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Last year, my company, Viximo, released its first product in partnership with BigDates Solutions, makers of the Birthday Calendar, one of a small number of Verified Applications on Facebook. Viximo provides a complete virtual goods platform that enables social media sites, such as social networks, social networking apps, and dating sites, to launch and grow a virtual goods based business model. Virtual gifting is usually the first, and often the most important, virtual goods feature on those sites.

Pioneers of virtual gifting, especially paid virtual gifting, have faced a considerable amount of skepticism. Facebook, in particular, was criticized for gouging its users when it launched its Facebook Gifts program in February 2007, and many predicted that the program would be a dismal failure. During its first year, Facebook Gifts generated an estimated $15 million, or 10% of Facebook’s overall $150 million in revenue for 2007. And virtual gifting has become mainstream enough to be featured on the front page of major newspapers such as the Boston Globe.

Revenue from online advertising on social networks continues to erode because social networking users aren’t receptive to and can easily ignore traditional banner advertising. But virtual gifting is fundamentally different — it both adds value to and is integrated into the social fabric of online communities. That not only means that people are willing to pay for virtual gifts, it also means that brands can play a valuable role in the dialog that is native to social networks.

Who is giving virtual gifts?

The first step in creating a successful virtual gifting based business is to understand who is sending virtual gifts and why they are sending them. Virtual gifting behavior closely mirrors offline gifting behavior — it is much more a function of gender than age. Women of all ages give gifts with significantly higher frequency and for a broader set of reasons than men. Men, on the other hand, give gifts primarily for romantic purposes.

Based on the data we’ve gathered, we’ve found that in a roughly 50%/50% distribution of men and women, women are responsible for 80% of virtual giftings while men are only responsible for 20% of virtual giftings. Women send gifts with equal frequency to both men and women (40% of virtual giftings are female to female and 40% are female to male); however, men are 3x more likely to send virtual gifts to women (15% of virtual gifts are men to women and 5% are men to men). Sound familiar?

Unlike many social networking phenomenon but like real-world gifting, virtual gifting is age agnostic. We’ve found that more than half of giftings through Birthday Calendar are sent by women between the ages of 22 and 32, but that is more representative of Facebook’s audience than virtual gifting’s appeal. The Boston Globe article that I referenced earlier profiles a 62 year old women who spends over a $100 a year on virtual gifts on Dogster, the pet-oriented social network that is popular with an older demographic than Facebook’s.

Why are people giving virtual gifts?

Virtual Gifts as Greeting Cards

The $7.5 billion greeting card industry is based on the notion that relationships need to be periodically acknowledged with a token that requires a small investment of time and money. In the U.S., people send 7 billion cards annually — that’s a little over 20 cards per person for a variety of holidays and events such as Valentine’s Day, Christmas, birthdays, and graduations.

As relationships move online, it’s inevitable that these offline social gestures move online as well. In fact, these gestures are more powerful online since virtual gifts can be visible to a person’s entire social network, whereas Christmas cards are only visible to the handful of lucky friends and family that get to see your mantel during the holidays.

Willingness to pay for these types of virtual gifts is easy to understand. After all, if people are willing to spend $4.00 on a small piece of card stock with some glitter glued onto it that makes it from envelope to trash in a matter of days, then a $1.00 virtual gift is a relative bargain.

Virtual Gifts as Signals

In medieval times, the act of one monarch giving another monarch a gift was an gesture of critical importance. Distance and subterfuge had robbed written words of meaning, and gifts became an important way for one person to gauge another person’s intent.

Why are gifts such an important medium of communication? Why do people agonize over what to give and how much to spend? It’s because gifts, real and virtual, are overloaded with meaning that is difficult or impossible to communicate with words alone. Gifts signify:

  1. the wealth and taste of the giver,
  2. the amount of value that the giver sees in his or her relationship with the recipient,
  3. and the extent to which the giver understands what the recipient wants.

