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According to the New York Times, Chinese experimental artist Cao Fei, known in Second Life as China Tracy, is creating the world’s first virtual art installation. RMB City is a virtual city in Second Life that is meant to be an artistic commentary on the rapid industrialization of China. The virtual city will incorporate elements of famous Chinese landmarks such as the Forbidden City, the Great Wall, and Tianamen Square.

Lombard-Freid Projects, a New York art gallery, is currently exhibiting RMB City. The exhibit is part art showcase and part real estate sales office. Cao Fei is offering art collectors and virtual real estate investors a chance to sponsor individual structures in the city for prices as high as $120,000. Sponsors get two years access to their structure in RMB City and a commemorative artwork at the end of their “lease”.

If Cao Fei is able to get those prices, she may just find herself in the 2009 Guinness Book of World Records for “Most Expensive Virtual Object”. She would be dethroning Jon “NEVERDIE” Jacobs, the current recordholder, who purchased an asteroid space resort in Entropia for $100,000.

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.

With all the focus on the electronic entertainment industry, its easy to forget that the video game industry has a long lineage that extends back to tabletop games. Tabletop games consist of traditional board games (e.g., Monopoly), pen-and-paper role-playing games (e.g., Dungeons and Dragons), collectible card games (e.g., Magic: The Gathering), and miniature wargames (e.g., Warhammer).

Of course technical advances have thrust electronic entertainment, including video games and virtual worlds, to the forefront of the broader games industry, but the tabletop games segment still attracts both a large casual audience and a smaller, but highly dedicated hobbyist audience. The tabletop gaming industry’s largest trade show organization, Gen Con, draws an audience of over 27,000 consumers to its U.S. Gen Con event.

The collectible card packs and miniatures that form the nucleus of many hobbyist tabletop games is the closest real world analog to the in-game virtual items that are driving the growth of the virtual goods economy. We can gain a new perspective on how to create engaging virtual goods experiences by looking to the example set by collectible card games and miniature wargaming.

Collectibility

Tabletop game manufacturers take significant steps to enhance the collectibility of their trading cards and miniatures:

High Production Value. Each trading card or miniature is designed to have high production value and adhere to an overall artistic theme. This focus on design enhances collectibility by making each piece an “art object” that can be admired and collected based solely on its aesthetic value.

Collectible Sets. Trading cards and miniatures are often grouped into sets of varying size. At the highest level, Magic: The Gathering groups cards into categories based on five different colors. At a more granular level, Magic: The Gathering cards belong to dozens of different sets ranging from 92 cards to 422 cards. By grouping cards or miniatures into sets, tabletop manufacturers take advantage of the natural tendency for people to collect and complete groups of things.

Booster Packs. Collectible card games and collectible miniatures are often purchased as part of booster packs. Booster packs are sealed packages of cards or figurines that contain a small, random assortment of items (5-15 cards or 3-10 figurines). Purchasers of booster packs can generally expect to get at least one rare item per pack. As a result, these packs appeal to the same “lottery mentality” that makes slot machines so compelling.

Uncommon and Rare Items. The supply of trading cards and collectible miniatures is constrained by manufacturers in order to introduce scarcity into the market for their collectibles. Items are typically categorized as common, uncommon, or rare. Scarce items typically have a unique look and higher functionality than their more common counterparts which further increases their value. For example, there are less than 10 copies of the most rare Pokemon cards and these cards trade for thousands of dollars.

Deck Construction. The rulesets of many collectible card games and miniature wargames require players to construct a deck or army by selecting a limited set of items from the player’s full collection. Oftentimes players construct a gameplay deck of fifty to sixty cards from their collection of hundreds or thousands of cards. Players construct decks based on what they know about their opponent, the strategy they wish to employ, and any variants to the game’s rulesets that are in place. This dynamic encourages players to amass as large a collection of cards as possible so that they have the most strategic options when they go to play the game.

