Epic Games’ Epic Battle on Storefront Space

The Wall Street Journal reported that Epic Games will challenge mobile app store business model dominated by Google and Apple. But what factor differentiates Epic Games from incumbents whose network effects are working in this case? The answer is disruptive pricing on the supply side of storefront (12% rake on revenue that apps generate). This is not surprising as Epic Games has already adopted the strategy at its Epic Games Store since December 2018 when it launched the online storefront. Basically gaming online storefront and app store share the similar business model of digital distribution.

WSJ also reported that Epic will start selling games (if you can distribute app game, of course you can distribute other apps) for Android devices where the ecosystem is more open (Epic distributes Fortnite at its launcher bypassing Google Play).

So what will Google react to that disruptive pricing? Mostly likely Google will wait and see until it senses that Epic’s storefront has the potential to become de facto app store on Android devices.

Analyst suggests that if Google decides to reduce the rake on Google Play, the move might force Apple to adjust rake on App Store. There might be a chain reaction but this is different from the competition on PC/Mac gaming storefront. Basically the customer bases between iOS and Android are different. The difference will determine whether Apple will follow the move, when to follow, and the magnitude in rake reduction if it follows.

Below is the chart illustrating how Epic Games’ disruptive pricing might impact game digital distribution (and more). Disruptive pricing will have less impact on closed ecosystem in the short term. That said, in the long run, closed ecosystem might be indirect influenced by another open ecosystem (Google Play’s move might have impact on App Store) and a functionality that makes the ecosystem less closed (Epic Games is rolling out cross-platform services in 2019). Enabling cross-platform will commoditize access devices for games potentially playable across platforms. Consoles with special form factors or strong exclusives will face less pressure from cross-platform. This might be the reason why Sony is reluctant to cross platform.

Disrupt_Pricing_DigiDistrWhile some industry analysts predict Steam will maintain its game storefront dominance, at least in 2019, my posts on game storefront competition analysis has showed that Epic Games and Discord’s potential to gain market share and disrupt the digital distribution space if they systematically execute strategies in their playbooks. Don’t be surprised if the competition landscape changes much faster than you think.

~ My Related Posts ~ 

Gaming-related Platform Ecosystem Competition and the Financing behind

Entering a market where existing platforms have network effect working

Networks can still be beaten

Gaming-related Platform Ecosystem Competition and the Financing behind

On December 21, 2018, it’s reported that Discord raised US$ 150M at a valuation of US$ 2.05B, bringing total funding to date to US$ 279.3M as of this writing.

The timing is particularly interesting because the online storefront price competition on supply side among STEAM, EPIC Games and Discord has heated up since Discord’s “Series E” funding round (Crunchbase classification) in April 2018.

Chart below shows the 2018 timeline of competition on online storefronts and more among STEAM, EPIC Games and Discord.

Storefront 2018 timeline

I have already done some analysis on online storefront supply side pricing and competition in my previous post (Entering a market where existing platforms have network effect working). So in this is post I’d like to briefly discuss implications on the financing side (my speculation only as no access to inside information).

[Discord]

The financing round in April 2018 was to further build the core product and to launch Discord Store. At that time, the next round of financing probably was structured as growth funding for the user acquisition on supply side or demand side of Discord Store and for subscription service. EPIC Games Store’s adoption of disruptive pricing not only forced Discord to follow similar pricing level but also probably had impact on the commercial terms of subsequent financing. Lower pricing means it takes longer for cac to recover and longer to reach profitability.

Thanks to  Discord, Discord Store might not have to spend a lot on demand side gamer acquisition. Discord Store might focus more on the supply side developer acquisition.

[EPIC Games]

EPIC Games had huge financing round in October 2018 that it raised US$ 1.25B making it 2018 largest venture round in the U.S.

The capital raised might go into various area such as technology, esports, online storefront build-up & scale-up and cross-platform online services for developers… In storefront segment, unlike Discord Store, EPIC Games Store has to put more efforts on demand side gamer acquisition.

TechCrunch reported that EPIC Games has generated US$ 3B profit in 2018. If it is the case and the accounting “profit” is not far away from cash flow, that means EPIC Games has US$ 4B+ cash from internal and external to grow its business. The scale is so large that it makes me feel the likelihood for EPIC Games to successfully execute an ecosystem strategy is quite high and that the next round of financing for the company will be the IPO which might be sooner than expected.

[Side Note]

Does the two percentage points difference between EPIC Games Store and Discord’s rake  matter? Business with positive feedback loop(s) tends to have increasing return overtime making market gaining process path-dependent. However, the only thing we can  infer from being “slightly” price attractive on the supply side in the short run is that it might help a little bit but it’s unlikely to be the only determinant since the competition is dynamic and firms are solving different problems and focusing on different things in the ecosystem when building up storefronts. This might be obvious but in fact it indicates the market structure might be market-sharing with some concentration rather than winner-takes-all (or most). This also helps us make prediction: incumbent’s market share will fall significantly due to the competition from new entrants. In other words, while network effect is strong, it can still be beaten.

~ My related Posts ~

Entering a market where existing platforms have network effect working

Networks can still be beaten

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 !

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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