Over the past decade many things have changed in the video game industry. One main aspect is, without a doubt, the move to a digital distribution of video games via platforms such as Steam (Valve Corporation) or Origin (Electronic Arts). With this change came a change in the business strategy of video game developers. Today two business models enjoy an ever greater popularity in the industry: free-to-play and episodic games. In this blog post I focus on the latter, i.e., on the concept of episodic games.

Let me first clarify what I understand under an episodic video game. Not unlike a TV show, an episodic game is divided into separate episodes that stand on their own, but are part of a larger concept. The episodes are released over a defined period of time – typically several months – and, compared to the complete game, have only a relatively short duration of play.

The concept of episodic games is not entirely new. Nevertheless, it was not until TellTale Games released The Walking Dead: the Game in 2012 that the concept was recognised as a business strategy with mass-market appeal. Since then there has been a surge in the release of episodic video games. Recent titles include TellTale Game’s adaptation of Game of Thrones or Dontnod Entertainment’s Life is Strange.

In times of ever faster consumption cycles it may sound paradoxically that spreading the release of a video game over several episodes can be a smart move for video game developers. In the following I will have a closer look at some economic aspects of episodic games and hope to convince you that this is indeed likely to be the case.

Consumption habits of digital consumers

The rise of downloading and streaming services, such as iTunes or Netflix, significantly shaped our digital consumption habits. As such, we, as consumers, developed certain expectations regarding availability, prices and our ability to choose when it comes to the consumption of digital media content like music or TV shows. Those expectations are linked to the characteristics of digital media content: piece-wise consumption (focus on tracks/episodes instead of the full album/season), easy and instant access and relatively low prices.

By releasing video games on an episodic basis game developers respond to these expectations. The result are lower price and non-price barriers to the consumption of video games that allow game developers to widen their sales basis and even to attract new user groups.

• Prices. Episodic games are released in several instalments that are each offered for a fraction of the price of the full game. As a consequence, consumers that are hesitant to purchase a game for financial reasons may be less reluctant to do so under an episodic release format. Dontnod’s Life is strange, for example, will be released in five episodes. At the moment of writing this post, the first episode is available for 4,99€. The full game, i.e., all five episodes, is currently priced at 19,99€ (with access to later episodes once they are released). 

• Instant access. The move to a digital distribution of video games via platforms such as Steam or Origin significantly contributed to the success of an episodic release format. As such it provides consumers with easy and instant access to the latest episodes and by this lowers their non-price barriers to consumption (imagine you would have to order each episode via amazon or run to the next video game store in order to pick it up).

• Commitment and risk-aversion. Video games are experience goods; prior to playing a game consumers do not know their private valuation for it. Moreover, under a traditional release concept video games are typically characterised by relatively high prices and long game play. It is then not difficult to see that more risk-averse consumers may be hesitant to download a game due to a combination of high price, long time commitment and experience good character (“I will not spend 60€ on a game that I will never finish anyhow. And what if I don’t end up liking the game?”). An episodic release format lowers these non-price barriers to consumption by giving consumers a legal and easy way to sample the good at a relatively low price as well as by reducing the perceived time commitment.

• Casual gamers. By releasing a video game in several instalments, complex games become more accessible. This may attract new user groups such as casual gamers.

Anticipation, buzz and consumer involvement

One challenge of an episodic release format is to motivate consumers to repeat their purchase with every release of a new episode. Luckily, an episodic release format features two effects that facilitate this.

First, releasing a video game episode-by-episode creates anticipation. We all know this from our favourite TV-show. An episode ends with a cliff-hanger, making us count the minutes until the next one is released.

The need to wait for the next chunk of the game adds to the excitement and anticipation, making the release of each episode feel like an event to be savored and enjoyed. (Ben Kuchera on Polygon)

Second, making consumers wait between the release of two episodes provides time for the emergence of a community of players. Episode-by-episode players can share their gaming experience, compare their progress in the game or speculate about the next episode(s). This not only creates a certain buzz around the game which attracts new consumers, but also ensures that consumers stay involved in the game.

We saw the strength in that model as the way to tell a story and it was tied into our digital distribution strategy, which was to break the content up in a way that would engage people over time and have them return to you, instead of just building a one-time experience. (Dan Connors, CEO of TellTale Games)

Continuous improvement and innovation

Similar to free-to-play games, an important advantage of an episodic release format is the existence of a feedback loop. By this I mean two things. First, developers can react to feedback from the gamer community and apply it to future episodes. Second, and in my eyes even more important, developers learn about their consumers and their gameplay. This gives developers important information on how to adapt future episodes. The result is not only video game content that matches consumer preferences more closely, but also that innovation and experimentation become less risky. It follows that under an episodic release format game developers have a greater freedom to experiment with techniques, different forms of narration and so on. Consumers thus benefit in form of higher quality and more innovative video game content and might even see the release of video games that otherwise might not have been made.

