Inside Social Games

MySpace is giving social gaming a big upgrade today, adding a new set of features, and partners, that intend to make third-party gaming apps a prominent part of the service.

The integration of games into MySpace’s core interface could specifically give game engagement a big boost. “Games” has replaced “Apps” as a tab in the site’s top navigation bar. Click on it and you’ll see a revamped page called “Games & Apps,” that contains a number of new features for games. Users’ home pages also now include a “Featured Games” window on the right-hand side that shows you games that MySpace staff has recommended. And, more updates from apps will now appear within users activity “Stream” of updates, including when friends score an app from 1 to 5 stars.

Meanwhile, the “Games & Apps” tab has gotten more features intended to help users find and engage with games. On the top right-hand module of the page, you can see your friends latest activities in apps. Another part of the page, “Featured,” shows games that are handpicked for quality by MySpace staff. “Suggestions” uses an algorithm to figure out which apps might appeal to each user the most, and includes a way to sort by only game apps. These suggestions are based on factors like which kinds of games users have already played, which ones their friends have been playing, and how well the apps are ranked by users.

Developers who have built apps for MySpace already will appreciate these changes, as the company previously gave games minimal attention. Some game actions showed up in users’ streams, and games appeared within a simpler apps page. That was it.

MySpace has still been the de facto place for social game developers to go besides Facebook. While many applications have gained millions of users — see our most recent list of top 25 MySpace games for more on that — a main way to gain an audience was through advertising within MySpace’s apps page. The company’s goal with the launch today is to have social games help increase the number of users and their engagement.

It already has around 100 million monthly active users worldwide, although this number has been falling in the past year. Of its users, 28 million use apps every month, and more than half of those play games; 56% female, and 44% male. With the updates today, co-President Mike Jones says the company is aiming to get half the site’s users gaming every month.

Social games launching on MySpace today include:

• Fish Isle (IGG)
• Hoop Fever Live (TheBroth)
• Kingdoms of Camelot (Watercooler)
• Paradise Paintball (CMUNE)
• SPP Ranch (Slide)
• Warlords (BitRhymes)
• Wild Ones (Playdom)
• Zombie Revenge (DeezGames)

The company is also announcing a couple other new, related projects today. One is an iPhone app called Neon, designed for games. You can log in with your MySpace account, see notifications and app invites from friends, and respond. While you can’t play games within the app, your responses will be recorded within MySpace. For example, MySpace’s Mobsters role-playing game might tell you that you’ve gained a free gun in the game, and you can click to approve this. When you accept friends’ invites to apps, MySpace will install the app on your profile on the site. This is not the only MySpace iPhone app planned, by the way — it also has more coming for the main site, as well as for other areas it focuses on, like music and entertainment.

It also has a few service partners it’s announcing: game development tool Unity, cross-platform social feature provider ScoreLoop and cloud gaming service Groovy Cortext.

MySpace’s gaming efforts have also included more fundamental changes to its developer platform, recently coming out with an analytics API, for example, that helps developers better track user metrics. The company has, as many readers know, been going through bigger changes. The News Corp.-owned company’s chief executive, Owen Van Natta, was let go last month; with Jones and another executive, Jason Hirschhorn, becoming co-presidents. All of these executives came on less than a year ago, replacing the company’s founding executive team. The company has spent much of the last year talking about how it’s going to become more of an entertainment service, but up to this point it has been focused on other areas, like music. Games are now front and center.

The number of big social applications that use Facebook’s virtual currency, Credits, continues to rise. The latest is Zynga’s smash hit farming game, FarmVille, the largest application on Facebook with nearly 84 million users a month.

The integration is pretty straightforward, as you can see from the screenshot below. Credits is shown as the first of several payment options — others include direct credit card payments, PayPal, and a variety of other payment services, including prepaid cards and offers.

Zynga has previously been running Credits in some of its smaller Facebook apps, like role-playing game Pirates: Rule the Caribbean. Credits is now also appearing on some of its other big applications, like pet-caring title PetVille. However, it’s not on others, including Café World.

> Continue reading on Inside Facebook.

