Tobold's Blog
Wednesday, August 11, 2010
What is failure?

Probably due to the usual summer slump in MMORPG gaming, the MMO blogosphere has erupted in another round of discussion on failure of MMORPGs. That discussion pops up from time to time, but always suffers from the same problem: Lack of definition of what failure actually is for a MMORPG, which then leads to very different impressions of which games actually "failed" and which games "succeeded".

I guess its time for some basic economics. Because if you base yourself on economics instead of public perception, it is actually rather easy to define success and failure. A MMORPG after all is a business venture, not unlike putting a new car on the market, or a new shampoo. A business venture starts with an investment, which in the case of a MMORPG consists mostly of the development cost, that is paying for all those programmers toiling for several years to make that game, their offices, their computers, and so on. Plus there is some investment in server hardware. For big MMORPGs that investment can be significant, in the $100 million order of magnitude. Smaller games can have much smaller investment cost.

Success or failure is defined by the return on investment you get. Imagine you had spent the $100 million on a 10-year treasury bond with 2% interest, then in 10 years you'd not only get your $100 million back, but also $20 million of interest, for a total payout of $120 million. That is "risk free", as long as you consider it unlikely that the government stops paying its debts. For a business venture like an MMORPG to be a success, it has to deliver *more* than those $120 million back after 10 years. Because obviously a MMORPG is a more risky venture, and only the idea that you could get a higher return on investment would justify doing something this risky instead of buying bonds.

So far, so good, but unfortunately we usually don't know the financial numbers for MMORPGs. We don't know the total investment (World of Warcraft plus the first two expansions is said to have cost $200 million in investment), and we don't know the profit. Sometimes we have an idea of the revenue, if we know subscription numbers and monthly fee. But even if you know that the game has 100k subscribers paying $200 per year for a total of $20 million, you don't know how much of those $20 million remain after operating costs, taxes, and the like. We have some data from Blizzard from a few years back, where they made $500 million of profit on $1 billion of revenue, thus half of the revenue was profit, but 50% profit margin is rather high, and it isn't sure that every company reaches that.

So we are back to public perception. But wait, all is not lost: Companies react to success and failure in predictable ways. Watch what the company does, and you can deduce whether *they* think their game was a success or a failure. One of the better documented cases for example was Warhammer Online. Was that a success or a failure? In this case the head honcho, Mark Jacobs, helpfully announced their criteria for success or failure before the game launched: He considered less than 500k subscribers and the closing down of servers as a failure. And that was exactly what happened, after an initial rush the game dropped to under 300k subscribers and closed over half of their servers. Even if you take Mark Jacobs' success criteria with a grain of salt, the fact that he and many other developers got fired is another sure sign that the game company considers WAR to have failed.

The ultimate failure is the game company going bankrupt, or the game closing down. But that isn't the only form of failure. Imagine you invested $100 million in a game, and that game makes $5 profit every year. It is clear that after 10 years you only got $50 million back, and would have been better off if you had bought bonds, or even just tucked the $100 million under a mattress. But as long as the game makes more revenue than the operating cost, and thus still makes a profit every year, it is better to let that game keep running, in spite of it being a failure, than to shut it down and lose all your investment. Better $50 million back in 10 years than nothing at all. So the fact that a game is still up and running isn't an indication of success.

So how does success look like? Companies making a profit have two basic choices, and usually do a mix of both: They can return the profit to the people who invested the money, or they can reinvest the money into a new business venture. Imagine you invested $100 million into a MMORPG, and that MMORPG is making $20 million of profit every year. Great, in 10 years you'll have $200 million, significantly more than what you would have gotten our of treasury bonds. But then what do you do with the $200 million? Having launched one successful product makes you think that you have a recipe for success, and you can do it again. And you don't even have to wait for the 10 years to end, you can already start investing in the next game by putting half of the profits into your pocket, and reinvesting the other half into the development costs of the next MMORPG.

So lets look at another example, Everquest 2. Everquest 2 launched in the same month as World of Warcraft, and at launch it wasn't obvious which of the two games would "win" that "race" for popularity. So as EQ2 obviously "lost" this direct competition, some people think of it as a "failure". But Everquest 3 (called Everquest Next) was just announced. That is a pretty strong indication that SOE considers Everquest 2 to have been a success, that they got their investment back plus some good rate of return on investment, and that they think they can make even more money by reinvesting their profits into the next Everquest.