Today, communication is cheaper and easier than it has ever been before, and that dilutes the meaning of e-mails, instant messages, and forum posts. Virtual gifts provide a valuable way to differentiate a message from the cacophony of information that people sift through every day — they show the recipient that the sender was willing to spend time and/or money to make their signal loud and clear.

HOT or NOT pioneered virtual gifting in the dating industry by letting users send virtual roses ranging from $2 to $10 to prospective dates. In an outcome that turns traditional economic theory on its ear, the $10 virtual roses have been the most popular because they send the clearest signal to the recipient, and HOT or NOT has found that recipients of virtual gifts are four times more likely to respond than users who did not receive a gift.

Virtual Gifts as Accolades

Today, eBay is a juggernaut of the Internet economy, so it’s hard to remember the days when eBay was widely considered to be one of those fringe business ideas that existed only because of dot-com exuberance. After all, who in their right mind would send money to an absolute stranger for a product that could only be seen in blurry, amateur photographs?

In the early days of Web 1.0, “reputation” was still a purely offline concept and it wasn’t clear that technology could replace or even augment the intricate network of factors that determined whether one person could trust another. One of eBay’s critical insights was that a person’s reputation is based on the collective opinions of many individuals who have had a meaningful interaction with that person, and cannot accurately be determined by singular authority. As a result, eBay enabled its users to influence each others’ reputations and that reputation system forms the foundation of trust that drives commerce on eBay to this day.

eBay’s reputation system benefits from the fact that one user can only rate another user after they have engaged in a transaction. This is a form of scarcity that imbues eBay ratings with significant social value. Many social media sites make the mistake of implementing reputation systems that are based on user-to-user accolades that are in infinite supply. As a result, these reputation system are easy to “game” and don’t hold the same weight as eBay’s reputation system.

Virtual gifts can be used in the place of ratings as the basis for a reputation system. Since virtual gifts are scarce and often have cash value, they have significantly higher social impact. In addition, virtual gifts can be designed to further enhance the effects of the reputation system with tiered accolades (i.e., gold, silver, and bronze), limited edition accolades, and accolades that are only accessible to elite members of the community.

Virtual Gifts as Social Play

In Virtual Goods and the Community values of Facebook, Bret Terrill analyzes the top gifting applications on Facebook to determine what is important to the Facebook community and why they send gifts. The applications basically fall into two buckets: apps, such as Free Gifts, Hatching Eggs, and Growing Gifts, which use the “virtual gifts as greeting cards” model that we’ve discussed and apps, such as Bumper Sticker, Pieces of Flair, and Stickerz, that features gifts with a witty, intelligent sense of humor. This shows that people often send virtual gifts for exactly the same reason they send YouTube videos or forward joke e-mails — they want to make other people laugh.

Although virtual gifts add color to the playful banter on social networks, humorous gifts face a lot of competition from status updates, joke e-mails, YouTube videos, photos, and other ways that people “play” with each other online. As a result, willingness to pay for gifts that are purely humor gifts is pretty low.

Virtual Gifts as Reciprocation

A few months ago, I was doing a presentation on virtual goods at a social networking conference, and I asked the audience to raise their hands if they had sent or received a virtual gift. A relatively large handful of people raised their hands, and I asked one of the audience members to tell me more.

She started out by saying, “I just don’t get virtual gifts. I can’t imagine why anyone would spend money on that stuff.” She went on to explain that a friend of hers had paid $1 to send her a virtual gift on Facebook for her birthday. Although I was pretty sure I knew the answer, I asked her whether she had ever sent a virtual gift. She said, “Yeah, I sent one to my friend to thank her for the virtual gift she sent on my birthday.” Surprised, I asked, “Did you pay for it?” She responded, “Of course. I don’t want her to think I’m cheap.”

Reciprocation is an essential part of giving gifts for the both the giver and the receiver. People give gifts, in part, because they want to elicit a positive response from the recipient, and recipients tend to feel indebted to the giver until they have reciprocated in kind.

If you are building a virtual gifting business, remember that a simple “thank you” virtual gift might just be the most important gift in your inventory.

