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From goods to services: The change in the video game industry


Tony Xie

By

April 23rd, 2018


In the age of distraction, video games are becoming a larger part of our lives. Tony Xie investigates how publishers are adopting new revenue models to take advantage of this growing market.


In his 1930 essay “Economic Possibility of Our Grandchildren”, John Maynard Keynes predicted that the greatest economic challenge of the 21st century would not be resource depletion or monetary instability, but instead how an average man would “occupy their leisure”. For many adolescents and adults, the answer is simple: video games. With the advent of mobile gaming, the video game industry has experienced tremendous growth, hitting $91 billion in revenue globally. However, the paradoxical nature of the industry is that within the last few years, the most financially successful games are in fact those which are free to download and play.

Trevir Nath of NASDAQ, an American stock exchange, has touted the industry’s transmutation from a stigmatised niche market to an industry which is now double the size of Hollywood. Much of that can be attributed to the new business model adopted by video game developers, which aims to release fewer games per year, and instead of capitalising on the initial sale, focuses on bringing in a stream of perpetual cash flows. For gaming giant Ubisoft, they claim that on average a traditional video game will generate 13% of its first-year revenue in its second year, whereas a live game can generate over 50%. This profitable approach has encouraged developers to transition their games from a one-off good to an ongoing service.

Although Blizzard was the first to adopt the service model in 2004 for its flagship game, World of Warcraft, it was Riot Games that defined the current system with their 2009 game, League of Legends (League). Over its nearly decade-long lifespan, League has become the most popular and profitable game in the world. This success could partly be attributed to the fact that Riot Games does not charge a monthly subscription fee nor an initial installation fee. Instead, League is free to install and allows players to access all features and functions of the core game without incurring a single cent. How then, did this seemingly free game rake in over $2 billion USD in 2017?

Obviously, League’s free to play model has attracted many players. The game has little entry costs and the installation process is relatively straightforward. For the majority of its target demographic – adolescents from high school to university – there would also be little need to buy any additional equipment, as most modern laptops are sufficient to run the game.

Unfortunately, unlike websites which can run advertisements, simply attracting traffic would not be enough to sustain Riot Games. Instead, League’s profitability lies in its in-game currency system, where there is ‘Blue Essence ‘and ‘Riot Points’. Both currencies largely serve the same purpose of purchasing new in-game content; however, Blue Essence must be earned through leveling up, a tedious process requiring hours of playtime, whereas Riot Points can be bought using real money.

Hence, for time-poor players, buying 1100 ‘Riot Points’ for $10 to unlock champions may be a more expedient and attractive alternative. In a world where people are free to spend all their time on video games, Riot Games will be bankrupt in a month, but in our current hectic lives, this clever business model has effectively used what economists call price discrimination. Riot Games has identified and segmented its markets effectively, pricing its champions with extraordinary precision to ensure that they remain attainable for those who would prefer to play for free, but too onerous for those with busy careers or rigorous schoolwork.

Moreover, an exclusive function of Riot Points is what really drives the revenue for Riot Games: they are able to be used to purchase ‘skins’, a quintessential element of the game, which allow individuals to change the appearance and sound of their in-game champions. Averaging around 1350 Riot Points (around $12), with new limited-edition skins asking for over 3000 riot points (around $28), these aesthetic makeovers actually make no difference or enhancements whatsoever in gameplay mechanic.

Riot’s ability to first hook players into the game, providing a platform which is immersive and interactive, will often lead to emotional investment from players. Those with an affinity for certain champions plead for the release of new ‘skins’ and rumours of new releases will typically circulate with excitement amongst forums months beforehand. For these fervent fans, price is of little consideration and they are insensitive to price changes. No amount of playing or accumulating Blue Essence can be used to acquire these exclusive flairs.  The beauty of the business model is, unlike traditional firms, Riot’s provision of ‘skins’ or new ‘champions’ come at effectively no additional cost to the firm. Apart from the initial development costs, Riot is able to sell millions of goods whilst incurring zero marginal costs.

In a marketplace with many competitors, no firm should be able to make supernormal profits. Although the video game industry is far from being a perfect market, this economic adage still rings true; companies are seeing Riot’s successful business model and have tried to emulate its successes. Even in the past few months, we have seen the rise of another popular free-to-play game, Fortnite, which offers a similar in-game currency system but eschews the pitfalls of League by providing a gentler learning curve. However, some companies have failed spectacularly when shifting revenue models. For instance, EA’s Star Wars Battlefront 2 sparked widespread criticism for its usage of microtransactions.

Of course, part of this pushback is due to consumers being aware that these new revenue models will cost them more in the long run. The gaming industry must walk a fine line between doing what’s best for shareholders and avoiding exploiting their customers. Regardless, the video game industry is slowly gravitating towards a service industry, and companies must escape the traditional notion of viewing their games as merely ‘goods’. Like Keynes remarked in his magnum opus, the “difficulty lies not so much in developing new ideas as in escaping from old ones.”

References

http://www.econ.yale.edu/smith/econ116a/keynes1.pdf

https://www.kotaku.com.au/2018/02/why-ubisoft-is-obsessed-with-games-as-a-service/

http://comicbook.com/gaming/2018/01/30/league-of-legends-top-free-to-play-revenue-charts-in-2017/

https://www.nasdaq.com/article/investing-in-video-games-this-industry-pulls-in-more-revenue-than-movies-music-cm634585

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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