The Rarest of Lawyers

No, I am not talking about lawyers who are disinclined to sue at the drop the hat (my apologies to all my lawyer friends out there). What I am talking about is a lawyer who understands economics. We all specialize in our field of expertise, and it’s refreshing to see a specialist in one field demonstrate insight in another.

Such understanding is on display in article by a pair of attorneys, Richard S. Eisert and S. Gregory Boyd in an article entitled “Virtual Property - Business Models And Pitfalls” that appeared in the Sept. 2008 issue The Metropolitan Corporate Counsel. Eisert and Boyd are lawyers at Davis & Gilbert LLP. Although the article is ostensibly about property rights issues, I found a couple of observations worth noting.

First, in talking about the contest between subscription based models (a la World of Warcraft), they distill the core argument for why RMT makes economic sense over the subscription model. As explained by Eisert and Boyd, RMT allows for the greatest extraction of value from an MMO by allowing customized levels of commerce.

"… traditional subscription models and even advertising are relatively blunt instruments for monetizing online worlds. Both of these methods tend to assign the same value to every customer. A subscription charges a customer a monthly or annual cost and advertising pays per user or per view at a set cost. But, people do not value goods this way. Each person places a different value or ‘willingness to pay’ to be a part of an online community. RMT helps companies extract that value." (emphasis added)

They describe the benefits of RMT if properly implemented:

"… RMT allows game companies to satisfy that need and extract appropriate value as well by ‘fine tuning’ the price point so that each user pays the price the service is worth to him individually."

To illustrate this point, I’ve prepared a couple of graphs. In both, the curved line represents the willingness-to-pay of the users. All the line says is that some people are willing to pay more for a game, while others will only pay less. The first figure depicts a hypothetical flat-fee subscription-based virtual world. I’ve indicated areas where revenues could be higher in two places. First, there are some potential players who simply find the game too costly: the flat-fee is greater than their willingness to pay for the game. Second, there are current players who are in fact willing to pay more for the game than they actually are, but since the game has a flat fee structure, there is no way to capture that untapped willingness-to-pay.

The second figure shows a hypothetical game based on RMT. In it, each player decides how much money he or she wants to spend in the game. Players who only want to pay the minimum can do so, while others can pay up to the maximum amount they are willing to spend. The result is that players end up paying much closer to their individual willingness-to-pay amount. It may not be a perfect match, but it comes much closer to the willingness-to-pay-curve than the flat-fee world. The revenue for each game is represented by the area of the red- or blue-shaded rectangles. If you were to actually do the math, you’d find that (in this hypothetical example) the blue-shaded area was larger than the red-shaded area.

Before I conclude, there’s one last point to mention about the Eisert and Boyd article. Toward the end of the article, they make a rather curious, albeit 100% accurate observation about virtual currencies.

"… most anyone would rather have World of Warcraft gold, supported by its 10 million player subscriber base, than the Zimbabwe dollar, which is currently in the midst of a hyper-inflation crisis."

Notwithstanding its virtual nature and the difficulties in converting it to U.S. dollars, virtual gold (or other virtual currency) would still be preferred over real world currencies that suffer from hyperinflation.

** As requested, I've edited the figures to add labels. For additional discussion on the issues raised here, see Matt Mihaly's post at The Forge, and Raph Koster's post at his blog. **

Blizzard L00t

A recent article in PC Magazine estimated that World of Warcraft brought in revenues of $120 to $135 million per month, compared to cumulative upkeep costs of just $200 million since Nov. 2004. The motivation for that article was a post on Kotaku reporting that during an analysts’ call, Blizzard Entertainment revealed that its cost of upkeep for World of Warcraft was $200 million. Although the exact scope of that amount appears to be vague and poorly defined, the implication was that it covered all ongoing costs (but not development costs) since Warcraft launched. That presumably includes hardware infrastructure (servers), marketing, customer service, and other expenses. The PC Magazine article based its $135 million estimate on the latest Warcraft subscriber count of 10 million as of January 2008.

World of Warcraft is unequivocally a highly profitable game. However, I seriously doubt it is really that profitable. Just to put things in perspective, Blizzard’s total revenues – including all its properties – was $270 million in the 2^nd quarter of 2008, or an average of $90 million per month, according to an article on Gamasutra. Clearly, PC Magazine was way off the mark with its “conservative estimate”; its estimate was 50% higher than all Blizzard revenue combined. I don’t mean to pick on PC Magazine, as I subscribe to it and enjoy reading it, but this article sparked my curiosity and got me wondering how much revenue Warcraft actually did generate per month.

There are two significant factors that PC Magazine did not take into consideration. First, the subscriber base of 10 million is a moving target. Although the author of the article did not imply otherwise, it is still important to keep in mind that revenue figures for previous periods would be less due to a smaller number of subscribers. For example, one year prior to the 10 million subscriber announcement, Blizzard reported just 8 million subscribers (Blizzard press release, 1/11/2007).

The second and more important consideration is the different subscriber model in Asia, particularly China. There, account fees are structured based on hourly usage, not a flat monthly rate. According to DFC Intelligence:

[T]hese Chinese users are not subscribers in the Western sense of the word: they do not pay a recurring monthly fee. In fact, they generate about 0.36 yuan per hour of gameplay; that’s about 4 cents an hour. Of course, Chinese users log a lot of hours. In the second quarter of 2006, World of Warcraft generated $32 million. While this is a substantial sum in the Chinese MMOG world, 5 million Western subscribers would have generated more than $200 million over the same time period. Thus, Chinese players generate about 15% as much revenue as their Western neighbors.