Communicating through Virtual Gifts

The act of giving a virtual gift is just another form of communication, and we know that effective communication must be powerful, relevant, loud, and clear. Virtual gifts have a variety of qualities, including content, pricing, scarcity, and customization, which determine how effective they are as a communication medium. Best practices are starting to emerge, and the following table provides some guidelines on how to structure virtual gifting for different use cases.

Content Pricing Scarcity Customization
Greeting Cards Large inventory of traditional greeting card content maybe with a unique twist Most often $1, use greeting card prices as an anchor Limited editions add value, gifts shouldn’t expire Personalization adds significant value
Signals Recipient should be able to discern price of content, so small inventory is usually the way to go Sky is the limit, how much is someone on the site willing to pay to stand out? Should expire after 2-4 weeks so that senders are encouraged to “refresh” their signal Personalization helps makes signal more relevant and, hence, more effective
Accolades Small inventory with explicit or implicit meaning tied to each item (i.e., bronze, silver, gold) Vary based on level of accolade, must be cheap enough to send but expensive enough to be meaningful ($0.25-$5 is a good range based on current prices) Expiration should be tied to level of accolade, cheaper ones expire faster, more expensive ones may last forever Not important, uniformity makes accolades more meaningful
Social Play Large inventory of witty gifts, in this case shopping is half the fun Willingness to pay is low so make free or price under $2 Limited editions may add value, no reason for gifts to expire Customization can add significantly to humor
Reciprocation Small inventory, there’s only so many ways to say thank you People like to reciprocate in kind, pricing should be based on prices of other gifts in the system Limited editions and expiration not likely to be important Personalization is very important; helps underscore apprecation

Cutting Through the Noise

Today, the volume of communication that individuals have to deal with on a day-to-day basis is increasing dramatically. Facebook, Twitter, dating sites, games, e-mail, SMS, and instant messages all vie for a person’s attention. In a world inundated with social media, virtual gifting provides an essential way for users to separate signal from noise and add impact to their online social gestures.

In January, Jeremy Liew at Lightspped Venture Partners estimated that Facebook was generating $15 million annually in virtual gifting revenue. Today, Jeremy posted an update to that initial analysis which suggests that Facebook is selling virtual gifts at annual run rate between about $28 million and $43 million.

Based on the January estimate, Facebook earned an estimated $15 million in virtual gifting revenue on total estimated revenues of $150 million. Facebook is estimated to do between $300 and $350 million in revenue this year, which means that growth in virtual gifting revenue is either keeping pace with or exceeding Facebook’s overall growth.

The analysis also suggests that nearly 80% of Facebook gifts are sold from the first screen of Facebook’s gift store. This tremendous bias towards the “first page of results” will come as no surprise to search engine optimization experts and web behaviorists — the majority of people just can’t be bothered to search below the fold.

As a result of this phenomenon, the relevancy of the first page of results is absolutely crucial to whether or not a user “converts” (i.e., clicks on a search engine result on Google, buys a book on Amazon, or sends a virtual gift). While Facebook is generating a respectable amount of revenue from virtual gifting (revenue most other social networks are leaving on the table), the full potential of their virtual gifting business won’t be unlocked until they follow the merchandising best practices of successful e-commerce sites such as a Amazon.

What’s the first step? Get rid of that one size fits all storefront and use some of the Facebook Beacon targeting goodness to create personalized storefronts for Facebook Gifts shoppers.

VentureBeat has a great article today that discusses how virtual goods are starting to pan out for Facebook game application developers.

According to the article, popular Facebook application (fluff)friends is making an estimated $1.00 per month per daily active user and Mob Wars is making an estimated $2.60 per month per daily active user. At those levels, (fluff)friends is expected to make $1.3 million annually on a base of 112,229 daily active users and Mob Wars is expected to make $15 million on a base of 483,824 daily active users.

All of this is very encouraging in light of the fact that the value of Facebook ads continues to fall. Advertising on Facebook applications is valued at between 7.5 cents and 50 cents per thousand ad impressions (CPM). Each daily active user would need to generate thousands to tens of thousands of advertising impressions per month in order to generate revenue on the same level as virtual goods based businesses.

