Over the last few years, venture investor interest in the game industry has skyrocketed. The industry is no longer just about video games; as cross-media experiences like Fortnite have shown, game developers are embracing multiple forms of entertainment at once.
Game technologies like the Unreal Engine that power these experiences are supplementing traditional film, television and enterprise production tools, seeing extensive use in high-profile, high-budget shows like Disney’s The Mandalorian.
A common investment thesis among VC and PE funds interested in the space is that there are opportunities for enabling game technologies that resemble other enterprise software solutions, like Autodesk.
However, video games as an industry has not produced a publicly traded tech product whose profit opportunity is seat-based software licensing. Rather, Unity, Epic, and others who provide tools (such as Amazon and Microsoft) have shown that game technology businesses drive services, platforms, and content which offer the potential for greater returns than enterprise software licensing.
Let’s step back for a moment and understand the opportunities for investors in games. Game investments typically fall into one of four funnels:
- Content/publishing, which is where most of the value in the industry lies, now and in the future
- Community platforms such as Twitch or Discord
- Store and distribution mechanisms such as the Epic Game Store, Steam or the App Store
- Enabling technologies such as Unity and Unreal Engine
Game content like Roblox or Pokémon Go have the potential to become something investors are very interested in, recurring revenue platforms. However, the content must be compelling and successful to become a platform. As such, content is a hit-based business that many software investors traditionally eschew.
Community platforms are a business that many startups attempt but few achieve, outside of those tied to hit content. Community platforms independent of content, such as Discord, have yet to find profitable business models — though they can get massive user numbers.
And distribution is difficult for startups to break into; big tech companies (Apple, Google), popular storefronts (Steam, Amazon) and console makers (Microsoft, Sony, Nintendo) dominate this space.
So many investors have recently set their sights on the fourth business, enabling technologies that start with games but can spread beyond games. These investors, quite rationally, are looking to apply their general expertise in enterprise software toward game tech, assuming that enterprise software and games are similar.
The key assumption taking place here is that game tech follows standard technology growth models: highly scalable software that can produce recurring returns as usage increases, such as with non-game software developers like Adobe or Autodesk.
The industry, however, has proven largely resistant to the creation of a wide ecosystem for startups in game tech software. It is worth analyzing the historical context.
For much of the video game industry’s existence, game technologies were built by the lead programmer and an internal studio team, and considered part of a developer’s competitive advantage. Early Atari games didn’t credit their programmers for fear that their talent would be snatched away.
In the 1990s and early 2000s we saw a cadre of middleware developers build solutions (lighting, occlusion, sound, physics) for developers working on their own engines (or as plugins to up and coming Unity and Unreal), but none of these firms (e.g., Umbra3D, Havok, Simplygon, FMOD) have reached Adobe or Autodesk scale. And most are now gone or have been absorbed into other companies; Umbra3D was just acquired by Amazon.
Above: “The Mandalorian” production team used Unreal Engine to display many of its environments on set.
Image Credit: Lucasfilm
This may be because there are not many game developers relative to the number of companies who need general enterprise software. Games are highly specialized software, and while the technology powering them is now becoming more ubiquitous in people’s daily lives, for much of the industry’s existence the technologies required were relegated to bit parts of a niche entertainment business.
As time passed, most of the value that was in middleware became absorbed into the professional game engines such as Unity and Unreal, along with recent open-source solutions such as Godot. This eliminated the dozens of companies comprising the game middleware market as we knew it, starting around 2010 and accelerating to the point where nearly all middleware solutions are sourced from four firms (Unity/Unreal/Amazon/Microsoft) in 2021.
Meanwhile, game engine makers, now the few real remaining pure game tech solutions, do not see most of their profits as businesses from licensing of their engine software.
Epic’s Unreal Engine has seen massive uptick in usage, thanks to large investments due to the success of Fortnite. But the majority of their business comes from content, and even their store business is likely growing faster than the engine business. While their revenues are not public, estimates are that the engine revenue is between 1/8th to 1/10th of their content revenue. Epic also gives away its services product for free as a way to increase market share for its account system, where it hopes to derive future value as a key identity system for the metaverse.
