The paper analyses the viral spread of an application and how/why are these processes occurring. SocialTimes.com did a great post that summarizes the academic paper. Alternatively, you can view the entire paper here.

Some of the key findings are summarized below:

• On average, each inviter has invited 26 friends while the median number is 10
• Just 10% of users account for 50% of successful invites
• Around 90% of users share their locale information
• Around 40% of users share their friend list
• Only 1% of users share their relationship status
• Invited users remain in the game longer: over 50% kept on playing for more than a day and 20% of all invited users were still playing 80 days later.
• Around 80% of non-invited players leave the game within the first day
• Overall, they find that invitation strategy is more important than demographics in determining invitation success rate

To determine how to create a profitable social game, please explore my previous blog post on the importance of Customer Acquisition Costs for startups.

After being pitched countless times by startups, as a VC I’d like to identify a common misconception that web-based startups often have about their own growth potential and the costs associated with their plans. Management of web services companies, SaaS companies and mobile (web-based) applications commonly believe that because they are situated online, customers will come across their service, submit a purchase order (or subscribe) and notify friends or other companies to use the service as well. Although this may happen from time to time, it is very rare for any company to experience sustained viral growth.

Many companies don’t understand the difference between viral marketing and viral growth. Viral marketing is essentially “word of mouth” or “person-to-person distribution” and is the latest buzzword. Viral growth implies a K-factor greater than 1 (i.e. for each new person who tries a product/service, they will each invite more than 1 registered user of the product on average). Since true viral growth is so hard to achieve in practice, many companies miscalculate the actual costs it will incur to acquire customers. As David points out in his article, the majority of startup pitches lack detail/emphasis on how much it will cost to acquire customers. I second this statement entirely.

Business Model Viability
For a business to be profitable on each new customer, startups must balance two variables: (1) Cost to Acquire Customers (CAC); and (2) Lifetime Value of a Customer (LTV).

CAC can be calculated by taking the business’s entire cost of sales and marketing over a given period (including salaries and other employee expenses) and divide it by the number of customers that the business acquired in that period.

LTV can be calculated by looking at the Average Revenue Per User/Customer (ARPU) over the lifetime of a business’s relationship with a customer.

As Steve Blank mentioned in his recent post, an early indication that a business has found the right business model is when the cost of acquiring customers becomes less than the revenues generated from the customer. “For web startups, this is when the cost of customer acquisition is less than the lifetime value of that customer. For biotech startups, it’s when the cost of the R&D required to find and clinically test a drug is less than the market demand for that drug.”

Credit: David Skok.

Zynga is a great example of a company that has managed to decipher the business model of online social gaming. After thousands of A/B tests and experiments, Zynga finally found a business model where CAC was less than LTV. Once they cracked the nut, the company spent so much on customer acquisition that it was rumored that they accounted for upwards of 30% of Facebook’s revenue in 2009 though its aggressive social ad buying strategies. Similar business models and opportunities exist in virtual worlds, massively multiplayer online games (MMOGs) and many other online businesses. Many social games, such as those created by Zynga, leverage virtual currency, micro-transactions, emotional response mechanisms and social influence to promote the sale of decorative and functional virtual goods.

Before investing in a web-centric startup, good VCs will look deep into a company’s business model and know to look for CAC and LTV metrics. In fact, Trident Capital recently held a meeting with their online advertising and ecommerce companies to help exchange best practices for customer acquisition and improving LTV. My advice to startups: prove out your business model and you will have a much better shot at raising VC dollars. Skok suggests that two key equations be followed by web startups:

• CAC < LTV (3x appears to be a rough minimum for SaaS businesses)
• CAC should be recovered in < 12 months (for subscription businesses)

Startups, if you’ve already figured out your business model and how to make CAC < LTV, stay very quiet and add as much fuel to the fire as you can afford. Your competitors will likely try to hone-in on your tactics and fight back for their share of the market.

Credit: Steve Blank.

Leverage Startup Metrics
Startups are different from larger companies and therefore need different metrics than larger companies. Metrics will give startups a lens into how well the search for the business model is going and help to identify when to scale the company. Besides CAC and LTV, some essential metrics that startups should be familiar with include Viral Coefficient (K-factor)  and Customer Lifecycle. Dave McClure from Founders Fund recently updated his Startup Metrics for Pirates presentation for web sales pipelines. Take a look!

Questions to my Readers
Please consider the following questions and share your perspectives with my other readers and the tech community at large.

1. What metrics do you consider the most valuable?
2. Do you use any tools to help measure specific metrics for your business?
3. What mistakes have you made (and corrected) that can help others succeed?

Market Growth

The estimated market size has gone from a nascent space in 2008 to approximately $500 million (Aug. 2009; Source: Viximo) to over $1 billion by end 2009 (Oct. 2009; VentureBeat) only 2 months later. If you are at all surprised by this vast market size, you should know that the Asian virtual goods market is seven times bigger than US (estimated at $7 billion for 2009).

