The Economics of Game Pass Demand a Playstation Launch

“Join us Phil”

The supply-side economics of subscriptions are fairly straightforward: get massive scale and distribute costs. Netflix has over 160M subscribers meaning a $100M production only costs each user $0.63. There’s zero marginal cost (unlike Spotify), so the more subscribers Netflix has the less a piece of content costs on a per user basis. At $11 per user per month, Netflix can spend over $1.7B on content each month and break even. In fact, as recently as 2019, Netflix does spend close to break even. In the long-run, Netflix has a incredible loop: content brings users, these users lower per user content costs, this accelerates more content spend, which brings more users. Rinse, wash, repeat until diminishing returns take hold.

But remember this wasn’t always the case. Content costs are fixed: the crew of Mindhunter doesn’t care how many subscribers Netflix has. They face costs unrelated to if 100M or 10M people watch the show. As early as 2010, Netflix only had 20M subscribers, suggesting a per user cost of $5 for a $100M production. There’s a gaping hole between $5 per user per $100M production and $0.96 per user per $100M production under their current 160M subscribers. This underscores the massive upfront investment needed for streaming to work on a supply-side basis.
Chart: Netflix Turns 20 | Statista

It’s this exact reason Microsoft needs Playstation users for Game Pass to at least have a chance at buying down per user costs. It also explains their aggressive sub & console bundling as well as rock bottom introductory pricing.

Microsoft has disclosed Xbox Live has 90M MAU while Game Pass has 10M MAU. At $10 per user per month, Microsoft has can spend as much as $100M in content per month and break even. Development costs vary widely, but let’s start with assuming a conservative $70M per game. From a break even perspective, that’s around 17 games a year and consistent with Xbox Game Studios current production. That may sound like a lot, but the Xbox One has had over 2,500 games released in its lifecycle or about 350 games a year. Supporting this sort of volume is going to require a lot more users. A lot more.

Let’s have a little more fun with the cost side to get a better handle. Consider a simulation assuming anywhere from $30-$70M per game and anywhere from 100-350 games per year. We’ll randomly sample numbers in both ranges, multiplying them together to arrive at a per year content cost (ex: our simulation might pull $40M a game and 125 games for a yearly content cost of $5B. The density chart below represents 100,000 such pulls).

Simulating Content Costs of Game Pass

Based on this, Microsoft would most likely spend ~$7B per year to maintain similar volume. At $120 per user per year, this means 53M subscribers or about 5x the current amount to break even. At a 60% profit margin the number of subscribers jumps to 93M or more then the current Xbox Live MAU. Microsoft needs more users for this to work and they know it. Of course, perhaps this volume is insane and Microsoft wants much fewer but higher quality hits. In this case, however, the entire cost-savings model of subscriptions to the consumer declines. Our gaming subscription paradox re-emerges: subscriptions make increasing sense to the consumer wherein they would instead pay for many distinct pieces of content. Like music. Or T.V.

In many ways this explains the expansion of Game Pass to PC, Project xCloud, and the new Xbox console subscription bundle. Subscribers are capped by those with a console and Microsoft wants to start to unshackle that cap. Netflix recognized this long ago with Roku, Smart TVs, and apps on every platform or hardware they could find. The ability to sell Game Pass on iOS or Android explodes the addressable market, but is dependent on Azure wrangling the explosive unit costs of streaming. Hello Sony and the Playstation user base.

Microsoft clearly understands the supply-side economics of making streaming work, but over and over again misses the fundamental difference in how players consume a game as opposed to a T.V. show. I’m not quite ready to short Microsoft, but critical questions remain in executing on this strategy.

The Intellectual Poverty of Game Steaming & Subscriptions

Lessons from the failure of the Ford Edsel - Business Insider
“We didn’t execute well. If only!”

Amazon has announced Luna, yet another stab at game streaming and subscriptions. It seems like the failures of Apple Arcade, Stadia, Gamefly and our oft forgotten OnLive have not been effective deterrents. Not to be outdone, Rovio’s Hatch continues to drain money every quarter. Perhaps this is what Bezos warned shareholders about when discussing new “multibillion-dollar failures”.

And despite overwhelming failures, media pundits like Matthew Ball prop-up skin-deep arguments in favor game streaming and subscriptions. Instead of discussing about why game streaming and subs might work, let’s talk about why they haven’t worked.