So how is the general state of the MMORPG market? As said before, MMORPGs are a risky business with an uncertain rate of return, a bit like making a movie and waiting for the first weekend box office receipts. The fact that some movies flop, and some games shut down or game companies lay off developers does not mean that the industry as a whole is in a bad shape. Not only do we have big new entrants, like Bioware with SWTOR, but also many of the existing MMORPG companies are successful enough to be working on their next games: Guild Wars 2, Final Fantasy XIV, the next generation Blizzard MMO, Everquest Next, and so on. The continued investment of companies that know the market very well tells us that the industry is generally profitable. The success can range from the billion dollar business of Blizzard to the small eGenesis game A Tale in the Desert running for 7 years now and starting their 5th telling. The total number of subscribers doesn't matter so much as the return on investment does, and it is the continued investment which is the true hallmark of success.
The problem with this subject is that most of these numbers are just made up in general. Even the Wall Street Journal had a print a retraction after reporting the Starcraft 2 budget passing $100 million.

Using $100 million as the "typical" MMO budget is too high, IMHO. Until recently, GTA 4 was the most expensive game of all time at that cost, not any MMORPG.

As I recall, the original WoW budget was under $50 million ($30 or $40 million, I believe). And that was for a game which was much more filled with content on launch than most games tend to, especially at that time. Darkfall never planned to have more than 30k subscribers, obviously it can be done for much cheaper.

The profits you list for WoW are from all of Blizzard, from last year. That was a year with no new game releases from them, so that $1 billion revenue is nearly all WoW. However, the $500 million in costs include development costs for Cataclysm, Starcraft 2, Diablo 3, and their unnamed MMORPG project.

I have seen other estimates for ongoing subscriber costs at $1-2 per player. Honestly, servers are not nearly as costly to run as people seem to think, and are fairly easy to downsize.
Yeah your numbers are way off, 2% of $100m is $2m. ;)

"I have seen other estimates for ongoing subscriber costs at $1-2 per player. Honestly, servers are not nearly as costly to run as people seem to think, and are fairly easy to downsize."

Is not hardware that is expensive, it the manpower to run them and customer service.

But to the main topic, this whole EQ thing reminds of the movies. A great movie is released and it does well at the box office (for its time) and becomes an instant cult classic.

The movie company says wow, we need to capitalize on this hype and release and follow up. The second comes out and it is OK, but isn't nearly as popular as the first.

So the movie company says we can recreate the hype of the original, lets make a 3rd. And the 3rd movie flops.

The Highlander I, II and III
Alien, II and III
Karate Kid I, II and III
Starship Troopers I, II and III
Yeah your numbers are way off, 2% of $100m is $2m.

2% of $100m per year for 10 years is $20m, in a simplified calculation without compound interest. With compound interest it's $21.9m.

The point is not whether a MMORPG costs $100m or $10m or $1m, but that regardless of you size of your investment you will want a return of investment higher than the so-called risk-free interest rate.
I'd argue that the game that's pulling in $20 million in annual operating profit after a $100 million investment might still be a failure.

By the time year five rolls around - with three years dev time, that's eight years since the investors kicked in the money - you've made $100 million in profit but this still leaves your investors behind the curve because of inflation. If your subscriber base hasn't dropped at all from its peak in 7 years (10 post-investment), you have a chance to come out slightly ahead of the treasury bond, assuming that 100% of operating profit goes straight into the investors pockets, and that payoff probably isn't big enough to make them feel all that good about risking the $100 million up front.

My guess is that this is where Mark Jacobs' number, the supposed 1 million number needed for SWTOR, and NCSoft's willingness to axe its smaller games all come from. It's possible to be generating a small or even significant operating profit over what it costs to keep the servers running and still have the endeavor be mostly pointless in terms of ever reimbursing your investors.
For me success is if i like the game and failure is if i dislike it. Your Definition is on pure business Terms and, while interesting, it is not what is directly Important to me.
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The reason why defining which games are successes or failures in purely business terms is important is that it helps to determine what types of games will be made in the future, since it strongly influences how and in what people will invest money in.
I'm going to play Devil's Advocate for a moment and argue that financial success is NOT the best measure of success.Particularly with MMOs where we don't have the complete picture.

Instead, let me posit that the best measure of success is the one found in the Court of Public Opinion.

This measure of success is entirely measured by the popularity of the product.

Why is that the better measure?

Because a popular opinion of a product presumes financial success and/or additional investment.

In economics, they measure this popular opinion on the overall health of the economy (Consumer Confidence). And it's perhaps one of the best indicators of future economic performance because it predicts spending trends.

The same concept holds true at the micro level. If people feel good about a product, they are going to use it. If people don't feel good about it -- they won't.

Thus, we wouldn't need any financial or subscription numbers at all to know that Warcraft is more successful than any other MMO.

Likewise, it was pretty clear as players were leaving WAR after three months that it was failing. We didn't need Mark Jacobs prediction of firing to figure that out.
@Nils: But of course, whether you like a game or not is hardly a proper way of defining success.

I do agree with Tobold, making games is a business and the one true measure that makes a game a success or not, will always be Return on Investment. If it doesn't make a proper profit, i.e. well over risk-free interest, it is basically a failure.

I think that unfortunately means Spore was a success though...
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