Virtual goods: The way forward for Social Networking sites?

The world’s largest social networking sites Facebook & MySpace have annual revenue of approximately $450mn and $250mn respectively. That is a good return indeed. But does it justify the amount of traffic on these two sites? Probably not. The revenue per user or page-view is very low for these sites as compared to the portals like Yahoo and MSN. (http://sampadswain.com/2009/05/social-network-monetization-deeper-insights).

Monetization has been a problem area for all leading social networking sites. The main source of revenue for these sites is from online advertising and experts feel that making web advertising work on social networks is very difficult as the members of the social networks spend more time interacting with their friends rather than paying attention to the advertisements. Facebook’s user base is increasing in a torrid pace, with over 600,000 users added each day. But this is not translating to revenue for them. Rather, they are spending $20-25mn only for the space that maintains its servers for around 200mn users. This article in New York Times (http://www.nytimes.com/2008/12/14/business/media/14digi.html?_r=2) discusses the frustration of both Facebook and advertisers regarding the difficulties in making brand advertising work in social networking sites.

One website that has been doing very well for itself is the Chinese web conglomerate TenCent. Its social network Qzone boasts of 200mn monthly active users, which is more than both Facebook and MySpace. TenCent generates annual revenue of US equivalent $1.2bn, out of which only 12% is accounted for by the advertising revenue. The remaining approximately $1bn comes from the sale of virtual goods, game packages and other digital items. This makes it the most lucrative social network in the world, though it caters to the niche market in China and does not have a global presence like Facebook and MySpace. Virtual goods are the non-physical goods sold in online communities. Examples are online games and digital items sold on the avatar service by TenCent, where virtual clothing, jewellery and cosmetics are put up for sale and lapped up by the people. The reason behind this success is that monetizing through virtual goods gives opportunity to earn with small marginal cost and high marginal revenue, which is not possible through advertising. The rampant success of TenCent is not just a one-off, 2 Japanese services DENA and Gree have emulated Qzone’s model for monetization and have been highly successful. It’s not that Facebook and MySpace have not realized these developments. In October 2008, Facebook launched a virtual gift shop based on a credit based system where users can buy 10 credit points for $1, which can be used to give virtual gifts to fellow users. The applications and online games like Mafia Wars and Farmville on Facebook have become so popular that it is estimated that the total revenue generated by companies running applications on Facebook’s platform would outperform Facebook’s revenue by the end of 2009.(http://virtualgoodsinsider.com/). This article (http://www.virtualgoodsnews.com/2009/03/is-tencent-the-model-facebook-and-myspace-should-follow-.html) iterates that TenCent’s revenue model based on virtual goods is the way forward for Facebook and MySpace and they should try to integrate the model to their existing structures.

Can this highly successful phenomenon in China be emulated in the West? Though there are cultural differences between China and the West and virtual goods seem to be more popular in China, I feel that Facebook and MySpace could update its business model to exploit the virtual goods phenomenon, given the high marginal topline they offer and the stagnant returns from online advertising. The virtual goods phenomenon has been growing fast in the West too, with the growing popularity of Second Life, where users sell virtual goods to each other, and online gaming sites. Analysts estimate that virtual goods would bring in $1bn in United States alone. Having said that, changing the business model is not an easy exercise at all. MySpace is currently focused on music and Facebook on user-based communication. Integrating virtual goods would require the change of strategy and personnel and there is always the risk of losing the user-base. But what is the point of being the most popular sites in the world when it could not be converted to revenue. It seems it is the time to rake in some moolah and probably virtual goods are the way to go!