Here comes the virtual goods bubble

As ad-based biz models lose lustre, a new monetization panacaea for digital media has emerged.

“Whereas last year all the business plans I saw said, ‘We’re ads-based,’ today, it’s ‘We’re virtual goods-based!’” says Tim Chang of Norwest Venture Partners. “Virtual goods is becoming the new advertising of 2009.”

Chang thinks this is good news for the gaming industry, where he regularly invests. Gaming can monetize in a lot of ways beyond advertising, and expects it to continue to lead growth in digital media. “You’re seeing a lot of people flock toward gaming as a potential safe spot,” he told me in an interview last week.

In the most recent sign of VC exuberance in the sector, virtual currency startup Jambool announced a $5 million round yesterday led by Madrona, which joined existing investor Bay Partners. Jambool’s ‘Social Gold’ platform lets developers create their own white-labeled virtual currency systems. It powers payment systems in online apps and games including Lil’ Green Patch and Mafia Wars.

The virtual goods market is expected to reach $6 billion by 2013, according to a recent report by Piper Jaffray. That's up from $2.2 billion this year. It's a fast-growing market, but one wonders whether the virtual goods sold in 2013 will be the kind pawned in the virtual worlds and social networks being funded today. Can we really buy $6 billion of hairdos, battle axes and birthday sheep?

One of the early breakout companies to find success through virtual goods was Gaia Online, a virtual world that in 2008 hired 3 full-time interns to open envelopes with change sent from youngsters hoping to purchase flaming swords and other imaginary items on the site. The company cut 13% of its workforce in December, but continues to see steady traffic growth. Whether the company is profitable remains a matter of speculation.

One challenges is the generation gap: while kids are the target for many games and virtual worlds, they don’t yet have purchasing power yet, and many adults retain a psychological barrier to online payments.

Not long ago, Josh Kopelman wrote a post about the “Penny Gap.” Roughly speaking, the notion is that the barrier between $0 and $0.01 is much greater than the gap between $1 and $10 for online consumer spending. However, that’s changing as kids grow up on platforms like Club Penguin, according to Chang. “You’re going to have a lot of young users being trained and educated on how to interact and pay with these virtual goods system from games and websites early on and it will be a very natural fit for them to then move over to microtransactions.”

But is this training in microtransactions a good thing? Impulse buying may be boon for the economy, but the idea of an education in microtransactions reminds me, a bit ominously, of a line from Mark Crispin-Miller, Communications Professor at NYU, in the Frontline documentary Merchants of Cool:

“When corporate revenues depend on being ahead of the curve, you have to listen, you have to know exactly what they want and exactly what they're thinking so that you can give them what you want them to have.”