Microeconomics 101: A Lesson for Linden Lab

[Deltango Vale]

Having been an active resident and business owner in Second Life for nearly seven years, I am deeply saddened by Linden Lab's lack of basic economics and business skills. Having a monopoly in the realm of virtual worlds with user-generated content, Linden Lab functions more like a government bureaucracy than a private commercial venture. It is indeed a testament to Second Life as a product that it has survived in spite of such bad management.

Considering Linden Lab's long history of ignoring its customers, why am I creating this thread? What does any of this have to do with microeconomics? Well, I suppose I feel a duty to try one more kick at the can in the hopes of penetrating the mental paralysis of Linden Lab's owners and managers.

I wish to talk about a very basic concept in economics called 'relative price'. In economics, specifically microeconomics (individuals, firms and households), all prices are relative prices. There is no such thing as a price given by God; all prices are relative.

Microeconomics 101, class 01, day 01, first lecture in any schoolroom in any country in the world:

• the price people are willing to pay for something depends on the price of an alternative
• if the price of apples relative to oranges goes up, people will buy fewer apples

Yes, it's that simple. No hidden tricks, no math, no heavy-duty philosophy. The price we pay for something depends on how bad we want it relative to the price of an alternative.

What on earth does this have to do with Second Life? The answer is the relative price of land tier.

The price of tier in SL has remained fixed since 2006. In theory, that's good, right? Wrong. Since 2006, the price of similar technological products and services has fallen sharply. Not only has the relative price of alternatives fallen, but new products have come into existence, which too have fallen in price.

• Wordpress 2003 (free, now better)
• Facebook 2006 (free)
• Twitter 2006 (free)
• iPhone 2007 (now better and cheaper)
• Kindle 2007 (now better and cheaper)
• LCD TV 2007 (now better and cheaper)
• iPad 2010 + games + apps (now better and cheaper)
• Personal Computers (now faster, better and cheaper)
• web hosting services (now better and cheaper)
• digital cameras and services (now better and cheaper)
• online games/graphics (now better and cheaper)
• online movie streaming (now better and cheaper)
• mobile phone apps (free, greater variety)
• internet broadband (now faster, better, cheaper)
• 3D graphics software and services (now better and cheaper)

This is just a partial list of the vast cloud of technologically rich information and entertainments products that have come into existence, have improved and fallen in price while Second Life remains stuck in 2006 in terms of quality and price. Yeah, okay, SL graphics and functionality have improved slightly since 2006, but SL has degenerated significantly in terms of customer experience (though some might argue that SL has merely remained the same).

In other words, the RELATIVE price of land tier has risen sharply since 2006 (compared to the available cloud of products and services in the technologically rich information/entertainment space).

Imagine Apple marketing a 2007 iPhone today at the 2007 price. Imagine if Canon continued to sell 2006 makes and models of camera today at 2006 prices. Imagine if Sony continued to sell a deluxe improved 1990 cassette Walkman in 2013 at the same 1990 price. The result in all cases would be bankruptcy.

Bottom line for Linden Lab: your 2006 prices are now too high in 2013.

[Teagan Tobias]

The problem is that everything you have listed has alternatives, something that can replace it. That is what keeps the price down. But SL is almost a monopoly. Yes there are other virtual worlds out there but nothing that compares to the quantity of and variety available in SL. And also there is supply and demand, LL is supplying what is needed and there are apparently enough people that are willing to pay the price they ask. Not until the people are unwilling to pay that amount will the price come down, and we do not know at what point LL will agree the prices need to be lowered.

Just to point out one thing that I have not seen brought up is the business move that LL made by purchasing X-Street and On-Rez, if the two stores had (and they could have easily) sold items to other grids, the other grids would have grown faster and faster and LL would have had competition and would have had to lower prices to keep up. (IMHO)

[Ted McGregor]

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Deltango Vale wrote:

I wish to talk about a very basic concept in economics called 'relative price'. In economics, specifically microeconomics (individuals, firms and households), all prices are relative prices. There is no such thing as a price given by God; all prices are relative.