We’ve seen the same thing since we launched Viximo’s virtual gifting system on the Birthday Calendar application on Facebook. In order to compare virtual gifting with social network advertising, we look at total virtual gifting revenue divided by impressions of the virtual gifting offering. This gives us a metric which is roughly comparable to CPM. To date, we’ve been generating an equivalent CPM with virtual gifting that is about 10 times higher than the typical CPM for social network advertising.

Its been a long time since I posted to the blog. Launching our product, growing Viximo, and lots of summer activities have conspired against me. My goal is to get shorter posts up on the blog at least once a week. Wish me luck, and please stay tuned!

Sometimes virtual goods get a bad name. After all, what father wouldn’t load his shotgun at the thought of his daughter getting a Polka Dot Thong on Facebook? And what mother wouldn’t shake her head knowing her teenage son had spent $1 of her hard earned money to send that thong?

Well, virtual goods aren’t all innuendo and frivolity. Sometimes virtual goods can make the real world a better place. Causes, a popular Facebook Application with over 9 million installs, lets users send over 20 different Charity Gifts to their friends. Charity Gifts range from Blankets (a $10 donation to the American Red Cross which is used to purchase two blankets for people suffering from a disaster or emergency) to Baby Chicks (a $20 donation which helps a hungry family in Cameroon start a flock of chicks) to a Laptop (a $200 donation that provides a laptop to a child in a developing country). Charitable donations are made in the recipient’s name and can be displayed on the recipient’s Facebook profile.

The notion of charitable virtual gifts wasn’t lost on the team at Facebook. When Facebook Gifts launched in February 2007, all proceeds for the month were donated to Komen for the Cure. Facebook chose the foundation because Breast Cancer Awareness is the largest cause related group on the site. Today, Facebook Gifts is a for profit enterprise (quite profitable, Facebook made an estimated $15 million in virtual gifts during the first year of the business). However, if you are willing to rummage through a few thongs, you can still find the Pink Ribbon in the Facebook Gifts store.

CarePages is a free website that helps family and friends communicate with a loved who is hospitalized or receiving health care. Patients and their families can create a CarePage which is very similar to a social networking profile page. Owners of a CarePage can leave updates and upload photos, and visitors to that page can leave messages and virtual gifts. Virtual gifts are free to give and organized into helpful categories such as Encourage, Kids, Smiles, and Support.

PrayAbout is a unique social community that has been described as a way to “hack into God’s inbox”. Members of PrayAbout can submit prayer requests. A prayer request is non-denominational prayer that the submitter wishes to be answered. Members can add photos and update their prayers over time. Visitors to the person’s prayer request may leave a message and may light one or more virtual candles for that prayer. Virtual candles can be purchased for about 10 cents to about 25 cents per candle. They can also be earned by inviting friends to the site, receiving candles for a prayer request, and lighting candles for a popular prayer. Lighting candles is a way for the community to virtually hold vigil for a prayer and show their spiritual support to a member in need.

Handipoints is a kid-focused virtual world that puts a different twist on things. Kids earn points by completing chore charts setup by their parents. By completing these “quests”, kids earn “handipoints” that can be redeemed for real world items and bonus points that can used to purchase virtual goods in the Handipoints online world. Online game designers have known for years that players will do almost anything to earn virtual rewards. Handipoints is betting that they may even be willing to do chores.

Virtual rewards provide a very real incentive and virtual gifts add very real value to our online social gestures. We’ve seen virtual goods at work in the most frivolous parts of our lives, but they can have as significant an impact on the things that really matter like standing by a friend in need or teaching kids that positive habits have long-term benefit.

Erik Bethke, CEO of GoPets, conducted a session on how to apply MMO principles to any experience to make it more engaging. For good coverage of his talk, check out Worlds In Motion and Lightspeed Ventures. You can get the slides for the session here.

