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Today we’ve got a guest post from Matt Mihaly. Matt was the founder of Iron Realms Entertainment and CEO from 1996 to early 2008. He launched four successful text MUDs while at Iron Realms and pioneered the virtual goods business model in 1998 with its first MUD – Achaea, Dreams of Divine Lands – leading to 10 consecutive years of growth. Iron Realms spun off Sparkplay Media in late 2007 to develop casual MMOs and social media games, and has its first game – Earth Eternal – under development. Matt now serves as Sparkplay’s CEO and Creative Director.

Matt is truly a pioneer of the virtual goods business model in the West (vs Asia) and I have a great deal of respect for his experience in this area.
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Jeremy asked me to talk a bit about the virtual goods business model, how to make it work, and what some best practices are when implementing it. There’s a broad area of subjects to cover there, from making microtransactions work in light of processing charges to protecting yourself from fraud to finding that balance between selling functionality in virtual items and not alienating the large proportion of your user base that will end up paying you little or nothing. I’m going to focus on one area of the subject matter: Unlocking the demand that’s latent inside your non-paying user base.

In a subscription or advertising-driven model, everyone using your service is generating revenue for you, barring exceptions like free trial periods. This provides a certain level of comfort to a publisher, who knows that costs like bandwidth aren’t going to be incurred without at least some revenue coming in to balance that out. In the virtual goods model, on the other hand, I’ve seen strong men grow weak in the knees when faced with the prospect of bucket-loads of non-paying users. Those operating costs add up quickly when you’ve got no incoming revenue to balance them out.

There are two points to touch on regarding that fear:

1. If you’ve created a context that people care about, some of them will pay you. In other words, if you have lots of users it’s because they care about what you’ve created. If they care, at least some proportion will buy virtual goods from you. I’m not going to spend any more time on this, as it’s pretty self-explanatory.

2. While it’s true that non-paying users are not directly generating revenue for you, there is almost certainly an enormous amount of untapped demand among that group of users. The trick is to unlock that demand in such a way as to effectively get those users to pay you indirectly. How? The key is a dual-currency system.

Flash back to 1998. My previous company, Iron Realms Entertainment, had pioneered selling virtual goods and was deriving 100% of its revenue from the sale of ‘credits’, which were used to purchase skills and virtual goods in-game (Iron Realms develops and runs niche MMOs called MUDs). Credits (as well as the goods you purchased with credits) were not transferable to other users, ensuring that if you wanted credits the only place to get them was from us, for real money or by winning various contests/competitions we ran. The result was that if you couldn’t afford to/weren’t willing to pay you were effectively locked out of the game after a certain point. Beyond a particular threshold, non-paying players were unable to raise their ‘skills’ (generic word for most of the combat-oriented abilities a character can gain) and thus were permanent second-class citizens. It was a very frustrating time to be a non-paying user, and we heard about it a lot.

At the same time as we were getting complaints from non-paying users about being unable to progress (since this required credits that they could not get), some of our credit-buying users were asking us to sell them gold (the in-game currency one gets from completing quests, killing monsters, etc). We steadfastly refused as we didn’t want to mandate an exchange rate and didn’t like the idea of the endless ‘faucet’ of gold that would flow into the game (potentially causing major inflation problems), though this was a little painful. In the short-term, clearly we’d have made money by selling gold to players ourselves. In the long-term, I think it would have severely damaged the game.

Then it occurred to me, in early ‘99: Everyone can get what he wants here. Simply turn credits into a currency and allow players to trade one currency (credits) for another (gold). Everybody wins!

* Paying User buys credits from Iron Realms, giving Iron Realms what it wants – revenue.

* Paying User sells those credits to Non-Paying User for gold, giving both Paying User and Non-Paying User what they want (the essence of healthy capitalism).

Effectively, what we did was allow non-paying players to sell the result of their time (through completing activities that require time, like quests and hunting) to the paying players, but only via a currency that had to be purchased from us to begin with. Suddenly, the teenager with lots of free time but not a lot of money could get anything in the game that paying players could get, and a busy professional who has disposable income but not nearly as much free time could gain large amounts of gold without having to spend the time in-game. (Of course, it’s important that paying players still have to play the game to achieve something that matters. There has to be some time investment on everybody’s part.) It was a win for everybody.

The end result of this kind of system, especially with as many frictions removed as possible is that you’ve unlocked a good deal of the pent-up demand that exists among your non-paying users. They aren’t paying you directly but they’re driving a healthy portion of purchases made by your paying users, which is nothing but good for the publisher.

Some tips for those implementing a dual currency system:

* As I said just above, remove as many frictions as you can from the currency trades. Create a simple currency exchange that lets people quickly and anonymously (to the other users at least) buy/sell the currencies.

