXSW.” See 2007, Twitter.

Indeed, “it’s a four-day event in which everyone who already knows about both those products is already down there. It’s a ton of fun, meeting all the people who have pitching for you and supporting your stuff,” says Foursquare co-founder Dennis Crowley.

The two players don’t exactly have the field to themselves, however. Also doing new launches are competitors like Brightkite and Loopt. And, here come the big guns: Yelp added a check-in service, Twitter just got into the geolocation area, Google Buzz has a competitive product, and Facebook announced it’s jumping into the space.

For now Gowalla, based in Austin, has a home-field advantage, “but despite that Foursquare arguably came out on top last year,” says Mooney. “I think whichever people find provides the most social value, practical utility, and entertainment will win out.”

That may be, but Robert Scoble, a SXSW conference veteran and influential blogger, cautions that neither will win if the phone network of Dallas-based AT&T (T), which supports the iPhone, experiences the service problems again that plagued it last year.

Beyond that, the outcome will also depend on how each of the services can handle the traffic onslaught. Says Scoble: “Whoever stays up will win.”