Monetization service providers that first got traction on Facebook are continuing to diversify, with the latest example being offer company Super Rewards. It has just launched a new version of its offer wall, intended for Flash game developers who distribute their creations across the web. The service is basically the offer wall that Super Rewards already provides, but available for developers to embed within their Flash game interfaces. Advertising offers are performance ads, drawn from various ad networks and advertisers, and users can participate in the ads in exchange for virtual currency in games.

Super Rewards is letting people who play Flash games that use virtual currency take these offers and earn the currency without having to leave the game page. In this example, you can see how it works: Click on “get more coins” and you’ll see the offer window appear overlaying the game. Then you take the offers, get the currency, and buy virtual goods within the game.

While the company offered a way to add offer walls via an XML integration, the new service allows developers to do so in what it says takes less than an hour. Developers can check out the implementation information here. Other companies that provide in-Flash payment services include Jambool and its Social Gold product. We should note that social games on Facebook that use Flash normally include offer walls on separate pages within applications.

Super Rewards, a part of online advertising company Adknowledge, hasn’t announced any developer partners yet. But the service is live, so we expect implementations to start popping up soon.

Offer quality has been an issue for basically all offer providers on Facebook, and Super Rewards has been trying to improve what offers appear where. Here’s what the company tells us about its efforts for Flash developers: “All the functionality of the core SuperRewards product applies to this including the industry’s first white and black listing functionality. We work as closely as we possibly can with both platforms and publishers to ensure that our offers meet both the letter and the spirit of platform guidelines as well as more specific controls that the publisher wishes to apply.”

Mochi Media, the Flash gaming platform company that sold to China media giant Shanda Games for $80 million earlier this year, is continuing to focus on social. It’s announcing new tools for developers today, allowing them to provide ways for users to play games against friends and share activity to their social networks. It’s also offering a new $10 million fund for Flash and social games, in conjunction with its new corporate parent, to help finance promising new ideas.

The company worked last year to apply concepts from free-to-play social games to the Flash widget games on its site, introducing a platform-wide virtual currency, Mochi Coins, and a way for users to find friends from social networks and share things like high scores with them.

Mochi had begun live providing ways for developers to integrate pre-roll and other advertising into their widgets. Developers can then let anyone embed their games anywhere the web, and make money for themselves (with Mochi also getting a cut). On top of this, Mochi provides game analytics tools so developers could track usage and figure out where to improve their products. The company now says it reaches 150 million monthly active users, who play 15,000 games on 40,000 different web sites.

The Social API (application programming interface) lets users sign in to play a game via their identities on Facebook (using Facebook Connect), MySpace or Twitter, then play friends from across these sites and and access each site’s communication channels — say, posting a big gaming win to your Facebook wall.

But the API goes beyond what the company launched last fall, as vice president of product management Ryan Nichols tells us. It’s a layer on top of these other networks, and mimicks Facebook’s API so a social game developer on Facebook could easily port their game to it. Once a user adds a friend on Mochi from one of the social sites, that person becomes their Mochi friend — if Facebook goes down, for example, Mochi can still maintain its connection between the two people. The API =also includes a way for developers to message all users on a game, regardless of which social platform they are on.

This is a smart idea, but one issue is that many social gamers prefer playing games on social networks. Why? Many don’t even realize that they’re playing “games,” per se, but rather passing the time doing something entertaining with friends on the site.

The $10 million fund, meanwhile, “will be managed by members of the management team of Mochi Media and Shanda Games. Through participation with the fund, developers will gain access to technical, design and testing resources from Shanda Games, as well as a host of development tools and distribution….”

The big picture here is this: Shanda Games, a publicly-traded company controlled by Shanda Interactive Entertainment Ltd., wants to compete outside of China. Mochi offers distribution and monetization services that allow it to do so; the social features are another step in that direction. The fund is, too. The other interesting angle we’ve been hearing is that netbook usage is exploding in China, and the lightweight devices can’t handle the processing power required for many of the downloadable and massively multiplayer online games popular in the country. The company has organically gained millions of users in China — people who have just found Mochi-powered games on their own — so Shanda is aiming for Mochi to bring its 15,000 games to bear on the Chinese market.

