August 2007


I don’t imagine we have too many artists reading f2p.biz, but if you are that guy or girl you might want to check out Jagex’s latest job posting. Seems they’re looking for a designer in Cambridge to do the following:

We are looking for a talented web designer to join and help create websites that will be viewed by millions of people each year.

With over 1.1 million paying subscribers to our online game, RuneScape and a further 6 million other active players visiting the website regularly, you will be responsible for designing the site they visit to play our ever-popular game.

Seems like a cool opportunity for a designer who wants to be on the cutting edge. If we had you at hello, go ahead and send your resume here. Tell them F2P sent you.

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Motley Fool has a good wrap up of Shanda’s just released Q2 numbers. I’ve included a couple quotes from the article below.

Further to my previous article on the potential acquisition costs of the Asian F2P leaders, Shanda seems already unaffordable for all but the most well-heeled Western suitors.

Revenue soared 39% to hit $74.1 million in the second quarter. Earnings, before a one-time gain related to the company’s sale of its stake in SINA (Nasdaq: SINA), soared 78% to $0.42 per American depositary share (ADS).

Wall Street was expecting the company to earn just $0.36 per ADS on $72.4 million in revenue. The pros have been perpetually humbled by Shanda. This is now the fifth consecutive quarter in which the company lapped the market’s profit targets by at least $0.06 per ADS.

And most interestingly:

Yes, China’s online gaming market is getting crowded, but just three players — NetEase (Nasdaq: NTES), The9 (Nasdaq: NCTY), and Shanda — account for roughly 60% of the market. [Ed: emphasis mine]

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Last month my family traveled to London, a city of less than 500,000 in Southwestern Ontario. While there, I watched my 7 and 13 year old cousins, Brad and Kyle, play games on their family computer.

Somewhat surprisingly, Brad and Kyle had just one retail PC game between them (Settlers). Instead, their favorite games were Puzzle Pirates, Habbo Hotel, and Runescape – all free to play, virtual item sales games (with the exception of Runescape, which uses tiered subs rather than virtual items for its revenue).

What does this say about where the North American PC market is headed?

Based on overwhelming anecdotal evidence, it’s clear to me that the younger set (under 20) is embracing free to play and virtual goods games because the budget and engagement model is tailored made for for them. And as the younger set is further weened on the same virtual goods business model that’s already dominating Asia, retail only pay-to-play PC games will be ignored en masse.

In some respects, North American companies have begun adjusting to the F2P/virtual goods wave. With gifting sites like Facebook and HotorNot.com, microtransaction services like Xbox Live and casual MMOGs like Puzzle Pirates, one might argue that we’re at least keeping up with the pack in this emerging space.

But what are traditional North American game publishers (EA, Activision, etc) doing to adjust to this new, non-retail, online-centric business model? Are they seeding their own internal virtual goods projects? Building virtual goods into their existing or upcoming products? Acquiring early movers in the space?

At least right now, the answer appears to be “none of the above”.

North American game companies are taking the same “partner and acquire” approach that they’ve used to achieve growth and purchase innovation for the last two decades. When done correctly, this approach pays off handsomely. Activision partnered with Infinity Ward to produce the first Call of Duty, then opted to purchase the developer for a meager $5M just before Call of Duty 1 shipped. Activision knew that when CoD became a big hit, Infinity Ward’s asking price would grow immensely due to their successful IP.

In another bit of foresight, Take Two bought Irrational in 2005 for just $8.2M. Last week, Irrational delivered Bioshock – the highest rated new IP in years. If Irrational were for sale today, their asking price would likely be 5-10x what they sold for.

But studios with already successful IP (or a track record that indicates their next game will be huge as well), command a larger acquisition premium than the aforementioned deals.

For example:

IP Acquisitions

Track Record Acquisitions

But an even larger premium is paid for companies that couple good IP or a good track record with an online-only distribution model.

Online Acquisitions

Why the higher acquisition premium? Because online-only companies such as Club Penguin, Shanda, Netease, etc routinely see annual profit margins of 50% or more.

Look no further than Club Penguin making $35M profit on $65M annual revenue.

By contrast, retail game sector margins have been in decline ever since the last big reduction in costs: the move from carts to CDs in the mid-90s. Development and distribution costs have risen so dramatically in the last two console generations that EA’s net income has declined 87% since 2004, Take Two has lost $90M total over the last six years (50M units of GTA sold and still a loss?), and Ubisoft and THQ are considered a profitability leaders at nearly 10% annually. *

So it’s no wonder that deals like Disney/Club Penguin and EA/JamDat have much higher valuations than their retail counterparts. They have a far better ROI.

But let’s get back to my point: the “partner & acquire” approach Western companies have traditionally used to internalize innovation will likely prove cost prohibitive as it’s being applied thus far in the virtual goods space.

Some of the recent virtual goods partnerships made by publishers include:

These are all great relationships, but they are bridging strategies primarily suitable for the short to medium term. The acquisition portion of these partnerships would be cost prohibitive. Which North American game publisher would be able to afford the acquisition cost of a Nexon or Shanda based on the latter companies’ very healthy margins and rapid revenue growth?

