3 ways companies profit from virtual goods
Companies like Zynga make millions off of gamers. But will the market continue to grow?
By Socrates Alvarez
A report released in late 2011 predicts that the market for virtual goods, items existing exclusively on an online platform, will reach $2.9 billion this year. From the faux agrarian homesteads of FarmVille to the world of RuneScape, the virtual goods economy has already surpassed the GDPs of real-world countries such as the Cayman Islands and Aruba. Among the public companies finding success selling digital wares, Zynga (ZNGA), maker of popular Facebook games such as the aforementioned FarmVille and Mafia Wars, maintained a market cap of nearly $10 billion early in April. In 2009, Electronic Arts (EA) purchased Playfish, a U.K.-based developer of social media games, for $400 million dollars.
Anyone unfamiliar with popular social media gaming companies may be left wondering why so much money is being tossed at companies that are practically selling nothing. Though they are bought and sold like a commodity in their respective platforms, virtual goods are best categorized as a service; they enhance and improve the gaming experience, but aren't a prerequisite for game play.
Why then, when games are often made freely available, do users pay real-world money for these goods? A product is as valuable as the price a consumer is willing to pay for it, and companies in this industry have managed to tap into several key areas they can monetize, while maintaining a free-to-play model.
Much in the way a shopper spends money to buy a garment at a retail store, certain games and gaming platforms allow users to purchase clothing and accessories for avatars and characters, with no other benefit beyond aesthetics. Microsoft's (MSFT) Xbox Live Marketplace gives both gold and silver members the ability to buy items to dress their avatars, and in Blizzard's World of Warcraft, you can purchase a "Celestial Steed" for $25.00. (Microsoft owns and publishes TechBiz, an MSN Money site.)
Some virtual goods increase a player's skills, while others simply serve to add a unique aesthetic flare to characters; when given the opportunity to customize the look and appearance of a character avatar, for the sole purpose of expressing individuality, people are willing to pay. During its initial sale in 2010, Blizzard saw $2 million dollars in revenue during the first four hours.
Besides purchasing virtual goods, free-to-play games such as RuneScape have capitalized on exclusivity and community by providing users the option of buying added bonuses for a nominal fee. Subscription accounts allow players access to mini-games, skills and membership into the player forums. Not having membership doesn't necessarily hinder the progress of an individual's gaming experience; however, having a subscription does add the additional benefit of connecting players with each other more effectively, while also giving users the sense that their payment will maintain the community.
Many games give users the traditional option of grinding through a game to accumulate points, in order to unlock new characters or abilities. Recent trends, however, have moved to allowing users to opt out of the time commitment required to broaden their virtual inventory, and simply purchase goods utilizing in-game currency bought with a credit card.
One example of a game that's free-to-play but employs a "freemium" model is League of Legends. Users can unlock new "champions" to play with by collecting "Influence Points" earned through game play, or, for a nominal price, they can buy credits (Riot Points) that can be used to buy the characters. According to Business Insider's estimations in 2010, the company producing League of Legends draws revenue close to $250 million with this model.
Why it matters
Over the past three years, the video game industry has seen a growing trend, from within both the casual and the hardcore-gamer communities, where consumers are willing to purchase goods with uses limited to the virtual environment. Subsequently, developers have entered the market in hopes of profiting from this demand, with some big winners (see: Zynga) standing out among the rest. Time will tell, however, whether or not this market will see the same prolonged growth and longevity as other industries, and individuals interested in investing in these companies are cautioned to tread lightly.
A study conducted last year by MocoSpace revealed that 18% of users over 35-years-old who bought virtual goods, accounted for almost half of the spending, yet paled in comparison to the amount of time spent playing said games by their younger counterparts. This dichotomy may serve as an indicator to the likelihood of whether or not the monetization of virtual items has long-term revenue generation opportunities, as younger generations will be more reluctant to spend money on games, because they either a) do not have enough disposable income to justify buying said goods or b) are tech-savvy enough to see alternatives to buying virtual products.
The Bottom Line
Regardless of its future prospects, the virtual market, as it currently stands, exists not so much as a bazaar providing users assets of economic value, but as a provider of services that can better the gaming experience. Notable public companies like Activision Blizzard (ATVI) and Zynga have found success bringing in profits with significant margins, due to the somewhat lower costs of input in these goods. With the proliferation of smartphone apps, the recently signed JOBS Act and the subsequent trend towards freemium games, we may see more and more jump-start companies producing game content, hoping to gain the same enormous margins as their predecessors.
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