Free to play business model versus traditional retail purchase; how it is more profitable to have item shops

There has been a large and growing movement in the video game industry towards the free to play business model. World of Warcraft, Team Fortress 2, World of Tanks, and League of Legends are a few prime examples. To compensate for being free to play, firms run in-game item shops that charge for additional gameplay content or provide services such as making the grind easier. The question for the economist is then, why are firms acting in such a manner?

Like many things, the answer is not so straight forward. There are multiple reasons all acting in conjunction, but let’s first examine this with some microeconomics. Below is your traditional monopoly and profit maximization. I use a monopoly model because a lot of games are monopolies. You may have substitutes in the form of other games in a genre, but realistically speaking, Halo is Halo. Marginal cost is constant for simplicity, but also because software (video games included) really don’t have a marginal cost. The cost of letting someone download a copy of your game is virtually negligible. Profits below ignore fixed costs.

As we can see, there is a fair amount of dead weight loss. Monopolies restrict output in order to raise price which means not everyone is able to play the game. By comparison, the free to play model has no dead weight loss although quality may suffer which is something that will be discussed later.

Price in this model is set at marginal cost. In the case of games, the marginal cost is basically zero, hence, free to play. Profits for the firm is then determined by the giant orange triangle. Here it gets a little more complicated. Profits made by the firm is determined by how well they can extract consumer surplus through price discrimination via item shops. In terms of item shops, this is the revenue of producing item shop content minus the cost of producing it and the marginal cost of production (because the firm did not cover that cost by selling on quantity).

The reason for why there is such a large range in the pricing for item shops is not because making premium content such as Pulsefire Ezreal is very expensive (it probably does cost a bit more than the usual stuff), but because it’s targeted at people who have high consumer surplus. For all the software developers out there, do be careful about what you market to your consumers. Eve Online’s monocles are still a laughing stock among gamers.

As we can see, if the firm can minimize the cost of item shops, there is much potential profits to have. Furthermore, the lower the marginal cost, the more effective free to play is in terms of producing profits.

There are other factors outside of the graphical models above. For instance, firms have a definite incentive to cheat on item shops by simply restricting content already in-game. Similarly, the restriction of content can reduce the quality of the product (i.e. Runescape). Information-wise, a free to play model lets consumers sample the product. If we think of information as an additional cost for the consumer, the free to play model basically removes it altogether. Demos exist for this purpose, but they’re not as effective having the full game.

Equilibrium in Video Games

Most competitive games reach an equilibrium stage that’s often called the metagame. An important distinct to note is that while gamers can reach an equilibrium, it is not necessary the solution to the game, rather, the metagame is the solution to what everyone currently understands and know in the game’s player base.

There are also games that do not have an equilibrium. For instance, there is no equilibrium strategy to play in Rock, Paper, Scissors. By comparison, marines and medics is often considered an equilibrium strategy for playing Terran in Starcraft. The player can choose to build purely medics, purely marines, or a mixture of both. Their best decision tends to be to build a mixture. In game theory, this is called the dominant strategy because compared to the alternative strategies, the dominant strategy is always better.

Practically speaking, it is very difficult to design a game that has no equilibria. It is also very difficult to build complex games with an equilibrium in mind. Most games have evolved outside of their creator’s predictions; it’s why games tend to be imbalanced until substantial play testing has occurred. A game designer can try to influence the equilibrium, but it’s unlikely that he’ll predict what ultimately will be done in a competitive environment. The collective gaming community has proven to be far superior in finding the best strategies. Afterall, I doubt that the original designers of Starcraft even considered building supply depots in front of their bunkers.

From a game theory perspective, games that have no equilibrium have no solutions. To an extent, games, in particular, RTS, that do not have very strong equilibrium strategies tend to be casual. The lack of equilibrium strategies make it difficult to win, at least in terms of strategic thinking because there are no “solutions” that can be played by higher skilled players. In other words, there is no hierarchy; no ladder or ranking system because you cannot be better than another player. When strategic play becomes less important, the next most important factor is the player’s performance which is reflexes, mental state, micro, and other factors that can be improved by practice. It may not matter what you play in Rock, Paper, Scissors, but you can at least intimidate him with mind games which I suppose could give you the winning edge.