Let’s use Shanda and THQ’s most recent Q1 2007 results as an example.

THQ (Q1 2007)

  • Gross Revenue: $139M (down 12% from previous year)
  • Profit: -$10M (net loss)

Shanda (Q1 2007)

  • Gross Revenue: $68.8M (up 61% from previous year)
  • Profit: $58M

Western companies have huge revenues, but even huger development costs owing to their terrestrial products – resulting in little or no profits. Eastern companies have smaller (rapidly growing) revenues, huge profit margins from online only distribution and a big head start on virtual goods. This contrast holds more or less true for most of these Western/Eastern partnerships.

Shanda’s market cap today is $2B. It’s not far-fetched to assume their purchase price might be close to $3B. The only companies with that kind of cash on hand are EA and Microsoft.

While it could be a partial stock deal, why would Shanda would trade their high growth stock for low growth publisher stock? Any partial stock transaction would ultimately result in a higher overall purchase price.

Netease (NTES) has a market cap of $2.06B. The9’s (NCTY) market cap is $1.14B. Nexon is privately held, but with $235M in revenue two years ago, they won’t be cheap either. The point is, there aren’t many deals left among the virtual goods establishment.

The billion dollar question is: Where will these numbers be next year? Or in 2-3 years?

My gut says that in two years, North American companies will be “priced out” of acquiring a leadership position in the global virtual goods market.

To avoid this fate, big American publishers need internally developed/wholly owned virtual goods projects or partnerships with newer, smaller virtual goods companies whose acquisition costs are far below the big Asian players such as Shanda, Netease, Nexon, The9, NHN, etc.

So…

  • When will we see early stage virtual goods startups acquired by game publishers in massively undervalued deals a la ATVI/Infinity Ward? Are the big publishers even capable of spotting these deals as well as venture capitalists? Companies like Conduit, Three Rings and Areae would be prime targets for early acquisition if VCs like Charles River and others weren’t already all over them. Venture capital’s eagerness to fund low risk/high margin virtual goods plays (and not high risk/low margin retail game companies) will drive innovation in the sector, ratcheting up acquisition costs for publishers are late to the party.
  • When will we hear of internally developed virtual goods projects underway at major publishers? Perhaps EA and Ubisoft’s new casual games focus will bring about the next big Flash MMO or virtual world, but I can’t help but think most of their attention is still on on the try-before-you-buy $20 casual games, rather than F2P/virtual goods. Ironically, some of the biggest stateside-initiatives in free-to-play are coming from Asian companies like Sony Online (FreeRealms) and NCsoft (Dungeon Runners).

Until we see big American publishers announcing more than stop gap Asian partnerships, I’m concerned that the next generation of gamers – my cousins Brad and Kyle in London, Ontario – will be playing even fewer games from today’s North American publishing giants.

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Notes:

* For more of these numbers, check out the GAAP financials for big publishers using this link to EDGAR, then enter a stock ticker like ERTS to get to a 10-K form like this one for EA. Search for “statements” or “2004” and keep going until you get a table with last five years or so, then check out the net income row.)

At last month’s Casual Games Conference in Seattle, I spent about 30 minutes chatting with Daniel James, CEO of Three Rings. Daniel told me an interesting story about how Puzzle Pirates, the hit Java MMO, has accelerated user base growth.

Puzzle Pirates utilizes few other distribution portals outside of http://www.puzzlepirates.com. But one site Daniel has had phenomenal success with has been Miniclip.com, the browser-based games portal.

In Daniel’s experience, a stunning 1 million out of Puzzle Pirates’ 3 million players have come via Miniclip alone.

Because Miniclip users are younger, they don’t monetize as well as other players. Daniel’s estimation was 1% monetization for Miniclip users vs 5% among the rest of the Puzzle Pirates user base. However, according to Daniel a secondary wave of word-of-mouthers join Puzzle Pirates shortly after each wave of new Miniclip users and the conversion rate among this secondary wave is much better.

I bring this up now because of this very recent Ypulse article, which contends that Miniclip has been the primary growth catalyst for games like Club Penguin and Runescape as well. A degree of influence not surprising given the “explosive growth” of the Miniclip.com site itself, as illustrated on this chart.

Here are some quotes from the Ypulse article:

Without Miniclip, it is likely that there is no Club Penguin phenomenon. The product launched in October 2005 and was able to eke out a base of about 25,000 users. A few months later, the game was posted on Miniclip and experienced explosive growth. By September, the product had over 2.6 million users. Runescape’s user base saw a similar, if slightly less dramatic, increase from a niche game to a multi-million user success.

With a core demographic of 10-24 year olds, Miniclip has built a portal with the power to instantly launch a youth brand. What network TV was for The Transformers, so Miniclip has been for Club Penguin. Great products can travel virally, but the task is a lot easier if the starting point is 30 million exposures.

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US-CA-Glendale-Executive Producer, Neopets

Here’s an opportunity that doesn’t come around every day. Neopets is looking for an EP.

