Economies of scale don't apply to virtual worlds?
by Vladimir Cole 
{ Oct 2nd 2006 at 1:15PM }
The Economist returns to Second Life, exploring several facets of the fascinating virtual world. If you've been asking yourself, "What's the big deal with Second Life?" the article answers that question by giving several examples of how the virtual world makes an impact.
The piece is too big for us to break it all down here, so instead we'll use this space to argue with Philip Rosedale's statement that, because Second Life lacks economies of scale, local artisans are safe from the likes of Nike in the Second Life marketplace. He argues that local artisans who craft shoes are protected from Nike because producing one digital pair of shoes costs the same as producing two billion pairs of digital shoes.
That's not actually true. First, Nike's presence in virtual worlds will never be separate from its presence in this, the real world. Nike's brand-building activities on Terra Firma do benefit from economies of scale: because Nike buys so much advertising, it pays less per unit than a company that buys only limited advertising in a local market. As a result, Nike's cost of per unit of advertising is lower than the local artisan's. This means that Nike will always have a scale-granted advantage in brand building. That advantage then spills over into virtual worlds where Nike's brand recognition continues to influence consumer behavior.
Second, it takes time to design, produce and market shoes. Nike's already got teams of people who do just that, day in and day out. Because of the size of these teams, they've got spare capacity that they can tap for new ventures in virtual worlds. There's no incremental cost to that labor, as they've already paid for it. Here again, Nike's got an advantage as a result of scale.
Second Life's denizens are concerned that the entrance of big business into the world will drive them out. They're right to be concerned. Their businesses are as at risk as the local bookseller's business before Barnes & Noble comes to town.
[Thanks, substrate9]
[Image from SL Universe.com]
Get a WordPress.com Blog
Reader Comments (Page 1 of 1)
Mitsuo @ Oct 2nd 2006 1:25PM
I love those shoes. I would so buy them if I was a girl, and they didn't have platforms. I
WizarDru @ Oct 2nd 2006 1:36PM
"If you've been asking yourself, "What's the big deal with Second Life?" the article answers that question by giving several examples of how the virtual world makes an impact."
No, it really doesn't. An article about the economy of WoW? That'd be something. The orgasmic attention paid to a game with only 50,000 subscribers? I mean, really...WTF? TOONTOWN ONLINE has more subscribers!
Why is Second Life such a media darling?
Ive Been Jipped @ Oct 2nd 2006 1:39PM
Posts like these are why I continue to visit Joystiq. Good stuff, Vlad.
Thomas Crymes @ Oct 2nd 2006 1:43PM
I think the difference is that people in a virtual world will probably be less likely to purchase a corporate branded item. It will come down to aesthetic appeal. And if Nike can make a prettier shoe, then it stands to be more profitable.
I don't think your line of thinking is wrong per se. I just don't think that Nike's mindshare is worth a whole lot in a virtual environment. We'll see what happens.
2nd Life gets all the attention because its economy is based on real money. WoW and others have an indirect relationship and depend on "black market" value of gold.
cringer8 @ Oct 2nd 2006 1:43PM
Vlad is trying to be smarter than he is...again.
Brand recognition *alone* doesn't sell a product. Consumer faith in the *quality* and *durability* of a company's products builds brand *loyalty*. Once a company has convinced the masses that its product is "better" than the competition's, they can grow. Once they become as big as Nike, they can acquire materials, labor, and advertising for much cheaper on a large scale and thereby make more profit.
In a virtual world, however, quality and durability are removed from the equation as are manufacturing costs and payroll costs. Nike loses its biggest advantages.
You are wrong, again, Vlad. Big businesses hold no advantage other than brand recognition in Second Life. That isn’t enough to put other people out of business.
virtuadept @ Oct 2nd 2006 2:09PM
Will Virtual Hookers start wearing Nike pumps? Inquiring minds want to... gee, slow news day, huh?
DG @ Oct 2nd 2006 2:36PM
Why doesn't VC just create videogameeconomistsfanboy.com and get it over with, huh?