Microeconomics 101, class 01, day 01, first lecture in any schoolroom in any country in the world:

• the price people are willing to pay for something depends on the price of an alternative
• if the price of apples relative to oranges goes up, people will buy fewer apples

Yes, it's that simple. No hidden tricks, no math, no heavy-duty philosophy. The price we pay for something depends on how bad we want it relative to the price of an alternative.

What on earth does this have to do with Second Life? The answer is the relative price of land tier.

Bottom line for Linden Lab: your 2006 prices are now too high in 2013.

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The price of tier cannot be dropped by LL. It's not only their main source of income ( I doubt premiums make the largest part of revenue ), but the price of land ( which includes tier ) depends on it, that is to say .. tier seperation from normal value keeps land prices low enough. Yet, if, let's say, tiers were fully dropped ( admitted .. all servers are already paid for or have had most of their write off .. err.. written off of them ? wellyaknowzilchfinancialvalue .. ) the entire economy would collapse. Their would be nothing, not even merchant sales, left to sustain the Linden as a currency. Wouldn't that finish off SL as a whole ?

 

At least I think that is what they fear and hence they avoid the discussion about tier at all. Do you think they'll open up here in General Discussion ? Who would decide that within LL ? That person should be reached to discuss this, if possible at all.

[LepreKhaun]

Your argument that a price that has remained stable is somehow higher through inflationary times is not only amusing but fails first grade common sense.

[Teagan Tobias]

OK, I did not like first grade, could be that is somehow why I don't follow your reasoning. Could you explain for me because I disagree with you.

[Qie Niangao]

The problem would seem one of cash flow. Unless a change would yield immediate increase in revenue, I doubt the Lab dare be interested right now.

Linden Research surely spent a lot on these new app projects. The roll-outs have been the slowest new software product introductions I've ever seen apart from government contracts. I have no idea how they've been so delayed and so feature-poor at launch. It doesn't matter, however, why these have been so disappointing. What matters is that the only thing generating income is Second Life, and unless I miss my guess, they're still sustaining high burn rates for those other projects. (Do we think they've shed any of those project developers yet? I doubt it.)

Eventually, that will change. They'll have to stop the bleeding by terminating any or all of those projects that show no prospect of success. The trick, of course, is having the business sense to be timely in making those decisions before it's too late to save the balance sheet.

Until they cut out those extra costs, they can't afford to incur a decline in SL revenue any more abrupt than the familiar long gradual decay, even if a change is necessary to reach a stronger future position.

[LepreKhaun]

http://www.usinflationcalculator.com/inflation/current-inflation-rates/ shows we are in inflationary times. A stable price through that time is actually dropping in cost.

In other words, what we are being charged for tier now is really, truly, actually less than what was being asked for 7 years ago. Simple, yes?

[Qie Niangao]

We're veering dangerously close to a discussion of "Chained CPI" here. :smileytongue:

I think Deltango has a point in comparing SL costs with those of competitors for entertainment value. The problem is that this is a complicated space. On one side, gadget prices have constantly dropped, of course, and cloud/apps have supplanted many pricey software packages. On the other side, cable rates have risen and cinema admissions have skyrocketed over the same interval. Go figure.

[Thinkerer Melville]

Excellent analysis.  There is another factor to be considered in the pricing of land.   To quote:  the three main issues are location, locaton, and location.  An acre in Manhatten can cost a lot more in taxes, utilities, maintenance (tier), than an acre in west Texas.  The value of these acres comes from what you can do with them.

Similarly, the value of land in SL is higher than in other grids because there are many more people in SL.  So an increase the relative cost could be acceptable up to a point, if the online concurrency were increasing.   Regrettably, the online population seems to have become stagnant for the last few years.   That may be partly the result of the loss of non-profits, produced by the short-sighted decision by LL to eliminate the discount for non-profits.  LL seems to have reversed this decision recently, but a lot of damage is done and beyond repair.