So, let’s take another look at these back-of-the-envelope calculations. Starting with North America and Europe, let’s assume all these users pay a flat monthly fee ranging from $13 to $15 per month, depending on the length of subscription. Furthermore, some of these accounts are in their first month of free play. Blizzard also gets revenue from the provision of services, such as paid realm transfers. Thus, a conservative assumption is that the average monthly revenue per Western player is $13 (including service revenue, which would pull the average down). Blizzard only provides an estimate of the number of Asian players, and presumably the average revenue per player is higher in South Korea and Japan than in China. Still, to be conservative, let’s assume DFC’s estimate holds for all Asia, so that in generating 15 percent of the standard subscriber rates, Asian players average $1.95 in revenue each month.

With 4.5 million subscribers in North America and Europe paying $13 per month, the associated revenue would be $58.5 million per month. With 5.5 Asian players at $1.95 per month, their revenue would be $10.7 million. Worldwide, one might reasonably estimate Warcraft’s subscriber revenue at $69.2 million, and perhap shigher.

According to financial statements, Warcraft’s subscriber base had risen to 10.9 million by mid-year, an increase of 9%. Assuming even subscriber growth across geographic regions, a 9% increase means that monthly revenue from Warcraft is currently about $75.5 million. Thus, the $135 million estimated in PC Magazine appears to overstate subscriber revenue by nearly 80% according to my calculations.

In addition to subscriber revenue, Blizzard also earns revenue from sales of the game software to new players. There is also revenue from merchandise and other sources, though probably not much. Although there are a variety of different software options, the base package runs about $20 and versions go up from there. (The upcoming expansion Wrath of the Lich King will cost $39.) The updated subscriber count from Gamasutra suggests that new unit sales of Warcraft software run somewhere in the neighborhood of 150,000 per month [900,000 new subs / 6 months]. If we just arbitrarily assume that unit sales average $30 (though I have no basis for that figure), the implied sales revenue is $4.5 million per month. Combined subscriber and sales revenue from Warcraft, therefore, total (very) roughly $79.96 million per month.

As noted above, Blizzard had 2^nd quarter revenues that averaged $90 million a month. If Warcraft generates $80 million a month, the implication is that all of Blizzard’s other games generate $10 million a month. Does that sound reasonable? It’s hard to say, but I don’t think it’s unreasonable. In fact, I wouldn’t be surprised if it were a bit high. Although Blizzard has some highly-anticipated games in development, like Diablo III and Starcraft II, it has no other major property actively generating revenue. Warcraft III: The Frozen Throne, for instance, was its last major release, and it came out in 2003. The latest Diablo and Starcraft releases are 7 and 10 years old, respectively.

Thus, $80 million in monthly revenue from World of Warcraft appears to be a reasonable, if extremely rough, back-of-the-envelope estimate. Returning to the original impetus for this post, if the total cost of running Warcraft is a cumulative $200 million since 2004, then the game is indeed highly profitable, though perhaps not as profitable as suggested by PC Magazine.

However, I remain skeptical about how comprehensive that $200 million figure is. I did not listen in to the analysts' call, so I don't know the context for the statement, but I suspect it only paints a partial picture of the costs. Consider that Warcraft has been out on the market for approximately 43 months as of mid-year 2008. That means that upkeep of Warcraft has averaged a rather meager $4.65 million a month. Even if you were to fit the $200 million to a monthly exponential growth curve (which would shift costs toward the present), you’d still get average costs of just $19 million a month during the 2^nd quarter, versus revenues of $80 million. These numbers would seem to indicate a monthly profit of $61 million for a profit margin of 76%. The net income for the entire operations of Activision Blizzard Inc. was just $59 million for the entire quarter! While possible, it does not seem plausible that Warcraft’s profit in one month would exceed its parent company’s combined profits for an entire quarter. My guess is that the ongoing costs of providing Warcraft is significantly greater than $200 million.

Well, I didn’t intend to get into all these calculations, but there you have it. Feel free to comment and point out what I overlooked or may have done wrong.

The Air Force Embraces Virtual Worlds

The U.S. military has been at the forefront of exploring the uses of online gaming technology, primarily as a training tool. In January 2008, the Air Force published “On Learning: The Future of Air Force Education and Training,” a white paper from the Air Education and Training Command. The paper was notable because it laid out in some detail a proposal for an Air Force virtual world called MyBase.

Well, now there is an official RFP (request for proposal), with an October 3^rd deadline. According to the Statement of Need, the proposed MyBase virtual world is rather limited in scope, with just 600 total users. Still, the Statement of Need envisions a fairly complete virtual world:

AETC requires a software application capable of simulating a training classroom on a typical Air Force base with both a flying and technical training mission. … The experience inside the virtual world will be 3D, geospatially accurate, and real-time. Users will participate in MyBase as avatars as well as take part in real-time live audio/video activities. The virtual world is persistent and when users are in-world, any changes they make to MyBase affect it forever forward and for all users until new changes occur. Users feel immersed in their experience as they engage with other users and content.

Returning to the white paper, the AETC foresaw a number of potential uses for MyBase.

Through an Avatar, Airmen will be afforded opportunities to participate in live, virtual and constructive learning opportunities in online classrooms, receive mentoring or personnel services, attend [Professional Military Education], participate in meetings, access knowledge bases, or collaborate on projects. Upon leaving the Air Force, some Airmen may even remain as valued mentors in the MyBase learning environment. …

Another appealing use of MyBase is assessing skills and aptitudes of new recruits:

Air Force systems must support the assessment and selection of the best and brightest to serve as future Airmen. Precise identification of viable recruits using advanced aptitude and skill assessment tools will ensure optimal selection and career field assignment and learning management systems will “push learning to the left.” The Airmen of Air Force 2.0 will supply the versatility and agility needed to increase Air Force combat capability in an era of smaller force levels and constrained financial resources to sustain them.

