Creating an “Ideal” Game Publishing Market

I’ve avoided writing articles on this subject over the years on the off-chance that I would want to start another online game publishing business at some point but my interests have evolved over time and I suspect that many people would benefit from a better understanding of how to create really successful game publishing marketplaces (Sony, Microsoft, Nintendo, Apple, Facebook, I’m talking to you guys).  Today Facebook and Apple stand as the “best” examples of relatively open game publishing markets on the Internet.  As successful as they are,  they lack several important properties of what I would consider an “ideal” market.  Obviously the definition of “Ideal” sounds fairly subjective so it’s important to define what I mean as clearly as possible before we talk about how to construct one.

By “ideal” market I mean that the interests of all of the various participating parties are balanced and “fair” in the purest capitalist sense.  By “capitalist” sense, I mean that all participants in the market are rewarded in direct proportion to the paying consumer’s perception of their value contribution to the market.  An “ideal” market defined in this fashion is also an optimally efficient market, meaning that the markets total size is maximized because there are no artificial biases in the market that favor one participant at the expense of another.  Most real world markets are biased in favor of  the channel over others which generally results in the channel making a greater profit at the expense of the markets overall potential size.  Facebook and Apple are both examples of biased markets that sacrifice scale and efficiency for bigger profits to Apple and Facebook.

Both Apple and Facebook charge a 30% sales tax on all commerce revenues and dictate that all market participants rely solely on their commerce platforms.  The result of course is that a certain body of games that some people may want to consume cannot be profitable on these channels with a 30% tax imposed on their revenues.  Both the channels (Facebook and Apple) lose potential market size in favor of extracting higher profits from the smaller market of content that can be profitable with a 30% tax imposed on all of their commerce revenues.  In a large marketplace such as these companies operate it might be fair to observe that the 30% commerce tax helps eliminate bad content from the channel, which is true, BUT it also prevents innovative or new content from being discovered because the risk of creating games that are innovative is much greater given the increased cost of recovering the developers investment in the presence of a 30% tax on all revenues.

To properly analyze how to create an “ideal” game publishing market let’s start by defining the interests of each of the markets various participants.

Consumer:

The consumer has a limited amount of time available to spend consuming entertainment and presumably a limited budget.  The consumer wants to maximize the quality and flexibility of their limited entertainment time at the lowest price possible.

Channel:

The “Channel” generally represents the “shelf-space” provider for the content as well as the “cash registers”.  In an online world a channel can be more abstract but most people understand that Apple devices and Facebook are good examples of online channels that fit this descriptioin.  They provide virtual shelf space for online games as well as the commerce vehicle for consumers to purchase content.  The Channel’s interest is to maximize the revenue and profitability of their limited shelf space.

Developer:

Developers create the content that consumers hopefully want to consume.  Their goal is to minimize the cost or initial risk of their content investment and of course maximize their return.

Advertiser:

Advertisers are third parties who want to monetize a gaming audience that popular content has attracted to a channel.  Online an advertiser can generally be thought of as an alternative to a commerce transaction, which means that in order for an advertisement to be worth showing the advertiser must be willing to pay more to show the ad than a consumer is willing to pay not to see it.

The relationship between advertising and commerce is extremely important in constructing an “ideal” business model for online games because advertising is generally sold in an auction, which as most readers will know is the most efficient way (known) to establish a market price for a good or service.  Advertising also has the property that it can be transformed into a commerce equivalent price by the following equation;

 CPM value of game content = The probability of the user engaging in a commerce transaction      X     The probable value of the commerce transaction    X    1000

*Note that for this equation to have practical application the games that adopt it must be divisible by units of content value that fit in a $.50-$200CPM price range.  This is true of MOST microcurrency based social games

Lastly, in most cases, the most valuable potential bidder for advertising space in a game is…. another game… which means that an advertising auction provides an efficient mechanism for many games participating in a marketplace to compete for shelf space by buying advertising from one another.

