Entering a market where existing platforms have network effect working

The title of this post is very generic because I observed or studied cases in different industries that new entrants want to penetrate markets where incumbents already have their network effect working.

By leveraging its resources or capabilities, new entrants might be willing to acquire “users” (depending on dynamics of business, platform might want to focus on particular side of users) by providing monetary subsidy or aggressive pricing.

Digital Distribution in Gaming (PC/Mobile)

If we put the recent “price war” between distribution platforms chronically, it looks like below:

[STEAM]

On December 1, 2018, Steam announced it would introduce tiered revenue split mechanism based on revenue level to its long-time 30% rake on games sold on Steam.

  • “When a game makes over $10 million on Steam, the revenue share for that application will adjust to 75%/25% on earnings beyond $10M”
  • “At $50 million, the revenue share will adjust to 80%/20% on earnings beyond $50M”
  • “Revenue includes game packages, DLC, in-game sales, and Community Marketplace game fees”

Some smaller developers think the adjusted mechanism is still in favor of larger publishers and developers who are more likely to hit those revenue thresholds.

Charts below illustrate STEAM rake schedule and overall rake on game revenue.

Steam

Steam Overall Rake

Not every developer/publisher on the supply side of the platform are equal, STEAM clearly wants to focus on those with hit games and hopes their pipeline can keep network effect working.

As shown in the announcement about the new revenue share tiers posted on STEAM community:

It’s always been apparent that successful games and their large audiences have a material impact on those network effects so making sure Steam recognizes and continues to be an attractive platform for those games is an important goal for all participants in the network.

Our hope is this change will reward the positive network effects generated by developers of big games, further aligning their interests with Steam and the community.

The rationale behind is the characteristics of the digital distribution platform without control of gaming experience access: Power law and long tail on revenue distribution across suppliers, and multi-homing on both consumer and supplier sides.

Two underlines in the quote above need some discussion:

  • Large audience / traffic certainly brought by marquee suppliers certainly benefit smaller suppliers. However, making the the platform attractive to marquee supplier will never be a goal for smaller suppliers. There is not much smaller supplier can do besides focusing on their own games and audience.
  • Actually, the adjusted revenue sharing system does not “further align the interests with STEAM and community” but just reduce the likelihood that marquee suppliers leave the platform. All other other things being equal, the new revenue sharing system will make marquee suppliers more likely to distribute their games on this platform rather than starting their own storefronts/launchers or moving to other platforms permanently even though they have choice to multi-home. More audience a developer has, the more economics of scale it can enjoy: bargaining power on 3rd party digital distribution or even internalize the digital distribution.

Steam Revenue

On a separate note, you can see different attitude toward developers on different type of digital distribution platform. Just look at Nintendo eShop. I know it’s console gaming, I know it’s Nintendo (with access platform supported by its strong 1st Party IP) but the point I want to make here is consumer bases / communities on the demand side for each platform are not created equal. The attitude toward existing suppliers in term of pricing somewhat reflects its consumer base behavior which is path dependent for established digital distribution platform. For emerging digital distribution platforms, besides leveraging its existing resources/capabilities/credibility…, they tend to solve chicken-and- egg problem from the supply side. Emerging platform can gain some initial traction by securing some exclusives or timed exclusives. As shown below later, financial incentive might be the easiest way to get the ball rolling. In the longer term, platform might go deeper in demand and supply side ecosystem or facilitate communication between two sides. As multi-homing is one of characteristics that digital distribution platforms share,  building lock-in factors in the ecosystem without increasing frictions might be a key to success.

The last question on the move to change revenue sharing scheme is:

WHY NOW?

[EPIC Games Store]

On December 4, three days after STEAM’s new revenue tiers got revealed, EPIC Games announced they would launch EPIC Games Store outlining several principles. Among those principles, the most eye-catching one is:

All Developers Earn 88%

In other words, the rake on this emerging storefront is only 12% for all size of developers compared to STEAM’s tiered rake system where 20% rake is the limit (overall rake is approaching 20% when gross revenue get larger).

Rake comparison

As the chat above shows, the pricing to distribute on EPIC Games Store is so attractive to all size of developers that the tendency to multi-home is inevitable. The exclusives or timed exclusives might be limited due to limited initial consumer base which represents relatively small addressable market compared to established distribution platform. Pricing aggressively is a way to secure enough initial supply and attract other suppliers later on.

EPIC Rake

By covering the 5% engine royalty for sales on the Epic Games store, out of Epic’s 12%, EPIC makes effective rake 5% higher for games using UE4 on competing distribution platforms.