A program such a MyBase would allow targeted training exercises that can enhance and nurture decision-making abilities.

Advances in scenario-based virtual learning and decision simulation will mature and refine the learner’s innate talents and experiential skill sets, as well as give the learner an appreciation for the limits of software, hardware, and “brainware.” (pg. 13)

The paper shows recognition in the military that for today’s recruits a virtual world like MyBase will seem a familiar interface.

Our future Airmen are comfortable with these technologies and they will enjoy learning and working in these environments. Due to the sophisticated social networking websites in operation today, our newest Airmen will be extremely comfortable networking, collaborating, and learning through MyBase.

This MyBase project, along with other similar ventures underway or planned elsewhere in the military, will be worth watching to see how they develop and if they prove effective.

Virtual Inheritance

Ben Duranske (as well as Virtual Worlds News) picked up on an interesting article in the Swedish daily newspaper Göteborgs-Posten, the nation’s second largest. Although it is in Swedish, a couple of Entropia fans have posted translations at EntropiaForum.com (see here and a more polished version here). The main point of the article is that MindArk will begin allowing residents of Entropia to draw up wills to allocate rights to the decedent’s virtual assets. This is an interesting development, but hardly unexpected. The article quotes MindArk Chief Marketing Officer Carl Uggla about the motivation:

“There is land in the game of considerable value which if the player would die is uncertain who would claim [it],” says Carl Uggla.

In fact, at the 2006 State of Play/Terra Nova Symposium, William LaPiana, the Director of Estate Planning at New York Law School, observed that “Anything you own in a very broad sense that has value is property for purposes of these [estate] taxes.” (You can find audio of his comments here, under the Tax and Finance panel).

Of greater significance is the indication that Sweden has begun to tax virtual worlds, as pointed out in this passage:

The [Swedish version of the] IRS has since spring begun to tax the activities within online worlds. “We’re not performing any bigger investigations. It’s more of a service and a way for us to be clear about the rules. I have got questions from several entrepreneurs who want to start activities in these worlds and about how they should go about it. People want to do what’s right,” says Dag Hardyson at the Swedish IRS.

Martina Bertilsson sees the IRS's actions as the logical one. “it’s about validating this business sector,” she says. “A lot of what happens online is still in a legislative gray area and open for pure legal interpretation, but there are now rules implemented regarding income tax for people living in Sweden,” she says.

I believe the translator of this passage has substituted IRS in place of the Swedish tax agency, the Skatteverket. A look at the first sentence of this passage in the original article in Swedish confirms this to be the case: “Skatteverket har sedan våren börjat beskatta verksamheten inom onlinevärlden” (emphasis mine). Also, I’ve added quotation marks where I believe them to be appropriate, as they don't appear in the original article (perhaps Swedish doesn’t use them).

Regardless of the punctuation, the key take-away here is that Sweden has apparently stuck its fingers into the financial aspects of virtual worlds. This could be a precursor to similar moves by other E.U. nations, and even the United States.

Duranske on Virtual Law

Ben Duranske, the man behind the excellent site Virtually Blind, recently published a book on the state of the law in virtual worlds, titled, appropriately enough, Virtual Law. The book is a valuable contribution and I commend it to anyone with an interest in the topic.

The book is a timely addition to the literature, as most legal questions confronting virtual worlds remain largely unresolved. Ben does an admirable job of surveying the legal landscape and distilling the applicable statutes, case law, and legal doctrines into the most relevant principles for each area of law he covers. That he does so without resorting to too much legalese makes Virtual Law highly accessible, even to a non-lawyer like myself. Although published by the ABA, Ben is clearly writing for a wider audience than just fellow members of the bar.

With Ben’s gracious permission, I have selected a few passages from his book which tackle particularly important issues in virtual law today.

Property Law

Property rights are perhaps the thorniest legal question facing virtual worlds and the subject of the longest chapter in the book. Duranske does a superlative job at setting up the issue and reaching reasonable conclusions. His outline of the arguments for and against virtual property rights is extremely well assembled and easy to follow, incorporating the research of such scholars as Joshua Fairfield and Richard Bartle. His identification of misconceptions and faulty logic is well written, too. Take, for instance, this passage in which Duranske neatly debunks users’ intuitive first take on virtual property:

We have an instinct that because the item has obvious value, it must be an item that can be owned. The reality, however, is that the ability to sell something to someone else for money, while intuitively implying “ownership,” doesn’t establish anything at all from a legal perspective. (p. 87)

Duranske’s overall assessment of the virtual property rights issue is that such rights will come in to being sooner or later, and that an important legal distinction should be maintained between play worlds (e.g., Blizzard Entertainment’s World of Warcraft) and non-play worlds (e.g., Linden Lab’s Second Life):

This chapter will argue that the law needs to acknowledge and provide protection for virtual property, but that it must do so in a way that preserves virtual worlds and games as play spaces, at least to the extent that the developers desire their worlds to remain pure play spaces. On one hand, many game and virtual world providers seek to avoid real-life implications in their social and play spaces. Where providers take reasonable steps to draw a line between the real and the virtual, the world or game should be protected by the “magic circle” that protects other play spaces (from theme parks to family Monopoly games) from taking on inadvertent real-world implications. On the other hand, it is both inevitable and desirable that some game and virtual world designers will seek to include real money trade (RMT) and offer a real cash economy (RCE) in their platforms. Users of these platforms need the protection of virtual property law. (p. 81)

A sticking point for me is Duranske’s provision that “providers take reasonable steps” to qualify as a play space. The question of what is “reasonable” is left unanswered.

Duranske also examines the important issue of the End User License Agreement (EULA) and the Terms of Serve (TOS) agreement. Duranske recognizes that the central problem looming over these ubiquitous contracts is the absence of actual case law to back them up. Lacking litigated judgments, it is hard to know the power of such agreements. Duranske, however, believes that the courts will eventually uphold EULAs and TOS.