There is another form of competitive gaming that should be noted. There are games that are won by strategies which we can discuss using the tools of game theory, however, there are also games that rely on performance. Games like Soccer and Counter-Strike have some degrees of metagame, but compared to a RTS, they tend to be more dependent on player performance (ie. how fast you can headshot someone with the AK as opposed to choosing between building more troops versus expanding). Competitive gaming exists outside of game theory solutions, but those tend to be games of performance rather than strategy.

Economist at Valve: a blog to follow

A friend linked this to me.

I’ve written a small bit about Valve and their digital distribution system, Steam, but it’s from an outside perspective and admittedly, an amateurish one at that. A blog on one of my favorite video game developers combined with a professional economist’s analysis with what would seem to be unfettered access to all the data has got my attention.

Why massed marines beat massed zerglings

There is a very common phenomenon in RTS games that’s often forgotten: massed ranged units tend to beat massed melee units. Even more so, good massed ranged units will beat inferior massed ranged units. The benefit from massing ranged units is their ability to lower the firepower of opposing units before they can inflict harm. For instance, a pair of zerglings will beat a marine, but 24 zerglings will lose to 12 marines.

During my time as a volunteer balance developer for a mod, I had to understand and apply core game mechanics. Below is an instrument with a very basic model that I call the Effective Range Firepower (ERF). It measures how well a cluster of units perform. We can interpret X as simply the number of units. Alpha would be a measure of well the unit performs when massed. In Starcraft, this is the unit’s attack range. In a more complex game such as Company of Heroes, this is the unit’s attack range, accuracy, cooldown/reload modifiers, etc.

There are two assumptions that the model makes. 1) There is no limit to the number of units aggregated. This is generally true until your units start physically blocking one another from attacking. If that’s the case, their ERF simply comes to a plateau. 2) There are no stacking penalties. In certain games, units actually debuff each other.

In Company of Heroes Opposing Fronts, there is actually an upgrade for the Panzer Elite faction that makes aggregating units even better. Although it’s only speculations, the fact that the design team behind that title was inexperienced leads me to believe that whoever designed that ability didn’t have a good understanding of how massed ranged units function. Subsequently, there was a huge host of problems associated with the blobbing of Panzer Grenadiers who inherently already had pretty good ERF.

When balancing these effects, we have to take many other variables into account. Generally speaking, we ask ourselves how easy is it for players to pull off unit aggregations. We don’t want to make the unit so expensive that only the best players can make use of the unit. At the same time, if we price the unit so low so that even the weakest players can use the unit, we risk having skilled players maximizing the unit’s ERF. In the worst case scenarios, we employ hard caps which effectively stops the unit’s ERF at a certain value. My favorite solutions tend to be the introduction of abilities or other units that punish unit aggregations. These things can range from the ensnare ability on the queen from Starcraft, or something like the machine gun unit in Company of Heroes that gets more accurate as the enemy gets more units together. These creative solutions have their own dangers of introducing even more variables to a game, but the risk is often worth the freedom that it will ultimately grant players.

The platformer parody game

I Wanna Be the Guy (IWBTG) is a devilish platformer parody that plays on the absurd difficulty of older games like Ghosts and Ghouls. Whereas gamers may have slammed their foreheads into the ground during their youth after dying for the tenth time, IWBTG will make them want to blow their brains out after dying for the hundredth time. This is a game that would be considered cruel and unusual if used as a punishment.