* Make sure that there are very desirable things to be bought with both currencies. This system only works when people ultimately want to have some of both currencies. Keep an eye on the exchange rate. If it tilts too far one way or another you probably need to do some work on beefing up the value of currency that’s dropped. (The prevailing exchange rates are kind of fun to watch actually. For instance, when one of IRE’s text MUDs – Achaea – put in user-owned ships recently they priced ships in gold. Overnight the exchange rate changed somewhat dramatically as the value of gold went up substantially.)

* Let the market set the exchange rate. The non-paying users will always feel that credits cost too much gold. If you need to nudge the rate one way or another, put in something valuable priced in the lagging currency, as above. Never just mandate an exchange rate to make the nonpaying users temporarily happy as to do so is to effectively take ‘money’ out of the pocket of paying users (who are, on a 1:1 basis significantly more valuable than non-paying users on average). It can be hard, because you will have far more users interested in making credits cheaper to purchase than the other way around (most of your users won’t be spending much, at least in a game environment), and this will manifest itself in forum posts, emailed complaints, and so on. Be strong and trust in the proverbial invisible hand here.

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  • http://www.virtualgoodz.com Simon

    Thanks, surely my most interesting reading of the day ;)

  • http://wowpanda.blogspot.com/ wowpanda

    This is so interesting! And big thank to Matt to bring me your blog :-)

  • selim

    Another example of this is found in Puzzle Pirates.

  • http://www.kidmercuryblog.com kid mercury

    wow. killer post, i have to go do some thinking. thanks.

  • http://www.chris-dodson.com Ravenborne

    After years of experience wrestling with this issue, I think this is the ideal solution.

  • http://journals.aol.com/lcourtines/AOLGamesLarrysCorner/ laurent

    This is a great blog and very insightful. Keep it up.

  • qpdo

    An interesting read … but I ask myself where the professional farming entities (chinese students ;) ) come in there. With Gamers buying ingame gold equivalent to credits at a price lower than that your company asks for the credits… how does that influence this secondary currency model ?
    Is it possible that with a low enough “time for each gold” ratio the farmers might undercut the company? (which needs more revenue than the farmers obviously)

  • http://www.facebook.com/apps/application.php?id=6023549244 sumit gupta

    Matt, that was a very insightful post. I think in the coming years, we will see convergence of amateur gaming and social networks. This is evident from the emergence of plethora of dating, virtual gifts and gaming applications on facebook relying on point based systems. And now a few of them have started to experiment with dual currency systems, one you get by investing time and skill, the other you buy. You are spot on.

    I normally do not promote my startup in blog comments, but your post captures the essence of what we offer. SocialMints is the first social currency on facebook with real monetary value. We offer application developers ability to offer their users ability to buy “mints” for premium content/points/gifts. We provide them with payment solution pre integrated into facebook which facilitates secure one click pay on facebook. Essentially, this becomes another monetization vehicle for application developers. Just like facebook made $24M on virtual gifts last year. If you want to test drive our solution.. http://www.facebook.com/apps/application.php?id=6023549244

    Presently we have set a fixed value for the currency, but as the adoption of mints becomes widespread, we will look for feedback from users and application developers whether to let market supply and demand set the exchange rate.

    Jeremy and Matt, if you don’t mind, we would like to highlight this blog on our website.

  • http://lsvp.wordpress.com jeremyliew

    @ Sumit – feel free
    @qpdo – I think it is inevitable that if there is a labor for money arbitrage to be made that someone will make it. The key then is to build that expectation into your own economic models

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  • Adam

    I would be interested to hear if there are any tax accounting issues with the dual currency system described above and if so how they were dealt with, thanks!

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  • http://golergka.livejournal.com golergka

    IMHO, he point in setting dual-currency system after you implemented both-way trade by users has just been lost: there are no “premium” items in the game that only paying user can get. It seems that you could just leave one game currency (gold) and sell it straight to the users, without any need for credits.
    I’ve worked with such a system in several games, and the main principle is simple: you buy gold, and then you spend it not in the shop, but in the auction house, buying items farmed by non-paying players by dynamic price, which perfectly describes the cost of their time (just like currency exchange rate in your variant).
    Of course, with such open systems there are a lot of risks and hidden problems. For example, you always should fine-tune player gold income in the game and always understand how much the player can earn per hour farming gold. The main source of income for non-paying player should be the selling of exchangeable items, and in-game sources of the currency should give him maximum 50% of estimated income: that way you’ll be sure that paying users are paying for the non-payers, not you :).
    Also, judging from my experience, the main and most effective moneyleak for paying players are various consumables – so you should watch their price carefully too: it shouldn’t be too low (becouse you don’t want your game to be _really_ free) and they shouldn’t be too high (there are games that allow you to spend 200$+ one evening on active PvP battles, and they are succesful, but cover very specific audience).

  • http://datingpro.com/social Elena Dorofeeva

    Great Post!

    Thanks to online games, Dual Currency and Virtual currency concepts are now very popular in Social networking. It’s a great way of monetizing your active database.

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  • http://jdphan.wordpress.com jdphan

    Nice Post! I’ve posted my own article on virtual currencies, as well, come check it out! http://jdphan.wordpress.com/