It's All Virtual

Future brand loyalist or virtual goods buyer?

Introduction

Social gaming start-ups are a hot commodity these days.  In the past 12 months, Playfish was acquired by Electronic Arts and Playdom (more recently) was acquired by Disney.  Zynga, which remains independent, has a valuation that’s reported to be as high as $5B.  I expect that CrowdStar, another independent gaming start-up, will be acquired before 2010 closes.

These gaming companies provide “free to play” games on the web and on smartphones.  They then sell virtual goods (within the games) so users can achieve an elevation in status (e.g. a sharper sword, more crop for the farm, designer sunglasses to replace your generic pair, etc.).

Sustainable Growth Can Be Challenging

These gaming start-ups have attractive attributes:

1. Ability to generate hundreds of millions in revenue (in some cases, more)
2. High growth rates in users, revenue
3. High profit margins, since the “cost of goods” (for virtual goods) is virtually zero

While it’s hard to argue with the results that these start-ups are turning in, I wonder if we might be in a mini-gaming-bubble, in terms of current valuations and the potential of sustainable, long term growth.

Social games can be similar to the recording and film industries.  Success depends on the blockbuster hit.  Over time, it becomes more and more challenging to consistently produce the blockbusters, especially in the face of growing competition.  Today, Facebook serves as a great “record label” for the gaming companies.  It provides a marketing vehicle that you can’t find anywhere else – “distribution” to its 500+ MM “listeners” (users).

The gaming companies know, however, that they can’t put all their eggs in the Facebook basket – hence, the plans from Zynga to launch their own Zynga Live platform (as one example).  The gaming companies need their blockbuster hits to turn into self-standing brands (e.g. FarmVille), which then relies on a variety of distribution vehicles.

We know that consumers can be fickle, however.  Recall the progression of “hot social network”, from Friendster to MySpace to Twitter/Facebook.  Games will have a related challenge.  FarmVille is not going to be the #1 game forever, which means that Zynga is already figuring out the “next FarmVille”.

I believe there will be a short list of winners in a market that will be increasingly fierce.  In addition, I wonder if over the long term, the rate of virtual goods purchasing is sustainable – or whether it will continue to grow over the long term.

A New Game in Town?

One of the challenges of the virtual goods model is the funding source. Revenue growth is dependent on fickle consumers, who could love your game one day and move on to another game the next day.  And yes, I realize that part of good game design is to build in the hooks to create user loyalty.

That being said, what about services whose funding source comes from brands that want to reach consumers?  The bills in their “wallet” are of higher denominations than the $1’s and $5’s that consumers use to purchase virtual goods.  In addition, “brands are already brands”, which mean that they have a pre-existing following from consumers.

Foursquare

Consider Foursquare.  Some consider it a “location based service”.  I view Foursquare as an engagement platform that’s built on top of a location based system.  In fact, Foursquare has a loyalty program that generated successful outcomes for Starbucks, Ben & Jerry’s, Whole Foods and many others.

The Foursquare business model is both powerful and scalable: powerful in its use of technology (e.g. location based check-ins) and scalable in leveraging existing brands (e.g. Starbucks) for the consumer following and activity.

Location based technology is great, but the long term success of Foursquare is more about the engagement and loyalty programs it facilitates for brands, based on the applicable and available technology of the day.

Nitro Participation Engine from Bunchball

Keep your eye on the Nitro Participation Engine from Bunchball – a Silicon Valley start-up who counts NBC, Warner Brothers and Victoria’s Secret as clients.  The Nitro engine “drives participation using Gamification”, which means that any brand can easily add gaming elements to their web site(s) – and then leverage the Nitro engine to track user actions, points, status and leaderboard. In addition, brands can use Nitro to deploy and sell virtual goods.

What This Could Mean

I think we could be witnessing a transformation of the advertising industry.  If the 90’s and the 00’s were about banner ads and paid search, this coming decade could be about engagement and loyalty platforms.

Foursquare, Bunchball and others have much to gain – if they can tap into a small percentage of the $100+B spent on advertising annually, they’ll make their investors very happy.

These engagement platforms can move from brand impressions (90’s) to brand engagements – where the engagements are longer lasting and more valuable than a click on a paid search ad.  They’re more participatory and can result in immediate purchases (e.g. the latte that someone just purchased at Starbucks).  In addition and perhaps more importantly, they enhance loyalty between consumers and brands, which is great for the long term.

Of course, sustainable growth is a challenge with any technology. Engagement platforms will face their own challenges as they see adoption grow.  Consumers will only be able to participate in so many engagement or loyalty programs.  That being said, consumers are taking batting practice right now – the first inning has yet to start.  Enjoy the ballgame!

I’ve now managed to speak enough.  Leave a comment below to share your thoughts on this topic.

Related Links

1. ClickZ article (by Christopher Heine) on brand engagement featuring Booyah, Loopt, Brightkite, Gowalla and Stickybits
2. “Foursquare’s Future Slowly Takes Shape“, by Om Malik of GigaOM
3. “Social-media games: Badges or badgering?“, by Caroline McCarthy of CNET