by Alphaville Herald on 08/11/08 at 9:11 am

Open Space sims and how Linden Lab got it right – for themselves

by Maximilian Proto, Department of Random Guy Posting

After Linden Lab introduced a new pricing policy for its highly popular Open Space (OS) sim product, residents joined to celebrate the cherished tradition of feverishly complaining about price increases (“they’re making it too expensive”), price decreases (“they’re devaluating my investments”), new product introductions (“they’re hurting mainland owners with those islands”), product changes (“they’re are hurting island owners with those OS sims”) or even when Linden Lab doesn’t do anything at all (“they’re not doing anything at all”).

But why did Linden Lab decide to respond with such a steep price increase for a highly successful product risking alienating their customer base (further)? In particular when the RL economy is on the brink of a recession? And wouldn’t Linden Lab suffer considerable losses if estate owners would really abandon their OS sims as a reaction?

Unfortunately, the idea that JIRA issues or threats of abandoning sims will change Linden Lab’s pricing plans is futile. In fact, Linden Lab’s move makes a lot of economic sense for the company, and even large scale abandoning of OS sims will likely have little to no impact on Linden Lab’s financial performance.

And this is why:

It seems that OS sims turned out to be much less of a success to Linden Lab when they compared the profit and loss statement with that of standard sims. Apparently, on a like-for-like basis the average operating costs of OS sims are considerably higher compared to standard sims which turns an OS sim into a lower margin product for Linden Lab.

Hence, Linden Lab decided to rectify this situation by introducing a pricing structure that deliberately reduces the incentive to purchase and maintain OS sims in order to make people chose standard sims instead that are generating higher margins for the company.

Obviously, Linden Lab’s move (understandably) infuriates OS estate owners and leaves them with four basic options:

Option 1: Keep going and pass the extra costs to tenants (if they are in the land business), customers (if they are in the content business) or group members (if they are a non-profit community).

Option 2: Convert OS sims (back) into standard sims and hope to keep your tenants/customer/group members.

Option 3: Give up and sell the OS sims to another resident.

All three options will have only very little impact on Linden Lab’s revenues as they will continue to receive the tier payments for the sims. In fact, they will get more revenues and better margins due to the increase in tier fee.

That leaves option 4: Give up by simply abandoning the OS sims.

This is the most interesting option to look at – not only because the other three options are pretty straightforward but also because many estate owners are using the abandonment argument as a threat to convince Linden Lab to change its course.

Let’s look what would happen to Linden Lab’s revenue if OS estate owners would decide to abandon in droves and see if the company would be impressed. In order to be able to do so, we need to make a few sensible assumptions and do a bit of math (you have been warned):

1. How many OS sims are there actually?

When the new OS sims where introduced in spring this year the Second Life grid had about 14,600 islands. By the end of October this number will be 27,000, an increase of more than 12,000. Considering the popularity of OS sims, there may well be up to 10,000 of them on the grid by now.

2. How much revenues is Linden Lab generating from those OS sims?

Assuming roughly 10,000 OS sims, Linden Lab is currently generating monthly revenues of US$750,000 from those sims (note 1).

3. What would happen if Linden Lab lost 50% of all those OS sims as a result of the new pricing structure?

Obviously, the effect of the new pricing structure and the adjustments to it will be felt over a certain period of time, probably up to 6 months. Let’s think a little about Linden Lab’s revenue development over this period of time by making a few simplifying assumptions:

If Linden Lab had kept their pricing policy unchanged, they had 10,000 OS sims generating US$4,500,000 over 6 months (note 2).

If Linden Lab loses half of those OS sims as furious estate owners leave the grid and simply abandon their sims at the beginning of January Linden Lab’s revenue will fall to US$3,750,000 (note 3). This would be a shortfall of US$750,000.

However, abandoning those 5,000 OS sims frees up server capacity for either 5,000 new OS sims or 1,250 standard sims. Assuming that OS sims have fallen a bit out of favor, Linden Lab will now go and connect those 1,250 sims for a setup fee of US$1,000 each. In addition, Linden Lab will generate tier revenue of US$295 per month from those newly connected sims.