From a property law perspective, there is no good reason to believe that these provisions will not generally be found to be enforceable… (p. 89; emphasis in original)

Regarding legislation, Duranske believes that virtual property will come to exist, but warns against outside efforts to impose virtual property rights onto game spaces:

Any effort to legislate the existence of virtual property will – and should – be met by fierce resistance from the game design and user communities …. Forced commodification would ruin much of what is good about play spaces. (p. 97; emphasis in original)

Tax Law

Duranske’s chapter on tax law is a good starting point for analyzing the issue. He leads off with an excellent summary of the problem:

It seems intuitive that when a player is enriched entirely within a game world, the increase in character strength and accumulation of gold and valuable weaponry should not be taxable, even though it does represent an investment of time, and time clearly has a certain amount of “value” to the player. The wealth, so long as it remains within the magic circle of the game world, is pretend wealth. It is not any different than the accumulation of pretend wealth while playing Monopoly in one’s home with one’s friends.

However, unlike Monopoly dollars, currency, virtual goods, and skill increases in game worlds do have value outside the game world, precisely because they do represent an investment of time, or, from another perspective, an option not to invest a certain amount of time. (p. 227-228; emphasis in original)

While Duranske’s comparison is valid, I have to take issue with his underlying economic analysis. Value is not a question of “an investment of time.” After all, one could arguably “invest” an equal amount of time in playing Monopoly. The real difference, that which makes virtual assets valuable, is the simple fact that people are willing to pay money for them. The most basic way to value something is not what it costs to produce, but what another person will give you in exchange. And when it comes to World of Warcraft gold vs. Monopoly money, the unavoidable fact is that people can and do pay significant sums of U.S. dollars for the Warcraft gold, but rarely will anyone fork over their cash for Monopoly money. Of course, the main point – that virtual items have real value – remains unaltered, as are conclusions based on this point.

Duranske expands on the point he makes in the previous passage with a look at the issue of real-money trading (RMT). In particular, he points out that the only real barrier are the ineffective “click-through” contracts that players routinely agree to without reading.

The only thing prohibiting the sale of virtual goods from games and virtual worlds is a click-through agreement between the player and the game company – the practice is, of course, not prohibited by law. And however much game companies may express a desire to prohibit RMT, prohibitions in End User License Agreements and Terms of Service are simply not effective. (p. 228)

Duranske moves on to the heart of the tax question. He starts by setting up the legal framework for conducting such an analysis, succinctly laying out the core elements necessary for examining the virtual world tax question:

All tax analysis starts with Comm’r v. Glenshaw Glass Co. Under Glenshaw Glass, income is “any undeniable accession to wealth, which is clearly realized by the taxpayer, over which the taxpayer has complete dominion.” The key terms from the decision are “accession to wealth,” “clearly realized,” and “complete dominion.” In addition, the concept of “basis” must be understood. (p. 232)

With this framework established, Duranske considers each of the four key terms he identified, providing the appropriate legal interpretation and significance. Duranske then follows this legal analysis with the hypothetical “Wendy,” a participant of WoW and SL. By running Wendy through a series of plausible scenarios, Duranske is able to draw out the legal analysis based on Glenshaw Glass and apply it to virtual worlds. This approach is helpful in moving from abstract legal principles to meaningful application.

Duranske does a good job hitting the legal pressure points on taxation, but I personally found his analysis somewhat unsatisfying. Whether motivated by space considerations or a desire to avoid over-analyzing the question, Duranske appears to fall into the same trap as many commentators, namely only investigating the two extremes of Second Life and World of Warcraft. While these two ends of the virtual world spectrum are certainly important, it is equally important, I believe, to consider the worlds that don’t neatly fit into these two categories, as well as the dynamic reaction that worlds will have in response to tax laws. (See my earlier, related post “Apples & Oranges, or Shades of Grey?”) In the discrete WoW/SL dichotomy that Duranske lays out, it is easy to see how WoW falls inside the magic circle while Second Life lies outside. But what about, say, SOE's Everquest II, a seemingly pure game world in the model of WoW, but one that permits players to sell their characters via Live Gamer. Similarly, MindArk’s Entropia and even NCsoft’s Exteel exhibit characteristics of both WoW and SL. And how will publishers react once the tax rules are determined? Will developers respond by altering facets of their worlds so as to avoid taxes? What if developers want elements of both play and RMT spaces – is there any middle ground? I don’t necessarily have the answers to these questions myself, and I can hardly fault Duranske for not delving into every possibility. Still, it would make for a good next step of the analysis.

Criminal Law

One aspect of Virtual Law that generally serves the reader well is that Duranske does not easily get sidetracked into the minutia of the issues. He drills down to the heart of the issue at hand and discards extraneous or unnecessary aspects of the large issue. This focus is most evident in his chapter on criminal law.

Virtual crimes encompass a broad range of unsavory and/or unwanted activities. Examples include virtual prostitution, gambling, money laundering, fraud, terrorist training simulations, and virtual child pornography. Duranske addresses each of these generally and specifically (if only briefly), reaching the following rather simple overall assessment:

The application of criminal law to virtual worlds is the most headline-friendly aspect of virtual law.… These issues do not, however, raise many novel questions in virtual worlds. Most actual crimes that occur in virtual worlds are financial crimes, and they can be addressed through simple application of existing criminal codes. The laws regarding financial fraud, money laundering, data theft, and gambling have been updated to take into account Internet-based activity, so they already cover virtual worlds and games as written. (p. 197)

Conclusion

Virtual Law is an undeniably valuable contribution to the literature and worth reading for those seeking an understanding of the legal issues facing virtual worlds. Nothing I’ve read has done a better job at addressing all the myriad legal questions. Indeed, because Duranske’s analysis comes in book form, he has the ability to address a far wider breadth of issues than law review articles and other studies. As it is, I’ve only touched on a few of the many topics covered in Virtual Law. That’s a shame, because Duranske’s take on securities law, contract law, and privacy issues, to name a few, are worthy of discussion as well. That being said, you’ll just have to get the book and read it yourself to get the full treatment.

