A Deal with the Devil: Part I

How Blizzard's attempt to monetize Diablo 3's virtual economy is embroiled in crisis – both for gamers and the company itself
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While the financial dysfunction in the Eurozone slowly fades from the headlines, there is far more fascinating economic calamity unfolding that would take its place were it not so out of plain sight. It has far reaching implications for a booming multi-billion dollar industry, is threatening the credibility of one of the sector’s patron-saint companies and is revealing incredible new insights on monetary policy. Best of all, to participate, all you have to do is login to kill Diablo and his minions.

Even for those of us who have been forced into early gamer retirement due to the demands of adulthood, Blizzard Activision’s Diablo III was still one of the most hotly anticipated games of all time. I remember fondly the countless hours (and I do mean countless) spent on the series’ earlier installments; they were visually stunning, finely crafted and most of all, addictive. After almost a decade of development time, by all accounts, the third edition measures up well against this lofty standard.

That is, however, except for one crucial element: the in-game economy. Despite all the tweaks and improvements, the very mechanism that drove so much of the franchise’s addictive quality has broken down. Hyperinflation is rampant, trade and exchange has frozen and as a result players are abandoning the game in droves. With seemingly all possible game play remedies at odds with the very economic model Blizzard has developed, this in-game crisis seems poised to become a real-world disaster for Blizzard.

The ascent of money

To say that the in-game economy is crucial to the survival of the Diablo franchise is, if anything, an understatement. Unlike other games that require immense skill to reach the upper echelons of the game’s elite, Diablo has always revolved almost entirely around one’s ability to collect the most powerful items. Players spend hours repeating the same quests in the hopes of scoring rarer items that could then be used or traded with others. Online forums even commission large statistical analyses to devise ideal strategies not for beating the game, but rather, accumulating rare items. While on the surface Diablo may be a medieval fantasy, it is equally a capitalist one.

Like any economy, commerce in the world of Diablo has evolved in fits and starts over time to gradually make transactions more efficient. In its earliest stages, users struggled to navigate a hopelessly decentralized barter system, jumping between hundreds of games in the hopes of finding the right person, with the right item at the right time. Trade was difficult and so the economy remained small.

Amazingly, however, the first breakthrough financial innovation for this nascent economy didn’t come from the game developers but rather the users themselves through the adoption of a common currency. Though the specific item used as currency would change several times over the course of Diablo’s history, each time it carried with it similar properties:

  1. 1. Sufficiently common that it was findable for an average player
  2. 2. Sufficiently rare that it maintained its value
  3. 3. Powerful enough for players to desire using it in game play, rather than merely trading

The results were profound, as gamers now converted their treasures into a currency that they could stockpile for a larger desired purchase. With transactions now easier and the flow of goods between players increasing, prices on items were bid down – making them more attainable for the average player and the game that much more fun.

For nearly a decade, the series’ second installment, Diablo II, existed in this state. While not without its imperfections, the economy was ultimately both vibrant and inclusive, and so players remained happy. Surely Diablo III, whenever it arrived, could best its predecessors, make commerce even more efficient and deliver a sort of virtual economic utopia.

Crossroads

Yet while Diablo continued strong into its old age, in the top 10 of PC games sold as recently as 2010, all was not well for its real-world overlord Blizzard.

Exhibit 1

At the time of redevelopment for the series’ third feature, Blizzard, the historical connoisseur of high price, high quality gaming, stood at an industry crossroads. Since the Diablo series’ glory days in the early 2000s, the cash cow torch had been passed several times but ultimately landed in the hands of World of Warcraft (or WoW, aptly acronymed from a profitability perspective). Not only had WoW had been one of the most played games of all time, but it brought with it a novel approach to monetization through subscription pricing. While not the first to experiment with such a strategy, given the high replay value of their games, Blizzard stood to potentially gain the most (see Exhibit 1).

Yet, for all their merits, by late 2011 the tide had turned against subscription priced games. Consumers were fatigued with monthly fees and the popularity of free-to-play (F2P) games such as Team Fortress 2 and League of Legends were undercutting more renowned titles, including Star Wars: The Old Republic, who rapidly moved to the F2P model after subscribers dwindled. While WoW maintained a sizable but declining user base, it was clear to Blizzard executives that Diablo III would only cannibalize it further, particularly if it too had a monthly fee. As a result, by the time Diablo III was preparing to come to market, subscription pricing was off the table.