Some estate businesses have adopted the Manhatten model: for valueable acres, build up and turn an acre into many.  In SL, of course, the limit is not just area, but prims.  I know of one estate that knows how to reuse the prims with rezzers.  It rents homes that rez only when some one enters the area.  Since only a few homes will be occupied at any one time, it can rent many more homes than the prim limit allows.   This private initiative could lower the cost of renting and increase the value of estate sims.

LL has also tried many ways to increase retention of new people.  Those of us who have been in SL for a few years naturally regard this a marketing failure, because we know a lot of people who do stay in SL.  My own opinion is that SL not marketing to the right people. But I don't expect that to change.  What could change is that SL businesses and activities could increase their targeted marketing to people in the old (RL) world.

TKR   

 

 

 

 

 

 

 

[LepreKhaun]

"Competitors"? I don't see any serious competition to the SL platform, now or in any forseeable future. And, it might be pointed out that with the monoply Linden Labs does have, they have not raised tier on us. I have no idea what motivated the OP's whine about what is, after all, a free to participate in venue that costs a lot more than any of us might be capable of understanding but I do know this:

 

If you don't like it here, vote with your feet and I hope the door doesn't spring back too fast.

[Qie Niangao]

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LepreKhaun wrote:

"Competitors"? I don't see any serious competition to the SL platform, now or in any forseeable future. [...]

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Of course they have competition -- competition for eyeballs. It's not sufficient that there be no other viable 3D user-generated-content virtual world thingy. There are ebooks to read on Kindle, videos to watch on YouTube, tweets to browse, forums to troll, even 3D models to Blenderize (1. Aim at foot. 2. Fire!).

It's very easy to corner the buggywhip market.

[Perrie Juran]

 

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Thinkerer Melville wrote:

Excellent analysis.  There is another factor to be considered in the pricing of land.   To quote:  the three main issues are location, locaton, and location.  An acre in Manhatten can cost a lot more in taxes, utilities, maintenance (tier), than an acre in west Texas.  The value of these acres comes from what you can do with them.

 

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In Manhatten they don't deal in acres.  They deal in square inches now. 

And Manhatten is cheap compared  to Tokyo.

[Deltango Vale]

"Unless a change would yield immediate increase in revenue"

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It's a basic microeconomics problem: sell 100 units at $10 (revenue $1,000) or 150 units at $8 (revenue $1,200) or 300 units at $5 (revenue $1,500). One look at the Grid Survey data shows a continual decline in the quantity of estates as the relative price of tier has increased. I believe that the number of private estate sims would increase significantly if the price were reduced - increasing overall revenue. At the very least, it would stop the bleeding.

For those who didn't understand the original article, let me simplify: $300 per month buys a hell of a lot more and better infotainment in 2013 than it did in 2006. People have been moving their $300 per month out of SL and into other things.

To make it even more simple, would you continue to pay $10 for a pizza if all the restaurants in your neighborhood began offering big, juicy sirloin steaks for $5? That is the meaning of a change in 'relative price'.

[Qie Niangao]

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It's a basic microeconomics problem: sell 100 units at $10 (revenue $1,000) or 150 units at $8 (revenue $1,200) or 300 units at $5 (revenue $1,500). 

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Imagine how much revenue they'd get if we extrapolate to zero!

Seriously, though, I think they can't simply cut prices with the expectation that demand would more than compensate for the lost per-unit revenue. At the very least, they'd have to actually sell some more units, which is a dicey proposition even if they splurged on an actual marketing budget.

The thing is, even if that worked, the invisible hand takes a while to respond, and I don't think they can afford that, due to the (surmised) cash flow issue I raised before.

What I think they could do is keep the same price points but gradually increase the amount of land they each cover. I doubt many people would tier-down (unless there were a huge change all at once), and I don't think many are tiering-up with the current pricing, so not much would be lost there, either. Then, the market would have time to react to the better values, and maybe land would get some more owners.

The problem is that anything that gradual only really works on Mainland. (And perhaps multi-sim Estates where maybe 4 sims tier would cover 5 sims, or 2 sims gets a free Homestead, but even that is large-grained enough that it may cause at least temporary tiering-down.)

