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Forecasting ad sales for web startups April 3, 2008

Posted by jeremyliew in ad networks, advertising, business models, models, start-up, startup, startups.
3 comments

Andrew Chen has a good post on how to forecast advertising for web startups:

The right way to model out inventory is a number of equations – I’ll pretend that a site has two types of inventory, their “brand” stuff and their “direct response” (aka remnant) inventory:

Brand revenue = # campaigns sold * average campaign size * brand CPM
Direct response revenue = (total impressions – brand impressions) * remnant CPM
Total revenue = Brand + remnant revenue

In an actual forecast, you could get a ton more detail in the brand revenues side, since what you really care about is the # of ad sales people you have, how many campaigns they’re selling per quarter, the size, etc. Again, think of this as an enterprise sell, and treat it as such.

Essentially, he suggests that brand advertising is a function of the size and efficiency of your direct ad sales force (and is demand constrained) while remnant advertising can go to networks and is supply constrained.

As Ed Sim notes about a direct ad sales force:

… many entrepreneurs underestimate the direct capital and management costs necessary to build such a team. In many ways, building a direct ad sales team is similar to building an enterprise sales team. These thoughts may seem quite basic to you but here they are nevertheless. First, don’t ramp up your sales team too quickly until you have a product to sell. That means if you don’t have scale or enough eyeballs you are better off using Google Adsense. If you don’t heed this advice you may quickly burn yourself out of business. Secondly, I know that many startups may not know what kind of ad units to sell but be careful of not having a standard product list or rate sheet when you go out to the market.

This advice can be difficult to follow in a new market where there are no standard product lists, which is why new forms of advertising are hard.

Games as a hit driven business March 17, 2008

Posted by jeremyliew in business models, facebook, games, games 2.0, social games, social gaming, social networks.
10 comments

The games business has always been hit driven, and the move online hasn’t changed that. World of Warcraft alone commands 62% market share of all MMOGs. In the casual games business, the top 20 games constitute 75% of total industry revenue. As more games have launched onto Facebook, we still see a hit driven business. There is an order of magnitude change in the number of daily actives in just the top 25 games on Facebook:

Game, Daily Actives (‘000s)
Scrabulous, 697
Friends for Sale, 672
Texas Holdem Poker, 581
Compare people, 393
Lil Green Patch, 338
Speed Racing, 260
(fluff)Friends, 240
MindJolt, 189
Vampires, 156
PetrolHead, 144
Who Has The Biggest Brain, 135
Scramble, 126
Jetman, 121
My Heroes Ability, 96
Mesmo TV, 93
Have You Ever???, 86
Zombies, 85
Blackjack, 83
WereWolves, 79
Slayers, 77
Parking Wars, 68
Scratch and Win, 67
Fight Club, 64
Hotties For Sale, 59
WarBook, 56

The graph below makes this point even more dramatically, showing a strong power law distribution for the 2190 games on Facebook:

Facebook Games by Active Users

Game 100 has 6,000 daily actives, game 500 has 150 daily actives, game 1000 has 23, game 1500 has 6 and games 2000 and up have no daily actives at all.

In an environment with as long a tail as this, companies need to take a portfolio approach to their games. Zynga has taken the approach to cross promoting their new games on launch, to good effect:

Zynga Games

Although Zynga’s games also show a power law distribution as well, all but one of their games has made it to the top 100 in daily actives.

Social Games Network has built its portfolio through a combination of cross promotion and acquisition.

SGN Games

Their power curve is not as pronounced because they have bought some successful games to fill out their portfolio.

The difference between SGN and Zynga is really one hit game, Texas Holdem Poker.

Social games companies that learn how to repeatably create and launch hit games will become very valuable.

