How Games Went From Premium to Freemium? & What Could Come Next?
Premium to Freemium: How Gaming Changed the Monetization Game
The Famicom was my gateway into the world of video games in the late 80s. Games such as Super Mario Bros, Contra, Battle City, Tetris, Excitebike, and many more filled my childhood with unforgettable memories and they continue to hold a special place in my heart to this day.
According to Wikipedia - A business model describes how an organization creates, delivers, and captures value, in economic, social, cultural or other contexts. The process of business model construction and modification is also called business model innovation and forms a part of business strategy.
Premium Model in the West
In the 1970s to the 1990s, the old package goods model known as the “premium model” was the predominant method for game developers to put their games into consumers’ hands. Under this model, consumers would first purchase a gaming console, then buy individual games as separate, one-time purchases at physical retail stores The cost between the console and each game is around a 6:1 ratio, with games available in various forms of media, including cartridges, floppy disks, and compact discs (CD).
Coin-Operated Arcade Games
The coin-operated arcade games, once a defining aspect of video game culture, are an important part of video game history. The arcade games were viewed as one of the early examples of the microtransaction model that we see today, as they offered players a low-cost way to try out the experience. Instead of requiring a large upfront payment, such as $10, $20, or $30, arcade games only cost a quarter or 50 cents, making them more accessible to consumers. This approach broke down the barrier to entry compared to the more expensive console games of the time. However, due to technological limitations, consumers had to start the game from the beginning each time they played, as progress was not saved on the server side.
Premium Model in the East
Growing up in China, I observed that the business model for the console game industry was similar to that in the West, at least from a consumer perspective. Console manufacturers made margins comparable to the Western market, but game developers did not receive any royalty payments, due to widespread piracy, regardless of the number of copies of their games sold in the country. The situation for PC games was similar structurally, although the upfront cost of a PC was typically 10 to 20 times higher than a console. For example, in 1990, a Famicom console cost approximately ¥1,600 Yuan ($183 USD), while a PC, considered a luxury item at the time, cost at least 10 to 25 times more. With an average GDP per capita of $473.49 in 1994, most families could not afford to own a PC, let alone justify such a large investment, given the lack of infrastructure. This substantial upfront cost disparity led to the development of what is now known as the Internet Cafe model, where businesses purchased a large number of PCs and charged customers a small hourly fee of about 60 cents for access. In the early days of Internet Cafes, before the internet boom, multiplayer games were the main draw, attracting consumers to play LAN party games together. This model was similar to the arcade model, but much more lucrative, as the cost of software was close to zero (due to piracy) for PCs, while each arcade machine had a substantial upfront cost for adding just one game not to mention the limited retail space.
Piracy - the Seed of the Freemium Model
Piracy has been a persistent issue for not just video games, but all software and media businesses that rely on upfront payments to generate revenue from consumers. Bill Gates once spoke about the issue at the University of Washington, stating:
“Although 3 million computers get sold each year in China, people don’t pay for our software. Someday they will, though, and as long as they are going to steal it, we want them to steal ours. They’ll get sort of addicted, and then we’ll somehow figure out how to collect sometime in the next decade.”
Despite Windows being a must-have software for running PCs, Microsoft faced difficulty in making a profit from its software due to rampant piracy in the region. This was also the case for PopCap in 2005, when I was helping the company devise its strategy for entering the Chinese market. Despite the massive success of its games, such as Zuma, Bejeweled, Peggle, and Plants vs. Zombies, which were household names for casual games on the PC and Internet Cafes, the company’s revenue from China was about $100 in 2006 if I remember it correctly. We suspected that the five copies were likely sold to expatriates from the United States.
The Essence of Privacy
Piracy is a common issue in developing countries due to a number of factors such as weak intellectual property laws, limited enforcement, and cultural attitudes toward copyright infringement. In my view, the root cause of piracy lies in the misalignment of value between the perceived value of the copyrighted material and its actual cost, more of a mispricing in a simplified term. In developing countries, the cost of acquiring pirated material is often much lower compared to the price of the original product, which puts it beyond the reach of many consumers' discretionary budgets. It was clear that the cost of most software from the West was still “overpriced” even if the price was reduced by 50% based on the Big Mac or Coke Index. This disparity in pricing, it’s not the excuse to legitimize the act of piracy but is what drives software piracy in these markets at the time.
From my experience, I have seen that many big corporations take a reactive approach to combating piracy, investing millions of dollars in digital rights management (DRM) technologies both on the hardware and software sides. Despite these efforts, these technologies are often quickly bypassed by tech-savvy enthusiasts within weeks. This lesson has taught me that relying solely on technology is not enough to solve the problem of piracy and that a more comprehensive approach is needed to address its underlying causes.
Freemium Model Solved Piracy
The impact of piracy on the distribution of various forms of content, including software, games, music, and movies, cannot be understated. On one hand, piracy has allowed for the delivery of these products to millions of consumers without the need for marketing efforts from content creators or publishers. This was even before the advent of peer-to-peer (P2P) file-sharing platforms such as LimeWire. On the other hand, content creators and publishers have been negatively impacted by losing revenue and proper compensation for their work.
As the internet and personal computers gained wider popularity and other technologies matured in the 1990s, the demand for multiplayer games started to emerge. This was a significant shift from the early days of gaming, which was dominated by single-player or small-group experiences. Some of the most influential games in the development of modern multiplayer gaming include Doom, Warcraft, Command & Conquer: Red Alert, StarCraft, Half-Life, and Counter-Strike. These games are often considered pioneers in the world of multiplayer gaming and helped lay the foundation for today's digital distribution model and the underlying technology behind the multiplayer experience.
