The future of virtual goods

[Update: You can browse all hypergrid-enabled public OpenSim grids with Hyperica, the directory of hypergrid destinations. Directory indexes more than 100 shopping and freebie store locations. Updated hypergrid travel directions here.]

According to a recent Piper Jaffray report, US virtual good sales will total $621 million in 2009 — up 134 percent from 2008’s $265 million. And this total will rise to nearly $2.5 billion by 2013. The Asian markets are even further ahead. Research firm Plus Eight Star Ltd. estimates the size of the Asian market at $5 billion.

But as the market grows, so does the number of companies competing for the virtual customers.

A great deal of money continues to flow into the sector — more than half a billion dollars in 2008. And, in the second quarter of this year, $237 million was invested in companies that produce virtual goods, according to a July report by research firm Engage Digital Media.

But that doesn’t mean that every company looking to sell virtual goods can immediately find a market.

Take for example, Second Life, one of the more successful platforms in which independent companies can sell virtual goods.

According to the company, the second quarter of 2009 showed a record high of $144 million dollars in user-to-user transactions, almost double the amount during the same period in 2008. According to the company, this marks six quarters of consecutive growth. That puts the size of Second Life’s economy at around half a billion dollars — making it the “largest virtual economy in the industry,” according to the company.

But not everyone benefited equally.

According to data released in September by Linden Research Inc., almost 68,000 user accounts had positive cashflow in the month of August, meaning that they made money in Second Life. Of those, only 219 made more than $5,000. Another 264 users made between $2,000 and $5,000 that month. (Almost 1 million users total had logged into Second Life during that time period.) “Several” people make more than $1 million a year, according to former Linden Lab VP Robin Harper — of these most engage in virtual real estate, but one of Second Life’s top ten earners is in the virtual goods business, she said.

As the virtual goods market continues to grow, and evolve, there are a number of factors that affect profitability — factors which are likely to be influenced by the technological and changes affecting virtual worlds. These include marketing and branding, distribution networks, service, scarcity,  and value.

Value

The concept of “virtual value” is a strange one. After all, does a virtual sword actually any intrinsic value at all? It has no physical existence, just a picture in a video game — like one of the building blocks in Tetris, or one of the dots eaten by PacMan.

But, in fact, a virtual good can have value in several dimensions, including entertainment value, emotional value, social value, and utility value.

A movie, for example, or an electronic book are examples of virtual goods which have entertainment value. The consumer enjoys the process of watching the movie, or reading the book, and may be entertained further when remembering it, or talking about it with friends. Similarly, a virtual sword may provide entertainment value, allowing a consumer to have more fun inside a role playing game.

A movie can also change a viewer’s emotional state, eliciting feelings of sadness, or fear, or amusement. Dressing an avatar in a sexy outfit may make the consumer feel more confident and more attractive. A virtual puppy may help the owner feel warm and fuzzy inside.

If the consumer is in a virtual world occupied by other people, then virtual objects also have social value. A fashionable outfit may make the consumer more attractive to others. A funky hat could be a conversation starter. A virtual gift may repair a friendship or spark a new relationship. Virtual objects may also allow users to share experiences in order to further their relationships. For example, friends may play virtual golf together, or climb virtual mountains. Virtual objects can also serve as signs of group affiliation. For example, certain avatar shapes signal that the wearers belong to particular role-playing communities. Business suits indicate that they are  in the virtual world to do business.

Finally, virtual objects can often be useful. For example, a virtual PowerPoint projector can be used to show slides at virtual meetings. Translating devices are common throughout the virtual worlds, enabling users from different countries to communicate with one another. Virtual objects can serve educational purposes, help with communication and collaboration, and improve productivity. Virtual objects can also be used to model real world structures and events. Architects use virtual houses, for example, to allow customers to do walk-throughs and make changes before construction begins. And virtual environments can be used in conjunction with real-world sensors to monitor energy usage, or to track whether machinery in a factory is performing as it’s supposed to.

shaspa

This may look like the scene from a game, but the Shaspa 3D Virtual Operations Center is all business -- useful when managing live systems, and can also be used to perform simulations for planning such as space, thermal, power, or other planning needs. (Image courtesy Shaspa Ltd.)

