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Casual Gaming Is A Spectacular Business, With Profit Margins Near 90%
The casual gaming industry enjoys extremely high profit margins. It it also growing very rapidly in the U.S. and Europe, with sales of virtual goods likely to more than double over the coming year.
For hit games with significant revenue made from selling virtual goods, profit margins can be around 90%. This compares to margins of about 40% for the average successful console game.
The source of the huge margin is primarily low costs. The revenue potential of a casual game is currently far less than that of a console game (most are free and have less sophisticated distribution channels), but casual games cost much less to develop.
As in the movie business, most console games are not hits, and struggle to turn a profit.
To illustrate the different economics, here is a side-by-side comparison of P&L for a hit console game compared to a casual online game, given $100 million in revenue (we understand that no casual games currently generate that much revenue, but offer this for comparative purposes when it comes to profit margins):
Here are the key differences between the two respective P&Ls:
- Product Costs: Console games must package and ship games in discs and boxes while casual online games are essentially code with no delivery cost.
- Royalties: Publishers must pay royalties as high as 20% to the console maker whereas casual online game publishers pay a transaction fee for the sale of virtual goods that rarely exceeds 10%.
- Development/Marketing costs: Development and marketing costs can rival movie budgets for many blockbuster console video games, which can often include license fees paid to copyright holders of characters or places included in the game. In addition, advertising/marketing is usually done on expensive traditional media. Casual online games are less sophisticated technologically and cost far less to develop and market.
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Examples of successful casual games include Scrabble, Bejeweled, Farmville, and Mobsters.
1) Display Advertising - fairly self-explanatory
2) Virtual Goods - games are free to play, but players who want to progress through the game faster, unlock special abilities or add special items to their character's profile can buy virtual goods that lets them achieve this.
Usually, players pay for virtual goods using a virtual currency, which they accumulate through gameplay and can top up with real money.
To generate $100M in revenue in a social game (which is what you're really referring to - not "casual games" which are $20 downloadables on portals like BigFish, RealArcade, and Pogo) format, you'd have to make MULTIPLE games. You're not accounting for that. Nor are you accounting for the majority of the costs of running a social game including live team, server bandwidth, support/game managers, ongoing user acquisition costs, analytic services, fraud, 3rd party virtual economy software fees/license, and payment gateway fees. I don't see the retailer's margin in the console game cost stack either.
In short, while your conclusion is indeed roughly on target - ie. digitally distributed games typically have higher margins than physically distributed ones - the specifics are way off base and the headline is inaccurate.
I think you're overestimating costs on one side and underestimating them on the other.
For console games, I'm pretty sure product costs as you define them are much lower because pressing CDs and shipping them is a commodity business and now that distribution is consolidated most players have huge economies of scale. Of course the cost of goods sold of a video game has to include the titanic costs of actually making the *software* of the game. Maybe that's what you mean by product costs but that's not how you define it.
Conversely, I'd say sales & marketing for social games are at least as high for a social game as they are for a console game (as %). For Zynga to drive literally more than ten of million people to a new game *within a week* of launch requires a huge Facebook/in-app advertising blitz. I wouldn't be surprised if that was the big thing eating into virtual goods profit margins.
As for the other costs you mentioned , we included them in the $200,000 "general and administrative" costs. Do you think that is too low?
Back of the napkin - using user acquisition numbers from Zynga as an example yields an ad budget per title is almost 7x your entire G&A estimate. They've 37 games and it has been publicly reported that they are spending in excess of $50M/year on Facebook ads. That's $1.35M per game without even adding the other costs.
Appreciate the clarification - I believe this would decrease the overall margin by about 100 basis points or so.
Having looked at many of these businesses up close myself, you're definitely underestimating the costs of developing an A-list, potential hit console title (or a slam dunk franchise title) by at least 50% and that's old data from 3-4 years ago when average development costs were still on steep upward curve (have they dropped? I doubt it!)
OK as some that constructs business models for games I am in awe at your assumptions.
You seem to be using a best case scenario model i.e. a Guitar Hero Vs Mafia War's.
Here are some facts:
1. Facebook games are a pure top 10 business, as opposed to the App-Store which is a top 50 business. What I mean by this is that the financial vortex on facebook between being in the number 1 and being number 25 is massive. We are not talking about the a few hundred thousand, we are talking millions per year.
2. In the casual games market (I am not talking about Facebook alone here) people often talk about how many times there game has been downloaded, the key number is actually the conversion rate from demo to full or paid version. The average ratio is 1.5%-2.5%, if I get 2.5% I am over the moon. If you take a look at one of the most successful games in the casual space such as Diner Dash, they have a conversion rate of about 2.3% on a 32 million downloads. This is fantastic, but this is also one of the most successful games ever in terms of the casual space. However, they have built a crap load of titles and a lot of them are not even at the break even point yet.
3. The cost of creating a Flash based game is around 150k (on a low end single screen game that is top down graphically to 750k for more advanced titles. However, that is based on an outsourced model whereby the publisher would hire a studio to make the actual game. In this case the publisher would also pay the studio a royalty rate between 25%-35% net of platform and costs. This means that once the dev costs have been recouped by the publisher the developer then starts to see royalty checks.
4. So we have established that if someone like Zynga creates a game in house, they obviously get more of the revenues. As far as I know the do actually do everything in house.
5. There are actually three revenue streams on Facebook and not two as mentioned above:
A. Virtual goods.
B. Banner Ad's
C. Installs, by installs I mean that ask.com advertises there search bar and you get around .65-.85 cents per download.
5. I actually do not know where to start with regards to your marketing assumptions, they are way, way off. The rule of thumb over at Zynga seems to be that they are redirecting any spare cash they have back into advertising on Facebook.
In summation, there are currently three standouts on Facebook that I would estimate together make 90% of the revenues:
Zynga
Playfish
Playdom
Everyone else is maybe making $500 a day on a 150k investment, which is great, but blows your figures out of the water. For a small 3 man operation, they can live with that, but for a larger firm that would be a lemon.
One interesting thing is that currently the market place are all making facebook games based on either HTML or Flash, what will happen when the first successful game is written in C? We are talking 3D here, this is going to cause costs to sky rocket as the cost differential between to down flash and 3D written in any of the C languages is huge.
Conversion Rate
Shareware (downloadable software) < 0.5%
Downloadable game market 2%
Online Games 10-25%
Club Penguin 25%
Habbo 10%
Runescape 16.60%
Puzzle Pirates 22%
The value-add by comments is impressive. Good insights