Game Economics, Part 1: The Attention Economy
Every year there are new forms of fun, new engagement methods, and inventive ways of generating revenue from digital games. Virtually all…
Every year there are new forms of fun, new engagement methods, and inventive ways of generating revenue from digital games. Virtually all of these methods share one thing in common: they convert attention to revenue.
Whether you’re a game studio considering the business model for a new game, an investor trying to understand the economics of the game business, or a fan who’d like to peek behind the curtain, this series of articles is for you. Part 1 (which you’re reading) deals with the past and present of the industry and provides context for what follows. In Part 2, I’ll move to one of the most exciting new areas of opportunity: NFTs and Digital Collectibles. In Part 3, I return to the present moment for a deep dive on free-to-play.
A Brief History of Video Game Revenue
Let’s begin by looking at where the game industry has generated its revenues thus far.
Arcade Machines
The first games to reach meaningful revenue were arcade machines. Sometimes people who were born into a world of home-based entertainment are surprised that Pac-Man once generated over a billion dollars in sales at arcades, bars, and bowling alleys. These games monetized your attention as follows: You’d insert a quarter and focus your attention on the game. The game’s difficulty would then increase until you couldn’t continue; you’d have the opportunity to start over by inserting another quarter.
At some point, arcade machine developers realized that they were monetizing your attention inefficiently. By restarting the game after you ran out of lives, you returned to the easiest part of the game, where the conversion of your attention into revenue was slowest. However, if you allowed the player to continue with an additional quarter, they’d resume play from the hardest part of the game they’d reached, which meant you’d start spending more money for the same amount of time the deeper you got into the game (another innovation of this time was concurrent, multiplayer games that allowed one machine to monetize multiple people at the same time).
The business opportunity for arcade machines was simple: increasing the revenue per machine for the same amount of time spent. If you look at it through the lens of the consumer, people liked it because their time and attention is valuable to them — and far more valuable to continue (even at a high difficulty) than spending their attention on mastering the game enough that they could survive. This was the start of the attention economy.
Premium Games
The first home sales of games — whether in cartridge form for early consoles like the Atari 2600 or for home computers like the IBM PC — were products sold for a fixed price. Games like this continue to be an enormous part of the game industry.
The entertainment value delivered in these games is often enormous: for a single price of admission, a player can spend an unlimited amount of time. Buy a copy of Zork back in 1980 for around $30, and maybe you’d spend 100 hours in it ($0.30/hour for entertainment). Buy a copy of the Last of Us 2 in 2020 for $60 (as I did) and play for 100 hours, and you’d have spent $0.60/hour. There’s almost no form of entertainment that provides this level of value. Of course, many of us have bought a game and put it down after just an hour; in that case, you paid $60 for an hour of entertainment (or, perhaps, an hour of frustration).
In economic terms, a way to think of this is that it is an option premium: you pay a fixed amount of money in exchange for the right, but not the obligation, to lavish an unlimited amount of attention on the game. Sometimes your option is very valuable (i.e., no incremental costs for engaging with the game), and sometimes it is nearly worthless (you don’t like the game enough to stick with it for long at all).
Pay-by-the-Hour
Along the way, some games were created that charged by the hour. These tended to be large-scale, multiplayer games that could monetize a high number of players. Early examples included Island of Kesmai, GemStone, or my own game: Legends of Future Past ($1.80 in the ’90s). In exchange for a fixed dollar amount per hour, you’d be entertained. This business model was driven by supply-side economics (i.e., the distribution of these games took place over early networks and was priced for the time used, like a telephone call). Some of the earliest games to emerge in China, such as Fantasy Westward Journey, used this model in response to piracy: almost nobody was willing to pay for a retail game, but in a client-server game they’d have no other option.
In some ways, pay-by-the-hour was like the early days of arcade machines. The income potential of a game was fixed according to time rather than increasing difficulty. Today, games that charge like this are a rarity — people don’t like feeling as though the clock is ticking away, extracting money from their wallet even as they spend their attention on the game — and the underlying networks no longer bill according to concurrent user time.
Pay-by-the-Month
There’s no fundamental difference between pay-by-the-hour and a monthly subscription other than the amount charged and the unit of time. A $14.99 per month game costs a bundle of hours that is pre-sold to the player at the rate of $0.02/hour. At that rate, they’d “break even” on the cost of the subscription vs. my $1.80/hour game after only eight hours of play.
The problem with subscriptions is that they inevitably lead to cancellations. Once the player stops making use of the game, they’ll cancel their subscription, even if it takes them a few months to realize it. Since attention is essentially zero-sum, they are resistant to maintaining multiple subscriptions (in other words, the economic value of a collection of subscriptions gets worse and worse the more you have, since you can only be in one game at once).
Once they cancel, they rarely return.
Today, a few games still charge on a pay-by-the-month basis. World of Warcraft is a good example of one that’s been doing this for nearly two decades, but players are very hesitant to try new games with this business model and game companies have generally realized that it forces massive amounts of inertia into adoption.
As for the piracy issue that pay-by-the-hour and, later, pay-by-the-month solved in China — this was ultimately supplanted by a better business model: free-to-play.