In general, the price of an object is related to the value it holds for the buyer.

Virtual goods manufacturers looking to increase the value of a product may look for ways to make it more entertaining or more useful, have a stronger emotional impact, or more socially relevant.

Value alone is not always enough, however, to create a sustainable virtual goods business.

A consumer making a decision in a vacuum may make an offer based on what value the object represents to them. But in practice, buyers will also consider the price of other similar items, the effort it took to produce the item, and many other factors.

For producers of virtual goods, this could be a substantial problem, as almost no effort is required at all to produce additional copies of a virtual item. In addition, similar items may be available for free.

Fortunately for virtual goods creators, there are other ways of increasing the price consumers are willing to pay for a virtual product.

Marketing and branding

Much of the value of a virtual good is in the brand value associated with it. In much the same way that an expensive brand of aspirin seems to work better than the generic alternatives — even though the ingredients are exactly the same — so a branded virtual good can sometimes satisfy a buyer better, regardless of the underlying value of the product. As virtual world brands develop and evolve, the prices for these products will increase.

However, some traditional manufacturers may start to distribute virtual versions of their products at a free or low cost as a promotion.

To set themselves apart, virtual good producers may consider adding features to their products that would not be possible in the physical world. These include textures, fabrics or shapes that would not work in reality, as well as scripted actions — such as changing colors. Today, additional scripts can slow down the performance of virtual worlds, but as technology continues to improve, virtual goods are likely to become increasingly complex and interactive.

Traditional marketing and branding techniques can also be used successfully in virtual worlds. These include celebrity endorsements, guerrilla marketing stunts, viral campaigns, advertising, media placements, charitable activities and event sponsorships.

At the beginning, virtual goods manufacturers may have an advantage in these marketing efforts over their traditional counterparts because of better understanding of local market conditions and requirements. However, at some point this expertise will percolate out to marketing and advertising agencies.

History demonstrates, however, that there is always room for new players when the technology platform is evolving. The emergence of the Internet brought forth Amazon, eBay, PayPal, Facebook — and traditional companies have not been able to compete successfully against these innovators in their industries. And, as technology evolves, new market voids are created — and new companies and new brands emerge.

Successful marketing efforts require that a brand has a distinctive and consistent identity. Today, many virtual worlds make it difficult to brand products. In Second Life, for example, the creator of an item is identified by avatar name, and it’s not easy to reassign creator status to a third party, as companies would need to do in work-for-hire situations.

In addition, it may be difficult for brands to identify a clear brand advantage inside a virtual world. For example, in traditional marketing, a brand may position itself as using more expensive, higher-quality ingredients than other brands. Or it may have higher manufacturing standards and better quality control. Brands can also set themselves apart with characteristics that are difficult to copy — or are perceived to be difficult to copy. For example, a brand may boast of a secret recipe or better flavor — even if in reality customers are not able to distinguish them in a blind taste test. (See Psychology Today: “Even Better Than the Real Thing.”)

In a virtual environment many of these considerations do not apply. For example, customers of a high-end boutique may believe that the clothes sold there are made from better fabrics and will last longer than cheap knock-offs. Virtual knock-offs, however, can be made absolutely identical — up to the point where they would infringe on the other brand’s patents or copyrights. So a can of “Knock Off” soda can be identical in every respect to the can of “Brand Name” soda — except for the logo and trademark colors. More to the point, customers know this. In real life, the two cans might be identical as well, but customers will perceive a difference in taste and value whether one exists or not.

As a result, it will be very difficult for brands to set themselves apart purely on the material aspects of their virtual goods. These include size, shape, color, and weight.

