Online games is the fastest-growing segment of the $50 billion-plus video games industry. New gaming ventures have been popping up at a staggering rate, supported by cash infusions from investors attracted to the economics of the industry. However, given the low barriers to entry and limited visibility characterizing the industry, we believe that the number of long-term winners will be scarce.
The intrinsic challenge to achieving long-term growth in this sector is the hit-driven nature of the games industry. Most gaming companies rely on one unique title to scale. Only a handful of games—the most popular being World of Warcraft—have been able to deliver continued growth over time. This is why, despite some rare exceptions, the notion of platform is almost a prerequisite to any discussion around sustainable success in online gaming.
At Summit Partners, we’ve identified four traits of a successful online games platform. These traits increase the likelihood that companies in this sector not only are in a strong position today, but also can adapt and thrive in the years to come.
1. Attracting and retaining development talent
As the online games industry becomes more competitive and gamers become more sophisticated, companies require high-quality development resources. Relying entirely on external resources, as some franchises do, can put the company’s long-term expansion at risk. As the company scales, the control of its development engine weakens. Building internal development capabilities ensures a constant connection between the strategic vision and the actual production in a fast-moving environment.
However, with the significant inflow of capital into the sector, development talent has become scarce. Companies are seeing their compensation costs skyrocket and are experiencing pressure on their economic models, which leaves lightly capitalized private companies at risk.
In this dynamic context, gaming companies that want to limit cost pressure and significant shareholder dilution must think out of the box to attract and retain this talent. Companies can successfully compete for talent in two ways: by creating a desirable culture and by offering ownership.
Developing and maintaining a highly differentiated corporate culture is crucial for organizations that rely on creative talent. Top development talent wants to contribute to something unique and exciting, and it is management’s mission to uphold this culture. In addition, granting ownership remains the most powerful way to reward and encourage employees. While the most successful software companies have understood the necessity of offering equity ownership to their most valuable development resources, this is not yet a standard in the games industry. We believe this should and will change.
2. Building a unique distribution network
Zynga, a Facebook-based gaming company, has attracted significant interest from the investment community. Much of the company’s initial success was driven by the way its games were distributed to users via Facebook—an attractive new distribution channel for the games industry. Zynga’s ability to match the right product and the right monetization system with this distribution channel was key to its success.
Similarly, European online gaming leader Bigpoint—a Summit Partners portfolio company—early on recognized the need to build a highly scalable and profitable recruitment engine. The company convinced large international media groups to help promote its games across multiple platforms—including television—and across countries. These innovative revenue¬sharing partnerships allowed the company to quickly become a true international organization in a predominantly local industry. As demonstrated by Bigpoint, fast, profitable and sustainable growth requires the ability to open new channels in existing media while properly navigating the ongoing mobile revolution.
3. Optimizing monetization...without sacrificing retention
Monetization has long presented a significant challenge for the online games industry. In the casual segment, most gamers were not willing to pay for simple, low-quality games. As a result, companies had to rely on advertising to drive revenue. In the hardcore segment, the traditional subscription model restrained the ability of companies to materially increase revenue from their limited number of users. Virtual item selling has provided a compelling monetization model for the industry. Theoretically, it allows gaming companies to optimize the monetization of each user in line with individual levels of engagement and budget.
While selling virtual items is now recognized as the monetization system of reference across the industry, it can lead to lower retention rates. Although aggressive, short-term monetization is highly tempting, gaming companies should focus on the key metric—lifetime value per paying user. Those users who invest in a game are willing to engage themselves in a real experience. If the game does not deliver on this expectation, they will instantly leave.
Bigpoint, a pioneer in virtual item selling, understood at the outset the need to properly manage this delicate balance. The company’s ongoing commitment to deliver the right experience to its paying users is a key driver behind the long-term success of its most famous titles, including DarkOrbit and Seafight.
4. Dictating customers’ decisions
Even if a company succeeds at optimizing the monetization-retention balance in a given game, its users will eventually want to try something different. This is the nature of the entertainment business. Users will be aggressively targeted by competitors and over time will be increasingly at risk. Companies need to pre-empt this switch and give users the opportunity to access the new gaming experience they are looking for on their own platform. This calls for a coherent game portfolio strategy rather than a game-by-game approach.
Companies such as Bigpoint and Zynga clearly understand that sustainable growth will require extending lifetime user value across their entire online games platform. From the earliest stages of development, they think about creating logical bridges between games. Their close tracking of user behavior allows them to push these bridges at the most relevant time in each game. The Rama series of casual games developed by Bigpoint is a perfect example of the successful implementation of such a strategy.
While it is highly challenging to predict future growth in the online games industry, we believe that those companies that adhere to these four principles will benefit from a real edge when it comes to building long-term success. As a leading investor in fast-growing companies with high potential, Summit Partners works with entrepreneurs to fortify this edge across a range of industries.