Zynga, one of the leading social games companies, launched a game called Farmville in June 2009, and has already become the most popular game application on Facebook with 62.4 million active users as of October 29, 2009 and will easily break through $150 million in 2009 revenue.

Types of Virtual Goods

Developers are very creative. So far, the types of virtual goods can largely be placed into 2 buckets:

1. Decorative Goods: Do not affect game statistics / game play (e.g. avatars)
2. Functional Goods: Affect game statistics / game play (e.g. Farmville tractors — did you know users bought 800,000 of them yesterday)

Since functional goods affect game play activities, game developers should give users the ability to either earn these items/goods through game play or provide a shortcut in acquiring them with a virtual currency. Functional goods can be managed to have low or high value price points; generally, the value of these functional goods can be set by carefully managing and understanding scarcity. Ensure to have some items that are very common (Developers: ensure to “prime the pump” by getting users familiar with using some free and low-cost items), and some that are very rare and expensive.

While A/B testing how much users will pay for items, understand that as the aggregate number of social interactions per user increases within an application, each rare item’s value will proportionately increase for those users. Another consideration while establishing demand for your virtual goods is whether or not you need a secondary market where users can sell, trade or profit from their virtual goods (See more from Bill Grosso’s presentation on Managing a Virtual Economy).

There are many reasons why a user would pay more for certain items. Let’s try to better understand game user psychology.

Psychology of Purchasing Virtual Goods

Users will buy virtual goods for many different reasons. Buying decisions will be based on a number of factors including user motivation, several forms of influence, boredom and competitiveness. If you’re a developer, think carefully about users of your applications: Why would they want to buy a virtual good within your application? What added value would they receive? Which other people would see they bought this good, and could they benefit as well? Below, I outline a number of different reasons why users choose to purchase virtual goods:

• People are impatient (time = money) and want to advance through game play more quickly
• People are competitive and want to get ahead (of friends, peers, the world)
• People want to express themselves in unique ways (akin to the culture of decorating cell phones in Japan)
• People want to feel good about themselves (donating to charity and publicizing)
• Gifting allows people to foster and maintain existing relationships with others in an increasingly electronic world
• Gifting allows people to create new relationships
• People will return gifts due to the rule of reciprocation (influence), which prompts us to repay what someone has given us
• Provenance (e.g. did a famous user own this item in the past?)
• Branding (virtual goods branded by real-world companies)
• Rarity (scarcity)

5 Key Steps for Launching Virtual Goods

In a presentation by Amy Jo Kim, CEO of Shufflebrain, about why and how virtual goods work, she outlined 5 steps for launching virtual goods.

1. Create meaningful content
2. Prime the pump with free goods or currency
3. Create demand for premium content
4. Offer fresh content at a range of price points
5. Make it easy to purchase currency

There are many different companies that offer solutions to help with your virtual currency. If you’re looking for good vendors, try: PayPal, Gambit, boku, Zorg or $uperRewards.

Why are your users buying your goods? How did you generate interest or scarcity in your application? Please share your story and learnings about user psychology and buying decisions in the comments area below.

I particularly like the reference to South Park.

Here is an overview of what it covers (taken from the article):

Introduction
BlackBerry Platform
Development
– Look and Feel
– It’s the Network
– Background Apps/Memory
Pricing the App
DRM
Selling the App (Retailers)
– Handango
– Direct
– MobiHand
– BlackBerry App World
Initial Sales
Marketing
Sales Post-App World
Dealing [or not] with other companies
My Customers
Conclusion
Topic Outline

For all those BlackBerry developers out there. I hope you have had the chance to check out the App Store and apply for distribution through it’s channel; it can be extremely valuable. If you want to learn more about it, check out my blog post on the BlackBerry Partners Fund Blog called “The Next Wave: Mobile Applications and the BlackBerry Application Storefront,” which discusses some specifics about developing for BlackBerry App World.

Some BlackBerry developers (and outside observers) have recognized that there are some kinks in the process of getting onto BlackBerry App World. Kevin Talbot, co-manager of the BlackBerry Partners Fund, identifies some key issues plaguing BlackBerry App World and invites developers and others to comment and add their thoughts about what RIM can do to fix App World.

If you have just submitted an application, or are planning on developing an application soon, make sure to apply for the 2009 BlackBerry Partners Fund Developer Challenge.

Happy developing!

I am in the process of creating a whitepaper that brings in proven strategies as well as specific case studies of successful viral marketing efforts. The whitepaper will also cover more specific strategies centered around mobile App Stores and effective utilization of Facebook Connect and Facebook application pages. Lastly, it will contain a bible of social media strategies.

I kindly ask all of you to share any viral strategies that you have used to-date, along with key dates and timelines, screenshots, verbiage used in messaging, and key metrics (user growth, #downloads, etc…) achieved from the strategy.

Please leave comments below, or DM/@ me on Twitter with links to your story, my username is @jsookman. I will be tracking posts with the #UbiquitousVC hashtag, so please use it!