AOL-Bebo deal is good for the industry March 14, 2008

Posted by jeremyliew in advertising, aol, bebo, business models, social networks.
3 comments

There has been a lot of coverage on the merits of AOL buying Bebo for $850m in the last 24 hours. [Disclaimer: from 2002-2005 I was an AOL employee, initially as SVP of Corporate Development, then as GM of Netscape.] While there has been debate about whether this is a good deal for AOL or not, there is no doubt in my mind that it is good for the social media industry.

As Inside Facebook and Techcrunch have noted, the use of social media has far outpaced the monetization of social media. This is true for the web in general (21% of media time, 7% of advertising dollars), but even more true for social media. As I have noted in the past, I believe that this is because social media needs a standard ad unit. Today the bulk of monetization within social media sites comes from IAB standard buttons and banners. That is a good start, but it does not take advantage of the inherent social elements of social media. We have yet to see a standard ad unit emerge that is native to social media.

In social media, users can willingly affiliate themselves with a brand, an implicit recommendation of that brand to their friends. This is clearly valuable to advertisers. It can take many forms, including Facebook’s Social Ads (announcing the purchase of an item), Bebo’s sponsored profiles (where a user can “friend” Burger King), MySpace’s momentum marketing, Gaia’s product integration (e.g. with Scion) or Clearspring’s sponsored widgets. Each company today sells its own special flavor of social media advertising. But standards are set by industries, not by individual companies. An advertiser today who wants to spend $10m on TV advertising can do so with one call and one creative unit. But they can not do that today across social media – they have to instead custom craft a deal with each social media property. That is a problem for the industry and one of the reasons that advertising spending lags media use – there is too much friction in the system

With AOL’s purchase of Bebo, AOL now has a vested interest to help create a standard ad unit for social media. Moreover, AOL has the advertiser relationships and the clout at the IAB to be able to accelerate this standardization process. AOL now joins Fox (Myspace) as a big media company with both a vested interest in standardization, and the relationships to make this happen. We can expect to see a shorter timeline towards creating a standard, making selling advertising look more like sales and less like business development. This rising tide will lift all boats in the industry.

Virtual Goods and Real Money Trade: Paving the paths March 13, 2008

Posted by jeremyliew in business models, digital goods, facebook, friendster, games, games 2.0, gaming, myspace, social networks, virtual goods.
2 comments

As I read the coverage about the real money trade in MMOs panel at GDC, I was reminded of danah boyd’s thoughts on why MySpace took off and Friendster did not, which notes in part:

Friendster killed off anyone who didn’t conform to their standards, most notably Fakesters and those with more creative non-photorealistic profiles. When MySpace users didn’t conform, they were supported and recognized for their contributions to evolving the system.

A good analogy to both situations is what to do when faced with a nice green lawn on a college campus. Some students will always cut across the grass, leaving worn paths. There are three solutions to this problem:

(i) Erect a fence around the lawn and put up some “keep off the grass” signs. This keeps the grass green and pristine, exactly as the landscape architect imagined it, but forces unhappy students to go the long way around to their classes.

(ii) Do nothing, let students cut across the grass and tramp mud into classrooms.

(iii) Pave the paths. Students take the shortest paths, no mud in classrooms, and the rest of the lawn stays green.

Friendster put up “keep off the grass” signs. Myspace paved the paths.

Now if you ask students as to what should be done about the muddy paths, they’ll probably suggest option number one. But its those same students that created the paths in the first place! It is more important to watch what users do than what they say. Facebook is facing a similar dilemma with its apps right now.

Games companies have the same issue with virtual goods. The abundance of real money trading markets for virtual goods tell us what users want to do (despite their vociferous claims to the contrary). If game developers don’t pave these paths, they risk muddy classrooms or unhappy students.

