December 30, 2009

New Revenue From Virtual Goods During Ad Slump

Web companies are banking on the idea that people are becoming increasingly interested in buying virtual products, reported Reuters.

These digital bits on computers and cellphones, known as virtual goods, have become more popular in the past year as people's lives have begun to center more around the Internet.

Virtual goods are typically available for $1 or less, and range from video game accessories like extra weapons for shooting games, to electronic birthday cards and flowers for friends on Facebook or dating sites.

While they have been popular in other parts of the world, especially Asia, the trend is only now catching on in the U.S.

Digital merchandise is a key source of revenue for many Web start-ups to replace dwindling advertising dollars. A series of big-ticket deals also indicates that virtual goods are becoming more than just a mere trend.

In November, video game publisher Electronic Arts Inc paid $275 million for Playfish, which develops games for social networks such as Facebook that sell virtual goods.

And just one month later, a group of investors spent $180 million into Zynga, another social networking game company. Virtual goods currently make up for 90 percent of Zynga's revenue.

"The bigger companies are putting their weight behind this model," said ThinkEquity analyst Atul Bagga to Reuters. He believes the U.S. market for virtual goods could be twice as much in 2010 from an estimated $1 billion in revenue in 2009.

The boom in virtual goods offerings has come just in time to save free websites that have, up to this point, relied heavily on advertising sales, which have plummeted.

In the first six months of 2009, U.S. Internet ad revenue dropped by 5.3 percent to $10.9 billion, compared to the same period a year earlier, according to the Internet Advertising Bureau.

Many Web entrepreneurs have discovered that virtual goods are actually more lucrative and a better fit than advertisement.

"People don't want to click on an ad while playing a game. They don't want to be thrown out of the application (to view the ad)," said Netanel Jacobsson, a former Facebook executive who now advises the online social gaming firm Crowdstar.

Crowdstar recently replaced in-game ads with virtual goods, which he said has resulted in a substantial financial improvement.

An estimated ninety percent of recent online game start-ups are selling virtual goods, according to Jeremy Liew, managing director at Lightspeed Venture Partners.

"If people were not employing that model, then I'd have a lot of questions as to why they didn't have that," Liew, who has invested in several social gaming companies, told Reuters.

While there may be much optimism surrounding the emergence of virtual goods, no one knows if the business will take off outside the online games and social networking sites.

Virtual goods will not likely take the place of advertising as the primary money-maker at companies like Google Inc and Yahoo Inc, which make billions of dollars annually from selling ads on the Web.

The virtual goods industry also suffered this year after technology blog TechCrunch reported questionable business practices by third-party firms offering virtual currency. Since then, sites like Zynga, News Corp's MySpace and others have thrown out such offers.

For social networks like Ning, which began offering virtual goods in October, digital products will remain one of several revenue-generating businesses, including ads and premium services, said Chief Operations Officer Jason Rosenthal.

He believes the differences between virtual goods and ads will become more indistinguishable as virtual goods evolve.