I mentioned previously that, in contrast to a classic release format, consumers have to be motivated not only one time, but several times to purchase (part of) the video game. This implies that with an episodic release format each episode has to be a hit. Otherwise, what is the incentive for consumers to repeat their purchase once the next episode becomes available?

Funding

Episodic games involve two main types of costs: a project sunk cost (to be paid regardless of how many episodes are developed) and a variable per-episode cost (to be paid for each episode developed). As a corollary, getting the project started, i.e., developing the first episode, is less costly with an episodic concept as compared to a standard release format. New video game content may thus be released faster. Moreover, the sales from past episodes may, at least partially, finance future episode(s), resulting in an overall lower need for external funding.

Related is the following point. Episodic games are typically offered at different pricing plans. Take for example the case of Life is Strange. At the moment, consumers may download the first episode either for the episode price of 4,99€ or by paying the price of the complete video game (five episodes) of 19,99€. Consumers who opt for the latter option advance their payment in the hope that the full game will be developed. Episodic games, hence, share similarities with crowdfunding projects. For investors and developers this share of consumers may contain valuable information as it can be interpreted as a measure of confidence of the market in the video game.

Developing and selling a video game episode-by-episode may also be less risky. The reason is that the existence of the previously mentioned feedback loop gives developers the opportunity to adapt the game episode-by-episode. Or, in the worst case, an episodic release format gives developers the option to opt-out and stop the production of future episodes. In contrast, under a classic release format, developers have to pay the full development costs before receiving a feedback from the market.

Although the business model sounds very promising, it raises several important questions. In my eyes the most important, and challenging, one is “How to get the pricing and the timing right?” Also, in your eyes, are episodic games a promising concept to fight digital piracy?

Over the past decade many things have changed in the video game industry. One main aspect is, without a doubt, the move to a digital distribution of video games via platforms such as Steam (Valve Corporation) or Origin (Electronic Arts). With this change came a change in the business strategy of video game developers. Today two business models enjoy an ever greater popularity in the industry: free-to-play and episodic games. In this blog post I focus on the former, i.e., on the concept of free-to-play games.

Free-to-play games were born out of the success of massively multiplayer online games (MMOs) and the development on the app market. Successful titles such as Riot Game’s League of Legends or Blizzard Entertainment’s Hearthstone attract a large community of gamers. In 2014 more than 27 million people played League of Legends on a daily basis. Hearthstone, which was released in 2014, gained more than 20 million users in its first six months.

In economic terms, free-to-play games are freemium games. Freemium, a combination of free and premium, stands for a business model that is widely adopted in the digital economy (also discussed here on IPdigIT). Applied to the video game industry the concept implies that consumers may download a fully functional game for free. Additional, or premium, content, is available via so-called microtransactions. One can roughly divide these in-game purchases in two categories that depend on whether additional content is purely aesthetic or has a functional component. In the first case, sometimes referred to as pay-to-entertain, premium content is purely decorative and serves as a way for consumers to individualise the game according to their preferences. In the second case, also termed pay-to-progress or pay-to-win, additional content is functional and allows premium consumers to progress faster in the game, for example, by enhancing the performance of their in-game character.

It appears that the freemium model is hard to resist, even for established video game developers (see also this article on TechCrunch). In February 2015, Lionhead Studios, a British video game developer owned by Microsoft, made headlines by announcing that the next release of its highly successful Fable series will be free-to-play on Xbox One and Microsoft 10.

You’ll be able to play Fable Legends from beginning-to-end without spending a penny. That means you’ll have access to the entirety of Fable Legends’ storyline and all of the quests we release this year and forever. (fablelegends.com)

This change in strategy shows that Microsoft sees the future of the gaming industry, or at least of a significant part of it, in free-to-play. In the following I will have a closer look at why this may be the case.

User base and conversion rate

Two main factors drive the success of a freemium strategy: user base and conversion rate. The two concepts respectively refer to the number of (active) gamers and the share of gamers that purchase premium content.

Before delving deeper in the two concepts it is instructive to notice that a freemium strategy is essentially a strategy of price discrimination (menu pricing and personalised pricing). First, freemium games are offered via two different pricing plans, free and premium. As a result, even consumers with a very low, or zero, willingness to pay may download and play the video game (i.e., become active consumers). Second, the premium part resembles a strategy of personalised pricing. Consumers purchase premium content up to their reservation price and as such pay a personalised price for the video game.

What are the corollaries in terms of user base and conversion rate?

• User base. By lowering the price for a basic, but fully functional, version of the video game to zero, developers maximise the user base. This is especially important in the case of video games as their experience good character results in high (non-price) barriers to consumption (consumers are uncertain about their private valuation for a video game prior to playing it).

