Is Group-Buying Virtual Goods The Next Big Thing For Item Shops?

31st January 2011 by Martin

Without a doubt group buying platforms like Groupon or LivingSocial are hot right now. Groupon spectacularly rejected a $6 billion bid from Google and is the clear leader in the group-buying space at the moment. LivingSocial on the other hand recently made the news with the best selling group-buying deal ever. Over 1 million Amazon vouchers offering a 50% discount (pay $10 for a $20 voucher) have been sold on their website. No wonder, considering that for a regular Amazon user this is as good as printing money.

It made me think and I was wondering if something like this could also work for virtual items in the video games business. Shortly after we started talking about it internally, news sites reported that Facebook is planning to introduce just that (The startup Inhale Digital launched something similar several weeks ago and it will be interesting to see how Facebook’s plans will influence their strategy). One thing we immediately thought about is that such a platform would need a critical mass of users to attract potential partners. Additionally a lot of knowledge about the users is necessary to target the deals efficiently. Facebook has more than 500 million users which don’t just share which games they play on Facebook but also willingly share a lot of information about their hobbies and interests. I think it literally laughs in the face of our quickly chosen criteria.

The feature is still in development but if it takes inspiration from Groupon then we can expect users to share discounted deals for virtual items in games on Facebook with their friends. Potentially getting rewarded with a voucher or free deal if they refer enough friends. Groupon keeps around 50% commission from each deal, Facebook might do the same and we can start doing the math.

If a $10 purchase gets discounted to $5 and Facebook keeps $2.50 from each transaction, 4 discounted items need to be sold to get the revenue of one non-discounted item. With Facebook’s power and network of users this sounds achievable. But the question is who really benefits from those deals?

Groupon promises businesses new customers however there are reports that many are either already existing customers who would have bought something for the full price anyway or deal hunters who just follow the next deal and will never be seen again. Another problem for traditional retailers using Groupon is that each purchased deal effectively costs them money and Groupon’s commission has to be paid back with additional sales after the deal. Worst case, money has been spent without increased sales after the deal.

As a result, the businesses using Groupon have every incentive to limit the number of people using the promotion overall, try to use it to fill unused capacity, and discriminate the audience  who wouldn’t pay for the regular price in order not to cannibalize “legitimate” sales. The goal is to use it only when marginal costs of the additional sales are negligible.. That’s why Groupon offers tend to be from local brick and mortar businesses (so that the deal is interesting mostly for local people only), with limitations (such as one coupon per household), often in a service activity such as beauty salon or restaurant (where there is often unused capacity at off-peak times, when extra demand can be met for no higher marginal cost), or to get rid of excess inventory in the case of goods, and on “entry-level” offers (to make them less interesting for existing regular customers). The deals work best when they are about group activities, where some of the customers might go only because thir friends are (such as a restaurant or a parachute experience).  In the example linked above, the unhappy business was doing exactly the contrary : selling items that had a high marginal cost with no limitations or discrimination, with limited social appeal.

There is less of a problem of actually losing money with discounted virtual items but it does not mean that more profit could have been made without the deal in the long run. Since virtual goods have very little marginal cost, even each discounted item is something to be happy about. If you sell enough of them, the deal has been worth it. The main focus has to be on discriminating those customers who would have paid more and avoid cannibalized sales.

Godswar online tries to bait new users with a free pirate panda, but could they sell it through group purchase instead?

What about the extra benefits? It’s questionable that virtual item deals bring in new players to a game, I’d rather say that the chance is high that once again most of them are already existing players. It has potential to pull back players after they’ve stopped playing though. To attract new players, deals would need to offer a bigger incentive than e.g. a decorative item, they’d need to give a huge boost at the beginning of the game. That’s already a technique used by some games on Facebook, but not in a group purchase context (see image on the right). An idea would be to offer such a discounted starter boost to friends of existing players, or people playing a competing game. It could easily be done as Facebook knows exactly which apps each user is using however there is still a big question mark over how users will have to opt in to the deals (if not receiving a deal from a friend).