An excellent excel model of viral growth March 10, 2008

Posted by jeremyliew in business models, churn, models, retention, social media, viral, viral marketing.
7 comments

Last week Andrew Chen wrote an excellent post about the growth and potential decay of viral apps. Rather than just focusing on the elements of viral growth, Andrew also took into account the declining likelihood of an accepted invitation as you saturate a population, and the impact of churn. He provided a useful model to social media founders who are trying to estimate their growth, and what can go wrong when a viral app “jumps the shark”:

shark fin

He notes:

* Early on, the growth of the curve is carried by the invitations
* However, over time the invitations start to slow down as you hit network saturation
* The retention coefficient affects your system by creating a “lagging indicator” on your acquisition – if you have good retention, even as your invites slow down, you won’t feel it as much
* If your retention sucks, then look out: The new invites can’t sustain the growth, and you end up with a rather dire “shark fin.”

I think this is a very useful model, but that it doesn’t quite predict what we typically see in real life. Rather than dropping to zero, failed viral apps typically hover at a steady level much lower than their peak. Since Andrew made the model available under “copyleft”, I made a small edit to his model. Rather than treating churn as a constant percentage of users in each time period, I treated it on a cohort level, with a higher churn rate in the early periods and lower churn as time goes on. This is similar to the churn profiles seen for subscriptions businesses such as AOL’s ISP business. (I was at AOL from 2002-2005 as SVP of Corporate Development, and then as GM of Netscape.) This model better matches active user graphs that we typically see for failed viral apps.

churn by cohort

If you’re interested, the model is available for download here. Viral growth assumptions are in the yellow cells on the “viral acquisition” tab and churn assumptions and output are on the “user retention” tab.

Saving us from the games industry March 7, 2008

Posted by jeremyliew in business models, distribution, games, games 2.0, gaming.
5 comments

This is a guest post from John Szeder. John has been kicking around the gaming industry for a ten years now and is a frequent speaker at GDC and other gaming conferences. In his words:

John Szeder is an enthusiastic digital content creator and evangelist. He is presently working on a project in stealth mode, but ran two of his own companies successfully and profitably for most of the past eight years. He was a founding staff member at Digital Chocolate and early employee at Research In Motion. He holds a Bachelor of Mathematics degree from the University of Waterloo.

__________________________________________

I have been attending GDC for 10 years now and every year I am happy to say that I learn something new. I don’t think that everyone gets the same benefit from the tradeshow, and I have a little story to tell you about the importance of learning the lessons of history.

I recall back in 2000 when I first started doing mobile development sitting with a room of bright developers who said “Hey let’s go into the mobile marketplace! The mobile platform will save us from the games industry!” We all downloaded the various SDKs, bought some phones. We called Qualcomm, JAMDAT, and Verizon. Some of us started direct distribution of our own content, some of us did projects with publishers. I made a game in roughly four hours that paid over $100k in royalties over 3 years. These were good times.

In 2003, the bloom was coming off the rose. A lot of companies were making games and the carriers were getting overwhelmed. Fewer titles were getting placed. 10 new handsets, all rife with bugs, started coming out every month, and suddenly what started off as nice little cottage marketplace was full of people in business casual going “Here is our co-marketing agreement”.

So a group of developers at that point saw that there was opportunity to make downloadable games. I was not one of them but I heard a business pitch where someone was going “Hey let’s go make downloadable casual games! The casual games marketplace will save us from the games industry!” We won’t describe what happened next, it bears some remarkable similarities to what happened in mobile.

A short few years and 20 match-3 clones later, those same people gathered at the bar (bringing us to 2005) and realized that adding a set of smashing pumps to a match 3 engine and calling it “be-shoe-eled” was not going to buy clean diapers and beer anymore, but one of them had great news. “Hey I just got off the phone with Microsoft, and I can put my game on XBLA Marketplace!
Microsoft’s XBLA platform is going to save us from the games industry!”

It was a nice idea. They started off paying more than half the royalties to developers. Then it went to an even royalty split. And from what I hear, now the developer gets less than half, pretty much the same as in every channel.
It is sad to see people’s misguided monopolist instincts hard at work.
The same could probably be said for the Wii, but I didn’t bother getting one to put in my closet to gather dust after showing Tennis to my wife and her mother, I only buy hardware that I can play games on that I enjoy and Italian plumber games are *so* 1987.