Leeroy Jenkins!

I realize that this has absolutely nothing to do with the economics of virtual worlds, but I can’t help but love this video. Yes, it’s been around a while, but every few months I see something about and I watch it again and it makes me laugh.

My favorite part: When Leeroy defensively proclaims "It's not my fault!" right after he causes everything to fall into the crapper.

For a little background on the video, the player, and its cultural significance, see the Wikipedia page.

Top 5 MMOGs?

The NPD Group has come out with its estimate of the top 5 virtual gaming worlds, as reported by Gamasutra.com and GamesIndustry.biz. NPD's list does not include the number of subscribers, so to put things in perspective I have added subscriber counts (in brackets) that I gathered from various sources on the web.

Q1 2008 – Top 5 MMOGs by Subscribers

1. World of Warcraft [10 million subscribers]
2. RuneScape [1.2 million subscribers]
3. Lord of the Rings Online [1 million subscribers]
4. Final Fantasy XI [500,000 subscribers]
5. City of Heroes (CoH) [136,000 subscribers]

Overall, NPD estimated that there are approximately 11 million gaming subscribers per month in North America. The subscriber data was gathered over a six month period (October 2007 and March 2008). Unfortunately, NPD did not make public its estimates of individual subscriber counts, just the relative ranking. However, we know from NCsoft’s financial reports that CoH had 136,250 subscribers in the U.S. and Europe in December 2007.

When paired with subscription estimates, NPD’s list seem particularly striking for being so stratified. The drop-off of 9.9 million subscriptions between the #1 and #5 spots suggests a high degree of market concentration at the top, with many smaller players at the bottom. Raph Kosters has a good post on this large disparity.

The public part of the release had two additional nuggets of information. The first is demographic. According to NPD spokeswoman Anita Frazier:

While the majority of gaming website players are females over the age of 35, MMOG players are largely males under the age of 35.

The first part of this statement is a bit surprising, as gamers are typically thought to be young males, not females over 35. The second half is notable because the age figure is so high; this also implies that a large percent of MMOG players are over age 35. [NPD’s list of the gaming websites with the most subscribers are: 1) Pogo.com; 2) Realarcade.com; 3) Bigfishgames.com; 4) Gametap.com; and 5) Disney.com.]
The second bit of information is financial. Summing revenues from three categories – MMOs, casual games and consoles – yields more than $1 billion in annual revenue. NPD obtained this estimate by first estimating monthly average revenue at $87.2 million for the time period surveyed, and then multiplying that estimate by 12.

Although NPD’s list is interesting, it is not as revealing as it seems. First, it seems likely that a number of MMOs have subscriber bases close to or larger than CoH’s. Club Penguin from Disney has roughly 700,000 subscribers. CCP’s EVE Online reports having 220,000 subscribers at the end of 2007. NCsoft’s Lineage I & II had 2.1 million subscribers (86,000 in the U.S. and Europe). Sony Online Entertainment’s EverQuest I/II have some 250,000 subscribers and while Star Wars Galaxies is estimated to have some 100,000 subscribers. MMOGchart.com also estimates that Toontown Online has 100,000 subscribers and Dofus has 450,000 world-wide. Certainly there are important definitional and geographic differences between these estimates and NPD’s list, but the point remains that from a global perspective NPD’s list only reports on a segment of the metaverse.

NPD’s focus on subscribers also ignores the increasing use of microtransactions and/or RMT as a revenue source. I blogged about this trend in a recent post (“Money Transactions in WoW and NCsoft”), but see also the articles here, here and here. Some of the most popular virtual worlds (and granted, they are not all MMOGs) do not require a subscription, including Guild Wars (5 million games sold), Second Life (600,000 users logging in during past 2 weeks), Virtual MTV (600,000 registered accounts), Knight Online (4 million registered users), and Habbo (7 million unique visits per month). Sony Online Entertainment has been at the forefront of this shift toward use of microtransactions and RMT, implementing such capabilities into EverQuest II and the forthcoming The Agency. NCsoft’s Exteel, SOE’s upcoming Free Realms, MU Online from K2, and Nexon’s MapleStory (with 67 million registered users) are all free-to-play, making their profitability especially reliant on microtransactions/RMT (see here and here).

Research Conference in World of Warcraft

I had the pleasure of attending Saturday’s session of last weekend’s “Convergence of the Real and the Virtual,” a conference that took place inside World of Warcraft. Attendees had to be on the Earthen Ring server and have a Horde character. The locations varied by day, but on Saturday the session took place in the sewers of the Undercity.

I’ve attached some photos of session discussion (click to enlarge) that I took as well as a group photo (courtesy of Joanna Robinson) taken during the expedition to Booty Bay.The conference consisted of a research discussion followed by an expedition to different parts of the world. The expeditions were designed to highlight some of the more spectacular views and locations in WoW. The topics for each day were as follows:

Session 1: Research and World of Warcraft (May 9)
Session 2: Relationships between WoW and the "Real World" (May 10)
Session 3: The Future of Virtual Worlds (May 11)

Detail on the activities and discussions can be found on the conference wiki, including screenshots and video footage. Additional information on the conference is available from Virtual Worlds News and Science.

