Unofficial Realms: The Growing Influence of Dedicated Game Servers
By Matt Dion, Naavik Contributor
This is the introduction to a new research essay covering the boom in private / dedicated game servers. Read the full essay here.
The games industry has undergone a major change in the way that content is produced and consumed in the last few years.
We have seen expansive virtual worlds, “forever” games, and user-generated content (UGC) platforms. Games like Grand Theft Auto V, Roblox, Fortnite, and others are long-lasting, broadly accessible across platforms, and contain a greater variety of experiences than their predecessors. The enormity of these games has allowed them to dominate sales and streaming charts years beyond launch.
The massive audiences flocking to these platforms are younger, more diverse, and expect more personalized experiences than ever before. Though these games command enormous user bases, players are spread over myriad smaller experiences within each game’s boundaries, jumping from one to another with ease. These experiences are increasingly being created by fellow players rather than the platforms themselves, leading to a growing creator class of amateur developers, hobbyist tinkerers, and small server operators.
As games have grown and the experiences within them have become more personalized, game server operators have increasingly important roles in the growth and maintenance of these virtual worlds.
More bespoke experiences are being created by server operators, and more companies (such as Rockstar Games) are incorporating player-operated servers into their gaming ecosystems. And more gamers than ever are flocking to these servers.
They not only fulfill players’ needs but provide bespoke experiences that would not otherwise be available. Several have grown into businesses and cultural touchstones in their own right:
- Hypixel, a popular Minecraft server that spun out a dedicated development team to create its debut title, Hytale. Its trailer racked up more than 30m YouTube views in less than a month, and the team later got acquired by Riot Games.
- NoPixel, a Grand Theft Auto V roleplaying server that dominated the Twitch charts with its invite-only community and unique spin on the core GTA gameplay.
- DreamSMP, an invite-only Minecraft server that hosted a months-long political drama among several prominent streamers. It attracted millions of viewers on Twitch and YouTube.
In this essay, we drill into the increasing prevalence and power of these servers and their operators as new manifestations of the Creator Economy within gaming.
While one might think of streamers, influencers, esports pros, developers, and modders when we refer to content creators, there is an under-discussed community of server operators out there creating new micro-businesses that fulfill player needs and create value for the platforms they work on.
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Unity Tries to Gambit Goodwill for Profitability
By Mario Stefanidis, CFA, Naavik Contributor
Unity has unified just about everyone against it. Developers, gamers, and the media alike are in uproar after Unity proposed adding a per-install fee for games that reach certain thresholds on top of its existing pricing model. These changes are problematic for many reasons, and in the context of Unity’s sliding stock price and uncertain path to profitability, they can also be seen as a desperate effort by CEO John Riccitiello to turn the ship around.
Unity launched in 2005 with the goal of democratizing development. It is practically free to get started, and has facilitated amateur and professional game-making on a huge scale. This is why it has become so popular on mobile, commanding a 71% market share of the top 1,000 mobile games. It enjoys a significant market share on PC too, though triple-A developers are more likely to use in-house engines or Unreal. Indie developers, in particular, flock to Unity for its ease of use and availability on all major platforms.
This democratic ethos is part of why the community is so incensed. Unity’s game engine has followed a fixed pricing scheme for years, and depends on the size of the team and its revenue. Individuals, hobbyists, and small businesses making under $100k in the last year can get Unity Personal for free. Unity Pro, for businesses with revenue greater than $200k, costs $2,040 per seat annually. The Enterprise plan kicks in for businesses with over 20 employees and includes more features, but at a $4,950 per seat cost.
Its new pricing plan would change that dramatically. Effective January 1st, 2024, upon meeting certain plan-dependent install thresholds, developers outside of emerging markets would be charged anywhere from $0.01 to $0.20 per new install. This tiered rate is regressive – large teams using Unity Enterprise with over 1m new installs per month only pay a marginal rate of $0.01, whereas small teams and one-man shops using Personal or Plus pay $0.20 per new install, regardless of the number of installations.
The company has struggled with profitability since its inception, and that has been magnified recently. For one, the number of its customers with revenue exceeding $100k has declined, a fact Unity has tried to obfuscate by inorganically rolling up ironSource numbers (which it merged with last year). The decline began in Q3 2022, where these customers fell by about 1% – the first such decline since Unity’s IPO.
The company has also faced challenges with the post-IDFA digital advertising environment, some of which was self-inflicted: remember when bad data broke its algorithm for several months? Revenue from its Grow segment, which helps mobile developers to monetize and scale their business, has declined this year by about 3% on a pro-forma basis. Unity qualifies this decline by saying the “ads market in the prior year was still elevated from the impact of COVID.” This doesn’t seem accurate if we look at the performance of programmatic advertisers like Trade Desk and Magnite, both of which spent the entirety of 2022 trending downwards.
