Wednesday, October 1, 2008

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. **