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Last week’s Game Developer’s Conference put the limelight on the rapidly growing game industry, but it also highlighted a significant pain point - virtual good sales create very real accounting issues for successful virtual worlds and MMORPGs.

The video game industry has been way ahead of the game when it comes to implementing a variety of business models and accepting a variety of billing methods. In this case, necessity has been the mother of invention since many of the industry’s young consumers don’t have access to credit cards. Sulake, the makers of Habbo Hotel, have been particularly innovative in this space. The company accepts 186 different payment methods in 31 countries including credit card, SMS payments, money orders, and prepaid game cards available through major retailers such as Target and Walmart.

Sulake even manages to pass some of the transaction costs to consumers by varying the exchange rate between cash and coins, Habbo’s in-world currency, based on the billing method used and amount of currency purchased. Consumers get as little as 5 coins per dollar for high transaction cost billing methods such as prepaid cards and as much as 6 coins per dollar for low transaction cost methods such as credit cards or ongoing subscriptions.

Now that the industry has figured out how to get money into the system, it’s now faced with the challenge of keeping it there. The industry faces a number of challenges:

  • Lack of Parental Consent. If a child fails to get the consent of his or her parent before making a purchase, that parent can have the charge reversed. Although there may not always be sound grounds for reversal, credit card companies often side with parents regardless of circumstances. This not only results in customer service overhead for the virtual world or online game operator, it can result in lost revenue from the sale of limited edition or exhaustible items which cannot be reclaimed.
  • Outright Fraud. In many of the major virtual worlds and online games there have been cases of fraud where a user converts cash into in-world credits, uses those credits to purchase a rare item, sells that item for real currency on a sanctioned or unsanctioned aftermarket, and then cancels their original credit card payment. As a result, the user commits a form of “cybertheft” by profiting from virtual goods that the user never paid for. In some cases, the operator can recover the payment, but the credit card dispute process is time-consuming and often biased to the cardholder.
  • Stored Value Accounting. For years, airlines have had to keep significant liabilities on their books related to the accumulation of frequent flyer miles. The industry faces a similar problem. Should operators recognize revenue when cash is converted into in-world currency? Should the accumulated balance of all in-world credits by accounted as a liability on the balance sheet? What happens if a user abandons their balance? Should users have the right to claim a cash credit for their account balance at any point in the future? The answers aren’t clear.

As Joshua Jaffe mentions in his article, there is no turnkey payment solution that addresses the unique needs of the video game and virtual world industries. Certainly, with the emergence of economic platforms like PlaySpan and TwoFish, we’ll start to see industry-wide platforms and best practices related to payment collection, chargeback risk mitigation, and fraud deterrence.

Valentine’s Day reminds us that love is a many splendored thing - especially if you’re the CEO of Hallmark, 1-800-FLOWERS, or Godiva. This year Americans spent more than $17 billion on Valentine’s Day. To put it in perspective, that is more than the gross domestic product of half the world’s countries. Men spent an average of $163.37 per person whereas the fairer sex got away with a mere $84.72.

Sweet Nothings

The majority of Valentine’s Day spending consists of the usual suspects: greeting cards (purchased by 59% of Valentines Day consumers), candy (48%), and flowers (36%). But like the rest of our lives, love is moving online and virtual goods, in all their forms, are taking the place of the old standbys.

E-cards are the original virtual good and they continue to be a staple of online admirers. According to the Greeting Card Association, an estimated 14 million e-cards were sent for Valentine’s Day in 2008, and Valentine’s Day is the largest e-card sending occasion of the year.

Virtual gifts are, to some extent, an evolution of the e-card. Facebook Gifts is probably the best example of virtual gifting in the context of social networking. For the price of $1, a Facebook member can send another Facebook member any one of over 400 different graphical icons. Many of these gifts are “virtual” versions of traditional Valentines Day gifts, such as flowers or chocolate, while others, such as “Love Duckie” or “Polka Dot Thong”, are more creative or risque takes on the theme.

In How Real Is Your Love?, Susan Wu from Charles River Ventures explains, “Sending a virtual flower is a way of showing lightweight attention and affection to someone online.” Since virtual gifts are used lightheartedly and flirtatiously, they often make sense where a physical gift would be seen as too serious or too forward.

If you can’t bear the exorbitant prices of real flowers on Valentine’s Day, then virtual flowers might be the next best thing, and they can be had for an irresistibly price - free. They’re Beautiful is a free site where users can create a virtual flower bouquet and deliver those flowers to any e-mail address. Recipients can show off their flowers by embedding them into any other website. Brown thumbs need not apply since the flowers will wilt after a few days without a virtual watering.

If sending a free bouquet of virtual flowers just won’t make the cut, you can put down some hard earned cash at Bokay Me, a service from 1-800-FLOWERS where users can create a virtual bouquet and deliver it to an e-mail address, Facebook account, or mobile phone. Sending a basic bouquet is free but enhanced options can push the price of a bouquet up to $3.00 - not a bad deal for those times when real flowers a) won’t get there fast enough, b) won’t get there at all, or c) won’t make you look anything less than desperate.