A knock-off office chair can have exactly the same qualities as the brand-name chair. Brands will need to add features that are not easily duplicated — or are perceived as not easily duplicated. These include sounds — like the sound a can makes when you open it, or the soft whoosh made when you sit down in a chair. They also include animations. For example, a can of soda can include a drinking animation that feels particularly real or satisfying, or a chair can include a particularly attractive or comfortable sitting position. A brand can identify itself with these non-material features.

The most famous example of a brand identified with non-material features is Florida-based Eros, LLC, maker of the “SexGen” sex beds in Second Life. The beds themselves are not what is unique about the product — it is the animations that go with them that set the brand apart.

Another non-physical brand characteristic is innovation. If a brand successfully positions itself as being on the cutting edge of fashion — or of technology — then knock-offs will be perceived as training behind. Customers may be willing to pay extra to be up to the moment — even if, in reality, the clones are very close behind.

Distribution

A good distribution network can solve many problems for a virtual goods retailer. For example, Apple proved with its iTunes store that Internet users will pay for music —  even when that music is available for free online — when there is an attractive, easy-to-use and reliable alternative.

Some virtual goods providers are making it easy for their customers to find and buy products when they want them and where they want them.  Distribution channels include in-world retail stores, shopping malls, and e-commerce websites. Buying opportunities can also be embedded into social networks, games, collaboration tools, and other products and services.

Today, distribution networks are limited to individual worlds. Even in OpenSim-based platforms, where goods can be transferred from grid to grid, the major virtual product distribution platforms are currently associated with individual grids. Virtual goods can be taken to other grids, but customers need to register for accounts on the grids hosting the web-based shops in order to ensure immediate delivery. However, products purchased in-world from retail outlets may be bought by avatars from other grids, visiting by way of hypergrid teleport, and transported to other grids.

In general, retail commerce in Second Life and OpenSim is marked by a lack of information, difficulty finding goods, and difficulty in comparison shopping. There is also a frequent lack of correlation between price and quality, which can degrade the shopping experience.

The creation of a new distribution network which helps deliver products to buyers in a timely and convenient way, and which restores the relationship between price and quality, can help develop the virtual consumer culture. New distribution channels could include Web-based outlets for virtual goods, as well as in-world stores, chains, or malls.

Where Americans buy virtual goods (some buy through multiple=
Where Americans buy virtual goods (some buy through multiple channels).
Source: Frank N. Magid Associates and PlaySpan

However, closed channels are likely to dominate virtual good distribution in the near future, as the virtual worlds marketplace is extremely fragmented. For example, games such as World of Warcraft do not allow goods to be imported from, or exported to, other platforms. Second Life allows import of objects created outside the virtual world — for example, through using third-party software, or the OpenSim virtual world platform. Export of such objects is allowed only with the explicit consent of the object creators. There are pending intellectual property issues that need to be resolved before objects are allowed to move freely between Second Life and other compatible worlds.

According to a recent study by Frank N. Magid Associates and PlaySpan, 12 percent of Americans have bought virtual goods in the last twelve months — but almost a third of the buyers reported that they purchased goods from the marketplace of the virtual world in which they were playing. And 29 percent reported that they bought goods from the world’s official website. Only a quarter bought goods from authorized resellers of virtual items — demonstrating that virtual world platforms control the distribution of goods in their worlds.

As long as virtual platforms or their official websites continue to dominate virtual world sales, the distribution channel is going to be the major factor affecting sales. If a virtual world sells its own branded goods, or goods provided by third parties, it can ensure price stability, keep out competition, and otherwise manage this retail ecosystem.

However, the success of Second Life has shown that allowing multiple players to compete for the attention — and wallets — of virtual world users can create a more dynamic, rich, and appealing environment for users. According to a June report from The Nielsen Company, the average Second Life user spent 842 minutes a week in the world, more than on any other PC-based game, including War of Warcraft (though the latter had more total users).