It’s important to understand the brother/sister relationship of streaming and subs. Subscriptions unlock zero-marginal cost content consumption. Once you’ve paid Netflix or Spotify $10, there’s $0 additional explicit cost to consume another movie or song. However, there are transactions cost. In the “before times”, customers had to mail DVDs back to Netflix to receive the next DVD in their queue. This effectively limited how much content customers could consume in a given month. If mailing took 3 days in transit, on a 1 DVD at-a-time plan, a customer could only consume 10 DVDs in a 30 day month. This assumes the customer turned around DVDs instantly. Furthermore, the “queue” forced customers to plan consumption habits in advance rather then at the point of consumption. If you wanted Love Actually on Friday, but by Monday you were in more of a Pretty Woman mood then you’re shit out of luck. Let’s not forget that new releases were in strong demand, meaning it could be weeks before Transformers 3 lands in your mailbox. Steaming solved all this.

Non-steaming subs like Game Pass and EA Play exist in a weird middle, solving some, but not all of these issues. Games are distributed digitally, but not instantly. A game like Call of Duty: Modern Warfare can take 3-4 hours to download on a 135 Mbps connection. SSD’s aren’t cheering at the prospect of 200GB games either. But once streaming takes-off for games these problems are solved, right? No storage needed!

The incredible rise of free-to-play and GaaS (Games as a Service) render subs and streaming largely valueless to the player. Players do not consume games like TV or music, a fact that should have been made obvious in the last decade. Players are playing fewer titles in a given year, but are playing the fewer titles for longer periods of time. Games solve the content problem in a way that other mediums simply can’t.

The content consumed in a game like Overwatch or Clash Royale is the pursuit of strategy equilibrium and/or mastery of mechanics. A new unit in Clash Royale, for instance, can change how players organize their decks, even if they don’t use the unit directly (they must counter it). This can provide hundreds of new hours of content to consume relative to the near 1 man-week of labor to produce a new unit. Therefore, the content output of a given member of the 16 person (!) Clash Royale team is astronomical. Compare this to the thousands of crew members and weeks necessary to produce even a single one hour episode of Game of Thrones. It’s impossible for supply to keep pace with demand in the world of TV and movies. Netflix makes sense in this view because after binging 9 seasons of The Office, customers can immediately rip into 7 seasons of Star Trek: The Next Generation. It’s another reason why back catalogs are so much more important to Netflix then they are to something like Game Pass. If players are only investing in 3-4 new games a year, then the transactions cost reduction streaming provides is extremely small compared to the benefit it provides in high unit consumption TV and music.

It’s a similar story for the failure of gaming subs. If players are only consuming 3-4 titles a year, subscriptions don’t make economic sense to players. Not to mention these 3-4 new titles are increasingly becoming free. In the West alone, League of Legends, Fortnite, Apex, Warzone, and now Rocket League are dominating playtime. And let’s not forget the entirely F2P ecosystem of mobile. The march to F2P in the West will continue as long as MTX revenues grow and box revenues shrink. There isn’t a whole lot to save by signing up for $100 a year sub and streaming service when Fortnite doesn’t cost a dime.

Game streaming and subs don’t solve billion dollar problems for the player. In the absence of doing so, subs and steaming will continue to flounder.

The LTV-UA Rebate from Platform Fees

Like when you go to the airport for VAT refunds. Right?

Apple is increasingly under fire what’s claimed to be unfair practices in the App Store. The criticism takes three forms: (a) Apple’s 30% fee is much too high relative to cost (b) the rules are arbitrary and stifle competition and (c) the App Store as the exclusive avenue to install apps on iOS is unjust. That’s a lot to chew, so let’s focus on (a) for this post.

Eric Seufert’s criminally underrated podcast talks about this very topic but phrases the question as “Does Apple earn it’s 30%?” Various App Store benefits like payment handling and preventing fraud are discussed, but I wanted to scream by far and away the biggest way Apple “earns” it’s 30%: acquiring a mega fuck-ton users to iOS. Nearly the entire value of a platform to a developer is how many people it can reach. No one is rushing to get on Epic Game Store (EGS) or develop for Stadia because there are so few users. 12% or even a 0% fee is irrelevant: [88% * 0 users] = $0 versus [70% * more then zero users] = more then zero. This is an extreme example, but users are by far and away the most important ingredient of any platform. After all, developers can list in multiple stores with maintaining the listing or code for the particular platform as the only cost to do so. The fact that so few are willing to take on these small costs tells us a great deal about the user bases of Stadia and EGS.

