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What every Web 2.0 entrepreneur should know about virtual goods

The Virtual Goods Summit

As I mentioned in a previous post, my firm Mohr Davidow Ventures recently sponsored the Virtual Goods Summit, which I attended. It was a great experience, and I thought I’d share my perspective as a consumer internet guy looking into the games world.

Conference summaries
Since I’m late to the party when it comes to actually blogging the proceedings, here’s a bunch of links to people who have covered it in better detail than I ever could:

After reading these 3 excellent accounts of the conference, you’ll feel like you were actually there :)

Now, my impressions
First off, Charles Hudson did an amazing job putting the event together. And congrats to Dave Feinleib from Mohr Davidow Ventures and Susan Wu from Charles River Ventures for sponsoring and advising the Virtual Goods Summit. The event was truly the who’s who of anyone interested in virtual economies.

The group in the room was a relatively small one, and the number of companies making significant revenues off of virtual goods can be counted with a couple hands. It’s certainly not as ubiquitous as advertising for a business model.

Let me split my analysis along the framework of what I laid out in a previous article:

  • Product
  • Monetization
  • User acquistion

And obviously my commentary will be shaped by the web background from which I’m from, rather than a games background. I’m primarily thinking about, how can we borrow what’s been learned in games and apply it to the Web? Rather than the other way around.

Product
Clearly, the engagement factor of these games should be much envied by anyone working on consumer products. It seems that the sessions for these products are often measured in hours, rather than minutes. The staying power of these experiences is only rivaled by the most social of web properties, like MySpace and Facebook.

Ultimately, the effectiveness of virtual goods seems to come down in the creator’s ability to create a “ladder” of progression for people as they use the product. This is something that games commonly use, but web product often do not. I previously wrote about this: Level up for features rather than freemium? Then, as the users progress from level to level, they are presented with opportunities to augment their experience with virtual items. In fact, one way to think of this process is that it creates “artificial scarcity” of features, which drives social signaling within your community. This scarcity is at the core of making virtual goods work.

One important distinction made at the conference was the difference between functional and decorative items. With decorative items, they simply change the appearance of your avatar (or as web properties refer to, your profile). You might add pants or a new hairstyle or a new color to your background. With functional goods, however, new features are added. For example in a racing game, it might be a power-up or something similar. There was a huge warning about creating functional items, however, as they can upset the balance of the game – players might revolt if you can “buy” your way into victory. In fact, some of the properties presenting at the summit only had decorative items, which still generated millions in revenue.

So from a web perspective, it seems clear that the first place to start is by doing two things:

  1. First, you need “spaces” or “slots” for decorative customizations to exist
  2. Also, you need to think through how progressively expose new features to the user
  3. And to support the above, you need to build artificial scarcity into the system

For both issues, I believe web developers have to completely rethink their user experience. Rather than making it easy to DO something – that is, an emphasis on function and utility – instead, they must make products that emphasize a Russian Doll-like experience that unfolds new capabilities over time. And to repeat a point from earlier, the goal of this is to create scarcity which enables social signaling and value within virtual goods.

The difficulty, of course, is that the culture of the Web 2.0 world doesn’t encourage that. Instead, the culture is to pack in the features, and then make them all free and all accessible from the very beginning. The idea of requiring users to “earn” features by doing actions seems quite foreign.

Monetization
From a monetization standpoint, virtual goods still seem to be a tremendous complement for advertising. One of the most important numbers that was shared in the entire conference is that only 5-15% of your audience will ever buy virtual goods. Wow! That’s pretty interesting, and very similar to the dynamic within advertising where a small percentage (let’s say <20%) will be sold as brand advertising, and the rest will be sold as direct response and remnant. (As an aside, it was also mentioned that while the minority of users will actually buy, that the other users are just as important because they generate the “content” to be consumed by the paying players – so don’t neglect them!)

With that number in mind, a virtual goods-led monetization strategy begins to emerge. While 15% of your audience will buy virtual goods, the other 85% can be leveraged to provide indirect monetization through other means. For example, those who are time-rich rather than money-rich can be leveraged as “eyeballs” for an advertising strategy. Another angle would be to leverage the time-rich 85% to drive viral marketing, as to drive the indirect revenue producer of audience growth, while making money from the primary 15%.

In fact, it strikes me that ultimately virtual goods is a complement to advertising, not a competitive business model. The numbers indicate that it’s really rather close to subscription (and thus freemium) as a model – except that instead of buying a yearly subscription, you buy everything piecemeal to augment your experience. In fact, perhaps the way to think of it is subscription with many micro-gradients of subscription levels, rather than as a completely new model altogether.

One bundled strategy would be to use virtual goods for some percentage of the highly engaged users, and then you use advertising to monetize the other folks. In fact, I’d be quite interested to see an “ad blocker” virtual good that you either earn or buy, which turns off all the ads on the site! :)

User acquisition
But what about acquiring more users? This was definitely an area that the folks at the conference didn’t spend very much time on – it seemed that while their products were more engaging and generated more revenue, no one talked about directly applying virtual goods to user acquisition.

My guess on why that is has to do with the game industry’s traditional reliance on the retail channel to sell their goods. Thus, in order to get people onto the site, the goal is just to have great word-of-mouth that drives foot traffic to stores. While this is changing over time, particularly with casual games, the two worlds of scrappy internet direct marketing and creative game experiences have yet to meld.

That said, it’s obvious that you can use virtual goods to incent people to complete certain actions. For example, what if you had to invite a certain number of friends to get something? Or if you had to post it on your MySpace in order to receive a badge? These are all things you can do to drive more growth.

Conclusion
Ultimately, it’s clear that Web 2.0 folks can learn a lot from creating the types of incentive systems that folks in the virtual worlds industry can often do. But alas, the devil’s in the details. How often should you reward people? How do you price items? What things should you provide incentives for? These are all lessons that can only be gained by real world experience. I’d encourage everyone to learn more about the field and start reporting on their experiments!

Other posts of mine about games and virtual goods
If you want to read more…

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