You are blasted with a wave of nostalgia upon running the game. Starting with the Megaman theme sound in the introduction, you will encounter a great deal of references from older games including Dracula (with authentic voice acting) from Castlevania to Bowser from Super Mario. There are no lives and on the hardest difficulty, there are no saves. The game can be incredibly unforgiving. The level design is purposefully unfair. Anything from apples ignoring gravity to the old Megaman style ice blocks will make you suffer. Most of the game will rely on memory and a long series of trial and error. In fact, the greatest obstacle to the game is the gamer himself who has to deal with repeated failure and the nerve-racking feeling after making past a particularly difficult segment but have not yet found safety in the form of a save game. The game is a reminder of why we have deviated from games that required a Spartan’s mentality to win.

For the diehard platformers, IWBTG will be a worthy challenge and should you ever become the guy, wear that distinction proudly. Most of us would have tossed in the towel and either congratulate you or laugh at your misery. That said, a good let’s play of IWBTG is a great source of entertainment.

Link to the official website:

Anatomy of a game

A game is a system of constraints. Whether it’s Solitaire or Call of Duty, the player is restricted in what he can do. When we play any game, what we’re really doing is trying to beat the constraints. Sometimes beating the constraints can mean optimizing statistical probabilities in your favor. It could be reading your opponent and trying to figure out what sets of constraints you can impose on her, and conversely, how to deal with the constraints that she can impose on you. Whatever it is, constraints are central to any game.

Now let’s compare two similar games, Chess and Checkers. With tournaments across the globe and the prestigious title of Grandmaster, Chess is taken seriously. Checkers, on the other hand, is something you would play with your ten year old brother. The rules of Checkers is simple; your pieces can move forward in a diagonal pattern, and you remove opposing pieces from play by “leaping” over their pieces. If you get a piece to the opposite end of the board, it gets promoted and can now move backwards. Chess has a myriad of rules which are far too many to discuss.

An important distinction to note is that it’s not the number of rules that necessarily creates constraint. For instance, Go is very simple but is on parity with Chess in complexity. What ultimately matters is the ability to maneuver around constraints. In Starcraft, one of the major constraint is resources. Initially, the player has little choice in what he can do, but as the game progresses, he can choose to expand to acquire more resources, build less resource intensive units, or even cripple his opponent’s economy to give himself a relative advantage.

The key goal of a successful game is have enough maneuverability around constraints so that it grants the player enough freedom to experiment. When there’s too few constraints, the game becomes too easy, but with too many constraints, the game becomes static with little room for novel strategies.

Why Steam is so successful

Online digital distributor giant, Steam, has become a household name for gamers across the world. Shrewd business practices on the part of Valve, the makers of Steam, has kept the users of Steam generally happy and its competitors out. The very nature of Steam prohibits most users from using other digital distribution services. Who wants to run a handful of memory demanding programs in the background? In this respect, Steam already has a major advantage because it was the first to embed itself on our desktops.

To better understand why so many people use Steam, we need to first address the concept of network externality. Certain goods and services increase in value as more people use them. Take for instance, the classic example of the telephone. When one person has a telephone, he has no one to call. When there are two people, they can call each other. Each additional person raises the value of the telephone. Economists call this effect, network externality.

Valve understands very well how network externalities impact markets. Thanks to Steamworks, Valve has taken a step further to cementing our feet. Steamworks is the community building function of Steam; it encompasses everything from your friends list to your profile. Most of all, it’s a free service with the caveat that you have to purchase at least one game on Steam. Consider the telephone example. If you were the only person using Steamworks, how valuable would the service be? Since so many people already use Steam, the network externality must be immense, strong enough to prevent a competitor such as Impulse, another digital distributor, from entering. Impulse can technically match everything Steam does, but it cannot replicate the network externality effect without a substantial user base.

It is interesting to note that Steam is not flawless in its design. Origins, Electronic Arts’ digital distribution software, has begun hitting Steam in the one area where it is not invulnerable, titles. Origins has taken the approach of pulling away its loyal and diehard consumers in the hopes that it can build its own user base. While it is notably more successful than Impulse, it is unlikely that Origins will be able to sport enough exclusive titles to pull people off of Steam. Electronic Arts and Valve can realistically only make titles published under them exclusive. For the vast majority of titles, Electronic Arts and Valve will have to compete for sales licenses.