How much tier revenue Linden Lab can generate in the first 6 months that we are looking at depends on how fast they can sell the freed up capacity. Looking back in time, Linden Lab connected about 500 islands every month between October 2007 and March 2008. Let’s be conservative, and assume they can connect the freed up server capacity at 250 sims per month.

Let’s compare:

LL’s total OS-related revenue H1-2009 under the old OS policy: US$4,500,000

LL’s total OS-related revenue H1-2009 under the new OS policy + resell: US$6,106,250

Or in (hopefully) plain English: Even if Linden Lab lost half of all their OS sims as the result of their price increase, they would still end up with more than US$1,600,000 more revenues after 6 months since they can simply reconnect existing server capacity as standard sims. (They would even be up in the first quarter already)

Even more dramatically, if we believe that Linden Lab can actually connect 500 standard sims per month (which they did historically), they would still make more than US$600,000 additional revenues in the first 6 months after the introduction of the new pricing policy, even if people would suddenly simply abandon 90% of all OS sims. (Again, they would be up in the first quarter, too)

So where does these leave OS estate owners?

Firstly, although the real world mechanics will be more complex than the simple scenario above, the simple message is clear: Whatever you as an OS estate owner decide to do, in the end Linden Lab will not be bothered too much financially if virtually all OS sims would be abandoned by their owners.

Secondly, the price increase will very likely break a number of OS business models of profit-oriented estate owners. As a result, Linden Lab will probably end up with a more consolidated, better capitalized and more professional customer base as OS estate owners may decide to leave the market by either abandoning or selling to larger estate holders with sufficient time and capital.

In addition, the Linden Lab will operate higher margin products (standard sims) and can probably save customer service costs on top of it (It’s cheaper to deal with 20 people owning 500 sims each than dealing with 500 people owning 20 sims each…).

This is not a bad position at all for Linden Lab to be in when entering into an RL economic recession.

What should infuriated OS estate owners do?

On your business: Sit down and do the math to see what prices you need to charge the people that are on your land to make your efforts worthwhile. Communicate these prices to those people and see over the next few weeks if they can do this. Also see if they would be willing to transfer to a standard sim if you could convert your OS sims.

If you come to the conclusion that it doesn’t work for you anymore, find out if there is anybody out there that is willing to take over your sims. And it nothing helps it might well be the best business decision to cut your losses and give up.

This is what you probably want to do with Linden Lab:

Well, accusing Linden Lab in the Second Life forums or blog of doing something “illegal” or “breaking the contract” or asking to “give me back my money” is simply retarded and childish. Also, as shown above, threats to abandon OS sims are a waste of time as this will simply have no lasting impact on Linden Lab’s revenues and profits.

Instead, try to focus on what could actually work for both Linden Lab and you, keeping in mind that Linden Lab really believes that they are not make enough money from OS sims.

The best way to do this is probably not staging in-world cartoon protests or messing around with SL groups.

Rather, people that hold a larger number of OS sims should connect in RL to represent a few thousand OS sims, agree on 2-3 clearly defined realistic points that they want Linden Lab do to keep them as customers, and communicate those points to Linden Lab directly in RL.

On such point could be free conversion of 4 OS sims into a standard sim. If you have only 2 or 3 OS sims, suggest that you can acquire the “missing” sims you might need to convert for a discount. I’m sure that you have some ideas.

After all, even an upset customer is still a customer, whereas a new customer is a customer that is not yet there.

(note 1) 10,000 sims x US$75 old tier fee

(note 2) 10,000 sims x US$75 old tier fee x 6 months

(note 3) 5,000 sims x US$125 new tier fee x 6 months

(note 4) Calculations revenues Jan-Jun-09:

Setup fees: 1,250 sims x US$1,000 = US$1,250,000

Tier fees of January connections: 250 sims x US$295 x 5 months = US$368,750

Tier fees February connections: 250 sims x US$295 x 4 months = US$295,000

Tier fees March connections: 250 sims x US$295 x 3 months = US$221,250

Tier fees April connection: 250 sims x US$295 x 2 months = US$147,500

Tier fees May connections: 250 sims x US$295 x 1 months = US$73,750

Tier fees Jun connections: All free capacity sold