I found the session I attended to be interesting and insightful. I’ve posted the chat log from Saturday’s session for those interested. Tim Burke, a history professor at Swarthmore, made the following observation about the research value of virtual worlds:

My first angle of approach with virtual worlds is always to treat them as "accidental social simulations". They're richer and more complex than any model in normal social science. But they're simple enough to study in ways the world at large cannot be… Models in social science are predictable. Scholars can make them do what scholars want them to do. Virtual worlds aren't predictable: they have all the organic character of human society….So that's my answer to whether research in World of Warcraft is useful for understanding the real world. Of course it is. (and vice-versa). Yes, with very firm limits, but yes nevertheless.

It was also kind of exciting to be conducting a research-oriented discussion inside WoW, especially seeing all the other participants’ avatars ranging from Undead warriors to Tauren shaman Blood Elf thieves. The expedition was also an enjoyable group excursion. The underwater reefs off of Booty Bay were particularly neat to see (until, that is, I strayed too far from the group and was killed by a murloc).

Beyond the benefit of the session discussion itself, I left the conference with a couple important impressions. It seems desirable to see serious applications of MMOGs. In the real world, the most popular places for conferences are Tampa, San Diego, Atlanta and New Orleans. They are not places like Duluth, MN in January, or Odessa, TX in August. No slight to those cities, but people want the location of their conferences to be fun and exciting. The same goes for virtual conferences. If you are going to have a conference in a virtual world, why not hold it in a MMOG, where you can hand out goodie bags and participants can make friends for adventuring as well as research? In addition, to put a slightly different spin on the same point, it seems evident that such serious applications of MMOGs are inevitable. After all, as the most profitable sector of the virtual world market, MMOGs are more likely to produce technologically advanced worlds that attract serious applications. These impressions simply reinforce the points discussed in my earlier post, “Apples & Oranges, or Shades of Grey?”.

The conference was organized by Bill Bainbridge and John Bohannon. Bainbridge is currently affiliated with the Center for Social Complexity at George Mason University and is Co-Director of Human-Centered Computing at the National Science Foundation, while Bohannon is author of the Gonzo Scientist column in the AAAS journal Science.

Virtual Worlds & Pop Culture

Ren Reynolds has an interesting post up at Terra Nova about the mainstreaming of gaming and, indirectly, virtual worlds. That got me to think on the number of times virtual worlds had permeated plot lines of major TV shows. Although this list is likely not exhaustive, virtual worlds have made a central storyline for such popular prime-time shows as:

• CSI: NY, “Down the Rabbit Hole” airing 10/24/2007 on CBS
• Law & Order: Special Victims Unit, “Avatar” airing 10/2/2007 on NBC
• The Simpsons, “Marge Gamer” airing 4/22/2007 on Fox
• Numb3rs, “Primacy” airing 11/9/2007 on CBS
• The Office, “Local Ad” airing 10/25/2007 on Fox
• NCIS, "The Immortals" airing 10/14/2003 on CBS
• And of course the infamous (and a personal favorite) Emmy-winning episode of South Park, “Make Love, Not Warcraft” airing 10/4/2006 on Comedy Central.

I am not sure if I would really count it, but The Daily Show also had a “news” story/paraody about the Congressional hearings, airing 4/7/2008 on Comedy Central.

I may be missing some shows or episodes, so feel free to rectify my oversight with a comment or an email to me and I will update the list. UPDATE: I will continue to post additions and updates to this list over time, so keep 'em coming.

Apples & Oranges, or Shades of Grey?

In a post on Terra Nova, Richard Bartle articulates what seems to be the consensus on a key point regarding the legal treatment of virtual worlds:

it seems fairly clear now that game-like worlds (such as [World of Warcraft]) are a different kind of animal to non-game worlds (such as [Second Life])

Leandra Lederman, of the Indiana University Law School, echoes this sentiment in her recent article in the NYU Law Review, in which she advocates different taxing rules for different virtual worlds.

The Article concludes that transactions in game worlds, such as WoW, should not be taxed unless the player engages in a real-market trade (a cash-out rule)... that in intentionally commodified virtual worlds, such as Second Life, federal income tax law and policy counsel that in-world sales of virtual items be taxed regardless of whether the participant ever cashes out. (p. 1625)

While this distinction may seem obvious to gamers and virtual world aficionados, I personally do not think the issue quite as clear cut. Take the tax treatment of a virtual world like World of Warcraft (WoW) versus Second Life (SL). According to the consensus, because WoW is a closed system that explicitly prohibits real money trading (RMT), and SL is an open system that explicitly permits RMT, then the two worlds should therefore be treated differently. But it is no secret that despite Blizzard’s RMT ban, robust commercial activity in gold farming and power-leveling persists. Yet if a WoW player manages to sell his character, gold or items for US$, few would dispute that he has real-world (and hence taxable) income. Conversely, consider an SL resident, participating solely for personal entertainment, who sells her home for a profit but keeps the gains in-world. Should she be taxed on that easily-measured gain despite the fact that earning real world money was not her objective? Applying the dichotomy above dictates that we substitute the virtual world’s attitude toward RMT for the individual’s actual attitude. (That outcome seems to not make any sense, like judging guilt or innocence by what neighborhood you live in.) Of course, the intent of the taxpayer is irrelevant to the taxability of her SL income. And the fact that WoW’s EULA prohibits such commercial activity is also irrelevant (Al Capone’s was first big conviction came on tax evasion, not the legality of the income). The point is that it is hard to differentiate between similar actions on dissimilar worlds. Moreover, if one were to make that distinction, you could not base it on intent or legality, as both factors are completely irrelevant when it comes to defining taxation income.