[Editor's Note: Bobby McFarland of Super Rewards, part of Adknowledge, provides some tips on techniques for making money through virtual currencies in social games.]

Discount pricing programs have been used for years by online and brick-and-mortar businesses to acquire customers, promote products, drive brand loyalty, and materially increase profits. Similar programs have been proven to work extremely well for virtual currency and goods inside social games. Below are some discount pricing tips that social game publishers can use to maximize ROI and more deeply engage their players.

1. Tier Discounts for Virtual Currency

Creating different tiers or levels of discounts is a proven way to keep users engaged, especially for “hardcore” gamers. The Facebook game Country Life does a good job at this: gamers can pay $5 for 50 coins, $10 for 105 coins, $20 for 220 coins, etc. But once these direct pay ratios (or exchange rates) are set, it’s difficult to change them without irritating users who’ve grown accustomed to the pricing. One concern is that players will spend less when they get more. But this is a well-debunked myth. People will buy more than they need today, have a flush account, and then spend it all much more quickly than they intended. Brick-and-mortar stores have been proving this for years with massive bags of tube socks and ‘family-sized’ portions. Super Rewards provides simple tools for building these types of dynamic ratios.

It’s also very important to balance the payouts received from direct payments with those received from advertising offers to avoid cannibalizing offer revenue. For example, it would not make much sense to offer 100 coins for $10 via direct pay if the payout from a Netflix offer is $20 for 100 coins. Also, note that will cause some currency inflation as now you may have on average 125 coins going into your system for every dollar a user spends instead of your expected ratio of 100 points per dollar.

2. Set Proper Exchange Rates

Publishers and developers are increasingly using multivariate and A/B testing to help set their discount levels and currency exchange rates. Super Rewards is working with developers to help them set up accurate testing models to better understand user behavior in various scenarios. We encourage developers to build testing technology into their game designs to continually improve user experience and to maximize ROI. Many game developers have a ‘set it and forget it’ mentality when it comes to their exchange rate and use a number that they initially ‘felt’ was right. Virtual currencies are a science: go with facts not feelings. The Super Rewards Game Advisory Team or even our Account Managers can help with this, in addition to A/B testing tools.

3. Reduce Inflation with Dual Currencies

But over time, even smart discounts and exchange rates cannot completely escape inflation, which is the main reason why some games have developed two currencies (more details, here). The model works because it motivates both new and aggressive gamers to continue buying currency as they climb different levels. The model also improves user retention rates, enhances the overall game experience, and drives sustainable revenue for publishers. Mob Wars is a good example of the dual currency model in action. A user at level one will happily buy 10,000 coins for $10. A user at level 30, for example, may earn 100,000 coins a day on their farm. Make sure there is a compelling value proposition for all levels of players. This is where a dual currency easily allows you to offer more coins for the same price.

4. Tie Currency Discounts to Holidays & Special Events

Virtual currency discounts (e.g., a 20 percent off “across the board”) are also effective, particularly for casual gamers. While these “across the board” discounts are more volatile than the tiered discounts above, they can produce significant revenue spikes. Holidays (e.g., Christmas, Black Friday, Easter, 4th of July) and special events are good opportunities for publishers to offer this type of discount. For example, Galacticos Football has tied its discounts around World Cup soccer events, generally for one to two days. A pitfall to watch out for here is having players “wait” for a sale. If they know every Sunday is discount day, they will wait until Sunday to buy. Mix up the discount percentages and their frequency. You don’t want to be predictable. Having a sale will likely cause a dip in revenues as people ‘stock up’ on sale day, but the dip is always much less than the spike.

5. Discounted or Limited Time Virtual Goods

Finally, another simple but effective way to engage gamers is to discount virtual goods for short periods of time, usually one to two days or even for a few hours. This is most effective for role-playing games like World of Warcraft, or games where the goal is to accrue goods over time, such as Pet Society and FarmVille. In FooPets, you can find discounted water bowls or leashes for your favorite virtual pet. Having an ultra-rare item that is only available for a few days and then is no longer available or expires can often see spikes in revenue of 3-4x your usual daily rates with little residual revenue down turn effects in the following days.

