Saturday, August 15, 2009

Selling Virtual Goods - A Popular Revenue Model

Selling virtual goods has become a popular revenue model for games, online services and social networking sites replacing or co-existing with other models such as usage fees, advertising, premium services or sales of user data. Recently Fortune reported that the market in China for virtual goods is larger than the market for online advertising with Tencent, China’s largest IM+Avatar+SNS service, generating 1 billion USD in revenues in 2008, 90% from virtual goods.

What are virtual goods?

Virtual goods are non-physical objects (i.e. rights) that are purchased and exchanged on the Internet represented by pictures, animations or three-dimensional objects inside online platforms, communities and games, controlled by rules. According to Joshua A.T. Fairfield, an expert in the law and regulation of e-commerce and videogames, virtual property are designed to share three legally relevant characteristics with real world property: rivalrousness, persistence, and interconnectivity. Rivalrousness lets the owner exclude other people from using owned objects, persistence protects the investment by ensuring that it lasts and interconnectivity let's other than the owner experience or interact with the objects.

There are three main categories of virtual goods:

Decorative Virtual Goods: Similar to branded physical goods Decorative Virtual Goods are used to express individual personalities, gain status, impress on others, and to give a sense of belonging. Items can be virtual pets or furniture in an online hang-out or clothes, shoes, jewelry or other accessories to dress up an online character in an online game.

Functional Virtual Goods: In online games Functional Virtual Goods can be used to provide new functions, convenience or gameplay options for the player to improve the user experience. The items are functional in the sense that they help the owner to advance in the game and convenient in that users can take shortcuts to save time or lower risk. It can also be to alter the gaming interface, enabling short-cut keys or tools to enhance the visual experience.

Virtual Gifts: Digital flowers or a box of chocolates might not smell as nice or taste as good as real ones, but often the gesture is what matters the most. Virtual Gifts are given away daily at social networking sites and dating services and people are paying as much as $10 to send a virtual flower to the object of their affection. In games, occasions to buy virtual gifts can be extended from birthdays and Valentine’s Day, to include a number of occasions based on the fiction of the game. For virtual items such as flowers that have a physical equivalent, there is also the possibility for the operators to provide real offline gifts.

Virtual goods as advertising
Brand owners and marketers are taking notice of the development and are starting to use virtual goods as a substitute for traditional advertising just as product placements in movies. When the Sex in the City movie was promoted, New Line Cinema gave away free virtual Manolo Blahniks shoes on Facebook. During the first day members gave more than 500 000 shoes to their friends accounting for more than 220 million viewings. Last week Britney Spears announced that she will launch a line of branded virtual goods on Facebook. The gifts that are sold for $2 include virtual birthday cakes, which members can buy for themselves or for friends.

But it's only kids who are buying, right?
According to a recent study by analyst firm Frank N. Magid Associates 12% of Americans Bought Virtual Goods in Past 12 Months. As can be seen in the picture below the largest share is women and in the ages between 25-34, 17% of the women purchased virtual goods in past 12 months.

Why are people buying virtual goods?
In discussions about virtual goods I often get the question why people would spend their hard earned cash on objects that have no tangible substance, a discussion that often ends up in talking about brands, knowledge and money as such, that are all intangible. Why did you buy that expensive Swiss watch when you can get the same design with more functionality for a much lower price?

Basically people buy virtual goods for the same reasons they buy physical goods.
  • to make an experience more entertaining
  • to express individual personalities
  • to have a sense of belonging,
  • to impress on others
  • to explore new things
  • to save time
  • to lower risk
  • to have power
  • to collect items they like
  • to resell the item and perhaps make a profit
  • to give it away and make someone else happy
Value Proposition Versioning: Time vs. Money
In online games one basic idea is that some people have all the time in the world while others might have all the money in the world. The first group of players spends hours, days and weeks finding rare in-game items, earning in-game currency and leveling up their characters. The second group might instead use real money to buy in-game items, exchange for in-game currency or get a character that is already leveled up. According to estimates more than 400 000 people worldwide (primarily in low-cost locations) were employed to perform something called Gold Farming, doing mundane actions over and over in order to collect in-game currency and items that are later sold to other players.

There is of course a continuum from players not spending a dime and players buying lots of stuff. What is interesting is that the vast majority is playing for free, subsidized by a few that are paying much more than they would with for example a subscription based revenue model. More about Value Proposition Versioning here. An example of players buying lots of stuff was mentioned by Adam Caplan at Super Rewards in this video:

"We went back over the last 6 months, looking at the highest monetized individual on the Super Reward platform and we found an individual who spent US$ 30000 across two games in 6 months. You need to have a model that can capture those outliers, and no one can tell me in this room a pay-to-play or a monthly subscription model that can capture US$ 30000 of value from one individual." Adam Caplan, Super Rewards

Digital Product Life Cycle Managemet
In product life cycle management a product's lifetime is sometimes shortened intentionally to encourage customers to make repeated purchases and enable repetitive sales. This can be through quality deterioration or artificially by means of fashion cycles, technology development, new standards etc. For virtual goods there is no technical reason why virtual goods could not last indefinitely, so shortening of product lives is always rather artificial and in some online games items degrade with time or usage, sometimes vanishing completely, sometimes items have expiration dates after which they vanish. Another common method to increase sales of virtual goods is to limit the number of items a person can have at a time, forcing them to either dispose less needed items or purchase additional pockets for more items. In some games, such as Habbo, the operator offers to buy back items from the user for a fraction of the original purchase price.

New opportunities for Business Model Innovation
The opportunities for monetizing virtual goods are growing and providing new possibilities for business model innovation, not only in games and social networks. Virtual item stores are in their infancy but last week I witnessed an exciting live demo of a very realistic virtual 3D shopping centre made by MindArk, that operates, develops and market Entropia Universe.

Who will be the Amazon of virtual goods? Amazon…?

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