The distinction between WoW and SL may seem obvious, but basing conclusions on the dichotomy of these two worlds is misleading. According to Lederman and others, this is the state of virtual worlds:

If you only consider two extremes, you miss worlds that fall in between. By my last count there were around 200 virtual worlds. If WoW and SL capture the essence of two ends of the spectrum, then what of worlds that don't neatly fit into this black and white dichotomy? Take, for instance, EverQuest 2 and the Entropia Universe. Everquest is a straight-up, regular MMORPG, quite similar in most regards to WoW. However, Sony Online Entertainment has a sanctioned RMT portal hosted by Live Gamer. Through this portal, players on select servers can sell their Everquest characters and gold for US$. So although Everquest is not intended to be a commercial world, in practice players can use it as such. Now consider Entropia, a virtual world similar in most aspects to Second Life: residents can open businesses, make money, and exchange Entropia’s currency, the PED, for U.S. dollars, making it easy to withdraw profits from the world. Yet Entropia also features a deep back-story: an alien planet colonized by humans in the distant future. There are gaming elements as well, that go far beyond just a social network like Second Life, such as searching for valuable items in the environment, collecting resources and developing the skills of your avatar.

The point is that there is no dichotomy, only a spectrum of degrees of commercialization. Conclusions which rest on the assumption of dichotomy are very tenuous because virtual world operators will respond to tax incentives. If tax rules are set based on the dichotomy suggested by Lederman, VWs will simply re-orient their worlds and change their rules so they can be classified as a game world. There’s no escaping the flexibility of technology.

Returning to the tax question, should the IRS issue a separate ruling for each world, declaring in-world income as either taxable or not taxable? Such a course does not seem feasible administratively. Perhaps the better course is to follow the money – the exchange of in-world currency or items for U.S. dollars may be the appropriate trigger for taxability.

Let me be clear: I am not arguing for one treatment or another, and I am certainly not advocating taxing virtual worlds. I am merely asking questions. In addition, I am simply posing my own personal opinion, and would welcome any comments, criticism, questions, etc.

Of course, the tax question is but one aspect of legal treatment of virtual worlds. But the resolution of tax issues could well have an impact on other legal aspects.

Remember too that the likely end-point for many of these questions won't necessarily be a well-informed policy-maker, or even the legislature. Many of the relevant disputes will likely be resolved by judges or unsigned letter rulings from the IRS.

Before I close out this post, let me share with you a comment expressed by a well-respected expert in virtual worlds. Cory Ondrejka, former CTO at Linden Lab, posted the following to his blog:

Attempts to strongly separate “play” and “work” virtual worlds will stunt the growth of both. Communities that play together work together better. And vice versa. While different applications will need to find proper balance between play and work, being able to do both at a distance is a big part of why virtual worlds are so interesting.

Cory’s point, I believe, is that in the future virtual worlds will explicitly attempt to incorporate both gaming elements and commercial uses. If this holds (and it seems to me to be more likely than not), then the whole dichotomous approach breaks down.

On the Lighter Side...

Since my recent posts have been a bit heavy on serious policy and legal questions, I thought I’d post a link to a recent Foxtrot comic that just happens to be right on target. Enjoy!

Sweden to Tax Virtual Income

A post on Virtual Economy Research Network (VERN) by Vili Lehdonvirta notes that the Swedish Tax Agency (“Skatteverket”) recently issued a statement/ruling entitled “Virtual worlds — value-added tax” (original post). According to VERN, the statement signals the adoption of the idea that “in-game transactions may incur liability for both value-added tax as well as income tax under Swedish law.” According to VERN’s translation:

Transactions between participants in a virtual world, where the deal is about the sale of a “product” or a “service” against reimbursement in an internal currency, should be considered, according to the Swedish Tax Agency’s ruling, [actual] sales of electronic services, if the internal currency can be exchanged to a valid legal means of payment. If the internal currency cannot be exchanged to money, the transactions should not be considered [actual] sales. (emphasis added)

The VERN post correctly notes a critical question regarding this rule: do unsanctioned, secondary markets for virtual world currencies satisfy the Skatteverket’s requirement that “the internal currency can be exchanged to a valid legal means of payment”?

Note also what is absent: There is no requirement that the internal currency actually be converted to real world currency for a tax to be due. A U.S. analogy might be the taxation of unrealized capitol gains.

Just as important, the ruling makes clear that in-world transactions, be they in Second Life or World of Warcraft, are potentially taxable. Game world or alternate reality … there is no difference in the eyes of Swedish tax law. The statement goes on to talk about individuals engaged in professional trade, an activity that many would agree should be subject to taxation. But even then gamers are not exempt from being classified as professionals:

The Agency also finds that a participant who, without carrying on a trade, independently and with certain permanence sells electronic services for more than 30 000 Swedish kronor [about US$5,000], is carrying out an activity that is professional…

The significance of this is that even if a player is only engages in virtual trades for entertainment purposes, if the real-world value of those trades exceeds a certain threshold, Sweden’s value-added tax is due.

One additional point worth noting:

A sale has taken place in Sweden if the seller is a Swedish trader who sells electronic services to … a private person in Sweden or another EC [European Community] country. A sale from a foreign trader to a Swedish trader has also taken place in Sweden. The same applies if a trader from outside the EC sells services to Swedish private persons.

Thus, even U.S. citizens are subject to Swedish taxes in virtual worlds, as long as one of the participants is Swedish. The implication is that if similar tax rules are adopted around the globe, U.S. citizens could end up owing taxes to Sweden, Japan, South Korea, and other nations (depending on which and how many worlds they are part of) – all because they played some games.

The VERN post itself recognizes the difficulty in setting clear tax rules for virtual worlds:

If you categorically rule that transactions inside virtual worlds are outside the scope of tax law, you are creating a tax evasion channel for companies and individuals. … On the other hand, if you rule that all in-game transactions are treated like real trade under the law, you end up with a crazy situation where Swedish World of Warcraft enchanters may have to add value-added tax to the price of their services.