Lets face it. A virtual rose doesn’t smell as sweet and a virtual box of chocolates certainly doesn’t taste as sweet. Our friends at Mars have solved this problem by enabling Facebook members to buy real candy for each other. The UK division of Mars recently announced a Facebook application called Celebration. Using Celebration, a member can purchase candy and have that candy delivered to a friend. Rather than actually delivering the candy via the postal service (which would be time consuming and would involve disclosing personal information), a redemption code is sent to the recipient’s mobile phone. The recipient can take that code to any one of 15,000 PayPoint locations in the UK and redeem the code for the actual candy bar. Now thats innovation.

Whether real or virtual, flowers and candy might tickle your valentine’s fancy, but they won’t do the world much good. If you are looking to send a Valetine’s Day gift with a little more social impact, try Changing the Present , an application that features over 1,000 $1 gifts from leading non-profits. Instead of a “Love Duckie”, Facebook members can send a gift that both decorates their friend’s profile and helps make a difference.

Dating Evolved

If all this has you shaking your head and thinking to yourself, “Sending my valentine virtual flowers instead real ones will get me a one-way ticket to the couch.”, then you might just be dinosaur of a dater. Sure, you may have e-mailed a love letter or even met someone online. But have you broken up with someone by changing your Facebook status, had a dinner date via webcam, or been tempted to cut-and-paste your personality?

As the rules of dating transform to keep pace with our networked lifestyles, so too will notions of what is and isn’t romantic. One day those overpriced, wilted “real” roses from 1-800-FLOWERS might just be the tackiest arrow in your quiver.

Exactly a year ago, Facebook started testing virtual gifts. Reaction to Facebook’s foray into virtual gifting was mostly negative, sometimes violently so. Consider what some people had to say on TechCrunch:

  • “I don’t really see this idea taking off.”
  • “The icons are a little too cute to be interesting, and really valueless.”
  • “I think if any of my friends knew I paid $1 to post a puppy icon on a friend’s facebook profile, they would quit talking to me… that seems really creepy.”

The wisdom of the crowds would suggest that Facebook Gifts was a massive flop. But, that just hasn’t been the case. By some estimates, Facebook has earned $15 million in virtual gift revenue since the launch of Facebook Gifts. That is not an insignificant percentage of the $150 million in revenue that Facebook made in 2007.

So what’s going on here? How did Facebook make millions of dollars from “valueless icons”? Why are people around the world spending billions on stuff that isn’t “real”? The answer is simple, but it signifies one of the most profound shifts in the history of commerce.

Why people spend money on virtual goods

Why do people spend money on virtual goods? Its a case of straightforward economics. The marginal utility attributed to the virtual good by its consumer is higher than the marginal utility of an extra dollar, five dollars, or whatever the price of the good. In other words, the girl on Facebook who can’t be there for her best friend’s birthday would rather spend a $1 to send her friend a Birthday Cupcake Facebook Gift (that will arrive on the exact day and be seen by everyone who visits her friend’s profile) than spend a $1 (or more) on a greeting card (that will be seen only by her friend and likely go into the trash a few days later). Both Susan Wu and Jeremy Liew have excellent posts that describe, in more detail, the ways that virtual goods deliver value to their consumers.

Atoms vs. Bits

All of this is symptomatic of a profound shift from the economy of atoms to the economy of bits. In The Long Tail, Chris Anderson discusses how the economy of bits has, by eliminating inventory costs and reducing fulfillment costs to the pennies required to transmit digital content, transformed the hit-driven nature of the media industry and enabled a market where millions of niche consumers can be connected with millions of niche products. But the economy of bits is not a phenomenon limited to old forms of media, such as music and movies, which can be efficiently digitized — it extends the very definition of media to things that could not have existed before such as avatar apparel, virtual real estate, and interactive widgets.

To fully comprehend this transition, its important to realize that the fundamental forces of value behind the economy of bits and the economy of atoms are the same. We do not attribute value to a physical good based on the properties of the atoms that comprise that good. A great novel is worth far more than the few ounces of wood pulp that comprise it. A LIVESTRONG wristband means more than the silicon its made from. An exquisite, hand-painted replica of Picasso’s Les Demoiselles d’Avignon may be indistinguishable to all but an expert’s eye, but it will neither hold the same value as the original or cause the original to depreciate.

The same is true for virtual goods. The value of a virtual good is not defined by the properties of the bits that comprise it. Les Demoiselles d’Avignon is made from easy to find, relatively inexpensive oils and canvas, but it would be a mistake to determine its value from those materials. In the same way, it is a mistake to devalue virtual goods because they consist of bits that are easy to replicate and nearly free to transmit. The value of virtual goods stands on the same pillars that lift the value of physical goods: functionality, social context, brand, scarcity, and aesthetics.

As more of our lives move online, we’ll gain more and more utility and entertainment from goods that exist only in digital form. Our notions of “real” and “virtual” will forever change, and a large chunk of our attention and money will forever shift into goods that we, once upon a time, could barely comprehend as valuable. That shift is what this blog is about.

Goodbye atoms, hello bits.


Virtual Goods Insider covers the burgeoning economy of in-game items, avatar customization, virtual gifts, digital media, and other goods that exist purely in digital form. It is written and published by Ravi Mehta, a veteran of the online gaming and consumer media industries.



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