[Penny Patton]

I agree with the basic premise that if land were cheaper, more people would own land.

However, one of the issues no one considers with land price in SL is that right now, chances are, if you own any land in SL, you are voluntarily paying for upwards of four times as much land as you actually use.

Nearly everyone in SL does this by choosing build to about double scale.

Of course, this is a natural outcome from LL starting everyone with 7' avatars and really awful camera placement, but it's something anyone who wishes they got more for their money's worth should think about.

This island above uses about 1/8th of a sim and only 2,000 prims, including two underground caves not visible from the outside. Also included in that prim count are the off-sim mountains and several smaller islands not pictured here.

This group of floating islands all fits neatly into 1/4th of a sim. Below are some shots taken within the islands.

Let me repeat that, all four of the above screenshots show locations within the same quarter-sim area shown in the wide view of the floating islands in the screenshot preceding them. Plus a whole lot more.

If LL encouraged people to build more efficiently and to a better sense of scale, then land in SL would be more valuable, what most people need 1024x1024sq.m. for could be done in 512x512sq.m. A good builder can fit a sim's worth of content into 1/4th of a sim. When you're dealing with mesh, that's primarily a matter of building smaller. That would push land sales every bit as much as a reduction in tier pricing.

 

 If land costs less, more people will own land. If one can do much more with land, more people will feel it's worth owning. Combining approaches could result in a massive influx of landowners for LL if they played their cards right. They should really be pushing better building habits in the way LI costs are calculated, and in the content they use to showcase SL (such as the Linden Homes and the Welcome Areas).

[Theresa Tennyson]

There's a basic problem with the concept of lowering tier to increase the amount of land bought --

What if Linden Lab doesnt' want any more land to be out there?

SL isn't suffering from a shortage of places to go. Right now there are "only" 27,000 or so regions in SL. Let's say that only 2/3 are accessible. If you visited one new region a day, every day, it would take you FIFTY YEARS to see those regions. As far as businesses go, there are many categories where there are more businesses in SL than the equivalent market in RL, and there's no real need for "local" businesses.

I've visited a few regions in the past that have closed lately. One was the site for a mid-sized American university that was a dated, primitive model of the campus with a scavenger hunt for some sad freebies. Another was a breathtaking but utterly sterile set of constructions that was empty of avatars and owned by someone whose major promotional activity seemed to be complaining that LL wasn't lowering the tier on them.  I can't say that I miss either of them.

If regions are expensive, the owners will do things to make them interesting enough to attract visitors or make attractive products to sell to suport them. There are plenty of regions out there that make a profit for their owners at the current fee structure. If they're cheap the temptation is to let them sit out there and gather dust.

As far as residential space goes, I think most people don't realize exactly how many Linden Homes regions there are - their combined area would make them the largest continent in SL and a full LH region brings more cash into LL per month than a full-priced private region does and probably requires less upkeep.

So, short answer? If you can't afford the current fee structure, Linden Lab doesn't want your sim.

[Qie Niangao]

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... a full LH region brings more cash into LL per month than a full-priced private region does and probably requires less upkeep.

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Hmm.  I'm genuinely curious whether that's true, so let's do the math.

The most densely-packed Linden Home sim I found had 41,472 sq.m. of protected park land, leaving 24,064 sq.m. for homes.  At 512 sq.m. / home, that's 47 homes per sim. (That's being very generous, in fact, because these mini-continents contain many all-protected sims, and many others with far fewer home sites.)

Because Linden Homes are all just 512sq.m., they're covered by the Premium bonus tier, so the gross revenue per home is the Premium membership fee, which ranges from US$72/yr on the annual plan to about US$120/yr on the monthly plan. Let's guess that, on average, it's about US$100/yr, so a fully-occupied 47 Linden Home sim should gross US$4700 per year -- substantially more than the US$3540 that a full-primmed Estate sim generates per year.

