How our portfolio games make money: a window into the game industry’s transformation
From a sequential hit business to a SaaS one with venture-scale returns
We’ve previously discussed how the legacy “pre-VC” financing model that propelled video games past $100B in revenue was dominated by internal investment on the part of incumbents, and publishers doing revenue share deals with developers. A game would release at an upfront price point, target a recoup of its development and marketing costs, and generate a profit; if it did so, it was likely to spawn a sequel with the same objective, in the vein of Hollywood.
This model persists today with multi-hundred-million-dollar tentpole releases that can generate $B+ revenue (such as Elden Ring by Bandai Namco / From Software), generating many hundreds of millions in profit. The shift from physical boxed releases (in which a consumer literally picked up a disc or cartridge of a game at a store or received it in the mail) to paid downloads from digital storefronts like Steam did not dent the model; it in fact allowed it to grow faster.
The migration to digital also paved the way for games-as-a-service (GaaS), however, which allowed for "forever games" that simply needed to achieve product-market fit a single time, rather than having to repeatedly overcome content risk with a huge upfront development investment. GaaS provide a rich avenue for exponential venture-scale returns, rather than just a film-style multiple on development costs.
Developing a live service game requires upfront investment into design, engineering, and marketing as well, but once an initial player base is seeded for a multiplayer game in which people can play with and/or against each other network effects kick in. During successive stages of soft launch, developers gauge whether metrics suggest the game is worth investing in:
A) retention is strong enough if almost half of players come back the day after install, a quarter on day 7, and more than a tenth on day 30 (preferably more); and
B) unit economics must be profitable based on what it costs to bring in a new user (blended cost per install normalized across paid/organic) versus payback (and then profit) over the course of the initial month(s).
There are a host of other health indices that can point to the possibility of a hit- the average time played in the first session post-download being nearly an hour, for example- but healthy retention and unit economics are absolutely critical to making the Cost to Acquire Customer (CAC) > Lifetime Value (LTV) equation work. With CAC > LTV, the game can become a profit machine capable of generating a venture return in the same way as any other SaaS business. Predictability of the ROI on marketing investment, namely the way rate in which which players monetize to pay back the blended cost to acquire them, allows developers to refine their understanding of both which players in the market to target, and how to best serve players in-game to optimize retention and long term monetization.
Achieving CAC > LTV and sustainably driving venture outcome-scale revenue/EBITDA can take several forms. With a low blended CPI and a large addressable market of players (e.g. <$1/install), average revenue per user per year can be very low; conversely, a high-spending player base can be more concentrated. With acquisition prices keying off of revenue or EBITDA multiples depending on the needs of the acquirer, sustainable growth based on unit economics are the foundation of GaaS enterprise value.
Content risk does not disappear, however, in this model, but there are other factors that de-risk investment versus the legacy “Hollywood” model besides no longer needing to release successive games since a single live service hit becomes a “forever” revenue engine. These include:
1) No upfront price to play removes most of the friction from getting an initial player install, and opens the door for viral organic growth- a player or an influencer can suggest to friends/followers to play the game at no cost
2) Monetizing off of optional purchases and/or showing ads, including sophisticated formats such as rewarded video, in which there is a mutual value exchange between player and developer (player chooses to watch video in exchange for a virtual asset they would otherwise need to pay for), leads to a much more consistent and predictable revenue stream than monetizing upfront only at launch points for new titles or sequels
3) In multiplayer games, the interaction (social, competitive, cooperative, etc.) between players themselves within the systems and virtual spaces in the game world provide the bulk of the content, rather than assets created by the developer. Furthermore, many live service games provide tools in-game for players to create new content (such as levels and game modes) themselves. Half of the time spent in multibillion-dollar annual revenue Fortnite by players is on others' creations made using in-game tools.
The content risk that remains, however, derives from new GaaS products still having to get the attention of players, do so cheaply enough to allow for healthy unit economics, and retain those players to avoid continually having to re-acquire new or churned players. Investing in founders who have successfully done this at scale before (minimum tens of millions of revenue, preferably hundreds of millions or billions) helps de-risk that, as does focusing on "systemic" multiplayer genres in which players' experiences provide the bulk of the content. Such games are akin to curated, carefully designed sandboxes seeded with parameters that equip players dropping into them with the rulesets, tools, and boundaries in which they can go straight into meaningful social interactions with others that result in surprise, delight, and feelings of accomplishment. One powerful example of such is of course the duo play in League of Legends' bottom lane - working together to gain an edge against the opposing duo in-lane, winning full team fights, etc. We'll delve into many others in subsequent posts.