The final nail in the coffin for me came when two of the people I respect for their artistic talent and creativity both said to me this
year: “John, I have an idea. Let’s go pitch this project to Sony. Their new PSN marketplace will be awesome

[wait for it]

AND IT WILL SAVE US FROM THE GAMES INDUSTRY”. You need to drop your voice a few octaves and say that last part aloud to someone near you in slow motion, because that’s what happened to me. I dropped into slowtime as though I was in the matrix and people were shooting at me. The echoes of developer’s ideas from the past several years hit a strange resonance and harmonic that was almost physical, even though half the conversations happened at the Fairmont Hotel in San Jose and the other half were in the W lobby in San Francisco.

I have some shocking news for you.

Nobody will save you from the games industry.

You will need to do it yourself.

You need to stop signing bad deals. Retain control of your IP. Seek alternative financing for your game development dreams. Find channels where you can participate in distribution (and revenues) and move up the food chain. Most importantly, understand that the people who you think will save you from the games industry are the very ones you need saving from.

Interesting nuggests from Social Games Panel March 5, 2008

Posted by jeremyliew in advertising, asynchronous gaming, business models, social games, social gaming, social media.
8 comments

Yesterday I moderated a panel on social games at Graphing Social Patterns. The panelists were Mark Pincus (CEO of Zynga), Shervin Pishevar (CEO of Social Game Network), Michael Lazerow (CEO of Buddy Media) and John Hwang (CEO ofTrip Monger, whose primary app is Speed Racing). It was a wide ranging discussion.

First we discussed what differentiates a social game from other sorts of games, and in particular multiplayer games. The general consensus is that a game is social if the social context of the relationship between a player creates or enhances the gameplay. For example, if emotions like guilt, pride, reciprocity, gratitude or vengeance get evoked in the gameplay because of the combination of gameplay and player relationship, a game is social. These emotions of course greatly increase the level of engagement in a game. Scrabulous’ turn based game play (which can induce guilt for keeping a friend waiting for your move) and Warbook’s revenge attacks were both presented as examples.

We then discussed some of the specific game mechanics that have worked well for social games to keep high levels of engagement. These included asynchronous play and many of Amy Jo Kim’s game mechanics. Mark talked about the importance of dedicating resources to constantly tweaking and improving a game to keep engagement levels up since the environment changed so frequently. John Hwang talked about the need to focus on the “hits” in a hit driven business, rather than trying to make every game a hit.

The conversation turned to monetization. We noted that despite the early stage of the four companies, all of them were profitable. John Hwang said that an individual developer with a good game can make a great living off the ad networks. Mike Lazerow thought that “advergames” or sponsored custom games were going to become the standard ad unit for games. His company (Buddy Media) is trying to avoid the hit driven nature of the games business by building game skeletons that he can reskin for new sponsors. They have had great success, garnering a base of 24 blue chip brand advertisers so far, with each campaign averaging over $100k. Shervin said that SGN had been successful with both direct sales and with rich media ad networks, especially VideoEgg. Mark was most excited about the digital goods opportunities for Zynga. He noted that they had just launched their first game with digital goods baked into the game design, Ghost Racer, and with a base of just 30k daily active users, they were already seeing a run rate of over $20k/month in digital goods revenue. Shervin noted that while Warbook doesn’t have an explicit virtual goods model, Warbook gold had been showing up on Ebay and one player had made over $1,000 selling Warbook gold.