But that's gross revenue. The Premium stipend, however, is a source of L$s that displaces the same amount of freshly minted L$s the Lab could otherwise sell on the LindeX* so it is effectively a cost against the income from Premium membership fees. Although many of us get higher, grandfathered stipends, let's work with the current L$300/wk. At a nominal exchange rate of 250, that's a US$62.40/year the Lab pays out in stipends to generate each US$100/yr Premium membership fee.

Net of stipends, then, the picture is much different. Our full, densely-packed Linden Home region only nets US$1767.2 per year, or about half the amount of a full-primmed Estate sim.

 

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*People are often confused about this, so note that this is not because any individual resident would themselves buy the same amount of L$s on the LindeX if they didn't get the stipend. Rather, this is about the overall money supply. Any particular L$ may trade between residents many times, but when there's a shortage and the price rises above some target, Supply Linden sells new L$ into the market for the going US$ exchange rate. Were it not for the stipend source, those shortages would occur sooner and Supply would get to sell more L$s--generating more US$ revenue--by exactly the amount of those stipends.

[Deltango Vale]

"SL isn't suffering from a shortage of places to go."

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You make a good point about better utilization of existing land, but such an improvement on the product does not compensate for the now very high relative price of the product. I estimate that a person can purchase three times as much infotainment for $300 per month in 2013 as he could in 2006. In other words, the relative price of tier has tripled since 2006. I use the example of estate sims, but the same argument applies across all land tier prices.

It is important to remember that Second Life is essentially residential, meaning that the great majority of residents seek a 'second home' in SL separate from RL. Very few residents use SL as a raw business platform. Much of the commerce in SL is performed by mom and pop residents from their SL homes. No surprises here that SL is similar to RL socially and economically.

The core problem is that the price of a 'second home' in SL has tripled since 2006 relative to what can be purchased.as alternative infotainment in RL. In 2006, there was no Facebook, no Twitter, no iPhone, no iPad, no Kindle, no Angry Birds, no Minecraft etc. In 2006, self-publishing was a joke and very expensive. In 2006, an LCD TV was outrageously expensive and streamed content was not easy to get. In 2006, wireless cellphone communications barely existed. The world has changed dramatically since 2006; SL has not.

If SL were just a cellphone, it would have died a long time ago. Look at Nokia or Blackberry, both behind the curve, struggling to survive. If SL were just a camera, it would have gone the way of Kodak. Netflix is now producing content because the old model of renting out other people's content no longer works in the new infotainment age.

SL has survived, in spite of its increased price relative to the alternative world of infotainment, because it provides people with a unique social geography in which to live and work. Think of SL as a colony on another planet. A lot of people want to go there, but it's now becoming too expensive relative to new goodies available on Earth. Reduce the price of land in the colony and immigration will increase.

Of course, cutting the price of tier is not a long-term solution. Reducing the price of a 2006-model cellphone in 2007 makes sense, but, ultimately one needs to produce a better cellphone for 2008. Second Life needs to be rebuilt from the ground up by a new company. The world is hungry for a 2015 version of Second Life managed by people who understand the true potential of virtual worlds. In the meantime, clunky old 2006 SL needs a price cut - which, in my opinion, would increase (or at least stabilize) the revenue stream of Linden Lab enough to raise the venture capital necessary to rebuild Second Life. Yes, I know this is way above the mental abilities of Linden Lab, but it is a reasonable business plan nonetheless.

[Czari Zenovka]

This is a virtual world, a "second life" - where avatars can be cows.  Not everyone WANTS to "build to scale."  That is like saying everyone wants to look exactly like they do in RL.

[Penny Patton]

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Czari Zenovka wrote:

This is a virtual world, a "second life" - where avatars can be cows.  Not everyone WANTS to "build to scale."  That is like saying everyone wants to look exactly like they do in RL.

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No....it's actually nothing at all like that.

Clearly many people feel that land in SL is overpriced, all I did was show a way to get more, far more in fact, for your money. Literally four times as much for your money.

But while we're on the topic of SL being a birtual world where you can be anything you want, I feel it's worth pointing out that your imagination is limited by what you're capable of creating with the tools and limitations given. If you understand how those tools and limitations work, you can accomplish much more with them, letting your imagination soar.