The collectible nature of trading cards and miniatures is a significant revenue driver for the tabletop games industry. As a result, tabletop game manufacturers can afford to give their rulesets away for free while generating a lot more revenue per customer by selling collectible content. Virtual world and MMO operators in Asia have already figured this out and now that model is beginning to be adopted outside of Asia.

Personalization

Personalization of miniature figures is an entire cottage industry unto itself. Miniatures are typical sold as cast metal figures that must be painted before they are ready for the tabletop battlefield. For some players, figure painting is an integral part of the hobby, and for others its a job best left to professional figure painters. For the most serious hobbyists, there are even miniature painting competitions.

Personalization goes beyond mere painting. Some hobbyists alter the appearance of their miniatures by swapping parts of their figures, such as heads and arms, with parts from other miniatures or part collections purchased as “conversion kits”. Many wargamers also spend considerable time designing and constructing the battlefield scenery on which the miniature wargames are played.

For many hobbyists, personalizing miniatures and battlefields is actually more fun than playing miniature wargames. Tabletop game manufactures figured out a long time ago that personalization adds an entirely new dimension of enjoyment to the gaming experience.

Functionality

At their heart, trading cards and miniature figures are simply game pieces like a rook in chess. They aren’t just decorative, they are functional. Trading cards in particular have detailed functionality that is described on the card itself - for example, a particular Pokemon card might be able to steal a card from the other player’s deck. Many virtual items, such as a sword in World of Warcraft, are also functional, but there are still lessons to be learned from tabletop games.

For example, scarce items are generally more powerful in both tabletop and video games. However, game balance issues are much more acute for tabletop games due to the need to support fair competition. In other words, a player with the most rare cards should never be the defacto winner in a Magic: The Gathering tournament. How then do collectible card games tackle this issue? Rare cards have more powerful and unique functionality, but they require significantly more resources to deploy (i.e., they are only an advantage if the player has the tactical wherewithal to find the right time to deploy the item).

This alludes to a second lesson from the collectible cards industry. Oftentimes, the functionality of different cards can be used in concert to get a greater combined effect. Players call these combo decks, and these combinations further enhance the collectible nature of trading cards.

So while MMOs have learned the basic lesson that functionality should be proportional to scarcity, there is fertile ground for innovation in thinking about how to balance the impact of rare items on the economy and how to leverage interactions between a player’s collection of virtual items.

Tradability

In many respects, tradability is a knock on effect of the collectable and functional nature of trading cards and miniatures. However, tabletop game manufacturers also take deliberate steps to enhance the tradability of their products.

Firstly, tabletop games are designed to be highly social. When players gather into ad-hoc groups or at formal events, trading naturally occurs. Secondly, manufacturers deliberately create an economy where one man’s trash is another man’s treasure. They do this by creating clusters of items that work well together (so that a player with an existing collection is naturally inclined towards that cluster) and ensuring that booster packs contain a range of items, including rares, from several different clusters. As a result, every time a player buys a booster pack, he may get items that he doesn’t want but are valuable to his friends.

Tabletop game manufacturers know that a vibrant trading community may not directly generate revenue, but it does enhance engagement with the manufacturer’s product and indirectly drives booster pack sales. Instead of prohibiting aftermarkets, MMO operators should be following the lead of their tabletop brethren and doing everything they can to foster an active aftermarket.

Lessons for the Electronic Entertainment Industry

There is currently a raging debate about whether the MMO industry will move to a free-to-play model with virtual goods driving revenue or whether monthly subscriptions will continue to be the modus operandi outside of Asia. As today’s game designers envision the future of MMOs, they will be well served by looking to the past for inspiration on how to create a virtual goods economy that both enhances the game experience and maximizes the revenue opportunity.

Update (3/2/2008): Take a look at Saga which bills itself as “world’s first collectible online real-time strategy game”. Instead of charging a monthly subscription fee, they generate revenue by selling booster packs of troops for $2.95.

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 TechConfidential.com 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.

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.

About

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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