What does this observation about the value of advertising mean for creating an “ideal” game publishing market?  It means that if Apple and Facebook wanted to maximize the size of their game markets and participate “fairly” in the share of revenue their channels are responsible for creating they would charge as little as possible for commerce transactions and instead operate the market for advertising in their channels keeping only 100% of the revenue from non-gaming advertisers.  Economically speaking this is the portion of the revenue that corresponds directly to the market value of their shelf space + commerce platform independently of the value of the content ON the shelf space.  Since non-gaming advertisers are effectively bidding for the right to put content on the shelves that the consumers are explicitly NOT looking for they must bid the maximum value of the space to get a presence on it since presumably no consumer will pay the channel to buy the product being advertised.  (Microeconomic speak for “this is a fair way to determine the channels cut of game revenues”)

Why does this model produce an “ideal” publishing market and why should Apple or Facebook favor it over a business model that currently gives them a disproportionate share of the revenue generated by their channels?  Because the wonderful thing about a free online game market is that ANY inefficiency in one channels business model creates opportunities for competitors to capture a share of the market for themselves.  Theoretically if anybody created a completely efficient game publishing market, all other competitors would eventually die off.  In effect Apple and Facebook are making higher margins for themselves on MUCH smaller markets as a result of their business decision to operate biased markets.  The result is short term higher margins for themselves but less content and more competition for their audiences.  Increased competition not only means smaller audiences for their channels but also lower overall prices because consumers have alternatives they can go to for games if they feel that Apple or Facebook’s 30% tax on all revenue makes the games in their channels too expensive for them.  In other words, the overall online game market is smaller and everybody makes less money when the companies who control the leading game channels bias the markets they operate in their own favor.

Now let’s examine how an “ideal” game publishing market might operate.  In an “ideal” game market the consumer gets all the content they have time to consume in exchange for as much money as they are willing/able to spend for that content.  In an “ideal” market the channel profits in direct proportion to the actual value their channel and commerce vehicle provides to the content.  In an “ideal” market game developers profit in direct proportion to the value consumers place on the content they create and in an “ideal” market advertiser’s will pay as much money to advertise their goods and services to a channels “free” players as the paying players pay overall for access to premium non-advertising supported content.  In other words if you visualize a scale of justice, the total dollars spent by advertiser’s to sponsor free content to non-payers should balance the total dollars spent by consumers paying for premium non-sponsored content even if the ratio of paying to free consumers is 1:100.

In such an “idealized” market how much money will everybody tend to make?

The Channel will keep 100% of all advertising revenue that is NOT other games in the channel buying advertising.  What this statement means is that if Nike or Coke wants to sponsor free gameplay in a particular game, they will need to pay, on a CPM basis, as much money as it costs to replace the commerce revenue the game might otherwise have generated selling itself.  Since most games only monetize 1-3% of their audiences that means that 97%-99% of available gameplay is sponsorable by advertising.  Clearly there will be some in-game content that may be so valuable that it is too expensive for an advertiser to sponsor for free and that content will only be available for consumers via commerce purchase.

Those of you who have not read my previous articles on quantum economics may perceive that it is impossible to mix advertising and commerce because the availability of free sponsored play will cannibalize commerce revenues out of existence.  This is true in the physical retail world but as my previous articles on this subject demonstrate is a solvable problem in online commerce because the channel frequently has enough data about consumer behavior to predict algorithmically with very high precision which users are potential commerce buyers and WHEN they are likely to make a purchase.

The reason the total dollars earned via advertising and the total dollars generated via commerce should tend to balance each other is because in an “ideal” market the consumer is effectively bidding AGAINST advertiser’s for the value of their own entertainment.  In other words, sometimes the content is more valuable to the consumer without advertising than it is to any potential sponsor, which results in a commerce transaction, in MOST other cases the value of advertising to the consumer exceeds the consumers’ willingness to pay NOT to see advertising and an ad is shown.  In this respect you can think of ALL advertiser’s combined functioning as one unified bidder in an auction against the consumer who is bidding on their own behalf.  Clearly in a two person auction, one party will never outbid themselves so on a large scale advertising dollars will tend to balance evenly against consumer commerce dollars.

