When John Zdanowski first met up with Linden Lab creator Philip Rosedale to discuss the CFO post, they didn’t just talk numbers.
Within minutes of shaking hands, the pair were swapping stories about what they had programmed the Apple II Plus to do when they were kids. At 12, Zdanowski got his computer to solve the Rubik’s Cube puzzle. With such early technological leanings, it’s no surprise he ended up forging a career in Silicon Valley.
Since taking over as finance chief in September 2006, Zdanowski has been running not only Linden Lab’s finances, but also the economy of virtual world Second Life. While he is an old hand when it comes to the financial affairs of internet companies, he admits that virtual economics pose some rather unique challenges.
A different world
In Second Life, users buy land and create objects and services which are traded with other users for Linden Dollars, a virtual currency which is pegged to the US Dollar, and which is traded on the LindeX. Linden Lab manages the supply of Linden Dollars by charging fees to users for services, by giving them to premium subscribers, and by selling them on to the exchange. Part of Zdanowski’s role includes managing this economy, though in the virtual realm, he’s better known by his avatar, Zee Linden.
‘We basically monitor in real time, much like any market-maker does on Wall Street, the behaviour of the market to see where supply and demand is stacking up, just like you would when you look at the details behind any stock market or currency market,’ Zdanowski explains.
The virtual economy aside, Zdanowski says the company’s business model is fairly standard.
‘When you strip away a lot of the virtual worldness of it and really look at the revenue stream, it is a basic recurring revenue internet model and that’s what all four of the internet companies I’ve been involved in have been.’
What sets it apart from other internet companies, according to Zdanowski, is its monetisation per unique user, which at $72 (£36.5.) per annum puts it way above the likes of Google, Yahoo and ebay.
‘We have the highest monetisation of user generated content and it is also a much higher figure than any advertising model has ever dreamed of,’ he says.
About a quarter of Second Life’s revenue is derived by selling lands to users, while the bulk of its revenue comes from land maintenance fees. The rest comes from membership fees and by operating the virtual economy.
While Linden Lab aims to let this virtual economy run as freely as possible, Zdanowski says the company has had to face certain business realities. Last year it was forced to put a stop to gambling in Second Life, which took a big chunk out of the economy.
‘When we shut down gambling, the user-to-user transactions dropped by about 40%, so that would be the equivalent to shutting down real estate transactions in the US,’ he explains. ‘It had nothing to do with the FBI or anything like the crazy rumours that were circulating. The reality is that MasterCard and Visa don’t allow US companies to process gambling transactions and to continue operating we had to make the tough decision to shut it down.’
Rapid expansion
With Second Life rapidly expanding outside the US, the laws of other countries have also come into play. Last year Linden Lab realised that from a profits perspective, it would have to start charging VAT to European residents.
‘In 2006 our footprint in Europe was insignificant, but now more than 65% of our business is outside the US,’ Zdanowski explains. ‘It got to a point where we couldn’t absorb those costs anymore and we had to pass them on to our users.’
There have been plenty of scandals to deal with as well. A run on an in-world bank prompted a decision to shut down unregistered banks inside Second Life, and revelations about paedophilia, money laundering, terrorism and fraud taking place on the virtual platform have also attracted negative press.
‘People are responsible for their own actions inside Second Life,’ says Zdanowski.
‘Different countries have asked us to investigate certain residents from a subpoena perspective and we always try to work with law enforcement as best we can if illegal activity is going on.’
Going forward, he says complying with the regulations of so many different users’ countries is a real challenge: ‘That’s the difficult part about running Second Life as a global company. You can quickly get to the point where all that is allowed is the lowest common denominator of the most conservative laws in any country. We are trying to enable the tools that let people comply with the laws in their country and let other countries do what they need to do.’
Working on technologies that allow this, and other advancements, is the company’s key strategy moving forward, says Zdanowski, adding that a number of new features have been added to the platform in the past year.
‘The majority of our costs are engineering costs to continue to develop the features and capabilities of Second Life,’ he says. ‘We don’t do any sales, we don’t do any marketing. All of our growth comes from word of mouth.’
Though reluctant to give away too much when it comes to figures, Zdanowski says Linden Lab has been cash flow positive for over a year, and is now net income positive.
The company has grown from having about 70 employees to almost 250 during his tenure, and it’s this kind of growth that really gets his blood pumping. ‘I really enjoy the rapid growth and the entrepreneurial nature of the company. The intellectual stimulation here is off the charts,’ he says.
Interestingly, despite his success in managing the finances in such fast growing firms, Zdanowski was not formally trained as an accountant. He started out as an electrical engineer for General Electric, before going to Harvard Business School.
After short stints in management consulting and investment banking, he found his way into the internet, and 10 years on, he’s on his fourth internet company. The first two he was involved in were hosting companies, and before joining Linden Lab he was the CFO at HouseValues, a US real estate marketing website which he took public in 2004.
Watch this space
His experience with HouseValues’ IPO was reportedly one of the reasons he was hired at Linden Lab, and the recent announcement that Rosedale would be stepping down as CEO fuelled speculation the company may go public. Zdanowski was tight lipped on the topic, except to say: ‘We certainly have the numbers and we could go public now, the financial markets notwithstanding.’
With more than one million people logged into Second Life in February for approximately 28 million user-hours, virtual worlds are impressive but not exactly taking the world by storm just yet. Zdanowski believes it’s only a matter of time, however.
‘The number of people with email accounts in 1992 was extremely low, just as the percentage of people on virtual worlds today is extremely low,’ he says. ‘Over time, if the technology continues to improve, it will be normal for people to interact in virtual worlds.
‘Just like it happened with the internet itself eventually every company needed a website and eventually every company will be using virtual worlds as well.’
Virtual accountancy
So far the profession hasn’t exactly been beating down a path to the virtual world, but slowly and surely, accountancy is starting to trickle into platforms like Second Life. Those firms that have established a presence in virtual worlds have done so to connect with future accountants and potential employees, and universities have also been quick to realise the potential of virtual worlds as a learning tool.
The Maryland Association of CPAs set up CPA Island in Second Life, and also started up the Second Life Association of CPAs. They run virtual programmes and classes that allow American CPAs to earn CPE credits, and they also hold virtual world meetings, exhibitions, networking events and conferences to promote accountancy. Maryland accountancy firm Katz, Abosch, Windesheim, Gershman & Freedman were the first firm of accountants to set up a virtual office in Second Life.
Dutch firm Berk, an affiliate of Baker Tilly International, last year became the first European accounting firm to open a virtual office in Second Life. Their office plays host to meetings between employees, and is also used to engage with those currently studying finance.
KPMG recently turned to Second Life as a recruitment tool. Along with Yell and the Royal Bank of Scotland, KPMG took part in a job fair hosted by TMP Worldwide last year. Deloitte’s US arm used a virtual world team challenge to teach high school students about careers in accounting. IBM is looking to develop an in-house version of Second Life for businesses.
