MMO Economics: Quoting Syp's Quote of the Day

Reading Bio Break today, I got into a discussion which I decided to bring here. The original quote follows.

Things you’ll see in MMOs going forward (IMO):  More player created content MMOs (easier to ship and player demand is there), and more big IPs doing games/box games going to MMO (there’s too much money in the MMO model, F2P or subscription compared to box sales).

~ Carbine Studios’ Jeremy Gaffney

Tanek, a commenter on Bio Break, questioned the veracity of that last statement about there being more money in MMOs, regardless of revenue model, than box sales. Failed MMOs notwithstanding (after all, box games fail, too), I can totally understand the developers' motivation to get involved in an ongoing revenue model.

From my own comments on Syp's post: 

With a box game, even a series, you have to invest money in development and then hope for sales to recoup that investment. This includes DLC, which only sees revenue after the fact. With on an online service, whether subscription or cash-shop, you have an ongoing revenue stream that can be reinvested in further development as well as extracted as profit.

This is why, despite all the complaints by players, so many MMOs ship “unfinished” or missing features player have come to expect. The developers are using sub or cash shop revenues to further develop the game.

Smarter people than I have studied the business model known as razors-and-blades and reached no better conclusion than that it seems to work—and work well—despite some logical economic ".intuition" to the contrary. Regardless of whether the initial box (or razor) is profitable, the subscription or cash shop (the blade), creates a potential for further profits even if the project is temporarily in the red from an investment perspective.

I promised some math on Syp's blog, so here it is. Keep in mind I have no idea what the actual income statements look like for any game developer. I can only some assumptions, one being that the month-to-month operating costs of an MMO do not exceed the revenue, if they do, the company really only has a couple options, change the model or close down the MMO. We've seen both scenarios in real life.

Boxes, or One-time Revenue

 ($100,000,000=$50x2,000,000)

Here is the math for a box-only game. If the company invests $100,000,000 to develop the game and wholesales the boxes for $50 (MSRP $60: remember, the store has to make a profit, too), then 2,000,000 people have to buy the game before the company breaks even on their investment. If they don't move that many boxes, they're basically done. They can reduce the price a bit, but that just means they'll have to sell even more boxes. Oh, and from the time they commit the money for development until the two-millionth box is sold, they're basically operating at a loss of $100,000,000. Chances are that they will have to break even in the first week, or the game will be considered a failure.

One last thing: Once the boxes have been purchased any further revenue for that investment ceases. For a franchise like Madden football, this means the sequel has to be developed with profits from the prior box sales. I'm not saying this is not a profitable business model, but it has its drawbacks compared to the MMO model.

MMOs, or Ongoing Revenue

 ($100,000,000=$50x1,250,000 + $10x3x1,250,000)

Now if we factor in ongoing revenue, the potential for seeing a profit goes up. Same $100,000,000, but now, because we have the ongoing stream, our box sales don't have to be as high. Remember this is based on the assumption that the monthly MMO operation is in the black, making a profit. Let's say we anticipate a $10 profit per month per player and a four month window to break even. To break even on that same $100 million investment, we only have to sell 1.25 million boxes and have people pay for three months of subscription (the first month is typically included). If the game starts at free-to-play, then the cash shop revenue has to generate at least $90 profit per player in the first four months to achieve the same goal.

This does require some patience on the part of the developer/publisher of the game, but the long term profit potential makes it worth it. Obviously, more people may buy the box than will play past the first "free" month. That only lowers the number of people who need to stick around for the entire three months.

If the developer is even more patient, and is willing to push the break-even goal out to six months, less than a million people have to buy and play the game for six months. If two million people buy the box, then the game breaks even on the investment, and every cent of the ongoing profit (operating revenue less operating expenses) goes into the company coffers, enabling future development, updated content, expansions, etc. Welcome to Blizzard.

The Wrap-up

This is why the layoffs at BioWare a few weeks ago and the collapse of 38 Studios are very different situations. 38 Studios never got a chance to see a return on the investment. BioWare is working to bring monthly costs lower than revenues. The recent "soft mergers" are another effort to streamline costs while at the same time improving player experiences. (This has met with mixed success, for various reasons.) There is also talk today that BioWare is considering a move to F2P. While there are many who scoff that this is yet another sign of the failure of SWTOR, I point to games like LOTRO and STO that are still around and arguably doing just fine after changing to a F2P model. LOTRO is well on its way to, what, the third expansion, "Riders of Rohan"?

Obviously I used relatively simple numbers here and pulled them out of my butt. But the principles behind the numbers are sound. Any variances in the profit margins only change the timeframes. It's becoming a recurring theme on this blog that I don't think a game has to boast WoW-like populations to be a success, and comparisons to WoW are not helpful.

The key thing to remember here, from both an economic and accounting perspective, is the concept of sunk costs. Every dollar that goes into development prior the the release of the game is sunk cost. For a box-only game, the only way you'll get further investment is to make a profit on the box sales. In an MMO or other ongoing, service-based game, keeping the operating revenue higher then the operating costs is the only thing that matters. An MMO will continue to function as long as the developer/publisher can accomplish that, regardless of the long-term return on investment. As long as there is a profit to be had in the operation, the investment will eventually break even, given enough time. After that, all you have is profit, which can be reinvested in updates, expansions, and new games.