Unity is a pure game-tech business, not generating revenue from content. But even Unity, which went public in the fall, has the majority of their topline revenue coming from services rather than licensing. Services for Unity consist of Unity’s advertising solutions and their online game solutions. The minority of Unity’s income is from the engine, and even then, the majority of this engine income is enterprise-level, comprising 700 customers, despite that the Unity engine has hundreds of thousands of licensed users. The biggest growth areas for Unity beyond ads, and where they have made recent acquisitions to bolster, are sales of multiplayer operational services and cloud management solutions, as well as development support.
As a result, while there are many technologies that game developers now utilize to build hit products, a technologies’ value to a developer has migrated from software-based solutions to the services around that software.
Services in the game industry can be divided into three categories:
- Live services (online / accounts / multiplayer services largely now absorbed by the infrastructure providers, with engine makers increasingly competing)
- Payment services / Analytics (credit card processing, refund, inventory management, game stats)
- Distribution / Revenue Generation services (storefront management, ad tech, customer acquisition)
The first, live services, is one of the biggest areas of growth. Many startups have begun offering solutions to host multiplayer, improve pings, or enable better game modding. However, there are challenges: both big tech and the game engine makers themselves are offering their own services.
Above: Microsoft offers PlayFab and Azure to game companies using the cloud.
Image Credit: Microsoft
For example, Amazon and Microsoft both offer multiplayer solutions bundled into AWS or Azure, and they have acquired some of the best independent service providers such as Playfab. Epic enabled many of the services that were previously tied only to platforms like Steam, PlayStation Network, or Xbox Live into their Epic Online Services for free, and Unity has acquired companies like Multiplay to provide cross-engine, cross-platform services to developers.
Of course, just because some of this is offered by infrastructure and engine makers does not mean that there aren’t new blue oceans to be found in an industry that expands as quickly as games. High-concurrency multiplayer, low latency multiplayer and Interactive streaming solutions are all areas poised for growth.
The second, payment services, has largely consolidated over the last five years. On mobile, you have few options for third party payment providers (as the recent Apple/Epic lawsuit has shown), and on game consoles and PC, you are generally limited to the stores. However, once you move beyond payment processing, you need backend solutions to manage purchased inventory, to which both AWS and Azure offer some technologies.
The third, distribution and revenue generation services, are solutions like Unity’s ad tech or customer acquisition funnels. Similar to live services, opportunities here will grow as not many of the major tech players, nor Epic, have really pushed in this direction.
Game technology services are an exciting and relatively new sector where business scales as customers succeed. The more a game like Among Us does well, the more the game needs multiplayer servers, payments and analytics services in the backend.
Prior license-based middleware typically scaled with the development budget of the game (see the licensing models of FMOD and Wwise.) This doesn’t reach venture capital scale requirements, nor it is enticing relative to the growth you can experience when you service the success of content.
By tying the opportunity to the growth of revenue rather than the growth of cost, game technology companies will generate superior returns.
The myth of the game tech business is that game tech solutions based on the sale of scaled software or subscriptions to enterprise customers are the opportunity. The game tech business is not the same as the enterprise software industry. The customer base of game developers is growing but is unlikely to scale to support seat-based or subscription-SaaS based models at the level of customers that other enterprise software will have, by nature of the fact that the solutions offered by game tech are specialized.
Unity is the closest example, but proves the point: engine software sales are not the majority of their revenue nor where they are looking to for future profits based on their own statements. Rather, for Unity, ROI on Services is superior and the focus of their growth.
For investors looking to enter the game technology space, look for businesses transitioning from licensed products into services for content development that scale with the success of the product, not the number of developers being licensed to. One mega game can generate more service revenue than a thousand small games.
Successful game tech companies will look less like Autodesk and more like Snowflake with a content focus; services businesses that can survive competition with the tech titans, but that scale by the growth of content (that may be developed internally like Epic or by their customers like Unity.)
Jacob Navok is the CEO of Genvid Technologies and a former executive at Shinra Technologies and Square Enix.
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