Earlier this month, leaders from the barely two year old social gaming industry gathered in San Francisco at the Social Gaming Summit 2009. It’s hard to believe that in only two short years, Facebook launched the first social networking application platform, most of the other social networking players have followed suit, and an estimated 14,000 social games have proliferated across those platforms.

The 500+ attendees at the Social Gaming Summit included representatives from top social networks, major game developers, and a wealth of infrastructure vendors, such as Offerpal Media and Zong, who have sprung up to support this rapidly growing industry. The emphasis was largely on issues of player acquisition and retention with particular emphasis on monetization and deployment of virtual goods as a key contributor to revenue generation.

Until recently, Internet companies in the United States have lagged far behind the curve in the sale of virtual goods. By most estimates, customers spent about $1.5 billion a year on virtual goods globally in 2007. Tencent Holdings, a publicly traded Internet media company based in China, runs perhaps the largest virtual goods business in the world, with hundreds of millions in annual revenue from virtual goods in online games, social media, and other applications.

In December, Jeremy Liew of Lightspeed Venture Parters made his prediction for the consumer Internet for 2009:

“In Asia people have been paying real money for virtual goods for years. It is the primary business model for games and Internet companies in China and Korea, far more important that advertising. We’re starting to see similar behavior in the U.S., also led here by online games and social networks. On the back of the rise of social networks and games, 2009 will be the first real breakout year for this business model in the US.”

We’re only half-way through the year, and it looks like Jeremy’s prediction is already proving true. It’s estimated that the total revenue generated by companies running applications on Facebook’s platform will outstrip Facebook’s own revenue in 2009. Social gaming is leading the pack here, and rumor has it that major social gaming players, such as Zynga, are making upwards of $50 million on an annualized run rate.

Venture Capitalist Bill Gurley sees this phenomenon as the answer to the monetization problems faced by Facebook, MySpace, and other top social networks which are struggling to meet revenue expectations in the face of an increasingly difficult advertising market. He ended the article by emphasizing that Wall Street was all set to welcome this new business model.

Social Gaming Trends

Leaders from the social gaming industry revealed some important trends in social gaming during the summit:

Virtual goods work with mainstream consumers

Sebastien de Halleux, COO of Playfish, said his Pet Society game sold 20 million virtual Christmas trees and ornaments last holiday. Players paid up to $2 for each virtual item and many players spent more on virtual trees than the average person spends on a real Christmas tree. Sebastien noted that a real Christmas tree is seen only by a handful of family members and close friends, but Pet Society’s virtual Christmas trees and ornaments can be seen by hundreds of online friends. This is just one way in which online behavior is driving new trends in consumer spending.

Brands are playing a vital role in social games

John Pleasants talked about how Playdom’s Sorority Life sold $100,000 worth of virtual Volkswagen’s over a two day period. Brands have struggled to find a strong role in the traditional video game market and advertising on social networks has been plagued by poor performance. However, social games offer brands a powerful promotional and merchandising vehicle and both brands and social game developers have been quick to embrace this opportunity.

Social games have unlocked the latent value in social networks

Despite having large and fervent audiences, social networks have had a hard time monetizing their user bases. Industry experts debated whether the answer would come from traditional display advertising, integrated sponsorships, lead generation, hyper-targeting, or direct user monetization. Well, the social gaming industry are proving that “all of the above” is the right answer.

Virtual goods provide both a way to directly monetize social networking users and a way to weave advertising opportunities into the social fabric of a site or app. But no one anticipated that social games would also unlock a valuable new form of lead generation marketing. Offer platforms, such as Offerpal and Superwards, allow users to earn virtual currency by completing lead forms, and they share the revenue generated from these leads with the application developer. Anu Shukla, CEO of Offeral, cited that 30 to 40% of players will bite on offers. As social networks find ways to become part of the social gaming economy, they’ll open up new revenue channels and drive their ARPU (average revenue per user) to significantly higher levels. In an extreme case, Adam Caplan, CEO of Super Rewards, discussed a social game player who bought $30,000 of virtual goods for use in two different games.

The Future of Social Gaming

The Summit highlights the fact that the Social Gaming industry has and will continue to have phenomenal growth. In a relatively short period of time, social games have proven that selling virtual goods is a viable business model in North America and that social networking audiences can generate significant revenue. Strategy Analytics recently released a forecast projecting that microtransaction revenue will grow from $1 billion in 2008 to $17.3 billion in 2015. No doubt, social gaming will be one of the driving forces behind this growth.

What will social gaming look like when it turns 3? I can’t know for sure, but here are some thoughts:

• Social networks will monetize by providing virtual currency. Hi5, one of the social networks that followed Facebook’s lead by offering an applications platform has also learned from Facebook’s biggest mistake—not taking a share of revenue from applications and social games that run on its network. Rather than taxing applications for inclusion on its network, Hi5 opened up its Coins virtual currency to be used by app developers. This strategy provides value across the board by giving users a single currency that is accepted throughout the social network, giving developers access to a broadly-adopted microtransaction system, and giving Hi5 a way to share in microtransaction revenue. Facebook followed suit by launching the Pay with Facebook feature last month.
• Social games will spread to new devices. Although social gaming started within social networks, every major social game developer is bringing their content to new platforms such as the iPhone. With the introduction of in-app payments earlier this month, iPhone developers will now have the perfect microtransaction system to build their content on—iTunes. However, these games are staying close to their roots; many are based on the Facebook Connect API which allows developers to access elements of Facebook’s application platform outside of Facebook on a diverse array of devices. Facebook recently announced that it will provide Facebook Connect on Xbox Live, which means that we’ll start to see social games on video game consoles.
• Social games will spread to niche and international social networks. Wikipedia’s list of social networking websites includes over 150 sites, and the list leaves off many large international social networks. Social games are key to monetizing social networks, and we’ll see both lightweight and more involved social games become a key part of any social network which is serious about monetizing its users.
• Traditional game companies will continue to stand on the sidelines. What was the very first hit social game? It’ll probably sound familiar—Scrabble, well actually Scrabulous. Launched shortly after the release of the Facebook Platform, Scrabulous is a social game, based on Scrabble, that was released by two brothers who became the first lucky prospectors in the social game goldrush. Rather than recognizing their good fortune in finding a new, rapidly growing medium for their games, Hasbro quickly got to the business of shutting Scrabulous down and didn’t find time to release its own version of Scrabble on Facebook months later, after major players such as Zynga had staked their claim. None of the traditional game companies have played a significant role in social games to date, and this will likely continue until the major players, such as Electronic Arts and Activision, wake up to the opportunity and start acquiring players like Playdom and Zynga.

Social gaming will continue to evolve at a whirlwind pace, and will be one of the major drivers behind the global explosion of virtual goods revenue. If you’d like to stay up to speed on these developments, I recommend checking out the upcoming Virtual Goods Conference which is part of the Engage Expo (September 23-24, 2009 in San Jose, CA) and the Virtual Goods Summit (October 29-30, 2009 in San Francisco, CA).