We next talked about how social games can grow. Viral growth has obviously been the key driver of growth up to this point for all the panelists. Shervin noted that they had seen a strong positive correlation between App Rating and rate of viral growth – high quality games spread faster. Mark talked about the importance of supporting a game with advertising, especially at launch. He said that many of the Zynga games had bought their early distribution so that they had a bigger base from which they could grow virally. However, as Facebook has clamped down on some of the viral channels, the panelists talked about other growth channels. SGN, Zynga and Buddy Media have all made acquisitions to help with their growth. SGN and Zynga both talked about the importance of having cross promotional and viral channels beyond the control of Facebook. They are interested in creating networks whereby apps can cross promote each other directly in canvas pages, and hence are not subject to changes that Facebook may make in the future. Both companies mentioned their respective game promotion networks as possible solutions to this problem.

If I missed elements of the discussion, readers please feel free to add them in comments. I wasn’t able to take notes since I was moderating, so this is relying on my imperfect memory! The video of the panel is also available here (scroll down a ways). UPDATE: Unfortunately the video seems to have been taken down.

Free to play arguments February 27, 2008

Posted by jeremyliew in advertising, business models, casual games, digital goods, freemium, games, gaming, virtual goods.
3 comments

At GDC the argument continues over whether free to play and microtransactions are the future of games, or whether single sale and subscription models will continue to hold sway.

As I’ve opined in the past, the economic principle of marginal cost pricing suggests that free to play models will become dominant. At a round table on digital goods business models at GDC, one of the EA folks working on Battlefield Heroes noted that their surveys found that hardcore gamers and older gamers objected the most to digital goods, but that casual and younger players accepted it without comment. If the future of gaming is about breaking beyond the hardcore to the mass market, those defending the old models may be missing the larger opportunity.

Russell Carroll has an interesting post at GameSetWatch that sheds some further light on this issue. It is ostensibly about piracy in the casual game business and opens with the stat:

“It looks like around 92% of the people playing the full version of [the game] Ricochet Infinity pirated it.”

Carroll asks, if piracy can be stopped, can sales be increased by 12x? (i.e. would all the pirate players buy). After looking at all the methods by which the company could reduce piracy, and the impact of these methods on both downloads and conversion rates, he concludes:

As we believe that we are decreasing the number of pirates downloading the game with our DRM fixes, combining the increased sales number together with the decreased downloads, we find 1 additional sale for every 1,000 less pirated downloads. Put another way, for every 1,000 pirated copies we eliminated, we created 1 additional sale.

Though many of the pirates may be simply shifting to another source of games for their illegal activities, the number is nonetheless striking and poignant. The sales to download ratio found on Reflexive implies that a pirated copy is more similar to the loss of a download (a poorly converting one!) than the loss of a sale.

Think about this from the other direction. Currently, for every 1000 players, 80 bought the game and 920 are playing a free, pirated version. So the company makes around 80 x $20 = $1,600. If they were to eliminate piracy, they would sell one additional game, so their revenue would be $1,620.

At a recent panel on casual games, Alex St John said that he was able to sell advertising to support casual games monetizing at 15c/gameplay and that he was sold out of inventory.

To make $1,620 on advertising at 15c/gamplay, the 1000 players would on average need to play the game about 11 times each, which doesn’t seem unreasonable. (This assumes that the source of advertising dollars will be scalable.)

If you add to this a digital goods opportunity, the alternative becomes more interesting. Daniel James (CEO of Three Rings) has said in the past that the ARPU from digital goods is about the same as that from subscription, but with a distribution curve that looks more like a power curve – some heavy spenders and a long tail. An industry rule of thumb for digital goods monetization is around 5-10% of players will pay. Applying the same metrics to this game suggest a digital goods revenue stream in the $1,000-$2,000 range, incremental to the advertising revenue.

And finally, this doesn’t even begin to address the question on how many more players will play the game if the free period is not limited to 60 minutes. These incremental players all become candidates for monetization by both advertising and digital goods. Crossing the Penny Gap can dramatically cut the universe of users, as Josh Kopelman has noted before.

I would advise game designers to consider baking digital goods and advertising opportunities into the core mechanics of their new games so that they have the flexibility to explore both these business models as well as the proven subscription model.

UPDATE: Carroll has more data on his casual game pirating experience here.