Ultimately, Blizzard needed Diablo III not just to reboot the franchise but demonstrate a new ability to monetize their media properties. For at least the near term, the power of the Blizzard brand still allowed them to charge a premium upfront for their titles, but with F2P’s gradually changing consumer preferences they needed to show the diversity of revenue models that the market was coming to expect.

Once again, intrepid gamers showed the way. During Diablo II’s “boom years” of the mid-2000s, a small, dedicated set of gamers sought to capitalize on the game’s mounting interest and rapidly expanding economy by selling items for real world dollars through eBay. Many made good money doing so. While hardcore gamers loved it, average players hated it – feeling that it imperilled Diablo’s intrinsically meritocratic form of wealth distribution – yet both sides agreed that the situation was unsustainable. Items were frequently stolen, accounts were mistakenly deleted by Blizzard and finally, after eBay’s banning of the sale of virtual goods in 2007 pushed the sale of Diablo II items completely under the table, it was clear that some type of compromise was necessary. And thus, the real money auction house was born.

Best intentions

At its core, the RMAH represented merely a method of improving the old system of commerce within the game. As a ubiquitous, centralized marketplace for all players it immensely reduced the barriers to trade. Users needed only to deposit an item in the auction house and receive compensation when it was ultimately bought. The process was a passive one and required far less time and effort to complete, thus significantly increasing trade and the availability of items. As a way of counteracting these effects and keeping prices on rare items stable, Blizzard simply lowered the probability of finding them.

The RMAH would also shift to a new form of currency: gold. The old forms of currency had worked well in a system that primarily dealt with only higher-tier items, but would be inadequate for the RMAH’s purpose to oversee all transactions where smaller denominations were required. Gold was infinitely divisible, available from all quests within the game regardless of level and currently had only limited value. In many ways, it was a natural choice.

Exhibit 2

But the true value, from Blizzard’s standpoint, was the “real money” component that allowed users were able to buy items through the auction house using their PayPal account. For facilitating the transaction, Blizzard would keep a mere 15%, plus some fixed fees on smaller items.

With this move, Blizzard had essentially adopted a strategy long advocated by activists for the legalization of drugs. While overall participation in the “real money” process was expected to remain small, moving the sale of these goods from the black market to the open market would, in theory, help reduce the crime that had proved to be such a headache for Blizzard with Diablo II. Moreover, much like their drug legalization counterparts, they stood to gain financially from it.

The model seemed bound to be successful. Not only was Diablo’s item-centric gameplay perfectly oriented towards the auction house’s type of monetization, but online gamers were clearly becoming more comfortable with the idea as well. Virtual good sales on Facebook were steadily rising – reaching $1.26BN for the first half of 2012 – driven by a small core of users spending large sums per month. More specific to gaming, Zynga itself had built a $4 BN business out of the willingness of its consumers to pay for pixels and was generating upwards of $200 MM in revenue per quarter (though their failure to replicate the success on mobile is proving to be disastrous, but that’s a story for another day).

While the potential gains were poised to be small at first (see Exhibit 2 for estimates), with rapid growth expected to continue in the market for virtual goods, Blizzard’s would be positioned to reap the rewards for years to come.

If it ain’t broke…

Immediately, such hopes were dashed. From the very outset the game’s economy has lurched from one crisis to the next. In recent months, as Peter Earle of the Ludwig von Mises institute notes in incredible detail, hyperinflation has come to dominate the economy and effectively ground trade to a halt. A recent hack, that allowed users of auction house to essentially double their cash, has only made the situation worse. Blizzard temporarily shut down the auction house and punished those who abused the system, but by that point the damage was already done as trillions in new dollars flooded the economy, the USD exchange rate plummeted and commentators and players were left uncertain about Diablo’s future.

What Blizzard’s new system failed to recognize is that while the old economy was in many ways inefficient, it was these frictions that acted as stabilizers and helped it find an appropriate equilibrium. In the case of gold, there are still few in game uses, or “gold sinks”, to remove some from the aggregate money supply. This is in direct contrast to Diablo II, where, for example, the long-time preferred currency, the Stones of Jordan, were one of the best items in the game and extremely useful in multiple quests that were non-transactional. The effect was akin to an aggressive bond selling program by a central bank – by removing currency from circulation, these in game uses kept inflation low and maintained the currency’s value.