The distribution channels will likely evolve based on the interaction of two competing trends.

On the one hand, closed distribution channels are likely to keep growing with the continued emergence of new immersive games and social worlds.

According to a June report from  research firm Strategy Analytics, Inc., the total number of people worldwide using virtual worlds will grow from 186 million this year to 638 million in 2015, a compounded annual growth rate of 23 percent.

And virtual worlds aren’t the only platforms selling virtual products. Facebook, for example, recently started testing a virtual currency and selling branded virtual goods.

In order to successfully utilize these channels, virtual good manufacturers or brand owners must negotiate partnerships with the individual virtual world platforms.

On the other hand, a standards-based virtual world framework is evolving, based on the Second Life/OpenSim standards. There are already dozens of large public worlds accessible by hypergrid teleports, and hundreds if not thousands of smaller worlds owned by companies, individuals or organizations. Marketing on this hypergrid is less about forging partnerships with world operators and more about attracting users to a particular brand or shopping destination. In fact, the distribution channels on the Second Life/OpenSim platforms more resemble the distribution networks of physical goods.

A virtual product must be manufactured — sometimes by one person, but ever more frequently by teams composed of designers, programmers, and market experts. The product must then be delivered to retail locations, sold to customers, and then delivered to customers’ inventories after the payment has been processed.

Service

Virtual goods manufacturers are not typically known for high levels of customer service. The goods themselves are typically sold for micropayments, often in virtual currencies, and offering customer support would be cost prohibitive.

But some companies are using a high level of personal service to differentiate themselves from competitors — especially companies producing custom content for corporate customers. This content includes machimina like corporate training videos and virtual tours, as well as buildings and interior designs. There are hairstyle and avatar designers producing custom work. And there are firms that create business tools and collaborative workplaces or code custom connectors to enterprise applications.

Firms that provide a high level of customer service can gain loyalty and positive word-of-mouth.

Even retail outlets — especially those selling high-value goods or complex products — may use live sales clerks to help their customers at the point of sale.

Many people spend a great deal of time in virtual worlds, and are willing to work at extremely low wages in order to earn in-world currency and because they enjoy the experience. However, these employees may not be as reliable as those earning competitive real-world wages. If they think of the virtual world and their jobs as a game, they may be more likely to miss work, or not provide a consistent level of customer service.

Since virtual worlds are not bound by geography, however, employees can be hired from anywhere in the world, as long as there is a high-speed connection. There are people in Second Life, for example, who log in from India, China, and many other low-wage countries.

Scarcity

Virtual goods owners are sometimes able to drive up the prices of their products by allowing them to be available only in certain locations, or only to select customers.

One way to ensure scarcity is to fully control a distribution network — or an entire virtual world. For example, a role playing world like World of Warcraft controls how many virtual weapons, potions and other items are created and sold in the game.

A virtual world can also ensure scarcity in other ways. For example, Second Life does not support the importation of mesh objects such as those found in Google’s free 3D Warehouse — which includes buildings, landmarks, and even furniture and appliances from brand-name manufacturers.

IKEA furniture in Google's 3D Warehouse

IKEA furniture in Google's 3D Warehouse

Virtual world platforms that produce or control all virtual goods distributed in those worlds will continue to be able to adjust the supply in order to maximize earnings from sales of these goods.

This is not the case in other platforms, however. Second Life, the recently-launched Blue Mars virtual world, as well as some of the other Second Life imitators all allow third-party content development. Blue Mars, for example, allows users to import virtual objects from 3D modeling tools, including Google’s Sketchup. These virtual worlds make their money through land rentals, subscription fees, and fees on virtual world transactions or currency transfers.

This has created an environment in which virtual good creators have multiplied. And, while copyright and trademark laws may protect creators from illegal distribution of their goods, there is no way to keep competing original products from entering the market.