Freemium service models – paying for convenience in games February 20, 2008

Posted by jeremyliew in asynchronous gaming, business models, digital goods, freemium, mobile, subscription, virtual goods.
4 comments

Last week I noted that free-to-play games will become increasingly dominant. I’ve also noted in the past several use cases for the digital goods business models that will be one of the primary monetization mechanisms for free-to-play games. Selling increased functionality can result in user dissatisfaction if players perceive that the only way that they can “win” is to buy more powerful in game functionality. This can be managed through the use of a dual currency system, as Matt Mihaly noted in a guest post.

One other monetization mechanism that free-to-play games can offer is services. Some games, especially real time strategy games, can be somewhat inconvenient to play because they require constant monitoring and occasionally require actions to be taken in game at a certain time. Gameplay can inconveniently interfere with other activities, like work and sleep.

Travian is a good example of this. In Travian each action takes a certain amount of time, and there is no way to “queue up” orders (e.g. if you want to upgrade your mine after you’ve finished upgrading your farm field), or to “schedule” orders to be carried out at a certain time (e.g. if you want to time a raid on another village to be coordinated with another attack). Instead, Travian requires a player to be in the game at a specific time to give an order.

Offering a player the ability to queue up orders or schedule orders as a premium service is a non controversial way to monetize users. Players who do not want to play can be just as effective as players who are willing to pay (they just need to be able to get online at the right times to give their orders). Players who pay for the service are paying simply for convenience, not for additional in game power.

Managerzone‘s mobile premium service is another example of such a service. As I noted previously, the mobile service gives a player certain alerts and allows a player to take a number of actions in the game from their mobile phone, without having to log on to the website from a computer. This makes the game much more convenient to play, but again doesn’t disadvantage a player who choses not to pay for the mobile service since they can still do everything from the website. It looks like Blizzard may also be considering a mobile version of World of Warcraft.

I’d be interested to hear from readers of other examples of games monetizing premium services.

The invisible hand of economics will make free to play the dominant gaming business model February 12, 2008

Posted by jeremyliew in business models, economics, games, games 2.0, gaming, mmorpg, subscription, virtual goods.
4 comments

The latest charts of MMOG market share by business model show the free-to-play (F2P in green) model to be roughly neck and neck with the subscription (P2P in yellow) model, with buy to play (B2P in blue) making up just a small fraction of the total:

MMOGs by business model

However, I think that we’ll see the free-to-play model (monetizing through virtual goods and advertising) increasingly take share over the next few years and eventually become dominant.

In the last 18 months we’ve seen many more free-to-play MMOGs being launched in the West, joining pioneers like Runescape. K2 Network, IGG, Acclaim, Aeria and others have all come to market with westernized versions of asian MMOGs, and all are employing a free to play model. Other companies like Sparkplay and Conduit Labs are building their own free to play MMOGs for the western market. But this flood of MMOGs is not the cause of the increasing dominance of the free to play model, but rather the symptom of the underlying economics of the business.

Marginal cost pricing is the principle that the market will, over time, cause goods to be sold at their marginal cost of production. MMOGs, like all other software businesses, have effectively a zero marginal cost of production. This is particularly true when distribution is also online. As a result, you would expect that over time, prices will tend towards zero, i.e. a free to play model.

MMOGs are not special in this respect. We have seen a number of categories of consumer online/software products start out being able to charge a subscription, but eventually move to a free model. In online personals for example, the big story of the last few years has been the inexorable rise of plentyoffish.com, a free online personals site that is now one of the top online dating sites (with no marketing):

online dating sites

Anti spyware software used to be a premium service, and now it too is mostly free. Anti-virus software is the same story. And parental controls software. Now all are available for free.

In each case, it took a few years for the move from premium service to free, but in each case the marginal cost pricing principle eventually took hold. It is hard to hold the line against the invisible hand of the market.

MMOG publishers and developers should be factoring in a free to play environment into their business models.