LaughingTarget @ Oct 2nd 2006 2:40PM
The idea is because in just about every online game, production speeds are constant. You cannot get better at producing a specific item and are always bound by a fairly set speed. Like in WoW, it takes the same amount of time to hammer out a bronze breastplate, whether you just got the skill to do it or are a maxed out at 300 in Armorcraft.
cringer8 -
Brand recognition is a very powerful tool, though not immortal. Nike shoes have absolutely poor quality and sell purely on image. A pair of New Balance shoes last easily 10 times as long as a pair of Nikes, cost less, but aren't so sought after like they are. Even in a virtual world, you'd be surprised at how much someone would pay for the exact same product just with a specialy label on it. Just like how places like Armani can sell their suits for a thousand dollars more than at The Men's Warehouse even though they all come from the exact same place, or how women's retailers like Ann Klein get their clothing from the same factory in China as Wal-Mart does, but is able to sell it for a premium simply because of the name on the tag. The list keeps going like with various cereals. The box and the bag on the bottom shelf is the same cereal, but the box costs more. Brand labeling.
Nike can charge more that JoeBob Shoes in a virtual world and still put them out of business.
Akbar @ Oct 2nd 2006 2:49PM
cringer8, Durability may be removed, but quality most certainly is not. As all objects in SL must be modeled, skinned, and scripted by somebody, there's options for mis-aligned polys, skins that look sub-par, or scripts that are buggy. Quality could certainly be a factor in corporate allegiances.
Brian @ Oct 2nd 2006 2:48PM
Seriously Vlad, take your pretentious articles and GTFO the internets. I've had enough of your feigned intelligence, inflated vocabulary, and lack of a soul. Penny Arcade was right to call you out.
Lone Starr @ Oct 2nd 2006 3:40PM
@ Vlad Cole,
"This means that Nike will always have a scale-granted advantage in brand building. That advantage then spills over into virtual worlds where Nike's brand recognition continues to influence consumer behavior."
Not necessarily. This argument fails to take into account consumers' tastes and preferences. If, for instance, the populace of Second Life does not like the commercialism of Nike, the bulk advantage would actually be a disadvantage. Again, it all depends on how people view commercialism entering into the virtual world.
"There's no incremental cost to that labor, as they've already paid for it."
Also not necessarily true. Like a PPF curve, if there are two markets where Nike can advertise (A and B), then devoting more of that labor to one market will incrementally raise the cost of removing labor from the other market. This argument in part shows that the premise of non-existent additional costs for Nike is erroneous.
Regardless, interesting read.
DaveKap @ Oct 2nd 2006 3:23PM
My only question is about this line: "instead we'll use this space to argue with Philip Rosedale's statement"
Who is "we" in "we'll"? Joystiq? Do all the editors want to argue this point? Or is it simply the "royal" we? Just wondering if this is something all the editors are talking about or just Vlad's opinion.
Also, in my personal opinion, I believe that users of Second Life are not only protected against the likes of Nike, but actually have an advantage OVER Nike. Because the users have been in Second Life longer than any Nike executive, they're more likely to know what SL consumers want and more likely to know how to make it well. If anything, Nike would either have to hire Second Lifers to compete or be forced to spend enough time in-world to understand what the demand is and precisely how to meet it.
In the end, seems like it all evens out to even ground to me.
vc @ Oct 2nd 2006 3:28PM
Lone Starr wrote, "This argument fails to take into account consumers' tastes and preferences."
I agree. But it's Philip Rosedale's argument, not mine. If he had wanted to make an argument about consumer taste in SL, I'd have played along. Instead, he's trying to allay SL merchant fears with an argument that doesn't make sense.
Lone Starr also wrote, "Like a PPF curve, if there are two markets where Nike can advertise (A and B), then devoting more of that labor to one market will incrementally raise the cost of removing labor from the other market."
This assumes that Nike doesn't have significant excess capacity. Probably a safe assumption (else they'd lay that capacity off).
