Saturday, October 15, 2005

A Game Business Model: Learning from Touring Bands

Most metropolitan areas sport a wide array of bands that eke out a reasonable living by touring about the nearby countryside. At every stop, they get a bit of cash from the till, sell a handful of t-shirts and maybe even an album or two. If they are good, they build up a sizable population of groupies that worships the ground they walk on and follows them from show to show.

Very few people outside of the circle of fans know who these bands are. Yet the moderately successful bands make enough to get by and a few even manage to prosper. These bands do not sell a product like their mass market Brittany Spears brethren. Instead, they survive by providing a service to their devoted fan base.

Over the past several months I’ve been tracking several successful online game developers who operate in a similar fashion. Each operates profitably, employs a small staff and appears to be growing. Their names include Jagex, Iron Realms, Three Rings and Iron Will games. Chances are that you’ve never heard of them.

This essay is about illuminating a successful, alternative, business model that has the following key characteristics:
  • Supports large numbers of independent game titles in a low competition environment.
  • Is amendable to bootstrapping and thus avoids the need for large publishers, money men or other controlling interests.
  • Encourages unique pockets of innovation.
  • Offer an opportunity for sustainable, lower risk profits for a small group of developers.
A business lesson learned from touring bands
A touring band cannot rely on selling millions of copies at $17.95 a pop to anonymous music fans across the nation. Instead, they make their money by selling a wider range of goods and services to a narrow group of fans. There are really only two ways of creating a reasonable revenue stream. You can get a little bit of money from a large number of people. Or you can get a lot of money from a relatively small number of people.

Touring bands aim for the later. They build a brand based off a powerful social experience and establish a strong relationship with their customers. They then leverage this brand to encourage the sale of merchandise, event tickets and more. The result is a strong lasting brand and high per customer revenue.

There is a classic business case taught in most MBA entrepreneur classes that examines the 30-year reign of Grateful Dead. Even though they allowed free taping of their concerts and capped their ticket prices, they remain to this day one of the top grossing bands of all time. They bucked the trend of selling records through the corporate food chain and instead provided music directly to their fans.

There is a simple lesson here. A dedicated fan base combined with a service-based business model can be a great foundation for an owner run business.

Modern games are the equivalent of a Backstreet Boys album
Games have typically relied on the opposite strategy. In order to participate, you first need to get a giant publisher to fund your game development. Then the finished retail game is marketed to a broad audience and if everything aligns, a title can sell the million plus copies necessary to break even.

The result of the standard mass market business model is quite predictable:
  • Emphasis on big mega hits in order to break even.
  • Requires the upfront investment of large amounts of money. If you were a garage band, expect to lose your intellectual property.
  • Products tend towards bland ‘pop’ experiences in order to maximize the market opportunity. More than likely, you are a studio band assembled for the sole purpose of being the next Monkees.
  • High risks of failure due to intense competition in the broader market
What do touring bands have to do with games?
Games are by no means rock bands (despite the existence of lovely men like CliffyB.) However, we can apply the basic business techniques practiced by touring bands to the newly minted field of online games with good success.

Let’s look at what the companies I mentioned earlier are doing.
  • Three Rings produces an online game called Puzzle Pirates that focuses on casual puzzle games in a persistent online community.
  • Iron Realms makes a series of text-based MUDS.
  • Iron Will makes a 2D Ultima Online-style MMO.
  • Jagex makes a web-based 3D MMO.
  • Sofnyx makes a multiplayer Scorch Earth game called Gunbound.
  • There are others, but they all operate far below the radar of the mainstream gaming press.
The similarities are worth noting. Each started with a small community numbering in the thousands. Many customers have been with the games for years. Each operates either a micropayment or a subscription model that doesn't cap the amount of money the customer wishes to spend. Though none of these companies publish their numbers, rumor has it that they are almost all profitable.

Development costs were low and initial investment came from the team members, friends and the occasional angel investor. Publishers or venture capital was almost never involved.

The differences are also important. Core gameplay ranges from puzzling to shooting to turn-based combat. There is a bit of a focus on fantasy worlds, but from what I’ve gathered there is little overlap in the core user bases. Currently this means little competition from similar games and rumor has it that the impact of larger MMO’s is relatively insignificant.

These games are the equivalent of small successful touring bands. They provide a service, not a packaged good. They sell to a dedicated fan base that despite being small provides enough additional revenue per user to make the venture profitable. The result is a self-contained community served by small team of dedicated independent developers.