This idealized scenario isn’t always practical in the real world because there are many common situations that create inefficiencies in this kind of asymmetrical auction between advertiser and consumer.  For example the game designer may not have designed the game in question with small enough units of value to satisfy the needs of the Commerce to Advertising CPM transformation.  It would be impossible to get an effective auction going for $60 copies of Halo for example because there are few if any advertiser’s willing or able to buy $60*1000 = $6000CPM ad units.  (This was the whole reason for the failure of the foolish in-game advertising craze led by Massive a few years ago.  It was a stupid idea to try to stick advertising in games that consumers had already purchased)  On the other hand, the game may have such a low monetizable value that nobody would carry out a commerce transaction to buy a pennies worth of play, as is typical of many free flash games.

As a result of there being an extremely wide range of “values” that people assign to online games between free ad supportable content and premium commerce only content AND most companies poor understanding of how to hybridize advertising and commerce correctly, most online publishing channels are highly inefficient and capture only a small portion of their audiences available play time or potential revenue.

Returning to the original question of how much each market participant will tend to make in an “ideal” game market; Consider that ad dollars should equal commerce dollars and that the most valuable ad dollars will tend to come from other games AND that I have advocated that the channel really only deserves the portion of the ad dollars that DO NOT come from other games promoting themselves.  Ad dollars will tend to be 50% of the market and in my experience running WildTangent using a related model, 40%-50% of advertising revenue came from other games which would leave 25%-30% of the channels revenue to the channel provider (Facebook and Apple in this example).  Now those of you reading this article might observe that Facebook and Apple are already getting 30% of the revenue via their commerce tax and I just proposed that they get 25%-30% of the revenue so what’s the difference?  The difference is where the 30% of the revenue comes from.  In their current model it is taken uniformly from all games regardless of their value contribution to the service.  In my model the revenue is taken mostly from games that you would never find on their service today because they are excluded.  Abstractly speaking it’s 30% of the overall revenue but all FOUND money resulting from the change in business model!  Very little of it would have come from most of the kinds of games presently found in their services, because their economics ONLY work for premium commerce based content.

70%-75% of the revenue would tend to go to the game developers.  However the distribution of that revenue would be very interesting because;

In general a small number of games are responsible for the majority of revenue in most online game channels.  The ratio approaches the classic 80:20 rule.  20% of the games make 80% of the cash.  Why does this consistently tend to be the case?  Simple.  After years of studying top performing online games versus weaker performing titles at WildTangent (reference earlier quantum economics articles to see some of that data) I found that there are three ways that an online game can perform well.  It can be very good at engaging an audience but poor at monetizing itself.  It can be very good at monetizing itself but poor at engaging an audience and lastly a game can be GOOD at doing both which makes it a hit.  The number of games that I found in my channel that were actually “BAD” games that nobody want to play OR pay for was very small.  The problem with most “less successful” games was that they were simply inefficient at maximizing engagement and monetization.  Most games traded one for the other and if they got the ratio wrong, their game was a lot less successful than a game that had gotten the balance right.  In other words the major difference between a hit game and a mediocre game was a series of content decisions in the game design that collectively represented a poor balance in the games ability to market and upsell itself.  It was also common for there to be too many of the same kind of game in the channel competing with each other.

