Hot topic of the week would be the Linden Lab layoffs. 30% of the staff (roughly 110 or so individuals) were laid off this week in a round of layoffs that we spotted ahead of the official announcements. Additional staff have been shed since the beginning of the year.

Staff have been dropped from market-development, business development, engineering, quality assurance, human resources, community and executive management. Hardest hit this week are community and customer-advocacy roles and quality-assurance/testing.

What isn't hard to see is why these cuts were made, and in fact, why they are vital to Linden Lab as a going concern. At least it isn't hard to see when you're looking in the right place.

Through the course of this week, I've had a number of news journalists coming to me looking for help with interpreting Second Life economy figures, Linden Lab's business model and so forth. A number have expressed dissatisfaction at the responses (or lack thereof) from Linden Lab on these topics, and sought me out.

While I was working through some of the questions of Daryl Chin from The Straits Times, something occurred to me that I really already knew but had carelessly overlooked in all of the recent unwarranted hoopla about Second Life's economic growth.

So, bear with me a moment, and we'll get to the bottom of it.

Linden Lab has three basic ongoing revenue streams. There's tier fees, regions, and Supply Linden.

You might think "What about premium accounts?"

Well, count that under tier fees. The few dollars each month per premium account are negligible anyway, really. It's the tier fees that stack up there.

Regions are all the land fees that aren't covered by tier payments. That's new simulators and upkeep for existing simulators.

What concerns us at the moment is Supply Linden.

The Second Life economy is the sum of the demand for the available goods and services that can be obtained through Second Life. In order for Linden Dollars – as a medium of exchange – to remain stable and to not destabilize the economy, the number of Linden Dollars in Second Life must fairly closely match the value of the economy.

If too many Linden Dollars exist, for example, prices inflate and the Linden Dollar devalues. If the disparity were to become too great, the economy would simply collapse. You can look at any troubled or failed national economy through the last century or so for examples of how this happens in practice.

As the economy grows, demand for new currency grows and Supply Linden fills that gap.

Now, while Linden Lab's reading of the Second Life economic metrics are utterly unrealistic, there has been growth in the economy through 2009 and that growth has been matched by Supply Linden. Supply Linden generates revenue based on the growth of the Second Life economy, and not from its size. That's an important point.

We'll work in US Dollars and assume an exchange rate of 265 to one US Dollar, which isn't a bad rule-of-thumb. If you don't like that number, you can do the same math that I have with any exchange rate you find more realistic. The answers will come out very much the same.

Linden Dollar supply by quarter

Let's look at the four quarters of 2009, their growth based on Linden Dollar totals, and how much profit Linden Lab might have pulled in from them.

Q1 2009: 4.32% growth, about US$924,000 profit.
Q2 2009: 4.81% growth, about US$1.07 million profit.
Q3 2009: 5.8% growth, about US$1.36 million profit.
Q4 2009: 5.9% growth, about US$1.46 million profit.

There's roughly $4.8 million USD profit for 2009 from this one revenue stream. If it were to continue at Q4 2009 levels that would be $5.83 million USD each year or about US$17,380 per day.

That's a very tidy revenue stream, especially as it is one that has virtually zero costs associated with it.

Now in January, Linden Lab started advertising Second Life, which is a rare event in and of itself. It boosted user-to-user transactions, which the Lab mistakenly presently believes to be related to the size of the Second Life economy.

What happened with Linden Dollar supply in Q1 2010?

0.67% growth, or about US$177,000 profit. That's an eighty-seven percent reduction on the previous quarter!

At present, I'm making no suggestion that the advertising and the reduction are related or unrelated. What happened is that the economy leveled out. It stopped growing significantly. It didn't shrink, but just plateaued.

Q2 2010 isn't over yet, but according to Tyche Shepherd's figures, the first two months of Q2 have generated exactly zero Linden Dollars from Supply Linden. That's zero US Dollars profit for those of you keeping score at home.

In essence the Lab has lost roughly 1.5 million USD from its balance sheet every quarter from this single revenue stream. Almost 18,000 USD per day.

That has to hurt. And without risking collapsing the economy, that's pretty much where it has to stay until the economy starts growing again.

That makes cost-cutting absolutely necessary. Unavoidable. It's all about the bottom line.

Linden Lab has grown corpulent and jolly living off the fat that is Supply Linden, and now that fat is gone, and we're into lean times until the Second Life economy begins to move firmly upwards again. When that might be is beyond my ability to predict. It could be tomorrow, or a year from now or never.

If the economy has shrunk then it will take just that much longer for growth to generate any revenue on this stream again.

This article was originally published on Massively.