The most interesting user segment to target with these offers is likely to be the mass of people who play for free and never buy anything. Social Gold have shown that once a player has paid once, they are much likelier to make other purchases. 56% of the users they studied who have spent once will make a second purchase, and 25% will make 3 or more.  That’s why a lot of games give limited amounts of cash currency to encourage people starting spending it.

There are limits to this approach, though. First, other studies have shown that discounts on currency is much more likely to result in increased sales than discounts on items. Currency is perceived as a way of hoarding cash once the bargain is taken advantadge of, whereas items discounts only triggers impulse sales for players wanting that particular item. With Facebook Credits, the currency is more liquid than ever, and thus even more interesting to hold. However, only Facebook is able to offer deals on it, and the problem for them is that currency, contrarily to items, makes it difficult to discriminate those who would have paid more.

So on the positive side a successful deal might be the foot in the door and encourage players, who never bought a full price item before, to purchase more afterwards. They will also feel the commitment to continue playing for a while to justify the expenses they just made. Friends might bring back retired players who gave up on accepting normal gifts but can be seduced by a magical ‘save 50%’ sign in front of their eyes. Special deals could also generate coverage on various websites, if successful enough.

On the negative side we have the chance that more revenue could have been generated by using the money Facebook keeps and promote the full price items or currency with it because players would have already been willing to pay for it at full price. Especially in the discussions about Groupon there is the fear that customers get trained to wait. Once they’ve learned about the discount deals they become reluctant to buying full price items, worst case they run to a competitor’s game only to buy the next deal there – but that seems unlikely as the items only have meaning in the context of the game, and they tend not to be substituable so easily.

There are two parties who benefit for sure from discounted deals: The platform owner when it is purely 3rd party (e.g. Groupon) and the customers who would have bought the item for the full price anyway. Others can lose : Partners who offer a deal run the risk of missing out on potential revenue and customers who think they have saved money but essentially just paid for something they didn’t want to buy initially (and didn’t need). Also, there is always some revenue made on unredeemed coupons (that’s why every store has gift cards now). Here, Facebook is both platform owner and merchant, and the customers are hard to discriminate in order to select those who would will to pay more.

Each partner might have a different experience with group-buying deals. Some will be hugely successful and some will call it a failure. Just think about the pros and cons before jump on the hype. It also has to be said that my initial thoughts weren’t just about games on Facebook. In theory a platform could offer deals all across the board (client or browser based games), handing out voucher codes which can be redeemed in partners’ item shops (or maybe even for DLC). With Steam, Xfire, Raptr and co. there are already a few who know a lot about players and their behaviour. A new platform could also emerge and apart from implementing the technology nothing really stops a publisher from offering their own group-buying deals without having to pay a 3rd party platform any commission. However we come across the critical mass and knowledge about user behaviour again. A publisher on its own will have a problem to offer a deal to non existing players, even existing players might not have opted in to their newsletter and will have to find the offer on the website instead.

Before the post gets even longer I invite you to share your thoughts about it  in the comments section below. Time will tell if group-buying deals essentially bring down prices of full price items or partners can really benefit and ride on the wave of a successful deal.

(Secret: I wanted to call this post ‘Super Sale! Save 50% on your next virtual item!’ but it would have looked too much like a phishing attempt, don’t you think?)

2 Responses to “Is Group-Buying Virtual Goods The Next Big Thing For Item Shops?”

  1. Tweets that mention Is Group-Buying Virtual Goods The Next Big Thing For Item Shops? -- Says:

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  2. Julien Says:

    Steam's success is pretty much base on regular sales and group discounts. We can already see the impact on the business of PC game sales with many players now just waiting for a game to be on sale to buy it. A recent blog post by Recettear's publisher Carpe Fulgur highlights the good and bad sides of having a game in that sort of sale.

    In any case, it is very interesting and will become more and more common, although it's easier for publishers to put it in place in their own proprietary platforms where no 3rd party have an impact. We can already see it in gPotato's regular flash sales or in Turbine discount system highly supported on Twitter and by Newsletter.

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