This observation is important to designing an “ideal” market for online games because what it means is that games that are great at engaging an audience but poor at monetizing themselves are still a value to the channel, they “attract” audience to the store.  They are ideal advertising targets for high monetization games with poor engagement properties.  Thus games that monetize well will support games that engage well by buying traffic from them in the form of advertising!  Hit games will buy traffic from everybody and raise the CPM value of advertising across the channel thereby increasing the price at which non-gaming advertisers will bid to sponsor free play which in turn will generate more revenue for the channel itself.  Hopefully by now the “elegance” of this idealized marketplace is becoming clear.  We all know that hit games create the value for a gaming channel… for example the main reason that most people initially bought a $400 XBOX was to play Halo.  Thus a hit game shouldn’t have to “pay” for the privilege of being in a channel because it is the HIT content that is responsible for the channels success in the first place.  A game which is great at engagement but poor at monetization is a great source of potential advertising revenue for the channel and the game developer.  If the game developer keeps the portion of ad revenue that is generated just by other games advertising for their players, they will generally get roughly 50% of the ad revenue generated by their content while the channel pockets the other 50% in non-gaming ad dollars for themselves.  Premium games that are weak at self-marketing can buy traffic from other games in proportion to their monetization value.  Since the game developer is in control of their ad buys they can decide what percentage of their revenue they want to share with other game developers to acquire traffic.  If their game is “BAD” from a purely market point of view, then they will not be able to profitably buy traffic.

If I were to start an online publisher today or if I were Apple or Facebook, this is the model I would adopt in favor of my current model in order to increase my share of the game market.  Although they would be sacrificing some margin today, the result would be a much larger market for them over time because a much broader range of content would become profitable in their channels.

If you think these ideas sound too theoretical in nature, keep in mind that I successfully employed a more rudimentary version of this model at WildTangent which quickly became the #1 largest online game site in the US when the first Ad/Commerce hybrid business model was deployed in 2007.  Hi5.com became the 6^th largest online game network in the world in six months when I deployed another variation on this model there.  It’s not just economic theory for me anymore, these ideas have been tried in the real world on a huge scale successfully on at least two occasions and they are rooted in sound economic theory.

Before I conclude this article, it’s worth revisiting the subject of the channel provider’s investment in providing the commerce solution for their channel.  On one hand providing the commerce solution for a channel can create great efficiency of scale and ease of billing which has real value to the game developer and consumer.  On the other hand, dominating the commerce solution can stifle innovation in commerce models and monetization for games which is often unfortunate.  So the “value” of channels like Apple or Facebook controlling the commerce models in their channels can be questionable if they are not continuously investing in improving the efficiency and flexibility of their payment models to maximize their value to the developers and consumer.  Placing a heavy fixed tax on all commerce transactions in their channel certainly imposes a huge negative value on their solutions.  From an economic point of view, it’s a tremendous mistake indicating a lack of sophistication in understanding the economics of the businesses they are operating because they are discouraging premium content developers from entering their channel because premium content (hit games) don’t need their channel to attract players and they are discouraging engaging content developers because they can’t profit from making popular games with low commerce value.   Instead of embracing the value of enabling a rich inter-application advertising market between apps, channels like Apple and Facebook regard them as competitors to their commerce businesses and try to suppress them.  In short my instinct is to strongly suggest that these companies would be more successful over the long haul if they minimized their commerce tax in favor of providing a highly liquid inter-application advertising marketplace.

Given that Apple and Facebook are both publicly traded companies with a significant revenue base tangled up in their entrenched business models for gaming, they may not be in a position to be very innovative or competitive in this space… however I would also observe that there are all new online publishing channels entering the market this year in the form of next generation consoles from Sony and Microsoft that are NOT necessarily deeply committed to any particular online business model yet and who NEED to catch up with Apple and Facebook in online gaming by perhaps taking a more developer and consumer friendly approach to the business models they introduce for their new online services.  I would observe that if they wanted to gain a large base of developers and new audiences, it would be in their interest to consider offering a more “ideal” business model to compete with the ones that presently dominate the market.  They desirable property of an “ideal” game market is that it maximizes revenue with zero drag on audience growth and content acquisition.

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