There is no question that virtual goods is the hot new business to be in. Social networks, games and virtual worlds are implementing virtual goods at an increasing rate. $408 million of venture capital was invested in virtual goods companies in 2008 , and that number already exceeds $300 million in the first two quarters of 2009.
But virtual goods have been successful in Asia since 2000. Social networks, games, and even virtual worlds such as Second Life have been around for years. This begs the question, why are virtual goods just recently becoming the new “it girl”?
Advertising, The Lazy Mans Revenue
During the “web 2.0” era, a boom of social products, especially social networks, emerged. Users were flocking to them in large numbers and companies looked for easy revenue. Like most, they turned to advertising. Little thought or innovation had to be put into the business model. Product innovation was taking place, but left behind was parallel innovation in the business model.
Around early 2007, however, the impact of such laziness started to take its toll on most companies with social products. CPM’s were dismal for all players including Facebook, and most companies were barely profitable or running at a loss. It was time to stop jamming a square peg through a round hole, and start exploring alternative revenue streams.
US Economy Falls in 2008, and with it online ad revenues
In mid 2008, the US economy saw some pretty rough times. The stock market plummeted, banks were collapsing, and it was clear that advertising revenues were going to follow a similar path. Online Ad CPM’s started to fall everywhere including “hot” social networks and games.
Companies that were breaking even or running a small profit on ad revenues started seeing red. A fire had been lit, and “exploration” around virtual goods quickly turned to “action.” This has a strong correlation to one of the key reasons virtual goods emerged in Asia. Asia never had a robust advertising industry to lean on, so they were forced to find other ways to monetize right from the start.
The Facebook Application Platform Acts as a Catalyst
In mid 2007, Facebook released the first version of its application platform. Almost overnight, three person teams in cramped apartments had millions of users using their product. And while having this level of user adoption was exciting, most developers were there for one thing, to make money. Many tried advertising, but CPM’s were even more dismal on applications than on the social networks themselves.
Virtual currencies were originally used to incentivize users to invite their friends and spread the application virally. But agile teams of developers, with nothing to lose, started to test if users would pay or complete CPA offers to redeem the currency. Sure enough, the money started rolling in along with stories of individual developers making $1 million a month off of virtual goods. Facebook had unknowingly provided the catalyst which sparked experimentation with virtual currencies and goods.
Facebook tests virtual goods model with gifts
In February 2007, Facebook launched virtual gifts and eventually (as was estimated after the fact) their virtual gifts revenue approached $15 Million. While niche sites like Dogster and Hot or Not had previously been successful with virtual goods, it wasn’t until Facebook launched their gifts that a major North American social network with mass audience appeal was doing well with the virtual goods model. This was an important step in winning over skeptics that thought the virtual goods monetization strategy was just an isolated occurrence.
Virtual Currency Reaches Critical Mass
With the growth of Facebook apps, Myspace apps, and other large social sites with virtual currencies, a critical mass of users has been exposed to virtual currencies. Users now understand “how it works” and most importantly accept the model. This has two impacts. One, the model of a currency (or stored value system) mitigates micro transaction costs where so many in the past have failed. And, two, a company can now launch a virtual currency model in their product with much less confusion and larger initial adoption from its users.
While the growth of virtual goods is exciting in general, I find it more encouraging that we are finally getting away from business models that disrupt and interfere with user behavior, but instead enhance it. We expect the next few years to be even more exciting for the virtual goods industry here in North America and abroad.
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