Monetization Part II: Social Games and Virtual Currency

In Part I of the Monetization Story, I wrote about an insight that my friend Krishna had shared with me pertaining to monetization, and also about my other friend Max's monetization dilemma when it came to designing his service.

The world of social games and how they use virtual currency is really quite fascinating, and I think could prove instructive for Max. But first, let's take a quick look at how that world works.

The experience (a tractor to tend to your farm) is priced in a virtual currency (2000 Farm Cash for the tractor). Why buy a tractor? It helps tend your farm, which lets you grow more stuff, which lets you build a bigger farm than your friends (Read more about game dynamics from Gabe Zichermann).

And how does one come by 2000 Farm Cash with which to buy the aforementioned tractor? Well, you could:

• Play the game: Social games are almost always free to play. The more you play, the more Farm Cash you earn (but only a little), and the more involved you get. Maybe you invite your friends to play too. And just maybe now and then you accidentally click on an ad.
• Complete an 'offer': Want to get 250 Farm Cash quick instead of slogging at the game for two days? How about signing up for a free Netflix subscription? Netflix has estimated the average value of a trial subscription at $70 (I'm making up these numbers somewhat). So they pay an advertising network $70, who pays another network $50, who pays another network $40, who pays the game developer $25 for every new netflix signup. The developer pockets $25 and gives you 250 Farm Cash. You're happy, the developer is happy, all the ad networks are happy, and netflix is happy too.
• Whip out your wallet: Already signed up for all the free subscriptions and answered all the surveys you can bear? Still need some more Farm Cash to get ahead of your buddy? Pull out your credit card, and you can load up with 250 Farm Cash in seconds - for a mere $20.
• Subscribe: Are you a baller? Subscribe to Club Pharm and, for $15 a month, you can get 500 Farm Cash as well as special member-only farm itemz!

Most people undervalue their time (they're the ones willing to spend hours looking for a deal that saves them $5) and they'll tend to play for free or by completing an offer. But every now and then you'll get a few loyal users who value your service, or their time, enough to pay you in cash.

Although only a few people will pay, it's estimated that over 80 percent of game revenues come from direct payments.

Reflecting on this, it's important to note that using a virtual currency doesn't magically mint money for you - it's just a useful representation of value, and is only as valuable as the experience it enables.

Using virtual currency instead of real money is useful for multiple reasons:

• It provides an easy way for developers to incentivize specific actions within the game without actually giving away real money.
• It makes it easy to price items and charge users small amounts of money
• It retains the fiction of the game - it's less jarring to think about farm cash, rather than realize that you're spending hard-earned USD.

There are many tricks to making a virtual currency work well - like making it difficult for people to judge the 'real value' of that currency, making sure that the tasks that enable you to earn it are meaningful, and ensuring that there are sufficiently interesting things for people to spend their virtual currency on, so that they are enticed into figuring out how to obtain it.

However, what I'm really interested in doing is taking a step back and exploring if and how we can apply some of what games have done with virtual currency to the broader question of online monetization; hopefully in a way that will help Max. In my next post, I'll try to explain how I think games have been able to abstract away their monetization strategy, and then see if this is of general use to others.

Monetization Part I: Understanding Monetization

A few days ago I had breakfast with my friend Max to talk about growing and monetizing his online service. He asked about whether to monetize using advertising or subscriptions, and I drew something resembling the following:

He saved me from committing a start-up cliché by handing me an index card before I could use my napkin.

The Monetization Funnel

The idea for this came from my friend Krishna Motukuri. When I was still working fulltime on reporterist.com, I would periodically go on long bike rides with him, and listen to his valuable start-up advice afterwards over beers and burgers.

Krishna's insight was that in our economy everyone is funneling users towards a purchase/ consumption/ transaction point.

The farther you are from getting a user to that transaction, the larger your potential audience is but since, the value you are adding is tiny, you can only earn a small cut. On the other hand, the closer someone is to making a transaction, the higher your margins for getting them closer. But there’re only a few people who are that close.

So there’s actually continuum of monetization (using Crossfit as an example):

• brand advertising – A billboard for a Crossfit gym.
• various intent-driven advertising priced as CPC or CPA – An ad for Crossfit showing up when you search for “fitness” or on a body building blog.
• lead generation – A gift (first month of membership free?) in exchange for getting someone to come into the gym and take a tour.
• commerce – Signing someone up for their first crossfit class.
• subscriptions – Subscriptions are obvious for gyms– but think about something like amazon subscriptions or prime)

Understand your funnel

Saying “I’m going to get lots of users and then figure out how to monetize” is okay (if you have the runway) but it’s still important to have a feel for the numbers. Some questions to ask:

• How large of an audience are we talking about? A thousand users? A million? A hundred million?
• Who wants to reach that audience?
• How much is it worth to them?
• How will you connect with them (the advertisers, not the audience)?

Max needs to figure out which funnel his service fits into, and what its shape is. If he can compare the approximate areas (revenue per user * audience size) at different points along that funnel he can figure out how best to monetize his users.

Not that getting these numbers right is easy – how do you know what a user is worth? How do you predict the growth or virality of your service? If you build an ad-supported experience, what do you do if you got your numbers wrong?

This is something I've been thinking about recently in the context of virtual currency. I think there's a connection. In my next post, I'll talk a bit more about games and virtual currency, and then try to explain why I think they've hit on something more generally applicable.