The Neopets Executive Producer reports to a VP and interacts with the longest list of Director types I’ve ever seen included in a job description. I quote:

This position will interact closely with:

-Director, Technical Development

-Director, Multimedia Applications Development

-Director, Casual Game Development

-Director, Marketing and Operations

-Director, Promotions Marketing

-Director, Fraud Management

-Design Director, Neopets Creative Resources

-Director, Consumer Products

-Director, Research Analysis

But as we all know, the market for talent is tight. So I wasn’t surprised to see a relatively light set of prerequisites:

EDUCATION/EXPERIENCE:

-BA in a related field or equivalent experience. MA a plus.

-3+ years working as a Product Manager, Producer or Associate Producer on multi-player on-line games or similar position.

-2+ years experience with project budgetary processes.

And after listing off 23 bullet points under the KNOWLEDGE/SKILLS section, I always find it odd when companies throw in a line like this:

-Proficiency in the following software or systems:

-Microsoft Office, Visio, MS Project, Outlook

In any case, it’s late at night and I’m being overly critical. If you’re interested in this opportunity, email Mia Burgess (mia.burgess@mtvstaff.com) or go straight to the top by tracking down Kyra Reppen, SVP & GM of Neopets.

 

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From a Gamasutra interview with Nicholas Beliaeff, Sony Online San Diego studio head… here are a few quotes:

On reducing barriers to entry:

We’ve got a lot of streaming going on, and we’ve reduced the barrier to entry for players. There’s no big download, and no credit card required. We’re really excited about that.

On multi-platform development:

For us as a company moving forward, all of our MMOs in development have a console component.

On min specs:

Whenever you’re making a game and are proud of it, you want as many people as possible to play that game. In the PC world, the lower the machine spec you can get, the bigger potential audience you have, and the more chance you have for people to look at your work.

On Free to Play:

If you look at some of the free to play games like Club Penguin and RuneScape, it’s a huge market. If you look at the actual numbers of people playing RuneScape, there may actually be more people playing RuneScape than there are playing World of Warcraft.

Interestingly, Nicholas and I met in 2001 when I was pitching a product of mine to him and Trip Hawkins at 3DO.

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Virtual Goods Summit 2007 – Conference Videos

As has already been reported on several sites, the videos from June’s inaugural Virtual Goods Summit at Stanford are now online. Thanks to the organizers for making the videos freely available – I wish more conferences did this.

I took a heap of notes at the Summit, so why not share them now as well, both in “Top 10” and raw format.

My Top 10 Notes from the Virtual Goods Summit:

1. James Hong of HotorNot.com
On HotorNot, users can purchase a $10 rose to send to other users. The rose dies 2 weeks later. HotorNot figured there were three value propositions inherent to a real life rose: the flower itself, the gesture of giving it, and the trophy effect of having received it. HotorNot figured that for virtual roses, 2 out of 3 of those values weren’t bad – and they were right. The $10 rose is HotorNot’s highest priced item, but it is still their best seller. James Hong said re: price elasticity, “It’s not impossible that if we raised the price of the rose, we’d sell even more.”

2. Paul Thind of Habbo Hotel
Habbo puts spending caps on every payment method to control economy & keep parents happy – so users can spend money only on 2-3 set days of the week.

3. Craig Sherman of Gaia Online
Gaia has three full time people on staff whose job it is to open envelopes filled with dollar bills and coins because people are desperate to get money into their accounts but can’t find a suitable payment method.

4. Min Kim of Nexon
Average user lifetime in a Nexon game is 2-4 years; Audition, Nexon’s newest game, is 50% female; Maple Story and Kart Rider are 20-30% female.

5. Tim Stevens of Doppelganger
The typical console game would not benefit from virtual item sales because of its lack of a continuing connection with its audience. I.e. the game launches, everyone buys and plays it, then most if not all of them leave very quickly for the next game. The community doesn’t grow and care about their presence in the game long-term.

6. Daniel James of Three Rings
The average Puzzle Pirates user spends 2.5 hours per day in the game. Some drop in and leave, but others spend up to 9 hours a day in-game.

7. Raph Koster of Areae
Regarding preventing and tracing fraud: “You need to serialize everything – so you can trace the path of a virtual coin right back through to its minting.”

8. Kyra Reppen of Neopets
Neopets builds their item packages and costs around a template metric of $10-15 per complete outfit.

9. Kevin Efrusy of Accel Partners – Facebook’s VC
The Facebook gifting service was just an experiment. A third party will use the newly-launched Facebook Application Platform to deliver a far more successful gifting solution. He said if he were an independent developer, he’d be working on that right now as he believes it is a huge opportunity.

10. Eric Bethke of GoPets
GoPets users are 80% female, one third of whom are in North America. Users are spread throughout the 20s, 30s, 40s, 50s age groups. Interestingly, GoPets highest ARPU is from the low 30s age group.

All of my raw, totally unedited notes from the Virtual Goods Summit, after the jump.

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