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Forget advertising – is virtual goods the killer revenue model for Web 2.0?

The breath-taking numbers
First, let’s start with the numbers:

  • Habbo Hotel generates $77MM in 2006 (Source)
  • Club Penguin generates $65MM in 2007 (Source)
  • Second Life exchanges $1.MM in the last 24 hours (Source)
  • IMVU, Puzzle Pirates, and Stardoll are all doing very well also

These numbers are pretty exciting because they are NOT advertising dollars, but rather people directly purchasing merchandise on website.

Why do ads suck in Web 2.0?
The truth is, most Web 2.0 firms that use Google AdSense or any other ad network typically has a bad experience. When you display contextual ads to people who are browsing for hot girls, you are going against the flow. Ads don’t support what people go to social networking sites for.

Ads on people on MySpace are like coupons at a night club.

Because of this, it’s well documented that the CPMs for social networking sites are quite bad. Clickthrough rates are very low – in the case of Facebook, you’re talking about 0.04%, or 4 clicks in 10,000 impressions. Compare that to Google, which is delivering upwards of 300X the CTR.

Why do virtual goods work in community sites?
Ultimately, virtual goods complement the experience people are looking for in social networking sites. It lets them personalize their online identities more, whether their identities are represented by a profile page or an avatar. Virtual goods can also be exchanged or sold, which complements the idea of gifting or other social expressions.

Virtual goods in social sites is like dressing up or buying someone a drink at a night club

Because virtual goods go with the flow, in terms of what users want and expect, it makes it easier to monetize groups of people. Anyone who gets into an MMO will end up picking up some virtual goods, and by investing themselves, it’ll seem natural to spend money.

Where do virtual goods belong in Web 2.0?
Clearly, virtual goods can belong in Web 2.0 in one form or another. After all, MySpace or Facebook could charge points for profile customizations, and you earn those points through actions (like participating in the community) and/or by paying up. Facebook is already trying the virtual goods model, but that’s just about icons on the page. I think a better example is Gaia Online, which has done a great job turning a forum website into a full-blown virtual universe.

The really fascinating part about this model is that it support communities, rather than being something that interferes with the user experience. Go with the flow, and money will follow.

My prediction is that these in-browser casual games and online communities will start to converge over time, and you’ll start to see Web 2.0 sites start incorporating numerous game mechanics, goal structures, and rich avatar systems.

See you all at Virtual Goods 2007 :)

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