Once you understand that much, you realize there is no cognitive dissonance between my posts on SL's building tools and my own less than realistic appearance.

 

[Ciaran Laval]

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LepreKhaun wrote:

Your argument that a price that has remained stable is somehow higher through inflationary times is not only amusing but fails first grade common sense.

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You've completely ignored the benchmarks the OP is using to compare prices. Whether those benchmarks are valid is a different matter, I mean the OP is comparing apples to oranges, literally!

A local newspaper here used to run a few pages of their old editions in the weekend edition, in one they had adverts from around 1981, a microwave oven would set you back 500 quid.

500 quid today, taking into account inflation, is a lot less than it was in 1981, but I doubt anyone is paying 500 quid for a microwave oven, you can get them for 20 quid, a 500 quid microwave oven would look extremely overpriced in today's market.

[Perrie Juran]

 

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Ciaran Laval wrote:

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LepreKhaun wrote:

Your argument that a price that has remained stable is somehow higher through inflationary times is not only amusing but fails first grade common sense.

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You've completely ignored the benchmarks the OP is using to compare prices. Whether those benchmarks are valid is a different matter, I mean the OP is comparing apples to oranges, literally!

A local newspaper here used to run a few pages of their old editions in the weekend edition, in one they had adverts from around 1981, a microwave oven would set you back 500 quid.

500 quid today, taking into account inflation, is a lot less than it was in 1981, but I doubt anyone is paying 500 quid for a microwave oven, you can get them for 20 quid, a 500 quid microwave oven would look extremely overpriced in today's market.

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How about 3,000 quid for an HD? 

You are right, could proove lot's of things by selecting different benchmarks.

[Deltango Vale]

"500 quid today, taking into account inflation, is a lot less than it was in 1981, but I doubt anyone is paying 500 quid for a microwave oven, you can get them for 20 quid, a 500 quid microwave oven would look extremely overpriced in today's market."

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Exactly. $200 per month for a mainland sim ($300 per month for an estate sim) is extremely overpriced in today's market. No wonder Linden Lab is selling fewer "microwaves at 500 quid" in 2013 than it did in 2006. Linden Lab needs to lower the price to increase sales (and increase total revenue).

[Porky Gorky]

If LL were to lower tier I think it needs to be coupled with a move to charge listing fees on the MP. The knock on effect of these two actions could offset the loss in revenue from the tier reduction for the lab I think.

Lower tier for everyone, charge listing fees on the MP, Lower prices means more people pick up land. More land in use results in more content being sold to be used on that land. MP listing fees would drive merchants back onto grid either out of necessity, protest or because they are enthusiastic about expanding due to the increased demand for content and lower tier prices.

By lowering tier and charging for listing fees LL would be driving the pick up of land from multiple directions, initially it would be the normal users/consumers and merchants picking up land, then the service providers kick in as the demand for commercial and private rental is revitalized, clubs and malls and "destinations" would all be inspired to invest in cheaper tier to support the returning, expanding and new merchants and users/consumers. The recovery would be a rolling one spread over many many months, but I think LL could ultimately increase their revenue and user numbers from such a move.

[Perrie Juran]

Show us some real numbers here, not speculation.  Comparing the costs of durable goods to perishables and comparing one time expenditures to recurring costs doesn't cut it. 

Many, if not all of us would love to own our own SIM's.  But we all live with budgets and many of us don't have the kind of discretionary money to afford a SIM even if the price was cut in half.  And while if SIM costs were cut in half, it would be an assumption to think that twice as many people would buy one.  By what percent are you proposing SL reduces tier?

Many people claim that we are being price gouged by LL.  Could be but we don't know what SL's actual profit margin is, what SL's actual NET income is.

So show us some hard numbers.  Decide what a fair return on investment would be for the Investors and base your profit margin on that.  Take into account that increased SIM ownership would mean higher infra structure costs for things like support.  Reduce SIM cost by 25% or by what you think would be a fair price and then tell us how many more SIM's SL would need to sell to achieve the same net income.  Do all that and show us some hard numbers specific for SL.