In the early 2000s, Shanda licensed "Legend of Mir" the first online MMORPG from WeMade, the game was free to play until a player's character reached level 7, at which point they would have to purchase point cards to continue playing. In 2004, The9 licensed "World of Warcraft" (WoW) from Blizzard for the Chinese market and employed a localized business model compared to the prepayment + monthly subscription-based model used in the US. Instead, the game was sold for 30 yuan ($3.62 USD) and included a CD-key for first-time activation of the game client with 1,200 minutes of playtime. Additional playtime could be purchased for 30 yuan for every 4,000 minutes (5.4 cents/hour). Although these models were not entirely free-to-play, they still achieved tremendous success in the early history of the Chinese gaming market, breaking records for concurrent and peak concurrent users quarter after quarter. This success was due in part to the local pricing and the ability for players to save their progress on the server, allowing for continued play anywhere the consumers go from home or at Internet cafes.
Around 2003, the game "MapleStory" fully embraced the free-to-play model with microtransactions and gained widespread popularity in Korea. MapleStory was one of the first games to achieve success with this business model, which allowed players to download, activate, and play the game for free, with the option to purchase in-game items and currency with real money to enhance their gaming experience. Shanda brought MapleStory to China in early 2004, and since then, the freemium model has gradually become the dominant business model for games, spreading globally with the introduction of the App Store for the iPhone in 2008.
This business model provides better value propositions to consumers. Players have the option to try out games before committing to spending any money, and they are no longer under pressure to decide which game is worth spending $60 on out of hundreds of options. The free-to-play model provides a low-risk and low-commitment way for gamers to experience a game and potentially pay for enhancements if they enjoy it. This value proposition holds true in the Western market despite the fact that piracy is not as big of an issue as it is in developing regions. It's like trying to resist a free cookie, almost impossible for consumers to say no to free goodies.
What Could Come Next?
The video game industry has undergone a transformation over the past two decades, with a shift from a premium model to a freemium model. This shift was driven by technological advancements and changes in consumer behavior. The traditional business model in the gaming industry, which consists of "Create", "Delivery," and "Capture Value" components, has been disrupted with the evolution of the freemium model. Additionally, tools like Unity and other cloud services have become increasingly important in game development "Create", as they help game creators produce better products with less time and effort which should be a separate discussion.
However, recent changes in IDFA (Identifier for Advertisers) and ATT (App Tracking Transparency) have presented a new set of challenges in the "Delivery" component of the industry, making it harder for some less competitive products to achieve the exponential growth that was once common in the industry with a “good” user acquisition strategy. In response, companies are shifting their publishing strategies and placing more emphasis on game development ("Create"), rather than solely relying on data-driven marketing ("Delivery").
“Paid” to Play Model?
Is "free-to-play" losing its allure? Could "pay-to-play" be the answer, where consumers are incentivized (paid) to play the game? The Epic Game Store is a relatively new entrant in the digital game distribution market, but it has quickly gained popularity and become one of the most discussed topics in recent times for growth. The store initially started with the hugely popular game Fortnite similar to Steam with Half-Life and Counter-Strike. However, the Epic Game Store distinguished itself from others in its marketing strategy by offering one or multiple free games each week. According to GameRant, the estimated value of all the free games offered by the Epic Game Store in 2022 was about $2,244.03. This strategy seems to be working well, the Epic Game Store has seen impressive growth in its user base, doubling from 108 million customers in 2019 to over 194 million in 2021, just three years after its launch.
While the cost of the free games offered by the Epic Game Store may seem high, the impact on the company's growth has been substantial, especially if favorable terms were negotiated. This approach has helped the Epic Game Store stand out in a crowded market and attract a large and growing user base.
The Next Dark horse?
Netflix recently launched a gaming initiative in November 2021, offering mobile games as a free add-on to its streaming service for its existing subscribers. Non-subscribers are not yet able to access the games.
It is yet to be determined what the company's ultimate strategy for its gaming business will be, however, they do have many levers to pull. One intriguing option could be leveraging their existing vast content library. For example, following in the footsteps of the Epic Game Store, Netflix could offer free episodes or watch time as a way to acquire new users for their games or streaming service, or vice versa, using a popular and enduring game franchise as a means of attracting new users.
Such an approach has the potential to significantly lower the cost of acquiring new users (over $100+ per new user last I check) and reduce the churn rate. Additionally, it may solve the problem of shared accounts naturally when each account has its unique game progress saved on the cloud.
More About Business Models on HBR
If you're interested in exploring various business models across industries, I discovered a useful article from Harvard Business Review that you may find interesting.
“What Is a Business Model” Summary: A look through HBR’s archives shows that business thinkers use the concept of a “business model” in many different ways, potentially skewing the definition.
Many people believe Peter Drucker defined the term in a 1994 article as “assumptions about what a company gets paid for,” but that article never mentions the term business model. Instead, Drucker’s theory of the business was a set of assumptions about what a business will and won’t do, closer to Michael Porter’s definition of strategy. Businesses make assumptions about who their customers and competitors are, as well as about technology and their own strengths and weaknesses.
Joan Magretta carries the idea of assumptions into her focus on business modeling, which encompasses the activities associated with both making and selling something.
Alex Osterwalder also builds on Drucker’s concept of assumptions in his “business model canvas,” a way of organizing assumptions so you can compare business models. Introducing a better business model into an existing market is the definition of a disruptive innovation, as written about by Clay Christensen.
Rita McGrath offers that your business model is failing when innovations yield smaller and smaller improvements. You can innovate a new model by altering the mix of products and services, postponing decisions, changing the people who make the decisions, or changing incentives in the value chain.
Finally, Mark Johnson provides a list of nineteen types of business models and the organizations that use them.
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