KH Business Solutions

Over the years that the web has been mainstream (from about 1995 to the present) Internet companies have been fascinated with large audience numbers instead of traditional revenue figures. They believed that if lots of people came, then lots of people would pay (or advertisers would pay for them). The problem, as we learned in 2000, is that companies can’t pay office rent with eyeballs.

Unfortunately, I see game companies doing this as well. For example, a recent article on the rise of online games over console games discussed only the rising audience numbers with online games. Though I don’t argue against the premise that online games are rising in popularity compared to console games, the article seemed to ignore the big question of revenue. Console games have proven revenue, since the user needs to pay for the game to play it. Most Free-to-Play online games are not that way.

With the advertising industry collapsing wholesale and consumer spending down in most sectors, more online games (both F2P and subscription) are finding themselves struggling for air. Microtransactions are still in a relative infancy and larger percentages of players are holding off on buying more Gold, Points, Rewards, etc. Most of the F2P games are monetized by advertising with a minor (though growing) microtransaction component using either real money or CPA ads.

A lot of F2P game companies are now learning what the rest of the web industry learned in 2000 (and subsequently forgot). Eyeballs do not equal revenue. The Average Revenue Per User (ARPU) is the critical component to viability and success. In the past, the rule of thumb was 10% of users become paying users. Now I think that number is dropping significantly. I wouldn’t be surprised if more games are doing 5% or even less paying users. Unfortunately, such numbers are super-secret to each company.

As the economy recesses further, many companies that relied on eyeballs, registrations, audience size, etc. will be finding themselves without a revenue base to pay the bills and payroll with. This will cause an even greater shake-up in the industry than we have seen thus far.

This does not mean the end for gaming is coming, just as the dot.bomb crash did not kill the web. It means that our industry needs to focus on how to provide value to players that they are willing to pay for, instead of hoping that someday they will pay. Bubbles are founded on the hopes of future revenue, hopes for future ARPU. True growth is based on a foundation of current profit and incremental future growth.

Niche games based on a common platform are the future. A number of companies have worked on developing a platform that can be used for many different games. Make a niche game that pulls in 2k-3k paying users with a solid ARPPU (Average Revenue per Paying User) and a profit can be made provided development costs are kept in line. This would mean 20k – 30k active users, if we wanted to assume a 10% paying user rate which is common. The masses want everything for free. The costs involved with getting 1M active users (100k paying users) is becoming more difficult to cover.

Don’t try to make a blockbuster for the masses. Make a tight, focused game that can be developed to a beta stage in 2-3 months, released after a month testing, market within the designed niche and start making revenue. Use cheap pre-release marketing and buzz to gauge interest and market viability so that if the game has a low chance of success it can be canceled before all development and testing costs are incurred.

Once a base game is released, use the initial revenue to expand the game if justified. If the game flops (as Pareto’s Law of 80/20 says will), kill it and move on to another game. Only a maximum of 3-4 months of expenses are lost (instead of years with blockbusters). That leaves the company with enough capital to live another day with another game.

Remember the lessons of the dot.bomb. Active users alone do not make payroll. Only paying users pay the bills and the hosting costs. Find niche markets who are focused enough to be willing to pay for the game. When online game companies focus on that, the industry will recover.

Like all industries, the MMO game industry follows the business cycle of innovation, saturation and maturation. There was a grand period from about 1997 until 2004 when new MMOs were released with consistent improvement and innovation driving the industry growth. This innovation peaked with World of Warcraft in 2004. As WoW made ever more money, many other games (too many to count) were released as essentially WoW clones with a slightly different story, marginally different graphics, and slight twists in the gameplay.

Many of these newer games did make money, but it was as a result of the growth of the MMO gaming audience, characteristic of a new industry.

This changed in 2008,  as it became obvious that the innovation saturation point has been definitively reached. Games started collapsing on themselves as they lost (or failed to reach) the required critical mass for success. The much-hyped Tabula Rasa was shutdown after a very short life. Other games like The Matrix Online and Shadowbane are also belly-up and formerly subscription-based games like Dungeons and Dragons Online are changing to a Free-to-Play revenue model.

As 2009 progresses, I expect to see a number of other shutdowns of large games along with even more smaller games.

So what is the future of online gaming?

Here is what I as the future of successful MMO games:

1. Focus on the casual gamer. Many people are completely engrossed in their games, playing many hours each day on them. But there are many times more people who would prefer to play a game for a short time when they get a chance. The potential audience is much larger when a game can be enjoyed for as little as 15-30 minutes and does not require daily play.
2. Free-to-Play. Casual gamers are not willing to pay a monthly subscription fee. Many of them may go for a month or two playing very little or without playing at all. Additionally, people are reducing their monthly expenses and game subscriptions are one of the first to go. When a game can be enjoyed for free with in-game enhancements purchased when they feel the need (or have the cash), it opens itself to a much larger audience. MMO games require a critical mass of people. People have more fun in an MMO game when it has a lot of people playing and will be more interested in purchasing from the cash shop when they are having fun. This means that even players who never pay a dime for an MMO still bring value to the game by attracting and retaining paying players.
3. Niche games with unique gameplay. Not everyone wants to play WoW. Not everyone wants to play an MMO that features characters of different races and standard classes running around a fantasy (or sci-fi) world killing beasts for loot. Many people love this type of game, but not everyone. I see games with unique gameplay coming out of this industry shake-down. After playing games for 10 years, they all start to look and act the same. It is time that different ways to play are developed.

These changes will lead to a time of new innovation and a new business cycle. It will cause a lot of new startup companies to be created, as true innovation is very rare in large established companies due to shareholder demands of consistent profits. Many of these will fail, but there will be a couple that will rise above the ranks and be able to produce free-to-play niche MMO games. Look at the Facebook and MySpace games that have come out in the last year.

I see successful MMOs being produced by companies that create a game development platform allowing them to produce many smaller games that will, together, make the companies successful (Zynga is a good example).

It will be very interesting to see and play these new games.