Imaginary Worlds Mean Real Money

The Terms

Online Worlds can be categorized as such:

• Game Worlds: These worlds try to maximize the amount of time players spend online, engaging in deeper and deeper quests.
• Social Worlds: These worlds engage the players in a social setting in an artificial world. Players create houses, offices, governments, etc – all analogous to real-world properties and institutions.
• Product Worlds: A combination of Game Worlds and Social worlds. The world provider provides a creative and engaging series of quests or games, but only around a certain product or brand.

They can be either free or pay-as-you-go. Each of these types of games can be further categorized by the type of in-game monetization they have.

• Open Monetization: In-game currency can be converted to dollars easily and as part of the gaming system. Second Life is like this.


• Closed Monetization: In-game currency cannot be converted into real currency. This is usually part of the End-User Licensing Agreement (EULA)

The Hype

By 2011, four of every five people who use the Internet will actively participate in Second Life or some similar medium, according to Gartner Research, which recently did a study looking at the investment potential of virtual worlds. If Gartner is to be believed (and it is one of the most respected research firms in the field) this means 1.6 billion—out of a total 2 billion Internet users—will have found new lives online.

The medium sucks people in. A recent Dutch study found that 57 percent of Second Lifers spend more than 18 hours a week there, and 33 percent spend more than 30 hours a week. On a typical day, customers spend $1 million buying virtual clothes, cars, houses and other goods for their avatars, and total sales within this virtual economy are now growing at an annual rate of 10 percent. As a result, the money flowing through Second Life has attracted the attention of the U.S. tax authorities, who are currently investigating profits made in online businesses.

In fact, the genre is getting so large that secondary markets have surfaced, along with other issues -- if you own a virtual island and a virtual character hurts himself wile visiting, could you be sued for real money? Exactly what is the relationship between virtual goods (and money) and real goods and money?

The internet continues to abound with rumors that the IRS will have to move in on virtual goods. Play that wizard long enough, and you’re going to have to write a check to Uncle Sam. The kicker: you’ll probably owe the money even if you can’t convert your in-game items to cash. IF this happens, look for a major push-back for all virtual games to make their goods more liquid. In fact, the liquidity (or non-liquidity) of many virtual worlds is leading to both problems and opportunities for some entrepreneurs.

Meet Hayden Gill. Two years ago he started Massive Online Gaming Sales, or Mogs for short. Think of Gill as a commodities trader in virtual reality. His mercantile exchange is a terrain of rolling hills, dark caves, and jagged mountains. The goods are magical swords, gold bullion, and spells to make you invisible. But the fantasy economies are larger than those of some small countries -- World of Warcraft, for example, claims six million players.

The cash is real. It's given Gill a BMW, two Land Rovers, and a palatial house atop a private bluff in Rocky River.

"It's definitely not child's play," says Gill. "We're pioneering something right now."

Jon Jacobs, an independent filmmaker from Miami, became the first person in the history of online gaming to spend $100,000 on a single virtual item when he bought a space station in the game "Project Entropia.". Last year, Anshe Chung became the first virtual millionaire, when goods she owned in Second Life had a street value of more than a million real dollars.
Anshe Chung's achievement is all the more remarkable because the fortune was developed over a period of two and a half years from an initial investment of $9.95 for a Second Life account by Anshe's creator, Ailin Graef. Anshe/Ailin achieved her fortune by beginning with small scale purchases of virtual real estate which she then subdivided and developed with landscaping and themed architectural builds for rental and resale. Her operations have since grown to include the development and sale of properties for large scale real world corporations, and have led to a real life "spin off" corporation called Anshe Chung Studios, which develops immersive 3D environments for applications ranging from education to business conferencing and product prototyping.

Whatever the angle, investments in online worlds are huge, with over $1 Billion worth of development in the pipeline. People spend over $1.5 Billion each year on virtual items -- that's a big hunk of money for stuff that doesn't even exist.

The Truth

If you smell hype, you're not alone. Ever since Gartner came out with their 80% prediction, skeptics abound. How can there be over a billion people online in a virtual world in the next five years? Heck, high-speed access won't be growing that fast. And how can people spend so much of their time away from real-world productive activities? It's one thing for the relatively decadent westerner to spend his evenings in online worlds, but how about people who don't have so much free time, or money to play?

The answers are surprising.

First, virtual worlds are not just the totally immersive games that teenagers and 20-somethings play. Many websites are engaging more in "slightly" immersive play. HotorNot, the online picture rating site that became a dating site, is offering a more immersive experience by allowing admirers to purchase "virtual flowers" to give to ones they admire. The virtual flowers cost $10 (real ones cost $3). The founders of Hotornot were asked how much they think people would pay for virtual flowers. "We don't think there is a limit," they responded. Their first idea was to put the price on top of the virtual flower so that the receiver could see exactly how much was paid. At the last minute they "chickened out" on this idea, however.

So while a billion people won't be playing WoW anytime soon, it seems reasonable to predict that they will be involved in some sort of virtual reality as more and more sites create virtual worlds for people to explore.