Some brand owners may wish to create artificial scarcity by limiting the amount of goods that they produce if their product is unique and difficult to for competitors to emulate. This tactic can backfire, however — if prices rise too high, and there is too much pent-up demand, it may encourage increased creativity on the part of competitors.

As OpenSim-based worlds proliferate, and Second Life opens up its platform to allow the full import of mesh objects such as those in Google’s 3D Warehouse, the amount and variety of virtual content available in these worlds is likely to explode.

The prices for commodity goods are likely to drop to free or close to free as a result. These are goods that are simple copies of physical world objects — chairs, plants, and buildings — which are available for free on public platforms.

Virtual goods creators working in these platforms will be forced to either leave the field, or move up the value chain. For example, firms producing virtual goods might invest more in design, in order to make sure that their products are more attractive or fashionable, add complex scripted behaviors or animations, or improve their products in other ways — including building a better brand, a better distribution network, or a better service network.

maria@hypergridbusiness.com'

Maria Korolov

Maria Korolov is editor and publisher of Hypergrid Business. She has been a journalist for more than twenty years and has worked for the Chicago Tribune, Reuters, and Computerworld and has reported from over a dozen countries, including Russia and China.

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  • http://www.virtualworld.sl 3D Virtual World

    There is a question of supply and demand regarding Opensim based grid platforms. When there is enough demand for commerce, goods, currency, creators, marketplace it will be created. This is currently taking place, it will happen, it just takes time. You can expect to see different types of markets, different market places, some open, some closed. For example I expect to see an educational web marketplace for all those edu grids with low cost or free items to stock grids with objects and we will the same happen for other niche based grids.

    For example a business type marketplace to stock up company grids, office chairs, desks, pc's you name it. A company installs Opensim on a server, goes to this marketplace, spends 200 USD and has all the goodies they need to commence their virtual world meetings. Low cost, accurate, good for creators.

    You will also see many locked marketplaces such as xstreetsl, they are driven by a script, just a script, ebay is also just a script so it is just a matter of time before the script gets listed on Gforge. Once this happens more will become possible, better content, more interesting for people to visit a grid and so on.

    We do start noticing that creators are starting to smell money on Opensim based grids, they list their gestures and poses for sale not just to Second Life users but also to Opensim grids so they know there is money there. We always said that Opensim would be a good thing for content creators, so far we saw that content creators view Opensim grids as evil who will try to steal their content, they figured because there was no content these new Opensim grids would go out to copy things. Now that they see this isn't the case they start to turn around and see the benefits. Same work, more money for them, one doesn't have to make a lot of calculations to see the advantage of this for content creators, so instead of the big threat, the new grids will become their friend and they should embrace them really.

    Also for Second Life itself, these grids aren't really a threat, sure Linden will lose some market share to them but the grids will even make Second Life stronger in a weird way because the technology created by Linden becomes more universal and expands. So in long term this will benefit Second Life.

    Virtual

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  • http://www.plus8star.com Benjamin

    Very nice summary on the virtual goods business :-)

    Some comments about the economics of all this:

    (1) Second Life's "ECONOMY" is counting each transaction – it's like transaction volume on eBay. It's not equal to SALES.

    (2) The size of the non-gaming virtual world market in terms of revenue is generally in tens of million USD. Social networks market size is in hundreds of millions. Online games with virtual goods is in billions. It gives some idea on a profitable the direction forward for both virtual worlds and social networks.

    (3) Virtual goods are "digital" and not physical but certainly exist, as much as an MP3 song, a movie or else.

    (4) Virtual goods do not have to be in a virtual world, nor sustain an open virtual economy. The services working the best are generally closed systems (e.g. Tencent, DeNA, GREE, Cyworld in Asia, Stardoll, Habbo, etc. in the West). Virtual economies / currencies can be introduced into almost any online property to activate or monetize users in a variety of ways.

    (5) B2C scales a lot better than B2B