Village Games (Aka the Small Multiplayer Online Game)
I call these small online multiple games ‘village games.’ They are quirky, isolated communities much like a traditional village or small town. The communities tend to be a bit more friendly and insular then their larger city-sized brethren such as Everquest or World of Warcraft. The game play tends to be a bit more unique and able to take risks.

Here are some defining factors for a village game.
  • Focus on creating a small community numbering typically in the thousands.
  • Either subscription or micro-payment based revenue model. Often there is no cap on the amount that a single player can spend inside the game.
  • A small development team, usually numbering anywhere from 3 to 10 people.
  • The game experience is addictive for a year or longer.
  • The game focuses on a niche experience that is not provided by larger retail titles.
A village games is a distinct service-based offering that is separate from other forms of games. It certainly isn’t a retail title. It isn’t an ‘indie game’ or a ‘casual game’. Those are packaged goods titles that are merely trying to sell the same old shite through a different channel. It isn’t a mainstream MMO because the funding model and number of people served is radically different.

So why in the world would a designer be interested? If it weren’t for a few critical factors, we could write these titles off as a peculiar niche sub-genre.

Business factors
In order to paint a practical picture of how village games operate, I compared the genre to retail titles in eight major categories:
  • Core Business Drivers: How do you make money?
  • Upfront investment: How much does it cost to start the business?
  • Break even and Payback periods: When do I get my money back?
  • Sources of Equity: Who funds my game?
  • Ownership: Who owns the fruits of my labor?
  • Risk of Failure: What are my chances of success?
  • Potential Upside: What do I get if I succeed?
  • Competitive Insulation: Who is going to stop me from winning?

The results are fascinating and suggest that the village game market is a great opportunity for entrepreneurially minded game developers.

Core business drivers
One of the most tricky aspects of understanding village games is the fact that they are driven by completely different business metrics than games sold as packaged goods. Switching your brain over to thinking about quality of customers, not quantity, is the first step.

A retail title gains a developer roughly 70 cents per copy sold. The publisher gains about $18 per copy sold. The price of each copy is fixed and has mere weeks before substantial price erosion takes place. Making money is a matter of selling as many copies as quickly as possible. The viewpoint is always short term and focuses on shipping and placing physical goods.

A village game, on the other hand, is instead about keeping and maintaining customer loyalty. A typical customer will spend an average of $60 a year and stays on for an average of 18 months, with some players staying for years. The developer generally keeps all $60 in revenue. Making money is a matter of maintaining your current customer base and incrementally increasing that base over time. The viewpoint is almost always long term and focuses on maintaining and extending customer relationships.

To put these numbers in perspective a village game customer is roughly 130 times as profitable as a retail customer for the game developer. This means that a game developer can sell less and make more profit.

Upfront investment
However, a highly profitable venture is of no use to your typical game developer if the cost of starting up the venture is too high. Upfront investment is the amount of money that you need to put into a project until it begins to pay for itself. It is here that village games truly shine.

A typical retail game will run anywhere from $2 to $10 million over an 18-month development period these days. In my model I choose a mid-level next generation title that costs about $3 million to develop, plus another million in marketing. Someone needs to sink $4 million in cold, hard cash into a project before they see even the glimmer of profitability. A next generation mid-level retail title must sell roughly 800,000 to 1 million copies to reach profitability.

A village game requires total investment of roughly $250,000 over an 18-month period. In essence, you are paying for the salary of the development team plus miscellaneous marketing and server expenses. At 18 months, your game starts making enough money to pay for your monthly expenses without having to go begging. A village game with 3 to 4 employees needs to maintain a customer base of roughly 6000 to 9000 users.

At this point, you've reached what is known as 'Break Even'. That is when your monthly expense are equal to your monthly revenues. You'll notice that in my model both the retail game and the village game reach break even at the same time. The nice thing is that the village game consumer 12 times less cash in the process.

Payback
If you were an investor, there's another metric you'd be interested in called Payback. After you've sunk so much money into a project, at a certain point you'd like to get it back. If you took out a loan, you'll have to pay it back. If you remorgaged your house, you'd like to unmorgage it as some point. Payback is the point in time at which the vast profits from your venture accumulate to the point where you can payback your initial investment.

For a retail game, the sales come in a giant spike upon release. Payback occur almost immediately, typically 18 to 20 months after the start of development.


Here village games show their first sign of weakness. Payback occurs after about 30 months. If your goal is making large amounts of profit (or 'greedy pig profits' as a profession in economics termed it years ago) village games are a long haul.


