Second Life: Incredible innovator, but probably not sustainable

Second Life is interesting to me – I truly respect the service, but I don’t love it.  That is, I have a lot of intellectual respect for the way they’ve run their business – they’ve been bold, innovative, and relentlessly experimental.  But the service doesn’t grab me emotionally.   I also think that their high technical barriers to participation and the fact that SL is a closed standards system ultimately deters them from reaching mass market adoption.  Yes, they get a lot of publicity and their logins are growing at a fast clip – but I suspect there is a significant amount of churn. I spend a lot of time in the area of virtual worlds - because I think we’re just at the tip of the iceberg here.   

One day, there will be an open standards based platform that makes virtual asset/world creation as easy as choosing templates and widgets for your MySpace page.  In fact, today’s social networking services like MySpace and Flickr already incorporate some smart game design principles, such as levelling up, collecting virtual objects, and homesteading in the form of customization. I expect that virtual items will one day become a far more legitimate asset class and that there will be much improved liquidity for these assets in the future.  It sounds absurd, but there are some basic economic reasons why this concept of real money trade (RMT) makes sense, despite all of the negativity that RMT receives from the core gaming community:
1) Virtual goods can confer real economic utility,
2) It can be much cheaper to buy virtual goods than procuring them via more traditional methods – such as actually spending the requisite time necessary in-game or in-world,
3) Virtual goods can generate attractive investment returns.The folks who are already making their living in Second Life know this and they are the pioneers for what is to come. What the Electric Sheep Company and Edelman PR is doing with this business plan competition is exciting and I’m happy to be a small part of it.   For the record, CRV is not investing in any of these virtual Second Life businesses – I’m merely a judge.    I’m interested to see how these real entrepreneurs adapt to problems that aren’t idiosyncratic to virtual worlds (the stability of the currency) and ones that are idiosyncratic (how the recent CopyBot problem may mean that only services centric businesses can thrive in Second Life.)   Also for the record, I don’t believe that the current patterns of real estate values in virtual worlds will hold – for reasons that I’ll get into in a later post.

What I'm looking for in a business plan – in and out of Second Life

The Second Life business plan contest launch event was fun.  Here’s a snapshot from the event - we panelists are facing the audience: 

We were asked, “What are you looking for in a Second Life business plan?”

My answer is that I’m looking for the same things that matter in every other type of business.  None of this is novel – far wiser and more articulate folks have made the same points in the past. 

1. The team, and its authenticity and empathy for the user experience.  What I mean by this is that I’m looking for founders who come from the community that they aim to serve.  Do they speak the language of their customers? Do they empathize with their customers’ pain?  Do they feel passion for their users? Mitch Ratcliffe wrote in a great blog post today, “Social networks need some soul, not just a business school pedigree.”  For example, I would be a horrible Second Life entrepreneur.  I don’t use Second Life nearly enough to understand the relationship dynamics between its citizens and its service.  My starting a business in Second Life would be presumptuous and arrogant, because I’d be coming in as an outsider. 

That old Hairclub for Men line of “I’m not just the President, I’m a customer!” is comical but rings true.  We are looking for founders who deeply understand the customer problems they are trying to solve.  Don’t despair – even if you’ve never experienced hair loss, you could still build a believable Hairclub for Men business.  Do first hand research.  Go into the field.  Live amongst your subjects.  Take notes. Observe.  Listen.  If you observe and listen well, you’ll learn the local language and customs, internalize your tribe’s aspirations and fears, and your customers will soon begin to accept you as one of their own.

2. Unfair advantage.  This is the elusive secret sauce that sets you apart from all of your competition.  What about your business and your approach can’t be done by anybody else? Focus on that, and outsource/open source the rest.   That din you hear at your door? That’s [Google|guy in a garage] waiting to crush you.  Your unfair advantage is what keeps them at bay.  Unfair advantage can manifest itself as proprietary and differentiated technology, a superior business model, an incredible team iterating on past success solving similar customer pain, or a network of relationships that drives down customer acquisition costs. 

Furthermore, you need to demonstrate that this unfair advantage is sustainable.  Sustainable, unfair advantage is directly correlated to your ability to consistently receive better economic returns than your competitors.  Software as a service has a sustainable advantage over traditionally delivered enterprise software because it’s simply a far more efficient alignment of capital allocation and customer needs.  That being said, SaaS by itself is no longer a sustainable competitive advantage of its own – not in a market where every emerging software company employs a service strategy.  [I've written about the economic advantages of SaaS and open source on another blog.]

 3. Attractive market.  Let’s imagine that I’m the most cynical financier possible and the one and only thing that matters to me is delivering economic returns to my investors.  I’d be looking for businesses that served the entire world population and whose customers were completely price insensitive.   [Oil.] [Drinking water, in unregulated markets.]  Businesses with high customer switching costs.  [Cigarettes.] An attractive market doesn’t necessarily have to be sizeable – though size and [willingness to pay | average revenue per user] are on the same axis.  However, I’m happy to say I’m not a completely cynical financier.  Ideally, I’d love to back businesses that deliver sound economic returns and also do good for society.  [eBay. Google, maybe.]