[Editor’s Note: The following is a guest post by PayPal’s Peter Martin, who has managed the Risk consulting teams for the company’s Merchant Services, Debit Card and Credit business units, working with both large merchants and the digital goods merchant segments. Before joining PayPal, Peter managed risk for Wells Fargo Bank, Consumer Deposits Group and Barclays Global Investors.]

As a merchant, there’s a lot to like about the selling of virtual goods. The category is exploding, and projected to reach $1.6 billion this year in the US, according to the Inside Virtual Goods report. According to the research firm Forrester, 15 percent of U.S. consumers purchased software and games online to play on their PCs, and 8 percent purchased games to play on their mobile phones.

But while digital goods is a fast-growing business that is wide open to innovation, the reality of selling online is that – just like any business – there exists some level of risk. For digital goods, a faster sale/delivery cycle gives the bad guys a faster getaway, and a “borderless” customer base can attract a global community of fraudsters. In addition, digital goods merchants are often newer to the market and less experienced in combating fraud.

Digital goods vendors generally face three kinds of threats: account takeover, stolen financials and “not-so-friendly fraud.”

The good news is that many of the best practices used in curbing online fraud work well for digital goods merchants, too. The situations and economics are different, but the approach is similar: be aware of the vulnerabilities and act to prevent them.

Account Takeover

Account takeover tends to harm the user experience and reputation of your brand. Here, a customer’s user name and password are compromised, and their account is taken over. The perpetrator goes online and starts transacting, buying goods and selling on the open market. Other virtual currencies make it easy for third parties to facilitate the exchange. It all happens very fast, typically with the help of a scripting language.

The first bar of prevention is better password authentication. The higher bar entails a better understanding of a user’s behavior. If I only log into my account at home or work, a login from a different machine should attract some attention—and some challenge questions. The same is true if my IP address would indicate I live in North America but appear to be logging in from Iceland, or if my usual browser is set to American English but this one is set to Cyrillic. There are several of these identifiers, all of which can be used to better secure the login.

Stolen Financials

Compared with account takeover, which is restricted to your customers, stolen financial information casts a much wider net. Here, the fraudster sets up a “legitimate” account using stolen information, purchases virtual goods, then turns those purchases into real-world cash. This cycle also relies on scripting language, which in turn speeds up the process.

Typically after the legitimate cardholder reports the fraudulent transaction, the merchant will refund the money. But because the markup on digital goods is so high and the unit costs so low, digital goods vendors routinely tolerate a level of chargebacks that would sink a vendor selling jewelry or electronics.

The solution: be extra vigilant in verifying credit card information by using the Address Verification System, which matches the billing address provided by the customer with the one on file with the credit card company. Even better, require entry of the Card Security Code found on the back of the card. Most stolen card data on the Internet still doesn’t include that number. A third layer of protection is a NAP check: validating a customer’s name, address, and phone number, which can then be cross-checked with the customer’s IP location.

Not-So-Friendly Fraud

The industry calls the third threat “friendly fraud,” but for merchants, it doesn’t seem all that friendly. Not-so-friendly fraud is usually buyer’s remorse. A player gets wrapped up in a game, spends $200 and then wakes up the next day with a financial hangover. Instead of vowing to live a more sober online life, he denies making the charge. That’s the usual scenario. Variations include a child using a parent’s credit card, or a malicious player buying digital goods with the intent of later denying it. Because chargeback rules were designed for physical goods, people can abuse the system, knowing that most digital goods vendors won’t take the time to push back.

Whatever the form, not-so-friendly fraud is a growing threat for social networks. The best solution is a combination of fraud scoring and community negative files. Fraud scoring analyzes a merchants’s own internal data to try and determine the likelihood that any transaction will be fraudulent. For example, a game operator could determine from usage data the average velocity of a sword purchase, and then identify outliers—purchases that are well outside that norm. Community negative files are shared intelligence between vendors, so that a fraudster’s history begins to follow him or her from merchant to merchant.

