How Much is Your Game Worth?

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This article originally appeared in Develop in November 2010. It is focused on how the traditional games industry can learn from the emerging free-to-play business models. It forms the heart of my thesis on how the Internet is transforming the entire entertainment industry, which will be the subject of my book due out later in 2011.

How much is your game worth? It’s a question that developers and publishers don’t ask often enough. They think that the price is pretty well set (around about £30-£40 in the shop) and don’t bother thinking about pricing very hard.

But the truth is that the answer is this: “Whatever your customer chooses to pay”.

The games industry has long operated under a myth. It operates under the myth that the industry determines what price a consumer pays for a game.

This is not true.

Off the top my head, I can think of four ways that consumers can alter the price of a game:

• by buying a used game
• by waiting a few months for the price to drop
• by borrowing it from a friend
• by pirating it

In fact, retailers have a stronger influence over the price than publishers, so a fifth way would be to shop around and buy your game from Sainsbury’s rather than GAME or an independent retailer.

Now that we’ve dismissed the myth that games publishers have control over the price consumers pay for games, maybe it’s worth stopping for a moment and thinking why publishers set a single price point in the first place.

Selling physical stuff is hard

In the pre-Internet days, there was only one way of selling content; physically.

Selling stuff physically is difficult. Very difficult. You have to arrange for manufacturing, packaging and warehousing. You have to invest in hundreds of thousands of units, store them, distribute them and only then do you get to see if they sell or if you will be burying them by the truckload in the Nevada desert.

And that’s not including the royalties due to the console manufacturers or the cost of marketing the game.

No wonder a game cost so much.

(Note: it’s not about dev costs. Modern Warfare 2 cost $50 million to develop and $150 million to manufacture, market and distribute. For most games, development costs are a fraction of the total costs.)

Before we go any further, I think it’s time to talk about the price/demand curve.

The price/demand curve

This is the simplest illustration possible. The price/demand curve shown here – in fact a straight line – shows that as the price falls, the demand rises. If you set the price of a good at point A (indicated by the red arrow), then you will capture the maximum amount of value for all consumers who fall into the shaded area.

Customers who fall into area B are lost customers. They are not prepared to buy the product for $A. They would rather forgo the product than pay a full price for it.

A Simple Price/Demand Curve

Consumers who fall into area C will be delighted by the price. They would happily have paid more for this product, perhaps much more, but there was no mechanism to let them. By setting the price at $A, the marketer has left that money on the table.

The role of marketing, in a traditional sense, has been to shift potential purchasers up the demand curve: to use marketing techniques to increase their desire for the product to the level that they will start to view the price point as reasonable. This can be expensive, especially since, in the words of John Wanamaker, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.”

In the old world of physical distribution, there was nothing marketers could do about people who would happily have paid much more. After all, there was no easy way to separate customers who fall into group B from customers who fall into group C. Even if you could separate the groups, it was hard to offer them differentiated products.

So we were stuck with £40 RRPs and were forced to wait, trade-in or pirate to get titles we wanted at prices we thought were reasonable.

Welcome to the era of dynamic pricing

We have now entered the era of dynamic pricing. It offers huge opportunities to those who understand how best to make it work.

Don’t believe me? Ask Turbine. They were struggling to make Dungeons and Dragons: Online work commercially. So they took a deep breath and turned it into a free-to-play game, monetised by virtual goods.

The result was staggering: revenues were up 500% in the first six months. A struggling game became a very successful game. Commentators like me were ecstatic. It vindicated our arguments in favour of free. “See,” we said, “when you let people spend a dollar here, five dollars there, reducing the barriers to entry, you get much more money.”

Boy, were we wrong.

Not about the results. Free-to-play is clearly working. It works on Facebook (see Zynga). It works on iPhone (see ngMoco). It works for traditional MMOs (see Dungeons & Dragons: Online and The Lord of the Rings Online).

We were wrong about the reasoning. It turns out that dynamic pricing isn’t about releasing the potential of the cheapskates in the area labelled B under the price/demand curve; it’s about the area labelled C.

In short, it’s about the “whales” – the high-spenders – the fans who want to spend a lot of money on their title. It’s not about the tiddlers.

The concentration of spend amongst the whales can be staggering. One major online games company sees 80% of its revenue (which measures in the tens of millions of dollars) from just 23,000 users.

The real truth about free-to-play games is not that they allow many players to play for free; it’s that it allows a few players to spend huge sums of money on their favourite game. Jambool, a virtual currency provider, has identified high-spenders in the UK ($11,635), the US ($19,054) and Saudi Arabia ($25,540) and says that similar high spenders can be found right around the world.

Bigpoint has said that its Average Revenue per Paying User (ARPPU) is higher than that for World of Warcraft. The key to that statement is the word “average”. Some people are spending a dollar or two; others are spending $100 or more.

In truth, the price-demand curve for games looks nothing like the curve we discussed earlier. It’s a power-law.

The real price/demand curve

Most of your users want your game for free. They don’t value it very highly, will play for a bit, and then forget about it.

A few of your users value your product at exactly the price you would normally set it at. $40 for a boxed product. $10 for a subscription MMO. $0.99 for an iPhone app.

A very few, a small fraction of one per cent, love your game so much that they want to spend lots of money on it. Enough to make your game extremely profitable.

The ridiculous thing is that we, as game makers, already knew this. We already knew that we had hard-core fans who loved our games to bits. They would code their own mods, create their own websites, commit hours to gameplay and claim to be our biggest fans.

We just didn’t give them any way to show that appreciation though spending money.

Are we exploiting our customers?

Emphatically not.

Customers who want to pay more for the content they consume should be allowed and encouraged to.

There is a proviso. You have to offer them stuff that they really want and that adds value to their lives. (I do mean their lives; much of the value of this stuff goes beyond the game and into real life, but I haven’t got time to cover that here.)

In free-to-play games, it’s easy to see what you can offer. You can create in-game items and offer them for a dollar, ten dollars, a hundred dollars. Is it so easy in traditional games?

I think so. We are seeing premium “special edition” packs which come with bragging rights “I’ve got the night vision goggles”. We’re seeing downloadable content with very high tie ratios. So high, in fact, that I can envisage a time when the original game is a loss-leader designed to draw gamers in, to identify the whales and to monetize them through expansion packs, in-game items and other DLC.

In short, a variant of the freemium model is coming to every type of game.

The reason is clear: it’s happening because it is what gamers want (as evidenced by their wallets); it’s happening because it’s what makes sense for companies on a commercial level.

I believe that if you make games, you need to understand how the Internet has not just changed how we distribute games. It has changed the expectations of gamers. It has ushered in the era of dynamic pricing, of satisfying the whales and of making much of your content available for free to most of your users.

As a businessman, as a gamer, as someone who helps companies make games, I couldn’t be more excited.

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