What Other Businesses Could Learn from the Video Games Industry

The video games market is huge. Call of Duty: Black Ops, was released in November 2010 and racked up sales of $650 million in its first five days. The global video game market is estimated at around $60 billion in 2010. Equally interesting to the marketer is that in the U.S. the average age of players is 37 and 42% are female (according to the Entertainment Software Association).

How to make money at something is, for a business person, one of key questions at the heart of a business plan, especially a start-up. Studying how the video game industry is evolving provides some useful lessons for both those directly involved in video games and for other industries with some analogous features to gaming.

For example, the games industry uses something called the “freemium model” whereby you provide games free to all and then extract payments from a few fanatical fans who are willing to pay for in-game perks, extras and virtual goods. Since (as in many other industries) games businesses make at least 80% of their revenues from 20% of the player base (or even fewer) this approach makes sense.

Even more fascinating is the psychology of virtual goods. In a recent survey by The Economist, they observed:

Casual-game firms are testing a variety of ways to make more money from their users, from straightforward digital sales to subscriptions and advertising. One promising model comes from East Asia, gaming’s spiritual home, where internet access is widely available and piracy is rampant. It involves giving users free access to online games but then charging them for all sorts of extras.

One Western example is “The Lord of the Rings Online”, which allows players to live in an online version of J.R.R. Tolkien’s fantasy world. When the game was released in 2007, players had to buy the game for $40 and then pay a subscription for each month they played. Last year Turbine, the game’s developers, moved to a new charging model in which the game was made available for nothing but players could spend real-world money on “Turbine Points”, a sort of electronic currency with which to buy items that make the player more powerful. Turbine says its revenue from the game tripled.

In “FarmVille”, Zynga’s wildly popular Facebook-based farming simulator, players can earn coins to spend on crops, livestock or farm equipment by playing the game, or they can buy them with real cash. Such transactions make up the bulk of Zynga’s revenues.

Not all virtual goods offer players an in-game advantage. “Vanity items” such as a new design for the electronic homestead are just nice to have. Spending real money on virtual luxuries may seem odd, but a minority of dedicated players wants to show off to others online, says Nick Lovell of Gamesbrief, a games-business website.

Equally intriguing is the prospect of converting these virtual goods and currency to “real-world” cash with all of its attendant issues of taxation and liability.

 In Dark Orbit, a browser-based space adventure from Bigpoint, a German online-game studio, customers can buy a “10th drone” to beef up their spaceship for around €1,000. BigPoint has sold more than 2,000 of them this year.

This sort of trade allows players to work out a real-world value for their in-game items (and makes it possible for economists to calculate the GDP of virtual worlds). Some players sell desirable items to other players for real cash, a practice chronicled by Julian Dibbell in his 2006 book, “Play Money”, in which he earned up to $3,000 a month trading in virtual goods. Such reselling is generally forbidden by the games companies, though there are exceptions, including “Second Life”, a virtual world run by the American firm Linden Lab. But the players themselves treat their virtual goods as if they were real and can become extremely possessive about them. In 2005 a Chinese player, Qiu Chengwei, killed a fellow-player of “The Legend of Mir 3” for selling (on eBay) a rare virtual sword that Mr Qiu had lent him. He is now serving a life sentence.

All this raises some intriguing questions for governments. Should virtual income be reported to the real-world taxman? China thinks so, in principle at least: it has said it wants to tax its virtual-goods market, thought to be worth around $1.5 billion a year, although how the tax would work is not clear. The South Korean authorities have ruled that trading in virtual goods should be subject to a 10% sales tax. America’s Internal Revenue Service is wrestling with the same problem. And if a games company goes bust, can its players claim compensation for loss of valuable property? After all, “some players have accumulated wealth worth thousands of dollars in these games,” says Eyjolfur Gudmundsson, chief economist at Iceland’s CCP Games, which makes the sci-fi trading game EVE Online.

In 2010 South Korea’s highest court ruled that, against the wishes of the games companies, players’ virtual cash could indeed be converted freely into real-world money, provided it was generated in a game of skill rather than won in a game of chance. It is only a matter of time, says Roxanne Christ, a lawyer at Latham & Watkins, before Western courts will be faced with the same questions.

It is interesting to note that there is a fine line between a destructive addiction and an enriching (but nevertheless consuming) passion, pastime and hobby. For example, one can have a real passion and engagement in a video game without it becoming so consuming so as to have negative consequences on other areas of one’s life. On the other hand, sometimes these harmless addictions can become pathological. The same can be said for all manner of pursuits from eating to collecting knick-knacks.

In one sense, successful brand-building could be characterized as a kind of deliberate attempt to create positive addiction (that is an almost irrational need for the item or service without the bad parts of addiction) that drives loyalty and spending. The fan (a contraction of the word “fanatic” after all) willing to shell-out what seem to be irrational sums of money to non-fans for a sports ticket, a concert ticket, or a meal at a 3-star Michelin restaurant is in many cases the holy grail of marketing. In that sense, the video game business is full of interesting tactics and models non video gaming businesses might do well to study if not emulate.

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