Securing Your Site

Best practices only work if you implement them. Merchants we work with have reduced fraud by purchasing risk mitigation services from third-party vendors or developing their own in-house. Stamping out fraud is part of PayPal’s DNA, as well, and you will see more of safety measurements from us in the future.

PayPal maintains a microsite for digital goods vendors, including links to best practices guide and list of partners, as well as information on micropayments for digital goods.

April 20 | San Francisco

As we recently announced, Inside Social Apps 2010, our first conference on the future of monetization on social platforms, is happening April 20th in San Francisco, one day before Facebook’s official “f8″ event. We’re excited to see all of the developers and entrepreneurs from around the world that are planning to attend!

In addition to the 24 confirmed speakers at Inside Social Apps 2010, including executives from all the largest developers on the Facebook Platform, we’re very excited to announce three more speakers today: Season Xu, Co-founder and COO at Five Minutes (makers of Happy Farm), Dave Etling, VP Product Development at InComm, and Jeremy Liew, Managing Director at Lightspeed Venture Partners. They will be joining our full list of speakers listed below.

• Atul Bagga, VP Equity Research, Games, ThinkEquity
• Adam Caplan, VP Virtual Currency, Super Rewards / Adknowledge
  
• Renata Dionello, Chief of Staff to the CEO, eBay, and former Director of Consumer Business Development, PayPal
• Eric Eldon, Editor, Inside Facebook & Inside Social Games
• Dave Etling, VP Product Development, InComm
  
• George Garrick, CEO, Offerpal Media
• Vikas Gupta, CEO, Jambool
• Sebastien de Halleux, Founder and COO, Playfish, and VP Business Development & Strategic Partnerships, EA Interactive
• Ron Hirson, Co-founder and SVP Product, Boku
• Nick Lawler, Managing Director, Maverick Capital
• Keith Lee, Co-founder and CEO, Booyah
• Jeremy Liew, Managing Director, Lightspeed Venture Partners
  
• Vish Makhijani, COO, Zynga
• David Marcus, CEO, Zong
• Lisa Marino, CRO, RockYou
  
• Dave McClure, Investor, Founders Fund Angel and fbFund Incubator
• Rex Ng, Co-founder and CEO, 6waves
• Jason Oberfest, VP Social Applications, ngmoco
• Mark Pincus, Founder and CEO, Zynga
• Shervin Pishevar, Founder and Executive Chairman, SGN
• John Pleasants, CEO, Playdom
• Keith Rabois, VP Strategy and Business Development, Slide
• Peter Relan, Executive Chairman, CrowdStar
• Justin Smith, Founder, Inside Network
• Kavin Stewart, CEO, Lolapps
• Jay Weintraub, Founder, LeadsCon
• Season Xu, Co-founder and COO, Five Minutes

More speakers and a full agenda will be announced shortly.

Finally, a limited set of “early admission” tickets is now available through Friday at a special price of $299. This price will change after Friday, and space will be limited, so we encourage you to register now.

Inside Social Apps 2010 – April 20th in San Francisco

Three years after the Facebook Platform launched in 2007, what started out as sheep throwing and vampire biting has quickly become a profitable billion-dollar industry. Today, social games monetizing through virtual goods have quickly become one of the hottest sectors of technology and entertainment, both in the US and around the world. Where are social apps going, and who is leading the way?

Inside Network is proud to announce our first conference on the future of monetization on social platforms: Inside Social Apps 2010, happening April 20th in San Francisco, is bringing together the world’s leading entrepreneurs all in one place to discuss the future of social applications and games monetizing through virtual goods.

This will be an in-depth one day event geared toward developers on Facebook, MySpace, and the iPhone, senior executives, and investors. At Inside Social Apps 2010, founders and CEOs of the top social gaming, mobile social gaming, payments, and virtual goods infrastructure companies will be tackling the key issues facing the industry. We’re hosting it one day before Facebook’s “f8″ event in San Francisco, so this will be an excellent opportunity to learn about the key issues facing the future of the Facebook Platform and beyond before Facebook’s official event.