Free-to-play
Free-to-play (F2P) is the business model employed by nearly all of the games with substantial revenue on mobile, and a growing portion of PC and console games as well. In this model, players can download and play a game for free, and later have the option to spend money on the game on virtual currencies and virtual items.
There are several reasons this business model has become so common:
It maximizes the number of people who can try the game: there’s no financial hurdle.
Players are in control of when they choose to pay for items or currency.
It permits for moments in time where scarcity can be designed-in, which can further amplify the likelihood (and perceived value) of participating in the game’s economy.
There is usually no cap on the potential revenue per customer, so the lifetime value (LTV) of the average customer can be higher than pay-by-the-month or retail purchases.
Churn can be reduced due to endowment effect and because players feel they have less of an economic incentive to “quit” before moving on to something new.
In terms of the attention economy, it is important to understand that different players value their attention differently. Some players prefer to spend their attention on the game, and others prefer to spend their attention elsewhere and instead spend money in the game — in other words, players trade money for accelerated progress. This is the fundamental principle that makes most free-to-play games work.
Most publishers of free-to-play games are effectively an arbitrage business: they fund customer acquisition up front, purchasing downloads from advertising networks like Facebook in the hope that the LTV is greater than the sum of those up-front costs plus their cost of capital (i.e., interest on loans from a bank, from equity investors, or from the opportunity cost of their cash reserves). This is why the free-to-play game business has become so capital intensive. Funding the marketing effort is frequently a huge multiple of the cost of developing a game.
For a deep dive on free-to-play and the ways game developers drive engagement and monetization, read Part 3 of this series.
Advertising
Advertising is effectively another free-to-play model, although that isn’t quite correct. These games are not free; you are paying with your attention. There are two principal modes of paying with attention within games:
Interstitial advertising, which you are forced to look at for a period of time at various points during the game experience. For example, you might see an ad when you return to the game after an absence or between levels.
Rewarded advertising, in which you receive some form of in-game benefit (typically currency, virtual items, or temporary access to a feature or bonus) in exchange for watching an ad. It is actually a three-way exchange: you are paid with the in-game perk, you pay with your attention, and the game’s creator is paid in dollars by the advertiser. This model works best in games with a robust F2P economy in which the items and currencies you received correlate to the value of items you could have purchased with actual money. When designed particularly well, rewarded advertising often results in a net increase in conversion to paying: these systems teach players the value of currencies and items, and encourage them to buy more.
Play-to-Earn and Skill-Based Games
Esports provide an avenue for earning money from a game. The top performers are gifted with some of the fastest reaction times and highest throughput hand-eye coordination among human beings, which is often measured in terms of actions per minute (APM). The world record holder is currently Park Sung-Joon, with 818 APMs.
Other types of esports allow players to compete for money at all levels. Skillz is the largest platform for this category of games, in which players buy a ticket for admission to a competition and, if they win, are able to earn a share of the ticket sales (and the game developer earns a portion of all of the sales).
Obtaining true mastery — enough to actually earn money — requires massive investments of attention. Even then, most people cannot compete at the top of these games. For these ordinary mortals, games depend on carefully constructed matchmaking systems to ensure that players spend a lot of their time competing with players of similar ability (or risk losing the attention of their audience). Players who are not earning money are frequently paying for the game through advertising and F2P models.
The media of esports is itself also an attention economy: in this market, massive amounts of attention are being directed towards watching people play, rather than playing oneself.
Subscription Bundles
The newest business model within games is the subscription bundle. Examples of this include Apple Arcade and Xbox Game Pass, where players pay a fixed subscription fee each month for access to a list of games that are included in the catalog.
How do game developers get paid for publishing to these services? Although the exact formulas are somewhat mysterious and inconsistent among the platforms, it is generally understood that game developers get paid according to the overall engagement players have in their game relative to all the others. A simplified view is that a game studio will get a portion of the total subscription fees generated in proportion to how much attention players spend on their game; if someone spends 100 hours of their attention in Game A and 50 hours of their attention on Game B, then Game A will earn 66 percent of the subscription revenue (after deducting the platform provider’s revenue share).
What does this really mean? Games on these platforms will increasingly be structured as F2P — but without the in-app purchases and ads. Instead, they’ll become expert at getting the player to stick around for as long as possible. Many of the well-worn tools of F2P ought to play out in this market — and it is likely new techniques will be discovered as well.
Conclusion
Games today function within an attention economy. Players trade attention for experiences. The role of money is to give players the ability to shift their attention toward the experiences they most want to have or to serve as a form of “option premium” against the expectation of future enjoyment.
Your attention is among the most valuable (if not the most valuable of) things you possess. Games bring joy, escape, and entertainment — which is why you’re willing to spend so much of it on them. What do you think? How much is your attention worth to you, and what are you willing to trade it for? Let me know in the comments!
Ready to learn more?
In part 2 of this series, I’ll shift the discussion toward what may be the most significant change in business models for games since the emergence of free-to-play (F2P) — NFTs and digital collectibles.
In part 3, I return to a focused discussion of F2P to discuss in detail the state-of-the-art techniques that game developers use to create engagement in the fastest-growing part of the industry.