From a developer's perspective, this means two things. If you are in the business for making games, the path to profitability is roughly the same for retail and village games. If you want to simply make a big profit, retail games will get you there more quickly. However, you need to take into account both risk and your ultimate goals.

For the moment, I'm assuming that you are in it for the love of making great games and that the slow road is just as good. In that case, you need to consider how to fund your village game.

Sources of equity
Funding is the boogie man of game development. We have nothing like the 'producer' structure that exists in movie industry where rich folks toss good money at creative entrepreneurs. Instead, we have the publisher system, aka 'selling your soul'.

When you are dealing with millions of dollars in start up costs, the requirements of an advanced distribution channel, and low success rates, a portfolio model of funding retail games is inevitable. Publishers rule the roost for good reason. They are the only ones who have the critical industry knowledge to fund and maintain a quality portfolio of retail game titles. In general, a company must fund 20 to 50 titles a year in order to maintain a positive return on their investment. Your game can not simply be ‘good’. It has to be the correct puzzle piece that fits in the middle of a highly nuanced portfolio mix. Due to all these factors, getting funding for a retail title is nearly impossible.

A village game operates in a completely different world. Due to the relatively low burn rates, it can be funded with ‘sweat equity’, the main developers working for a pittance. It is also amendable to both friends and family investment as well as angel investment. As a village game grows its customer base, the revenue and profitability numbers became much more exciting to smaller VC companies. You'll need to find folks who are comfortable with the longer payback period associated with village games, but that is not an insurmountable hurdle.

The upside of all this is that unlike a retail title, a village game has readily available sources of start up funds and means of supporting growth at later stages if desired. This ready access to seed money is perhaps the strongest benefit of all that village games have going for them. There is no excuse to not make a village game.

Ownership
A major side effect of the funding model is that retail games and village games have radically different ownership models.

Retail games give over ownership to the publishers. They typically own the rights to original license and have full managerial control over the development and execution of the title. All of the risk and all of the potential upside is owned by the publisher. The game developers are studio musicians that do their job for a meal and a place to sleep. The result is often craftsmanship, not entrepreneurial breakthroughs.

A village game tends to be owned by the developers themselves. They take on all the risk, but they also get a bit of the upside if they succeed. Personally, I’m a huge believer in the entrepreneurial spirit. Overall, a company with an ownership culture will be more agile, more profitable and more innovative than one that treats their workers like hired guns.

Village games lend themselves well to lifestyle businesses. They are exhausting initially due to their reliance on sweat equity. However, as a steady subscriber base is built up, that company has more freedom to combine work and play.

Risk of failure
There is a more pratic reason to consider starting up a village game. Most games fail and there is nothing more crushing than working on a title for multiple years and seeing it crash and burn. Village games offer smart teams the opportunity to steer their way out of danger.

Retail games have an impressively high risk of failure. Only 116 games out of roughly 5000 released in the US since 1995 have broken 1 million in total unit sales. A mid-level title needs to sell almost a million copies to break even. For next generation console titles, a 5 to 10% break even rate will be impressive.

Releasing a retail title is like firing a solid gold cannonball at a moving target while wearing a blind fold. Retail games get one shot at success during a short 4 to 8 week release window. If all factors are not perfect, the title’s sales will suffer. This risk of failure is also almost entirely due to market factors that are outside the control of the development team. Items like the funding of other teams, the marketing spend, the release schedules of other major titles and the whims of the player all are big factors.

Village games, on the other hand, typically experience a soft launch. An initial version of the title is released into the wild and it attracts a few customers. The developer has the opportunity to adjust their title in order to fix the most egregious errors. Often a title will evolve over a period of years, until it matches the demands of the target audience nearly perfectly.

Village games succeed or fail based on the skill of the developer and their ability to successfully target a niche market with compelling game design. If you are an experienced game developer, you have a much greater chance of creating a successful village game, than creating a financially successful retail title.

Upside
At this point, some of you may be intrigued by the thought of making a village game. There will be some of you that are wondering how much money such a enterprise could gain you. It turns out that regardless of your business model, you still need to make games for love, not money.

Retail games can make over a billion dollars with a single title. That is rather exciting. However, as a developer, you are going to see approximately none of it. Royalties, for all intents, are a myth propagated by those good folks who wish to hire fresh labor at inexpensive rates. If you are a developer on a retail game, the upside of successful title is that you get to keep your job until the title is released. If you do a really good job, your team is signed on for a new title and you have job security until it is released or canceled.

A successful village game will produce a steady profit, but the money never becomes astronomical. Instead, you'll be able to provide above average salaries and many years of job security. This is far better than most games can promise.

