Pure (Digital) Gold
High-Margin Virtual Goods are Generating Very Real Profits
Chinese technology companies have a reputation for lacking innovation and original products. Yet upon closer inspection the industry is brimming with ideas. Despite the fact that Taobao resembles eBay, Baidu searches like Google, and RenRen looks very similar to Facebook, these businesses are not simply knockoffs. The “Copy-to-China” label grossly underestimates the power and ingenuity of China’s internet ventures.
Identical Western replicas do not work (there is a reason why no large multinational internet business is a leader here). Instead, local companies are innovating to serve the Chinese market better, creating products and services that appeal to the needs of the consumer. This is also true of other Asian markets, and the region is now a global leader in virtual goods. So much so that the businesses in Silicon Valley and elsewhere are starting to take notice.
For the unbelievers, there are enticing examples of the rewards to be had. Internet heavyweight Tencent recorded revenues of USD 1 billion, at a profit margin above 40 per cent, by selling virtual goods across its multiple online platforms for RMB 10 (RMB 1 = approx. USD 0.14) at a time. Home to China’s most popular instant messenger QQ, Q-Zone social network, and related game sites, it is one of a number of domestic internet sites making a very real profit from something “virtual”.
Shopping in Another Dimension
The popularity of social networking services (SNSs) and online games has driven demand for virtual items, which have become quite varied in their forms. On iPartment, a Taiwanese SNS, young couples move in together online in a virtual apartment to test their compatibility, buying everything from furniture to clothes and even kids for a few Yuan. Aside from generating real-money sales, iPartment’s noteworthy success lies in the high percentage of users who are middle to upper class female members – an elusive demographic online.
Examples of other popular (and profitable) virtual items across top sites include:
- Gifts
- Screen backgrounds
- Accessories for avatars, i.e. virtual alter egos
- Game items
- Ring tones
Not all virtual items have a fee. Often they are branded gifts from consumer goods firms. In QQ’s popular fashion “PKs” (or head-to-head competitions for the uninitiated) users compete in virtual fashion shows. They outfit their avatars with a mix of free and paid accessories and strut their stuff for a chance to make the top-ten list. In the end, as is the case with most virtual goods supported games, it is the user who pays the most who generally wins. While it also involves time and skill, it is practically impossible for users to be come top without spending a lot.
This has become the accepted norm for many Chinese users. One blogger gives her rationale for purchasing virtual clothing and accessories for her avatar, “There isn’t much difference between shopping in the real world and the online one. Just as I wouldn’t walk down the street naked, I don’t want to chat with friends with an undressed avatar. Having cool style online helps attract attention.”
A Necessary Solution
Virtual items became huge in Asia not due to their novelty, but because local internet companies marketed them out of desperation to find a viable business model. Many Western sites rely on advertising and premium memberships, but currently this is not as profitable in Asia.
Pioneered by Korea’s CyWorld and China’s Tencent, virtual goods have provided a rewarding ecosystem for both companies and users. This online ecosystem, which is in many ways more advanced than the Western advertising based model, has exploded in popularity. It is estimated that virtual goods in Asia have become a USD 5 billion industry.
Here are the top five reasons why virtual goods work well in Asia:
- The Limits of Advertising. Online advertising rates are low in China as users are accustomed to being bombarded with adverts. Most sites achieve low click-through rates with banner and text adverts.
- Micropayments. Chinese users are notoriously unwilling to pay for content. Subscription plans have had limited success, with most users preferring pay-as-you-go options with no big upfront fees.
- Affordability. Regardless of income level, most users can afford the small micropayments associated with virtual goods and can access their accounts at any internet café.
- Sharing. Online social networking is viewed as a public space in China, where users are more concerned with creating a special online identity rather than simply replicating their offline life and relationships. Virtual goods help them to be unique.
- Branding. Advertisers love virtual goods as they provide great opportunities to connect directly with target consumers for a great for branding experience.
Controlling Virtual Commerce
With so much virtual money being exchanged online, it is logical that governments want to oversee and control it. The QQ coin (Tencent’s virtual currency) scared Chinese officials when its exchange rate to the Yuan rose sharply. In June 2009, China was the first country to pass new regulations to restrict the trade and use of virtual money. The new law explicitly bans the use of virtual money to buy real world goods or services, and restricts minors from buying any virtual currency, including popular pre-paid gaming cards.
Given their real-world power, virtual currencies have been used for under-the-table payments, online gambling, and virtual money laundering. “Gold farms” pay young gamers to play to harvest virtual gold in games only to resell it later to wealthier players who wish to advance faster. The real and virtual worlds continue to move closer together.
Leveraging Strengths
The global internet landscape is finally coming full circle. In certain instances it is now European and US internet companies that are turning to Asia for answers, especially when it comes to virtual currencies. US-based Second Life initially introduced virtual items to US users, but it could be the social network sites Facebook and MySpace that take them mainstream. Both have stated their interest as they look for additional ways to monetise their user bases. Given their large amount of content (high page views) and relatively low advertising click-through rates, it could be a terrific solution.
The child-like games that are popular on social networks in China, such as online farming, have popularity beyond children. Twenty to thirty something year old adults, especially white collar workers who have constant internet access and free time, are driving the craze. This is a fad that has already been replicated in the West, with farming games becoming the top applications on Facebook. It is these sorts of social games that are ideal for virtual goods by allowing users to show off amongst friends. Watch for this trend next.
Real and Online Worlds Converge
Despite their rising popularity and the revenues being generated from them, virtual goods are still in their infancy. Currently, they are almost exclusively used for entertainment and provide little value beyond that, as another blogger points out, “Soon you’ll find that the accumulation of all these virtual things means nothing, especially in the real world. Furthermore, even the purported interactive and interpersonal aspects of the games on SNS platforms are very limited.”
Obviously, not everyone is satisfied with the current form of virtual goods, but like all products they will continue to evolve. This is just the beginning. Virtual items will quickly move beyond entertainment to more practical uses, something that has already started with online business software and web based education. As the online and offline worlds become increasingly intertwined, whether the goods you buy are physical or not will be a minor distinction.
Originally published in BusinessForum China.