But platforms fees also increase the LTV of the devices who run on the platform, if and only if, the firm internalizes those platform fees. For instance, the added platform LTV of an Android phone in China is less than in the United States because Chinese users install non-Google owned stores. In this case, platform fee revenue doesn’t accrue to Google.

If LTV of the iPhone X is say $1000, Apple should spend up to $1000 in UA to acquire a user. However, with platform fees the LTV grows. Sensor Tower estimates that iPhone users spend over $79 per year on apps. On a lifetime basis, that’s probably north of $250 (3+ years of ownership). That ups the iPhone’s LTV to $1250 and unlocks more UA budget for Apple to acquire more users. These marginal users benefit all developers. This is how Apple (or almost any platform holder) gives developers a rebate on the 30%. I’m not sure what the true fee is but it must be lower than 30%.

It’s Not Data-Driven or Informed You Want, It’s Science

Thomas Kuhn actually wrote “The Structure of Scientific Revolutions” to figure out why he was churning from Game of War

“We want to be more data driven” or “We want to create a stronger data culture” are common organizational refrains. Supposedly, having more data or data playing a larger role in the decision making process is profitable. It’s weird because I haven’t seen any research to suggest this is the case. In firms like Facebook, it’s obvious as more data improves ad personalization and thus revenue. But this is data as a engineering project rather then a tool in the decision making process. Firms want to make better decisions with data. This is a misidentification of the value chain. Data isn’t that helpful if it’s not packaged with empiricism, an epistemological way of acquiring knowledge.

To even get off the ground analyzing data, we need theory of measurement. What should we track, given limited engineering resources and raising storage costs? Claiming we should track, say payments and logins, at the exclusion of audio volume, implies a cost-benefit value ranking. Why are payment and login more value to track? The theory is that understanding payments and logins will unlock more insight then volume as volume plays a less significant role in the app. Is this true? Hopefully, the institution has the intuition or previously collected to knowledge to make an educated guess. Firms have discovered that refining this knowledge can make their bets more likely to succeed. As it so happens the West has created the best knowledge refinement process in the history of humankind: the scientific method.

Data or more broadly, empiricism, is a key part of the scientific method as it expands the sample size of a test beyond antidotal evidence. Doing this at scale, as well as the methodology of running true experiments, A/B tests, means that knowledge is more valid (less likely the result of antidotal evidence) and stable. Firms can now learn.

Arguing to be data-driven or informed misplaces the value in the supply chain. We need to more explicit in this endeavor – it’s not about data, it’s about science.

Why aren’t you doing analysis on your impact?

If A Tree Falls In The Woods And Nobody Is There To Capture It On ...
“If an insight gets delivered and no one acts on it, did it make a sound?”

Performance based marketing makes intuitive sense; of course you want to optimize ROI on spend that compose 30% or more of a your firm’s expenditures. But here’s the kicker: if it makes sense for firms why not individuals? Shouldn’t we be tracking the impact of our output?

Are co-workers actually reading your analysis, concept art or brand pitches? Imagine if you knew how long internal onlookers spent reading or viewing: how might that change future output? For instance, we might be able to find the optimal length of a memo or detail of a UX mock-up. With more widespread read receipts (on email, calendar invites, PowerPoints) I’d think we’d learn discovery of information within firms is rather low because search costs are so high. I’m routinely shocked by low view counts on important internal Google docs while on the other hand observing the willingness of participants to take a firm stance on the conclusions. Many firms haven’t invested in strong intrawebs to create easy ways to access content or for creators to push them to relevant parties.

This means information travels via internal networks via word of mouth. With a given game publisher distributed over many countries and time zones, this simply doesn’t scale well. Easy consumer discovery, regular “pushing” of content, and tools assist rather than inhibit creation are paramount to spreading the gains from Haykiean localised knowledge.

Why does Epic need $1B in new funding? Is this all about Roblox?