Competitive Insulation
The long life of a village game occurs because it is highly insulated from direct competition.

Such a thing is unheard of in the retail market. Since a successful game must capture such a substantial portion of the market in order to achieve profitability, games are almost always in direct competition with one another. The result is a massive arms race that is quite difficult to win.

Village games exist in a far less competitive environment.

  • First, they are able to target themselves at a niche game mechanics. The hardcore Scorched Earth-style gameplay of Gunbound is unlikely to be replicated by World of Warcraft anytime soon.
  • Second, they build strong communities that resist the siren call of external delights. Sure, World of Warcraft has some great content, but is it enough to make you leave your friends behind?
  • Third, they are very low profile. Since these games are often built through low levels of marketing and word of mouth, it is uncommon for their players to even realize that alternatives exist. For a retail game this would be fatal. Since a village game can survive on such a small number of subscribers, it is actually a competitive advantage. In that same population of 3 million WoW subscribers, you could have 300 completely viable village games.

All of this has a surprising impact on innovation. When you only have to worry about satisfying your little niche, it becomes more worth your while to explore local maxima in your game design. Irons Realms sports some of the most intricate political systems ever found in a commercial game. Puzzle Pirates has created a PvP combat system that appeals to 30 to 40 year old women. With innovation comes additional competitive insulation. Go ahead, EA. Just try to clone Gunbound. I would pay good money to see the results.

Wrapping it up
By this point, you should have a good overview of some of the business dynamics behind successful village games. In short, here is a unique business model that provide low entry barriers, low competition, easy access to seed capital and copious amounts of creative freedom. The money is good, but not great. However, the chance to build your very own profitable game company is nearly priceless. That is a dream that was crushed out of most developers long ago. The basic business drivers of small numbers of highly profitable customers make it all possible.

I’ve been looking at game business models for some time. Very few offer an entrepreneur any reasonable chance of success. I understand the retail business and keep my hand in it, but it is often too volatile for anyone except the bright-eyed youngsters and the sharks that feed upon their efforts.

As I slowly grow older and more conservative, I’ve started looking for a way to mixing game development with a stable family life. There are two paths. The first is to become a manager in the upper echelon of the current industry. If you can get to the portfolio management level of the retail industry, a lot of the turbulence lessens. But you lose the daily interaction with the development teams, and for a lot of us, that is what this is all about.

The second path is to go outside the industry and find a new niche for game development where the profit margins are still fat and the role of being an owner / developer is still a viable option. I’ve talked a bit about Serious Games as one option on this path, but to be honest I can’t stomach the steady diet of military and government projects it typically entails. Village games, on the other hand, excite me.

Here is a market niche where a passionate team with a bit of money put aside can carve out a viable, vibrant community that is insulated from outside competition. They can perfect a game over years of face-to-face interaction with their biggest fans. Most importantly, they can own their own destiny, be it success or failure. And to be honest, the odds aren’t bad.

Have band, will travel
Hundreds of bands have tried to make a living touring their local cities, playing gigs and selling t-shirts. Most fail, but a few succeed because it is a real business model that provides a solid service to fans of live music. It is a hard life, but you are your own person and you get to do something that you love. These scrappy little groups are hidden from the mainstream media until one miraculously breaks out to the surface. Maybe they are a Nirvana, or a Beatles, or a Grateful Dead. But when one emerges, the industry is changed forever. And the people in the suits who diddle with the numbers on their portfolio spreadsheets ask, “Where the heck did they come from?”

Village game developers are the true touring bands of the game industry. They are at a sweet spot with low competition, moderate returns and the chance to own your own game development company. You’ll need a game designer with a bit of a business head. He’s the songwriter. You’ll need a programmer who isn’t an asshole. He’s the lead singer. You’ll need an artist. He’s wailing on the lead guitar. You’ll need the web / infrastructure guy. He’s in the back laying down the drum line.

Given enough passion, enough skill, and enough years tuning your sound out on the road, and maybe, just maybe, you will give birth to the next great game that shakes the foundations of the entire industry. The simple truth is that the tour is an end all by itself.

So what are you waiting for?

Take care
Danc.


References

Escapist article on Boutique MMORPGs
This was a nice trackback on my article that describes quite a few more games that fit the criteria and also gives some solid numbers.
http://www.escapistmagazine.com/issue/75/15

Examples
Grateful Dead
Retail: Royalty break downs PS: Edited this at 11:36pm, Oct 19th to improve the flow. Edited on Dec 29th to add additional links.