You buy virtual goods

Jeremy Liew has a great piece in the WSJ about the central mystery of businesses that make money selling virtual goods:

Why do People Buy Virtual Goods? - WSJ.com: "My theory is that people buy digital goods for the same reason that they buy goods in the real world; (i) to be able to do more, (ii) to build relationships, and (iii) to establish identity."

• Practical utility - This is the tangible benefit that a product enables, whether that's transportation, warmth, cleanliness, or entertainment. Many products derive all of their value from this utility, online as well as off: generic drugs are pretty similar to a number of non-epic consumables in your average MMOG.
  
  
• Perceived value - This is the extra value a customer perceives as a result of good marketing, product design, product quality, or exception product/market fit. For example, many customers derive satisfaction from feeling like they bought the "best" product in a given category, even if that product has no objective performance difference from its nearest competitor. This is true even in cases where the customer derives no status benefit from the product (which we'll cover in a second). For example, home electronics brands like Sony and Bose work very hard to create an impression of exceptional performance even in products that are used primarily in private.
  
  
• Social value - When I can use a product to my benefit in a social situation, it can be transformed in value. All gifting-type products are influenced by this source, as Hallmark has long understood. But plenty of other product categories depend on social factors: status purchases, beauty products, fashion products, and (at least here in San Francisco) food and produce. For a non-brand example, look no further than De Beer's successful, if pernicious, marketing of diamonds.
  
  
• Identity value - This is the strongest source of value of all, and it's a little tricky to differentiate from the preceding two sources. This is the benefit you get from incorporating a product into your self-conception. For example, take your average Mac fanatic. When they buy an Apple laptop, they are doing more than enjoying a premium product and showing off. They are saying to the world and - more importantly - to themselves: I am the kind of person that buys Apple products. Apple has done a phenomenal job of convincing us that we, too, can be a little like Steve Jobs, if only we had one more iFoo in our lives. Many fashion and beauty products create this kind of affinity, especially in products that are not visible to others (don't make me spell it out). Identity products are not easily displaced, because the emotional investment is very high. This is every bit as true for online goods - just try and trade your friend's level 80 warlock for your "equivalent" level 80 rogue. Good luck.
  

I've tried to arrange these sources of value in a hierarchy, and although I don't have a lot of evidence that I got it right, this is my gut sense of how they stack up. The nice thing about understanding these sources is that consumers generally have separate budgets for each category. One of the biggest lessons I learned from my time at IMVU was that if you can move spending out of the entertainment budget (which is often constrained) and into the identity budget, you can make a lot more money per customer. Even in tough times (actually, especially in hard times) people spend significant sums to bolster their sense of who they are. For better or worse, products physical and online are parts of that formula for most people in our society.

So when thinking of selling virtual goods, consider combining sources of value into one product. This is true for online goods, for example in supporting item gifting. It's just as true for physical or even hybrid goods, as Webkinz has demonstrated by adding an online source of utility to a physical stuffed animal. Many virtual goods generate only mediocre returns when they draw from only one source of value, as Facebook has been finding out with their only-social-utility gifts, or dozens of startups have found out with their just-the-functionality technology offerings.

And when given the choice, try and move up the hierarchy of value. If given the opportunity to work with two customer segments, one of which sees your product as a basic utility and another of which sees it as a lifestyle statement, choose the latter. IMVU made that choice early on, when we abandoned some profitable customers who wanted to use our product as a regular-IM substitute. There was no way to service them while still engaging with the goths, emos and anime fans who were rapidly becoming IMVU's top evangelists. We doubled-down on identity value, and it worked out well.