Freemium and Segmentation

How do games on Facebook make money?

That’s how the conversation started: no hello, no context, right to the heart of the matter. I love it when fellow geeks IM me.

My friend has a lot of experience in software and tabletop games, but has stayed away from the Privacy Destroyer. From the outside, online games didn’t seem to make any sort of sense - if it’s one free click to add a game to a social profile, how do you sell your game? How do you make any money at all?

The answer is that there’s a bit of advertising and merchandising, but by far the bulk of the profit is in virtual currencies. Pay $10, get 75 gold coins you can spend in-game on items, upgrades, downtime removal, etc.

It’s successful because it allows for perfect market segmentation. Some of your customers are willing to pay much more for your product than others, whether you price low or high you’ll lose some potential profit. Losing potential profit is deeply painful to entrepreneurs, so you sell a copy of the product at the low price and another at the high — and to keep it from looking silly, you differentiate them by calling one “premium”, or limiting quantities of one, or selling it in a bargain bin after six weeks, or selling in different venues (soda machine vs. grocery store); anything that lets you charge multiple prices with a straight face.

If you do this wrong, people will mock you mercilessly and the nerds will point out you’re really selling only one product. (But you won’t notice because you’ll be busy trucking your wheelbarrows of cash down to the bank.)

This is so powerful that Facebook games (and a growing number of other games with low distribution costs) are “free to play” (f2p) or “freemium”. You can play as long as you like for free and buy virtual currency if and when you see something interesting.

Virtual currencies allow for perfect segmentation. If Alice thinks your game is worth $5, that’s what you’ll get from her. If Bob thinks it’s worth $5,000, you’ll get it from him for the exact same game. I’m not exaggerating; last week a payment processor shared data on their top five spenders:

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From a traditional gaming perspective, Facebook games look like the purest kind of bubble, a lunatic asylum dosed with crystal meth. Don’t charge for your game? Don’t sell expansions? Get everyone to bother their friends? Offer gold coins for taking surveys?

It’s not insane, low distribution costs and efficient capturing revenue so efficiently means a fundamentally different business model. And a great environment for making games.