Move over Gabe, there’s a new sheriff in town

Bloomberg is reporting that Epic is seeking to raise $500M to $1B in new funding. Tim Sweeney, Epic CEO and provocateur extraordinaire, owns 60% while Tencent owns the other 40%.

Why would Epic need more funding as it continues to rake in Fortnite money? Tim has bigger ambitions, let’s figure out what they are. As we’ve seen with Roblox, there’s incredible (and growing) money to made in user generated game content. Furthermore, consider the games spawned from mods: Counter Strike, the MOBA genre, Team Fortress, Auto Battlers, H1Z1 (which becomes PUBG which becomes Fortnite)… Imagine if you were able to take even 10% of the lifetime revenue of those titles. Despite Tim’s criticism of platform holders, Epic takes a cut of many games that run on Unreal as part of the licensing agreement. This is reportedly how Fortnite pivoted to BR: Epic got an enormous cheque when PUBG was blowing up.

The pieces have been coalescing:

  • Content creation tool in Unreal – which now scales to mobile
  • Direct to consumer distribution – Epic game store – which now scales to mobile
  • User Acquisition engine and revenue bedrock – Fortnite

But I think this play would blur more of the line between gaming and social networking. The biggest evidence comes from Epic’s acquisition of Houseparty, an app that essentially lets users join a Zoom call and play games together. How else do you explain that acquisition? It ties into their already created, but lesser known, Fortnite Party Hub app and recently announced Party Royale.​

The recent foray into non-gaming content via Fortnite concerts makes more sense in this light as well (or they’re trying to keep the Fortnite in the mainstream).

This helps explain hiring as well; in less then a year Epic has setup offices in practically every major gaming hub: Seattle, San Francisco, Stockholm, Montreal, Helsinki and Berlin. Recent jobs ads focus on the social.

Sort of Facebook circa 2010: lots of quizzes & confusion

Competition is spinning up in the meantime. Manticore games has already launched an alpha, and it’s hard to imagine Roblox being content with only owning the 10-14 yr old demo. It’s important to note this is nothing like a ‘metaverse’ as each game on the platform would retain a distinct identity, whereas a metaverse is closer to the failed PS Home or Second Life. Trying to squeeze hundreds of experiences onto one game presents a variety of complications and very little in the way of benefits.

Maybe when it’s all said and done, Fortnite let’s Tim become the social platform holder Zuckerberg always wanted to be at Facebook.

Why do contestents break the rules in Netflix’s Too Hot To Handle?

Too Hot to Handle's Francesca Reveals Retreat Life Was Strict ...

Economists like Tyler Cowen or Brad DeLong are too self-respecting to study reality shows. Fret not, this economist has no such self-respect.

Previously, we examined the economics of the reality show genre but just as interesting are the economics of the a particular reality show’s design.

To Hot Too Handle introduces of the most interesting examinations of communal property dynamics: a group prize is reduced when individuals act in their short-term private interest.

At a more practical level, the show gathers ten attractive 20 somethings into a villa in Mexico for three weeks. Cameras are littered around the villa with the exception of bathrooms (to be replaced with mics). The contestants are only informed of the rules once the cameras start rolling; if they masturbate, kiss, or engage in any sort of sexual activity the prize pool of $100,000 is reduced. It’s unclear to contestants how “expensive” each activity is or how the prize pool will be divided or won. Shockingly, interviews with the show’s producers reveal they didn’t have the rules or the costs figured out until they happened. While there’s no traditional contestant elimination process, producers will ask contestants to leave if they’re not invested in the “process”. Supposedly, the show wants to teach these singles how to form emotional rather then physical connections.

The spectacle for viewers is how hard it is for these contestants to keep in their pants – of the original $100,000, over $40,000 is lost. Seems like a lot, right? How could they give up so much money?

Well… It’s really not that much. On the face of it $100,000/10 = $10,000 per contestant. The tax situation matters greatly – U.S. contestants or those with residency in the U.S. will probably pay about 50% of that $10,000 in taxes. Interestingly, if the show took place in the U.S. rather than Mexico, all contestants would be subject to U.S. taxes. It appears to the case that the Brits and Canadians don’t face game show taxes.

On a expected payout basis, the costs are far less then they might appear:

  • $3,000 for a kiss is only $300 on a per contestant basis. Only $150 after taxes.
  • $6,000 for oral sex = $600 gross, $300 after taxes.
  • $20,000 for sex = $2,000 gross, $1,000 after taxes.