Erik’s talk focuses on a really powerful observation: the mechanics that make massively-multiplayer games so successful have universal appeal. While there has been some good thinking about how to apply general game mechanics to make applications more fun, MMO mechanics can have a much more powerful impact because they are derived from the social dynamics that are core to social media.

Virtual gifting is a common use case of virtual goods for social media sites. Facebook Gifts is the most well-known example, but other sites have had success with virtual gifting including LiveJournal, Hot or Not, and Dogster/Catster. Current examples of virtual gifting are distilled down to their essence - select a gift and send it to a friend.

Erik’s session highlights a number of ways that virtual gifts can be taken to the next level.

Leveling, Questing, and Crafting

Leveling, questing, and crafting are three of the most important mechanics of MMOs.

Leveling is the concept that there should be well-defined rungs as a person climbs an achievement ladder. This is something we all experience in our jobs, but other examples are just as powerful. How many of your have stuck with the same airline, through thick and thin, to make sure that you got “elite” frequent flyer status? Thats just a form of leveling.

Virtual gifting is exactly the sort of activity that could benefit from an achievement ladder. Like combat in an MMO, virtual gifting is initially very compelling but can loose its luster after the thrill has worn off. If virtual gifters earned levels as they sent or received more gifts and if those levels came with tangible rewards (such as an increased selection of available gifts), then users would be more likely to stay engaged over time. In addition, “elite” gifters would have an elevated status in the community which enhances their sense of achievement and projects a model for other users to emulate.

Some of the free gifting applications on Facebook have implemented simple leveling systems, but, to my knowledge, none of the “official” gifting programs have done this.

Questing is a mechanic were players are given explicit tasks to complete throughout the game experience. Players receive significant rewards when they complete a quest - rewards which are generally higher than what can be earned by the equivalent amount of ad-hoc play. As a result, quests encourage certain play patterns and thereby keep people engaged by structuring the gameplay experience. The “Profile Completeness” indicator on sites such as LinkedIn and OkCupid are great examples of “quests” outside of the game industry.

Right now, users give virtual gifts for holidays, birthdays, and “just because”. Its a completely self-directed process and one which is easily interrupted. Virtual gifting would be more enjoyable if there were little quests like “give gifts to three new friends”, “give gifts to three members of the opposite sex”, “give three charitable gifts”, or “give all the gifts in a particular set”. The social networks have a rich enough set of data about users to come up with really interesting virtual gifting related activities.

Crafting is a gameplay mechanic where player’s can transform less valuable resources into more valuable resources by investing time, skill, money, and creativity. Just as productivity is the engine of the real economy, crafting is the engine of many virtual economies.

Facebook Gifts encourages a form of crafting by suggesting that members chain gifts together to form innuendos, but this can go much further. How about allowing users to craft new gifts by uploading photos? What about using the gifts that a person has received as resources to create a new gift? For example, give the user an editor to create a bouquet of flowers - but they can only use the type of flowers that they’ve received as gifts.

Embrace Hardcore Users

Erik points out that even the most casual experiences have hardcore users - and those hardcore users have found something pretty fun to do in your application. Hardcore users will be 1) the largest revenue generators, 2) the product’s biggest evangelists, and 3) exemplars for the rest of the community.

Believe it or not, there are hardcore virtual gifters. These virtual gifters are generally women who are hubs of their social networks. They use lightweight social gestures, like sending virtual gifts and writing on friend’s walls, to maintain their friendships. Hardcore virtual gifters introduce new users to the virtual gifting feature and keep the flow of gifts going by encouraging others to reciprocate.

Virtual Gifting 2.0

The success of virtual gifting defies common notions of value, but Facebook and others have proven that people are willing to pay real money to enhance the social impact of their gestures. Sending a virtual gift is what Erik would refer to as a transaction - the basic unit of gameplay. But transactions lose much of their meaning when they aren’t driven by a broader set of measurable goals. Today’s virtual gifting features are just beginning to scratch the surface of a much deeper social media experience that can be unlocked by applying MMO mechanics.

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.