The engine business is contained under the Create segment. Its per seat pricing model does not allow Unity to fully scale with the growth of the applications it is supporting; contrast that with Epic Games’ Unreal Engine, which takes a 5% royalty on all revenues above $1m.
Game revenue is increasingly concentrated in live ops and games-as-a-service titles. Players are spending more time within individual titles rather than playing numerous single-player games, and this isn’t conducive to a pricing model that does not scale with revenue. In some ways this has always been Unity’s plan: build a low-priced game engine and upsell through adjacent services. But when it comes to the bottom line, things still aren’t clicking.
Unity also has a habit of overpaying for acquisitions. It paid $4.4bn for ironSource last year, a whopping 74% premium. It also acquired Weta Digital for $1.53bn in cash and stock considerations in November 2021 to bolster its VFX and animation capabilities. In its subsequent annual report, Unity noted it “incurred significant costs, expenses and fees for professional services and other transaction costs in connection with the Weta Digital Acquisition.” The company recognized $668m in intangible assets and $858m in goodwill (the premium paid over fair value). While Weta is private and a fixed deal premium cannot be ascribed, Unity clearly did not realize growth that would justify this acquisition cost.
In that one Runtime Fee blog post, Unity shattered customer goodwill it had spent years building up. The complaints of game developers are summarized in a collective letter signed by two dozen studios and endorsed by hundreds more.
Particular criticism was drawn to the retroactive nature of the terms. When initiated next January, developers’ eligibility will be determined based on lifetime installs. Then, the fee would kick in for all new installs that occur after January 1st. Unity also did not clarify how multiple installs would be treated or how piracy would be controlled. The pushback was so severe, death threats were called into Unity’s offices last week.
Unity’s CEO, President, and Chairman is John Riccitello, who has held the top post since late 2014. Riccitello was CEO of EA from 2007-2014, and before that was co-founder at Elevation Partners, a private equity firm specializing in media and entertainment. EA stock, at best, plateaued during his seven-year tenure there, and although he led Unity to a successful IPO in late 2020 his value creation record at the engine maker is beginning to look just as dubious. The IPO led to a massive payday for Riccitello, who cashed in $185m in time-gated stock and options, making him one of the highest paid CEOs in the world. The stock declined modestly in 2021 (-7%) and then dramatically in 2022 (-80%), though Riccitello still took in more than $21m in awarded pay – and continues to be a net-seller of his shares.
Unity has struggled with profitability since its inception and has never been GAAP profitable. However, Unity has been adjusted EBITDA positive since Q4 2022, and management claims adjusted EBITDA has accelerated – from $20.7m in Q4 2022 to $32.5m in Q1 2023 to $98.7m in the most recent quarter. GAAP net losses have remained pretty stable at around -$200m per quarter. How is this possible? Like most companies, the measure adds back stock-based compensation (SBC) expenses. Unlike most companies, Unity has paid a whopping 31% of its revenue thus far this year in SBC: $310m. Remarkably, this proportion has actually trended lower, as in 2022 it paid $538m in SBC on $1.39bn in revenue, or 39%.
Make no mistake — SBC is a real cost, and it should be considered when evaluating Unity’s general profitability. If it didn’t pay its software engineers so much in stock, there would be substantial turnover unless cash compensation rose, which would harm margins. As you can see, Unity’s go-to adjusted EBITDA metric doesn’t have a grip on reality, which makes it doubly depressing that the company’s profitability target is based on it (with a goal of a $1bn run-rate). Remarkably, it could pull this off but not actually be profitable in a real sense – all quite misleading.
In the context of the dire state of Unity’s bottom line, it becomes a lot more clear why the company proposed these pricing changes. It is in a tough spot, and it needs a big, higher margin revenue boost to turn things around. Unity’s Create segment after these changes would see a large windfall starting next year, allowing it to grow against what it claims have been tough comparables.
One big issue with the change was lack of communication. Unity dropped the Runtime Fee blog out of nowhere instead of soliciting feedback from its community and introducing more gradual changes. The company is set to walk back or clarify some of the changes soon, but the damage to its reputation is done. Unity remains the most popular engine, but the company appears to have overestimated its grip on game developers.
From a business standpoint, Unity shouldn’t necessarily 100% reverse the policy, but perhaps it can restructure its pricing to be less egregious and give more time for developers to adjust. An alternative solution would have been to cap its maximum take at a percentage of its clients’ revenue, perhaps at a mid-single digit rate like 4% – below Unreal’s 5%. This would allow developers to price the game as they see fit and not have to worry about the regressive Runtime Fee.
Unity was once a champion of democratized game development, but these proposed policies show a stark contrast between its foundational ethos and its current direction. With a sliding stock price, questionable leadership decisions, and declining customer trust, Unity's path ahead looks tumultuous.
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