Economic Activity in Virtual Worlds

I found an interesting article over at the TNL Weblog today, written by Tristian Louis. This is the first of a series looking at MMORPGs or 'virtual worlds' and the potential they have.

From the TNL Blog:

Over the last few months, I've been trying to get a better understanding of what is happening with the concept of virtual worlds. Let me go into more details as to why I think this phenomenon has some real potentials. In this first entry in a series, I will explore the economic activity surrounding this phenomenon.

Size of the market

When talking about virtual worlds, I am focusing on the new space created by the gaming industry that allows to create online avatars and interact with other players in a fully immersive environment. From an economic standpoint, estimates range from around 100 millions to a high of US$1.5 billion a year. These are not insignificant numbers and they point to an emerging phenomenon and potentially the rise a new industry, with its own set of marketplaces, gathers, owners, creators, and marketers.

Marketplaces

To understand virtual worlds marketplace, one must first understand what si going on in those virtual worlds. When a player sets up an account, he's given a basic set of skills. As he or she progresses and interacts with the virtual world and its denizens, the player gains more and more skills and goods. However, this type of interaction requires time. Some people have figured that, because time is money, the amount of time spend in a virtual world could be converted into real hard currency. Thus was born the concept of Real Money Trading (aka RMT), whereas players go to specialized sites and buy virtual goods with real financial currency.

The action initially started on auction sites like Ebay, where characters or other virtual goods range in price from a few cents to several thousands of dollars. Because the trades were largely unregulated, some companies, like Sony, decided to set up their own exchange while others (Internet Game Exchange, Massive Online Gaming Sales, Tek Gaming Supplies, Swag Vault, and Gamers' Loot) have created specialized marketplaces to cater to this new phenomenon. This, in turns has led to the rise of two new classes of activities: informational ones that provide analysis on the financial going ons in those worlds and arbitration, whereas companies use people in the developing world to build up assets they resell to people in the developed world. Let's go deeper in those areas.

Information Sites

There is now a nascent information industry surrounding the costs of goods in virtual worlds. For example, Eyes on Mogs is a shopping search engine for virtual goods. All the attributes of other search engines are part of it, including comparison shopping, comparisons of the different vendors, pricing, delivery date, and buy it now info. GameUSD tracks the financial value of virtual currencies over time, providing price trends across not only the provider but also the alternative marketplaces. MMOfx claims to track "over 18,000 price quotes daily" and provide information on the fluctuation of virtual currencies.

Arbitration

Another type of economic activity to have arisen out of the marketplace phenomenon is the arbitration of virtual work. As the primary pursuit in these worlds is the acquisition of wealth, status or levels, an emerging market has arisen to give people with real money a chance to bypass the time investment required to acquire those things. For example, Chinese workers get paid between $75 and $250 a month to work in World Of Warcraft, in 12 hours shifts, "killing onscreen monsters and winning battles, harvesting artificial gold coins and other virtual goods. Affluent online gamers who lack the time and patience to work their way up to the higher levels of gamedom are willing to pay the young Chinese to play the early rounds for them." Similarly, Romanian players can make a living wage (the ABC News story I linked to says that $200 is a good wage for Romania) on the same kind of activity.

Edward Castranova, the leading economist on the subject of money in virtual worlds has been quoted as saying that "They're exploiting the wage difference between the U.S. and China for unskilled labor." What is basically happening here is that these companies have found a niche on the global marketplace to accumulate goods at a low cost and resell them at a premium. This type of arbitrage has been the way a lot of developing markets have revolutionized industries, from the export of manufacturing capabilities in the 20th century to the export of some service jobs nowadays. It's a natural phenomenon and shows that those marketplaces are starting to develop a high level of maturity, which should be noticed by a lot more people.

Virtual Goods Ownership

Beyond the buying and selling of virtual goods in virtual marketplaces, there is also an emerging trend in the real estate business, which can be broken down into three main groups: real-estate owners, creators and integrators, and marketers.

Second Life is a virtual world more focused on the social aspect of virtual environments than on the goal oriented aspect of missions and war-craft. Fortune Magazine reported last year about the interesting case of Anshe Chung, a character created by a German woman who has accumulated more than US$200,000 in virtual land holdings in Second Life. She rents the property out to other people, after having developed the property. Similarly, the BBC reports that a 23-year-old spent £13,770 in Project Entropia and recouped his investment in under a year. In fact, the land rush has been so strong that Second Life has build a model around land use fees, generating a nice chunk of income in the process.

While visiting this world, I've talked to people who had few problems paying $75 per month to Linden Labs for those fees. This is pretty incredible when you think that all they are buying is portion of disk space on a server. In a way, the real estate market presented by those virtual worlds can be seen as a hosting fee in a 3D environment and could represent a high growth market (in a future entry, I will look at the opportunities in the Virtual Spaces in more details).

The Integration Model

Another nascent portion of this new industry is the integration game. As with any new technology, developing and managing something in a virtual world is an endeavor that requires specialized skills. New companies like The electric sheep company and Space Think Dream have emerged as developers/integrators, offering their services to other companies. Their main business is to use the skills they've acquired to help existing companies experiment in these new worlds. This is, in a way, similar to the type of work that was done by early web design agencies, treating virtual worlds as a new interface either to existing systems or to create a new value proposition.

Other companies have emerged with the sole purpose of selling digital goods in those worlds. SLexchange is a virtual market where people can buy and sell such goods. Similarly, the Electric Sheep company has created SLBoutique as a competitor to SLexchange. What is interesting here is that there is a whole ecosystem building around Second Life, allowing other companies to prosper based on this new platform. This is similar to what has happened with Ebay and allows us to better understand SecondLife as a platform for e-commerce rather than just a game, a fact that Philip Rosedale, CEO of LindenLab and the power behind Second Life, likes to emphasize. This explains why the company has received investments from people like amazon.com CEO Jeff Bezos, Lotus founder Mitch Kapor, Ebay founder Pierre Omidyar, and Microsoft CTO Ray Ozzie. Those people understand that this a new emerging platform and could see potentially high return on their investment.

Bridging the gap

The development of virtual worlds as a new platform is starting to take shape. Companies and organizations like American Apparel, the BBC, Major League Baseball, NASA, The American Cancer Society, Amazon.com and Wells Fargo are starting to experiment in that space. Increasingly, virtual worlds are becoming not only a new way to market but also a new integration point for e-commerce.

Some of the virtual worlds (Project Entropia, for example) have even gone as far as issuing ATM cards that allow denizens of those worlds to take virtual money and trade it for real money that they can use for regular economic activity.

Conclusion

With large amounts of real currency already moving through virtual worlds, we are looking at a major new economic phenomenon that parallels the initial development of the commercial web and the rise of software as platform in the last few years.

With a new ecosystem forming around some of the virtual worlds, there is a fair amount of incentive for a lot of people to see this phenomenon succeed. SecondLife will probably be an early winner in this race, largely due to how quickly it has managed to get other companies to rely on it. A few more established companies are also early in staking ground in this new space and will probably reap rich rewards for their efforts, expanding their brand into those virtual spaces.

While it may appear that this is largely a subculture of gaming, the phenomenon is much more widespread. In my next entry, I will go through the demographic profile of denizens of those virtual spaces, showcasing a rich and varied texture to this phenomenon.