Zac @ Oct 2nd 2006 3:34PM
Isn't "barrier to entry" the economic descriptor that you mean to be discussing here?
monkeysan @ Oct 2nd 2006 4:19PM
Vlad
This may be the kiss of death this week, but big props for a well-argued point. People may disagree, but you've made a more than plausible counter-argument.
monkeysan
aka Aaron Ruby
Moogle @ Oct 2nd 2006 3:56PM
WizarDru: There's a counter on the SL front page that says (as of right now) "US$ Spent Last 24 Hrs: 428,656".
It's tempting to people, it seems like easy money for the taking. I'm pretty sure most of it's going into linden's pocket in land usage fees, however.
ill trooper @ Oct 2nd 2006 6:30PM
"Why is Second Life such a media darling?"
I don't play either, so I could be innacurate here, but it seems like the way both are set up, I'm guessing making a pair of custom shoes that you somehow upload in WoW would be considered a hack, and you would be banned, where as Second Life encourages this sort of thing... Blizzard wants to be the only shoemaker in their world.
So the media likely loves SL because it's a more open two-way model, and weirder fads or trends could happen, like people selling custom shoes.
Just a guess though, i'm not that familiar with how the games work.
Next, although we're talking about virtual worlds with no physical production limits, there are real-life aspects to consider: While it's a virtual world, the people playing it are still in the REAL world. So marketing here still can hold influence. Cringer, you should read the book 'No Logo' if you think branding isn't enough to put people out of business.
Let's say some guy in one part of the real world is making a new shoe design every day, putting it up for sale, it gets popular, he has a couple of friends designing new variations, it goes nuts (not likely in the small world of SL, but let's just pretend) and some other guy in Ohio is trying the same thing - except that it's only him designing. He can't keep up with churning out the popular designs like the other guys, as there's only a certain number of hours in a day here in the real world. So the same things can apply - Nike could devote a group of designers to a project and follow or create trends in a world like SL as they did in skateboarding with the Nike SB line - muscling their way in where they were formally despised.
An Orc wearing Jordan 3's? That would be funny and people would want to do that - because other people seeing it on the other side of the screen would have been subjected to the same marketing in the real world, and would get the joke. It's the same thing as naming your character 'John Wayne' or 'Marklar,' you are bringing in other references for irony or humor. So the branding wins again, unless someone wants to make their statement with a) a smaller, more unique brand, or b) their own design.
The same thing can be said about small internet businesses; "the playing field is leveled," but it's not always true - some people are simply more 'on top of it' than others. I just went through a whole ordeal with some custom parts for my video camera, and although the parts are specialized, a few companies make them, so I checked out all three major people in the field, and contacted them - one company was very quick and professional getting back to me right away, while another guy was simply out of town that week, and was nowhere to be found, although his products are generally considered top-notch. Real-world limitations such as needing sleep, going out of town, and simple productivity can affect even a 'leveled' playing field.
On side-note, I don't think New Balance shoes are '10 times' better assembled than Nike shoes, and sorry for the super-long post.
Mr. Khan @ Oct 2nd 2006 5:20PM
One of the fun things about an MMORPG is that once you get everything you need, you can start getting cool little unnecessaries
Once you've got your level 200, 75, or 300 character, its fun to roll around picking up random crap, it's bags of fun seeking out pointless treasures, and paying too much in the process
Believe me, this will work, much as i hate Corporate subsidizing...
obo @ Oct 2nd 2006 7:49PM
Vlad, still waiting to hear about your economic credentials.
umair @ Oct 3rd 2006 1:26PM
Hi Vlad,
That was a good post. Despite what most commenters so far think, your analysis of scale economies is actually pretty nicely done.
Your argument will break down when you consider that the sources of scale economies you've talked about -marketing and product development - can be organized in more efficient ways in SecondLife by members themselves, potentially yielding even more powerful returns to scale than corporates like Nike can realize.
But that's another story - thanks for an interesting post.