But getting a numerical view into this racket is not going to be easy. The hype machine is in full swing, and companies will spin numbers any way they can to create a sense of momentum. It used to be that you could track online participation by simply contacting the companies and comparing numbers. That day is probably passed. More people are participating -- that's the good news.

From an investment standpoint, however, buyer beware. Every company cannot be the next Second Life. Even Second Life is going to have a hard time being Second Life, as their current strategy seems to be akin to world domination: extending the SL grid to all sorts of third parties. Does every virtual world want to be an extension of SL? I doubt it, but perhaps SL can make a play of it. One thing is for sure, however, the market is fragmenting, not consolidating.

More interesting are the liquidity issues around virtual goods:

• Opportunity Cost: Some people’s time is just more important than others. Because of this, a form of services-based consulting has arisen. People in poor countries who can play games can provide their services, either by creating something time-consuming in a game and selling it, or by taking a player’s character and doing something with it that would be time consuming for the player. This consists of two types of goods:



Fungible Items: (items that are all alike). Gaming gold, attack points, reputation, etc – these are all things that are easily interchangeable. If you have one of them, it looks just like any other one

• Non-fungible items: Things like complete characters or taking a character and completing a quest – these are things that are attached together in some way to make a more complex thing that is traded. It’s still a form of opportunity cost trading, but the product is highly customized




• Emotional Gesture: These are things which have no value other than emotional impact on both the sender and receiver. Virtual flowers, clothes, e-cards, etc

Items can be a combination of the above properties. Interestingly, this suggests that a promising line of business could be a gift store for virtual gift packages. “Have a nephew that’s into WoW? How about our Christmas Special which includes 1000 Gold, Armor of Hades, a Merry Christmas e-card from Hallmark, a virtual bouquet from 1-800-Flowers, and a gift certificate worth three months of DSL! “ Or similarly, you could sell gift cards at places like Target that the kids could go online and pick their own gifts. But I digress (quite a bit, actually!)

These ideas sound fanciful, of course, but Susan Wu from Charles River Ventures delivers the scoop on where real money is being made right now in virtual goods:

• 
  Tencent is one of the largest Internet portals in China with over 250 million active user accounts. They generated $100 million+ in Q1 of 2007 and over 65% of their revenue comes from virtual goods.


• Habbo Hotel has over 75 million registered avatars in 29 countries and 90% of their $60 million+ yearly revenue comes from virtual goods.


• Gaia Online does over 50,000 person to person auctions and 1 million message board posts a day- making them the 3rd largest auction site and the 2nd largest message board on the Internet. Their average user consumes 1200 page views a month. They employ 3 people whose sole job it is to open snail mail envelopes full of cash that people send in for virtual goods.


• There’s a commonly held misperception that virtual goods are only for online gamers. Both Dogster and HotorNot are succeeding with a hybrid ad/virtual goods business model. Currently, over 40% of HotorNot’s revenue comes from virtual goods.


• Major mainstream brands are now buying advertising in the form of virtual goods in social networks. Gaians can now purchase and pimp their virtual Scion xBs. Coca Cola and Tencent partnered to allow Tencent’s users to trade codes taken from real Coke cans for virtual objects in the Tencent network. Wangyou, a Chinese based social network, has also been extremely aggressive in experimenting with branded virtual goods.

Laugh if you must, but there's something here.

The Future

Virtual goods and virtual worlds are going to take off, that much seems clear. But there is an odd dichotomy in the marketplace: sites seek to engage players more and more fully in time-consuming activities. Since the cost of time varies throughout the world, there is going to be a heavy pushback to make most worlds monetized. In fact, we're already seeing a kind of prohibition and rum-running going on in WoW and many other games. I anticipate this will only get worse. The game companies cannot completely open their games up without spoiling the game, but it's impossible to keep them closed either. They will need to evolve.

My prediction is that most online worlds will go to a free model with an open monetization system sometime in the next ten years. Sure, there might be a few holdouts, but that will be the rule. Worlds will be funded by virtual goods and advertising. I predict that by 2012 virtual goods will amount to over $50 Billion, with tens of Billions also on the table in the form of advertising. My predictions are just a SWAG, but it is reasonable to project out a very significant market growing over the next few years.

I also think there's a lot of money "flying under the radar" when it comes to virtual goods and virtual worlds. Look for some big developments.

Now that you can buy Virtual World engines to make your own worlds, the long tail is going to be at work. There will be some big winners at the game, but the majority of activity will happen way out in the little custom sites. This means that consolidation ventures, or "meta" activities for you programmers, stand the most chance of making a buck. In-world commerce systems, like PlaySpan, are in a good spot, if they can pull off what they're attempting. Look for more successful companies doing similar things, like location-based in-world advertising, or multiple-world character management. I have my own ideas for such a company. Contact me if you'd like to talk.

This is a crazy field. It's a world-wide phenomenon, much more than the original internet was. Companies designing products without a clear view of the facts are going to have difficulties. Unfortunately, those facts are in short supply. That makes it risky. Many times in the financial sector where there is risk there is reward.

Whatever happens, it's going to be a wild ride!