MindArk, the Swedish-based firm behind Entropia, has reacted strongly to this announcement. In an interview on Realtid, MindArk CEO Jan Welter Timkrans said (according to this translation):

Skatteverket states that gamers should send invoices to each other. It’s unreasonable stuff they’re talking about. The users don’t know who they’re interacting with.

Timkrans also notes the difficulty posed by the anonymity of the users as well as international issue. Timkrans favorably observes that the U.S. Congress has taken a more reasoned approach thus far: “They have chosen not to make as rash statements as Skatteverket.”

According to MindArk, the number of Entropia users who generate enough in-world income to be affected by the ruling is small. This led MindArk Director of Special Projects John Bates to expand on one drawback of the Skatteverket's announcement in a comment to Virtual Worlds News:

Hopefully they’ll listen to the feedback from this announcement. I am happy to pay taxes, as I really love the US and I am clear that I get a lot of value from living here. I believe MindArk feels the same way about Sweden. I think the taxman has to be careful not to kill the golden goose, though. I think it’s a good idea to let the gosling grow up and figure out how to get as many golden eggs as possible, instead of one unsatisfying meal of baby goose.

I am sure that MindArk is just the first firm the take notice of the Skatteverket ruling. Other firms, and millions of their users, will likely have similar reactions, particularly if other nations begin to replicate Sweden’s tax expansion.

Note: The above translations of the Skatteverket ruling are courtesy of Vili Lehdonvirta of the Virtual Economy Research Network. The translated quotes of Timkrans are from Entropia Forum. The actual Skatteverket ruling, in Swedish, can be found here.

Money Transactions in WoW and NCsoft

Two giants in the MMO world have taken steps toward sanctioning the flow of U.S. dollars into their games. First, Blizzard Entertainment is currently hosting in World of Warcraft an Arena-based series of global tournaments hosted on special servers. In this Arena Tournament, players pay $20 to participate and in return get “to instantly create level-70 [the maximum level attainable] characters with epic equipment” and unlimited gold. These newly-created characters will be unable to explore or transfer to regular WoW realms that that host the vast majority of players. Thus, these new level 70 avatars are purely a limited creation and presumably expire with the end of the tournament in October. Nonetheless, the tournament is significant as it marks the first time Blizzard has embraced a money-for-advancement exchange. What is interesting is how Blizzard spins this project in their press release:

The tournaments will take place on special realms that allow competitors to instantly create level-70 characters with epic equipment, placing the focus on tactics and execution rather than normal adventuring.

“eSports is one of the most exciting facets of online gaming today,” said Mike Morhaime, CEO and cofounder of Blizzard Entertainment. “We’re pleased to expand World of Warcraft’s tournament options for players who want to focus mainly on the competitive aspect of the game.” (emphasis added)

Here Blizzard tacitly recognizes the validity of players’ preference to bypass the often-interminable grind required to level up to 70 in order to get to the “competitive aspect of the game.” That seems, to me at least, to be a meaningful concession. One of the most common arguments against RMTs is that they detract from the essence of the game, namely investing time in questing and exploring the world. This statement, it seems, appears to weaken the argument against RMTs.

Granted, players are not transferring money into or out of the game. And this move could very well be a one-time event, never to be replicated or expanded in the future. However, it is also possible that executives at Blizzard will sense a market demand for RMT. There are a significant number of players who want to engage in RMT. Perhaps, at some point, Blizzard might even consider setting up special servers where RMT is permitted.

A second and more significant development is that NCsoft has introduced a virtual currency called NCcoin. NCcoin’s micro-transaction system “will allow customers to use real-world money to purchase in-game items and upgrades.” In this system, one U.S. dollar is equal to 100 NCcoin. Currently, NCcoin is only available in Exteel, a third-person shooter released in 2007 in which players control giant customized mechs called Mechanaughts. However, NCsoft promises to have NCcoin “incorporated globally into many of NCsoft’s existing and upcoming games.”

As with Blizzard, the most interesting aspect of this move is how the company spins its decision. However, while Blizzard has taken the strongest stand against RMTs among MMO operators, NCsoft by comparison appears to be more flexible:

“NCsoft’s goal is to bring more and more people into the online gaming market, and part of achieving that goal is to continue to diversify how customers can pay and play,” said Chris Chung, NCsoft North America’s president. “This system will offer our customers much greater flexibility and convenience in paying for content. Micro-transactions are a growing part of the online gaming industry and NCcoin will allow us to support micro-transaction based games efficiently, allowing developers and players to quickly enjoy the benefits of those systems. We will soon be rolling out more contents that leverage the flexibility of NCcoin.” (emphasis added)

NCsoft appears to recognize that they are in the business of meeting customers’ demands. There is no disputing that some, perhaps many, MMORPG players would like the option to at least be able to transfer cash into their games currency (even if outflows are still banned). Many, if not most, MMORPG players are either neutral toward or oppose RMT. NCsoft’s statements above appear to suggest that they are looking for ways to satisfy both types of gamers.

An interesting scenario could arise in which NCsoft incorporates NCcoin into Guild Wars, giving MMORPG players a choice between the two biggest adult-oriented MMORPGs: Guild Wars with RMT versus World of Warcraft with no RMT. Consumers, it is said, vote with their feet and such a situation would give those WoW players who favor RMTs an easy place to emigrate to.

Update 4/23/08: NCsoft has announced that the NCcoin system will not be incorporated into current games, such as Guild Wars. As reported on Massively:

NCcoin will not be retrofitted in games that have business models that do not work with a micro-transaction system. We will, however, work to have NCcoin incorporated in as many of our games as possible. What role NCcoin will play in our future console offerings is yet to be determined.