It wasn’t long after Disney slapped down US$350 million to buy Club Penguin and Webkinz.com took over the toy world in 2007 that the hype surrounding kids virtual worlds went into overdrive – creators and venture capitalists readily flocked to the space in the hopes of producing the next big thing. It’s been two years now, however, and the fledgling industry has had one big virtual reality check.

For one thing, the level of VC investment has plummeted – and it’s not just because of the faltering economy. New York-based Engage Digital Media estimates that the more than US$1.4 billion plowed into virtual world development in 2007 shrank to just US$594 million in 2008. And from that figure, 19 youth-targeted properties shared just US$70.47 million. Moreover, the seemingly endless stream of internet-based communities isn’t yielding any big hits and it’s becoming even more challenging to grab a portion of kids’ already short online attention spans. The NPD Group recently found that revenue for the once red-hot category of web-connected toys, driven primarily by Webkinz, dropped 43% in the first six months of 2009 from the same period in 2008. So what does a virtual world have to do to make a go of it in this environment?

The folks at Sulake, the force behind teen-targeted virtual world Habbo, are all too familiar with the changing landscape, as well as the fickle nature of its target audience. ‘In early 2000, it was enough if you could create your own avatar, talk to your friends and make new friends,’ says Teemu Huuhtanen, EVP of marketing and business development and president of North American operations. ‘But nowadays, you have to offer so much more. The expectation level from the end user’s point-of-view is much higher than it used to be.’

Sulake, for its part, is big on getting user feedback, which has been an essential element in bringing its current worldwide registered user count to 142 million (90% of which are between ages 13 and 19). The site also requires a constant stream of new content, and Huuhtanen says smaller, two- to three-week features and promo campaigns have been much more successful than those that run for a couple of months. ‘The basic needs of socializing are still the same,’ he says. But the difference is that user demand for cooler ‘room’ items has increased along with facilitating new ways to connect with virtual pals. To that end, Sulake looks to stay on top of trends. Accordingly, it has just teamed up with Summit Entertainment to bring tween/teen sensation Twilight into Habbo. Branded virtual vampire-inspired furniture and accessories will be available at the site around the same time The Twilight Saga: New Moon hits big screens on November 20.

The company is also working on embedding Habbo on other websites. ‘I think that’s going to be the next phase of bigger development,’ Huuhtanen surmises. ‘It’s just not enough that you’re a destination site; you also have to be on different platforms. Wherever the users are, you have to find a relevant way to be on that platform as well.’

And for hopeful entrants, all is not lost. Even though investment in virtual worlds has dropped, it’s still an emerging market and venture capitalists are keeping a close watch. Among them are Montreal, Canada-based iNovia Capital and ID Capital, which invested US$2.47 million in digital game/virtual world company Tribal Nova (also in Montreal) this past spring to support its growth internationally.

Bernie Li, a principal at iNovia, says he found the Canuck developer’s well-seasoned exec team – which boasts years of experience in children’s media, TV and the marketing industry – attractive in terms of making an investment. Tribal Nova also has educational brand power on its side, having partnered with PBS Kids and French publisher Bayard to develop online worlds and services in the last 18 months. ‘Here we see a media partner’s confidence in a company such as Tribal Nova, which is benefiting from the existing audience of the media partner,’ says Li. ‘And that’s a very different strategy than we’ve seen other media companies pursue in the past.’ Additionally, Tribal’s focus on the international market was a selling point, as Li believes it will yield more expansion opportunities than most new virtual worlds which concentrate on breaking in North America.

Even State-side, a few new worlds are managing to get off the ground. Irvine, California-based Masher Media is a good example. Its upstart site MyMiniPeeps.com got the attention of investment network Tech Coast Angels and secured US$300,000 in funding. At press time, it was being considered for another US$500,000.

At the helm is CEO Sherry Gunther, armed with 20 years experience in kids entertainment, including work on Family Guy and various exec roles at Hanna Barbera and Cartoon Network. Gunther notes that the virtual world explosion also brought about a technology boost, opening the door to new possibilities. MyMiniPeeps targets the six to 13 crowd and is set for a fall 2010 rollout. It has many features now common to virtual worlds, but ups the ante by giving users control in contributing to the virtual economy. ‘The idea was to empower kids to really run the community and shape the world they play in, rather than just visiting and hanging out.’

The 3-D environment will house mini-games directly related to running the world. If an avatar wanders into an ice cream shop, it’s required to start serving up dessert – a chef yells out orders, and the roller-skating avatar has to navigate the hazard-filled dining room to deliver the right order to the right customer. Play fast enough and members are rewarded with bigger tips to purchase virtual goods.