Register Now

A limited set of “early admission” tickets is available through Friday at a special price of $299. This price will change after Friday, and space will be very limited, so we encourage you to register early.

From all of us at Inside Network, we hope to see you on April 20th in San Francisco!

WildTangent has been around since 1998, and its business has long included running ads within developers’ games, including incentivized ads where users watch videos or otherwise interact with an ad in exchange for limited access to a paid game. But its customers have been in more traditional parts of the gaming world, like console and downloadable games.

The company is now making a bigger push into online games — especially social gaming — by making it possible for users to earn virtual goods, or gain one-day access to online subscription-based games.

If this concept sounds familiar, it’s because a wide range of advertising offers companies have been using doing essentially the same thing in social games for years. But other companies have typically provided advertising offers that require users to take other actions — sign up for a Netflix subscription, take a survey, etc. However, in recent months they’ve been introducing ways for users to earn points through branded ad campaigns. Check out the video ads that gWallet and SocialVibe have been testing for some examples.

So, WildTangent may not be the first ad company to enter the social gaming market. But it has 75 of the top 100 advertisers in the US, and it has those advertisers used to advertising within games. The company  tells us it expects “virtually all” of these advertisers to use BrandBoost.

It also says it has some big social gaming companies lined up as partners, who it will be announcing soon. Clients with live implementations of the service, called BrandBoost, include Sony Online Entertainment, Outspark and OMGPOP. While WildTangent isn’t disclosing the exact revenue share with developers, it tells us the split is the same as what it does with download-game partners.

Facebook is partnering with eBay-owned PayPal, the two companies are announcing today, so that people can buy Facebook advertising and its virtual currency, Credits, using the online payment service.

Although some have speculated that Credits could become a PayPal rival, this partnership suggests that Facebook is going to continue building Credits as a virtual currency, and not as a payments service. The press release today says as much: “The goal of Facebook Credits is to give users a fast and easy way to buy virtual goods on Facebook, including items from the Facebook Gift Shop.” Other ways to buy items include mobile payments, via a partnership with Zong, and direct payments via credit cards.

> Continue reading on Inside Facebook.

[Editor's note: This article was written by Bill Gurley, a venture capitalist at Benchmark Capital. He published it on his personal blog, abovethecrowd.com, last week. Accounting for virtual goods is becoming a bigger industry issue, so we're running the article here with his permission.]

American journalists and corporate executives have been slow to appreciate the beauty, brilliance, and consumer allure of the virtual goods business model.It’s not that they did not have data points – China is chock full of multi-US$billion market capitalization companies that are based on this business model. That said, many luddites predicted it was an “Eastern” fascination that would never spread to the West. They never fully understood it.

As a result of this headstrong denial, I have often wondered what data point would finally convince me that the West had fully accepted the reality of the virtual goods business model. Last week I received my answer. Jeff Grabow from Ernst and Young asked my partner Mitch Lasky and I to sit down with Mick Bobroff, an audit partner developing an expertise in virtual item based revenue recognition. Now I wasn’t exactly waiting for a sign from God or anything – rather just a small signal that confirmed this new model was legit. Having an audit partner at a top three accounting firm become an expert certainly qualifies as a step in the right direction.

Mick had prepared a remarkably succinct and information rich presentation (they are working on a white paper I can post later). I was fairly excited to go through it – at least as excited as anyone should get when discussing accounting principles. Here is a summary of what Mick had to say in his presentation titled “Revenue Recognition Considerations for the Sale of Virtual Goods”. [If you want to reach Mick, his contact info: 415-894-8205, michael.bobroff@ey.com]