• Conversion rate. A certain share of the user base will purchase premium content. Most important, some users will spend more than they would have under a standard pay-to-play business model. By offering personalised prices video game developers hence maximise revenues and are able to give away a basic version of the game for free. Clearly, for free-to-play to be a viable business strategy, developers need to aim for a high enough conversion rate. The latter primarily depends on the scope of the free gaming experience and the value users see in the premium features.

Let me illustrate the two concepts further via the example of Lionhead’s Fable Legends. Fable Legends will be supported by microtransactions. During the game, players earn an in-game currency which, additionally, can be purchased with real world money. This in-game currency may then be spend on additional (functional) items. Moreover, in its free version, Fable Legends will have a limited number of in-game characters, or heroes, which, additionally will be rotated on a regular basis. Heroes may be unlocked permanently in exchange for in-game currency.

Network effects

I will come back for a moment to the group of consumers that does not purchase premium content. It is important to see that this group contributes in its own way to the success of a freemium strategy and as such is valuable for video game developers. The reason is that these consumers help to grow user base and conversion rate, either actively, for instance via word-of-mouth recommendations on social networking sites, or passively via network effects. In the case of free-to-play games there are direct (within-side) and indirect (cross-side) network effects. Direct network effects primarily imply that it is more enjoyable to play video games with a large user base (larger gamer community, possibility to play with or against one’s friends, etc.). Notice, however, that consumers may not only have greater incentives to download games with an already large user base, but also to purchase premium content when playing the latter. Gamers may want to become more competitive, by acquiring premium content, the more competitors, i.e., other gamers, they face. Indirect network effects now come into play because a larger user base gives video game developers stronger incentives to develop additional premium content. The prospect of a richer gaming experience, in turn, motivates more consumers to download the game and/or convinces already active users to purchase additional premium content.

Fable Legends optimally exploits those network effects. Consumers may play the game either alone or together with their friends. Even more important is the fact that the game is available for Xbox One and Microsoft 10 and features a cross-platform functionality. Meaning, the game not only appeals to a wider audience (Microsoft 10 and Xbox One users) but also intends that users with different consoles play against one another. What is more, Fable Legends builds on the fan-base from the Fable series and as such on a large potential market with an established gamer community.

Switching costs and games as a service

For video game developers the free in freemium is a double-edged sword. On the one hand it allows them to grow their user base rapidly. On the other hand, the same applies for their competitors. For a successful freemium strategy it is thus not enough to motivate a sufficiently large number of consumers to download a video game and to purchase premium content. Instead the success of the business model equally depends on video game developers’ ability to keep their user base, i.e., on a high enough retention rate.

This is where the premium in freemium comes into play. The possibility to individualise a game via microtransactions creates a unique gaming experience. Corollaries are a strong attachment and involvement of consumers in their game. That is, the premium content of free-to-play games creates significant switching costs; after having spent several hours, days, weeks or months and potentially a significant amount of money playing and customising a game consumers are less likely to switch to another (competing) title.

Free-to-play games are based on the games as a service approach. Among other things, this implies that for most free-to-play titles there exists no finalised version. Instead, the focus is shifted on the post-release development stage. Video game developers therefore have the opportunity to interact with the gamer community and to adapt future (premium) content to its feedback. However, as Will Luton mentions in Free2Play, it might not so much be about what consumers say, but more about what they do. In fact, the digital diffusion of free-to-play titles makes it possible to collect a vast amount of data on how consumers actually play a game, including when and what type of in-game content is purchased. This type of information facilitates the development of premium content that gamers desire and are willing to spend their money on. Notice that this is another way of how a large group of non-premium consumers may contribute to the success of free-to-play games. Although those consumers do not purchase premium content, their gameplay data contains information on how to increase the willingness to pay of premium consumers, for instance, by developing video game content of a higher quality or that matches consumer preferences more closely.

The games as a service character of free-to-play titles also provides developers with a way to reduce the durability of their video games. You may wonder why game developers may want to do this. The reason lies in the durable good character of video games which subjects their developers to the Coase conjecture. As I explain here on IPdigIT the Coase conjecture states that a monopoly supplier of a durable good has no monopoly power. Why so? The monopolist faces a commitment problem. Ex-ante he would like to set the monopoly price, while ex-post – once the first units of the durable good are sold – he would like to decrease the price to also capture consumers with a lower willingness to pay. Consumers, however, anticipate this and by postponing their consumption put downward pressure on the price. Assuming that the consumers’ waiting period is short enough, the monopolist is then forced to adopt the same pricing strategy as a competitive firm, i.e., marginal cost pricing. To overcome this commitment problem, one obvious strategy, among many others, is to reduce the durability of the product.

I am now wondering whether the future of the video game industry is free-to-play? Is the concept indeed sustainable for large titles that involve significant development costs? And can you think of other factors that determine the success of a freemium strategy in the video game industry (you may want to have a look at this article by Myriam Davidovici-Nora (2014) in the Digiworld Economic Journal)?