The show filmed for 3 weeks, at a max payout of $10,000 this is a yearly salary of $173k. Not bad, but many of the contestants already out gross that. Francesca Fargo is estimated to have a net worth of over $500k alone. Almost all of the contestants make money off their likeness or brand. Like Francesca, they model, sell clothing or act. Thus, building an Instagram following is directly connected to their revenue stream. Breaking the rules can help the contestants build that brand – losing out on $300 now could be much more in brand awareness later. Those without brands seemed to leave early or not attempt anything “interesting” – see Madison – a late arriver who never coupled up.

But the rules weren’t clear on splitting the prize and contestants could have been under the impression only 1 or 2 would win. Under an expected value model the payout is the same: $10,000 ($100,000 *10% chance of winning). However, if you feel as though you’re a weak contestant you might estimate yourself at less than 10% probability to win. I think this was the case for sorority girl Hailey who broke the rules a mere two episodes in and had no interest in continuing.

I think there’s room for improvement in the show’s design. It was rather strange to reveal to contestants who the rule-breakers were so early in the show. This introduced social shaming as retaliation for rule breakers, speculation and investigation makes for far more drama. If the show was about temptation, why not focus more on the money or relationships? Maybe contestants can choose to eliminate their show’s squeeze – money AND sex as tests of genuine connection. Discounting seems like a great lever for drama injection – this week sex is 50% off! Adding new contestants didn’t seem to work, everyone had coupled up by the time they got there. Subtraction or an elimination is lot more fun.

Well, here’s to a solid season two. Hopefully, the show remains tongue in cheek. But not literally – that would be a rule violation.

The Economics of Reality TV

The Circle Brazil | Netflix Official Site

In case you haven’t been paying attention, Netflix just re-discovered the reality/reality-doc genre. In 2 weeks:

  • Tiger King
  • To Hot Too Handle (international cast)
  • The Circle (4 international versions already released)
  • Love is Blind

I chuckled a bit when when Netflix remarked that they saw Fortnite as their biggest threat, but after 6 weeks in quarantine, they may have been on to something. Reality television is an awkward, but fun shot back at digital Travis Scott concerts.

The economics of reality shows have always favored cost. Casts cost $0, 1 or 2 filming locations, short shoot time (sub 6 weeks), and strong vitality potential that front loads views (no one is watching the back catalogue of Survivor). But why now, 7 years since House of Cards launched?

I think this is a simple growth parable: they’ve hit diminishing returns on drama, and this is the next highest expected marginal value item on the menu. In other words, they’ve picked the low hanging, high value fruit already. Widespread international distribution expands the watercolor effect and achieves economy of scale. Shows with live elements like Idol and Got Talent are forced in country specific renditions which limit audience reach. Subtitle support for international versions of shows like The Circle helps it reach English audiences and vice-versa. Living in Europe, you’d be surprised of the appetite for English content across non-native speaking countries.

They’re innovating reality game design as well (or at least the 3rd party studios are). Technology play a huge role in all shows, almost always as a form of communication (or lack thereof). To Hot Too Handle introduces of the most interesting examinations of communal property dynamics: a group prize is reduced when individuals act in their short-term private interest. The Circle asks how people make decisions on limited information – contestants can only communicate over text.

If the last last years have been golden age of TV dramas, maybe the next 10 will be the golden age of reality TV.

1950’s Peruvian Coke and Gacha

In the 1950’s, Peruvian inflation forced Coca-Cola to charge more per bottle of Coke. Unfortunately, their vending machines required physical updating to accept a new and larger domination. Instead, Coke devised a probabilistic system: the machine would charge the same amount as before, but randomly refuse to give a bottle. This raises the expected price of a bottle Coke while forgoing any physical  updating. But a miscellaneous software engineer has a better idea: raise the price of Coke, but instead randomly give the money back.

Our Surfer is ‘risk loving’

The increase in price for a  given ‘bottle draw’ would equal the expected payoff of a lower priced ‘bottle draw’ that randomly refuses to give a bottle. This is an interesting solution to player frustrations in gacha (“I didn’t get anything of value when I opened a pack!”).

Anyone care to reckon which model one would perform better: Higher draw price but gives money back or lower draw price but sometimes doesn’t give anything?