1. [Legal Point First] Michael made it clear that this document represented general observations and should not be used specifically as accounting advice. I understand and concur with regards to this post also. For your own books verify with your own accountant.
2. There are already a ton of companies that trade on American stock exchanges (NYSE, NASDAQ) that use virtual goods models and adhere to GAAP. To the point above, they are all in China.  Examples: ChangYou (CYOU), Giant (GA), NetEase (NTES), Perfect World (PWRD), The 9 (NCTY), Shanda Games (GAME).  [For the record, TenCent is Hong Kong listed.] The current GAAP revenue recognition policies were honed with these companies.
3. When a company sells virtual currency, this is not a revenue event (even though it may clearly be a cash event). When purchased but not yet used,  virtual currency sits on the balance sheet as a customer deposit or deferred revenue (i.e. a liability).
4. Revenue recognition commences when virtual goods are bought with virtual currency by the consumer. Exactly how it “commences” depends on the following.
5. There are two categories of virtual goods – (1) consumable items that are used once and gone, and (2) durable items that “work” over an extended period of time.
6. For “consumable items” you can recognize revenue when it is consumed.
7. For durable items (which many are), things are much trickier. You need to amortize the revenue (linearly) over the useful life of the good, or the average life of the actual user (i.e. – what is the average customer life of your customer?). This is a messy problem, especially when you understand how difficult it is to measure “customer life” when some customers never pay and others come and go in fairly random patterns. Also, your “average customer life” may change over time creating very complex accruals.
8. The bottom line: getting this right requires quite a few database entries for tracking the sale and usage of every single virtual good sold in your digital world, in addition to the supply and usage of each virtual currency account, and the activity levels of each user (to estimate average life).

These policies were not particularly surprising. That said, when I was listening to the complications of the “durable item” revenue accounting, it reminded me of something I learned for the early leaders in the virtual items space — innovative Korean companies such as Nexon.

The “Rental” Model

About four to five years ago, the team at LindenLab (SecondLife) held a pizza night at their offices with the goal of learning more about the virtual item games that were wildly popular in Korea. We invited two bilingual gamers to install and play Audition, Kartrider, and FreeStyle. My big takeaway from that night was that not one of these titles actual allowed for the “sale” of virtual goods. Rather, each virtual item could only be “rented.” In each case, the user was given the option of one, seven, or thirty-day rental. I assumed this was Darwinian, and immediately began to wonder why “renting” might be better than outright ownership when it comes to virtual goods.

1. In world inventory gluts. As virtual worlds mature, they often suffer from game-wide inventory glut. Items that were once useful to newbies become throw-aways for the more advanced user, and can literally pollute the world and compromise the in-world economy. Allowing rental is like having free garbage collection.  Everything eventually goes away.
2. User inventory clutter. More advanced users typically have a huge problem managing large inventories of items. Also, many items are trend-oriented and trends change. With the rental model, no user sits around thinking “wow, why did I really buy that two months ago and what do I do with it now?,” and “why am I buying all this stuff?” The rental model simplifies inventory management for the user.
3. More marketing opportunities. When an item expires, it offers a unique time to re-market to the user for either an extension of the current good, to a trade to a newer, fresher, and perhaps more interesting item.
4. Price segmentation. By offering 1, 7, and 30 day rentals, the merchant has basically price-segmented the market. This theoretically allows more users to experience the good than may have with a single, and arguably higher, price point.
5. Good business. Why sell something that lasts forever if you can sell something that has to be naturally repurchased?
6. Simpler accounting. I didn’t think of this sixth point until my meeting last week. The rental model does away with the notion of a “durable” virtual good, as they all expire. What’s more the time frame over which you recognize the revenue is now fixed at 1, 7, or 30 days. This dramatically reduces the accounting complexity.

Thanks again to Michael and Jeff at E&Y for reaching out and setting up the meeting. It’s great to recognize that virtual goods businesses are finally mainstream here in North America, and that they even have their own appropriate accounting policies. I also appreciate having one more reason to favor “rentals” vs “sales” when it comes to virtual items.

[I have received several comments that concern this post and how it relates to SecondLife. For those of you that don't know, SecondLife doesn't actually sell virtual items, its residents do. As such, this post does not relate to SecondLife at all.  It pertains to the 98% of virtual worlds where the hosting companies ALSO is in the digital goods business. Nothing would stop SL from offering rental as a choice to its developers, but the main message is that this post does not pertain to SL (which has a different business model altogether.)]