Everyone knows that when you download a free game on your phone, there is a solid chance it will try to get you to buy some type of 'power ups' to make playing more fun. While your decision to buy a couple of extra coins may seem benign, the business models behind these virtual economies are very real.
A recent article by Venture Beat tells the story of a new startup company called Gondola that specializes in creating efficient virtual economies in 'freemium' smart phone games. You heard that right; there is a company that helps regulates virtual game markets. By far the most popular business model in app development, 'freemium' apps provide free access to their service (be it game or utility), but then offer premium content by charging you through your choice of online payment with the press of a virtual button on your touch screen.
Popular tactics designed to get consumers to buy include escalating the difficulty of play, increasing the time delay between rounds, and making you watch ads to continue. The genius behind this model lays in the fact that producing those extra coins or lives you purchases costs developers theoretically nothing. Without marginal cost constraining production, developers gain 100% profit for each additional virtual good created that sells. When done right, a developer can make millions on zero additional input besides the occasional update. This business model might also explain why consumers are hesitant to purchase an in game bonus, realizing the product provided just adds to an already free activity.
Nonetheless, the freemium business model works and Gondola wants to take freemium to the next level. Using a proprietary algorithm, Gondola boasts the ability to maximize the profits of app developers by creating markets that incentivize consumers to keep picking up their phone to play and buy more. Even crazier (and possibly creepy) is how Gondola's algorithms calculate and account for the behavior of individual consumers to create pricing that best suits their demand. In other words, Gondola pits consumers against their own marginal decision-making.
By learning how much a consumer values an in game virtual good, Gondola can then create an entire market that prices right at an individual's threshold of purchasing. At not too much or too little, the price becomes just right for the consumer to maximize their potential purchases. Just think about it, how willing are you to buy a can of soda for $0.50? $1? While the differences are tiny, the consequences of such price differences are huge. Many people will not buy a soda at $1, but for just 50 pennies less, are willing to buy. The same goes for virtual coins and power ups, and a study by Harvard backs this up by showing that a 2% price change can increase revenues by 10%.
Despite fitting the cliché of an ever more 'exploitative' business model, Gondola makes a real point at the end of Venture Beat's article:
By utilizing prices to design a better game experience, we are creating a win-win situation for players and developers alike.
In other words, they tailor the game's market mechanism to best fit your preferences, maximizing your utility gained (aka, fun) while also making a buck for the people who made the game. If only Carl Menger, a co-creator of marginal analysis, saw how videogame developers are using economic theory today…
Footnote: This is not the first time economic theory has popped up in video games. Diablo III, a game by Blizzard Entertainment, once experienced hyperinflation comparable to Zimbabwe when the virtual economy did not have enough 'money sinks' for users to spend on.