Though further gold sinks are on the horizon for Diablo III, the existence of gold “farmers”, who can obtain upwards of $60 MM per hour with their specialized programs, suggests that inflation is unlikely to ease anytime soon. For a “normal” player this would prove financially disastrous, as the probabilities and quantities of gold found by average players has barely budged – comparable to the severe implications of inflation on your typical worker due to the stickiness of wages.

Other economic features have only made this issue worse. In particular, recall that the probability of finding items was decreased as a method of counteracting the increase in supply due to the auction house. The effect essentially was that it would be impossible to find desired items on one’s own without involving in trade. When coupled with a player’s inability to obtain adequate currency to make a purchase due to hyperinflation, however, it’s no wonder players are left feeling as though they play for hours and get nowhere.

A worthy foe

As with all economic policy, there is no shortage of online opinions on just how to revive Diablo III. Perhaps a tax on all gold held in deposit longer than some specified period of time would reduce the distortions caused by huge sellers in the marketplace. Or, alternatively, a limit on the amount of gold that could be obtained in a single session, to reduce the huge influx of currency from gold farmers and, in combination with additional gold sinks, will shrink the money supply. Nearly all seemingly have merit, and even the most potent academics would likely struggle to prescribe a single, perfect remedy.

Yet for Blizzard, the implications are clear. In what was supposed to be a large step forward for their business model – an attempt by a traditional gaming company to adapt to the trends set by its social gaming and F2P peers – it has instead been forced to stagger back.

Blizzard’s ability to learn these tough economic lessons will not just shape the future of Diablo III, but many of its other franchises as well. Clearly the functioning of these new in-game economies, cleverly refined through mechanisms equally intricate to our own in the non-digital world, cannot be tampered with lightly. Ultimately, turning those animal spirits into a source of profit may prove a more daunting challenge than Diablo himself ever could.

Writer’s note: In the process of writing this article, it dawned on me just how big this topic is and how many stones have been left unturned. How does Blizzard fix the Diablo III economy and its revenue model? How will the integration of a console version impact the game’s economics? What lessons has Blizzard learned for its upcoming franchise, codenamed “Project Titan”? As such, I plan on a second installment of “Deal with the Devil” in the coming weeks. In the meantime, I’d love to hear your thoughts on any of the numerous questions that are still unanswered or what Blizzard should do next.


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COMMENTS
  • nlubczynski

    First off, I agree with much of what you state in this article. However, I would like to know your opinion on how the real money auction house (RMAH) has changed the play-ability of the game – beyond the economics.

    Deep down, the RMAH has fundamentally changed the way Diablo is played. I agree that it is perhaps a logical progression as it facilitates trading and attempts to kill the grey market. That being said, I don’t think it is the correct logical progression as it also creates two negative effects: monetary motivation, and the concept of pay-to-win.

    I appreciate the comparison to the Marjuana industry – but there is a fundamental difference in D3. While they “legalized” the sale of gold for real money, the most effective gold creation methods, such as using robot characters, are still “illegal”. So rather then destroy the grey market, Blizzard actually made it easier for these “botters” to sell their illegally produced products. By having this easy access to cash, Blizzard increased the monetary motivation users have to cheat.

    Further, the best players in D3 can achieve their elite status through playing countless hours of Diablo – a difficult/expensive task – or by throwing money at the auction house. Sure, there are simplistic barriers in place to stop this, but the fact remains the easiest and quickest way to earn an item is to pay for it. While this is good for Activision-Blizzard, it’s bad for the gameplay. Not only does it alienate users who feel paying more money, after purchasing the game at full price, is unreasonable. It also cheapens the “win” of having a powerful character. As you didn’t work hard to build this character, you don’t have a sense of satisfaction when its complete. This can help explain why people bought the game, but have stoped playing – they have no more motivation.

    Both of these points can be shown to have a big effect on the economy of D3. Further, the creators of Diablo never expected the auction house to be so popular – and since addmitted it was a mistake (http://www.escapistmagazine.com/news/view/122980-Blizzard-Admits-Diablo-III-Auction-House-Was-a-Mistake). My point being – with real money apart of the picture, the focus of the game has to be that of real money. Therefore, my question to you is: is it really possible to fix the RMAH in Diablo 3, or is it time for Activision-Blizzard to say goodbye to this monetization model and dismiss it as a failure.