That all being said, there are some tangible differences between building a Second Life startup and building a more traditional startup.  Though it may seem like the traditional startup business resembles the Wild West, the Second Life frontier is far hairier.  The risks inherent in Second Life startups reminds me a bit of investing in China – there’s a mostly benign dictator (Linden Labs, in this case) who wields enormous regulatory power over the landscape.   Audience members at our session had a lot of questions about currency and economic stability in Second Life.  Just as we trust the Federal Reserve of the United States to keep our dollar stable and valuable, so too must entrepreneurs have faith in Linden Labs to maintain the stability of the Second Life economy.   The Linden dollar has only as much value as you have faith in Linden Labs.

[sidebar:
friend (12:12:09 AM): What are you up to?
me (12:12:18 AM): I'm writing a blog post about unfair advantage and how it's critical to startups
friend (12:12:29 AM): What's your unfair advantage in writing about it?
....
me (12:15:23 AM): my sparkling personality?
]

Second Life's Virtual Economy in Peril?

So…very timely to our launch tomorrow of the Second Life Business Plan contest is the Copybot scandal that’s threatening to undermine the entire SL virtual economy.   

CopyBot captures the data being streamed to a local SL client and allows the user to clone that data in a way that creates an identical copy. Furthermore, this copy is not linked to the original in any meaningful way on the server-side and thus can’t be identified as a direct copy.  Needless to say, this disrupts SL’s entire economy because it’s now easy to create millions of perfect knock-offs of the virtual Hermes boots it took me 15 craftsmen and 2 months to painstakingly build. 

(Not Hermes Boots by Sol Columbia available for sale at the SL Boutique)

My friend Raph Koster wrote an awesome post yesterday analogizing the situation to the heated debates about DRM in the music and video markets: DRM is good when it works to protect your economic interests, evil when it prevents us from enjoying the data we want.  Raph says, “CopyBot is a mirror, and what we see reflected in it is the unsavory fact that we all want DRM, if it favors us.” 

A lot of controversy has erupted within the SL community over what to do about this issue, with many content creators vocally attacking SL’s developer, Linden Lab, for allowing the situation to occur.  Interestingly, CopyBot grew out of an open source library that was developed by third-party OSS developers but is unofficially endorsed and supported by Linden Labs.  Once CopyBot fell into the hands of end users for the purposes what amounts to basically SL piracy, the libsecondlife developers removed the CopyBot source code from their servers at the request of Linden Labs.  But of course, once something like this has been unleashed, it is essentially impossible to contain it.  In fact the press surrounding the scandal only amplifies the tool’s popularity amongst the folks who are most likely to abuse it.

The interesting question that arises is how do you close Pandora’s box?  What can Linden Labs do now?

The simple answer in most cases is that you can’t close Pandora’s box, at least not completely.  Linden Labs has begun to take a hardline stance on this issue by threatening people caught using the CopyBot with world banning, based on Terms of Services violations.  I suspect they will also go down the obfuscation road in future patches of the SL software.

Data and code obfuscation is something that software developers have been dealing with for a while now.  As computer languages (such as Java and C#) emerged with rich metadata that allowed developers to use programming concepts such as reflection, the amount of descriptive data in the executable that runs the program has grown to the point where it is often trivial for a decompiler to reverse engineer the program back into usable source code.

There is no real bullet-proof way to avoid this situation without losing all the benefits that the meta-data provides and so the primary way of dealing with the issue is to obfuscate the code before shipping it out to users.  Basically, this involves running an executable which reads your executable, and using many of the same meta-data constructs that allow for de-compilation, it does a lot of renaming of identifiers, so that every method or public variable in your program will be named a, aa, aaa, aaaa, etc. instead of the real names that are in the original source code.  The end result is an executable that can still be decompiled, but when decompiled is so confusing to a human reader that it is pretty much useless.

This exact type of obfuscation isn’t directly applicable to 3D data as used in Second Life but I can easily see Linden Labs employing the same basic strategy of complicating the 3D mesh format they used for the sake of being harder to reverse engineer.  This doesn’t stop things like CopyBot from being written (in fact, there are already graphical capture software programs that work at the OpenGL or DirectX driver layer that could have done what CopyBot is doing a long time ago) but it does make them a lot more difficult.  And in the end pretty much the best you can hope for when it comes to digital data duplication is to make it so difficult to do that it is just much easier for the user to acquire it legally than it is to steal a copy.  Which gets us back to the DRM debate. 

And with regards to the Second Life business plan contest – I’m interested to see whether or not it dampens the entrepreneurial spirit within SL or whether new folks will see all of the fear and concern as an opportunity from which to build new businesses.

Second Life Business Plan Contest

I am excited that my friend Giff Constable, of the Electric Sheep Company, invited me to participate in a business plan contest that focuses on fostering entrepreneurship within Second Life.  This event is being jointly produced by the Electric Sheep Company and Edelman, the PR firm. 

 I invite you to join us this Friday, November 17th at 1:00 PM Second Life time (Pacific Time,) as we kick off the event with a live panel.  Speakers will be me, Rick Murray (head of Edelman’s me2revolution practice,) and Sibley Verbeck, CEO of the Electric Sheep Company.

More details about the event and the business plan contest can be found here.