Yes, I put this under Hacks, even though technically you’re not changing core files.
In certain circumstances – the main one being your blog has been active for more than 30 days – when you try and create a network, you’ll receive a message stating that your blog is too old, and you will not get a choice of format. You’ll be forced to use subdomains. this is because the subfolder format stuffs a /blog/ in the permalinks on the main site only, to prevent URL collisions with subfolder sites that may be named the same as some pages.
What if this doesn’t fit your plans? What if wildcard subdomains are unavailable at your webhost or you’re off in a folder?
You can actually change the format. You just need to do it after you create the network. Follow the usual steps as listed in the Create a Network codex page. Once the setup is complete, open up wp-config.php one more time. Find this line:
define( 'SUBDOMAIN_INSTALL', true );
See where it says true? Change it to false. Now you have subfolders. The only other thing to do is go back to the network setup page and grab the new subfolder-specific rewrite rules.
You will still have /blog/ in your permalinks. I’ll go over how to remove it (and the hazards) in another post.
I also covered this in my free ebook on how to set up multisite.
Please note that if you have an exisiting network with working, usable subdomain sites, you cannot use this method to convert them to subfolders.