This revenue split might look attractive to those who distribute their games using UE4 (not sure if any exists) at variable cost higher than 7% of gross revenue. If this platform can provide benefits similar to operating their own storefronts/launchers while saving fixed costs in operation, probably having in-house distribution channel might be hard to justify economically.

Leveraging own capabilities and being competitive on pricing are probably not enough to beat existing network effect so EPIC Games takes ecosystem/community approach reflected in principles shown in the announcement.

  • Have a Direct Relationship With Players
  • Connect with Creators
  • Developers Control Their Game Pages
  • All Engines Are Welcome

Within 10 days, EPIC Games went one step further with the announcement of their 2019 Cross-Platform Online Services Roadmap.

At Epic, our goal is to help game developers succeed. Throughout 2019, we’ll be launching a large set of cross-platform game services originally built for Fortnite, and battle-tested with 200,000,000 players across 7 platforms. These services will be free for all developers, and will be open to all engines, all platforms, and all stores. As a developer, you’re free to choose mix-and-match solutions from Epic and others as you wish.

Market Dynamics

It seems the STEAM’s new sharing revenue tiers was an attempt to preempt EPIC Games Store. However, it’s quite likely the the rake gap is so large that STEAM’s move cannot reduce the multi-home tendency.

There are other emerging platforms who might be agile enough to follow the price war in short period time.

So, Chain Reaction?

[Discord]

On December 14, 2018, 10 days after EPIC Games Store released its disruptive rake, Discord suddenly announced that they had figured out it doesn’t cost 30% to distribute games in 2018 so it decides to reduce their rake from 30% to 10% from 2019.

Turns out, it does not cost 30% to distribute games in 2018. After doing some research, we discovered that we can build amazing developer tools, run them, and give developers the majority of the revenue share.

So, starting in 2019, we are going to extend access to the Discord store and our extremely efficient game patcher by releasing a self-serve game publishing platform. No matter what size, from AAA to single person teams, developers will be able to self publish on the Discord store with 90% revenue share going to the developer. The remaining 10% covers our operating costs, and we’ll explore lowering it by optimizing our tech and making things more efficient.

Discord let all users have access to store beta and new Nitro subscription options in October 2018. It’s unlikely that a company has venture capital firms on its cap table to roll out some major business / features without strategic simulation and operational / financial modeling. So it’s not about how much it costs to distribute games but how much storefront wants to monetize or subsidize (the new market dynamics and second underlined sentence in the quote increase the likely this likelihood) on distribution. Apparently, it’s a strategic move driven by market dynamics.

While having some advantages on the consumer side and strategy on the ecosystem, Discord still needs to at least match the rake to make their platform relevant on the supply side in this kind of price war if it has resources to do so and being supported by capital providers. Discord stated 10% rake is enough to cover “operating costs” but what’s its role in unit economics and at what scale are unclear.

Maybe we can borrow some strategic perspectives from venture capitalist.

Charts below show the rake and net revenue comparison among three platforms.

Rake 3 Comps

Rev 3 Comp

~ The Platform Being Disrupted ~

Certainly, the pricing offered by emerging platforms is disruptive. However, the reason why STEAM might be being disrupted is that if the cost structure /organization is built on 30% rake, it will be very difficult for the platform to overcome internal frictions to take timely, bold counteractions.

The introduction of revenue sharing tiers might be an early indication. It’s very interesting to see how long it takes for STEAM to make next move.

When it comes to competition among platforms, defender or passive side generally doesn’t have luxury to adopt wait-and-see strategy.

! TAKE ACTIONS BEFORE IT’S TOO LATE !

*    *    *

Digital Payment in Japan

This is basically a game of user acquisition by subsidy among fragmented, multi-homing platforms.

[PayPay]

On December 4, 2018, PayPay launched a 20% rebate program with total allowance amount of 10B Japanese Yen subject to certain T&C. The amount was used up by December 13, 2018.

[LINE Pay]

On December 14, one day after PayPay’s program ended, LINE Pay launched a similar 20% rebate program from December 14 to December 31, 2018 without limit subject to certain T&C.

[Merpay]

Mercari is planning to launch its own digital payment service next year. It definitely can learn something from user acquisition wars between PayPay and LINE Pay. With its C2C marketplaces, hopefully Mercari might be able to adopt a more sophisticated, less cash burning way to launch service.

The case of digital distribution platform shows “your margin is my opportunity” and “network effect can still be beaten.” This is one of major risks that Mercari’s C2C marketplaces might face in the future.

~ Related Posts ~

Epic Games’ Epic Battle on Storefront Space (follow up post)

Gaming-related Platform Ecosystem Competition and the Financing behind (follow up post)

Networks can be still be beaten

Mercari (4385.JP) – Initial Analysis

5 thoughts on “Entering a market where existing platforms have network effect working

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