The hard limits of the subscription business model in gaming
Navigating the Catch-22s and complexities of running a successful subscription based gaming business
Did you cancel your HBO+ subscription when Game of Thrones ended? Did you ever sign up for a free month trial just to cancel your subscription immediately when it expired? Did you ever pay for a new streaming service, just to binge watch some TV show and then cancel it as soon as the season ended?
It started with Netflix. It’s the year 2021 and subscription services are everywhere. Apple is hawking its Arcade, Google is trying to convince you that you need more storage on your Drive. Microsoft desperately wants you to use its SharePoint. I am pretty sure that soon the likes of Roomba or Neato will in the near future launch their own premium subscription service and that you won’t be able to use your robo vacuum cleaner without paying $10 per month.
The same trend is evident in the world of gaming. There is already Xbox Live Gold. Apple has been pushing heavily its Apple Arcade, first as a standalone service, and now as a part of Apple One, a bundle of its other cloud-based services. They have been also aggressively promoting the idea of subscriptions to game development teams running free-to-play games on iOS, by offering better revenue-sharing terms.
To be sure, subscription services have their advantages. To some players, they are seen as the more appealing option than free-to-play or a premium model. To some of the companies, they represent a more predictable business model offering seemingly a more stable source of revenue.
However, subscriptions as a business model are nothing new. Newspaper, magazine, and cable TV industries have been employing it for decades. As they have learned, this business model has one fundamental flaw that severely limits its growth potential. This is the lesson that these industries have learned the hard way.
If you are running a game as a service, it pays off to at least be aware of it. This is especially important if you have experience in operating a successful free-to-play game.
KEY IDEA: The subscription model puts a hard ceiling on the amount of money users can pay for your service.
This should be obvious. Assume that you are charging a subscription of $4.99 per month. The revenue that you can expect from every user that stays with your service for a full year will be 12 x $4.99 = $59.88. This is a decent amount of money and as long as the cost of acquiring your users and the cost of production of the content that they consume remains below this level, you should theoretically be able to profitably run your business.
The interesting things, however, begin to happen once a company starts approaching the practical limits of its user base. This is the predicament in which Netflix and HBO are getting into right about now. By now pretty much everyone that cares to have one already has a Netflix account. As the user revenue has a hard limit, the revenue growth begins to stall. Retaining the existing users becomes the priority.
This is the point at which the true limitations of the subscription model start to unfold in several ways. In these circumstances, a company has two prime objectives:
- Retaining the existing users,
- Growing revenue.
There are essentially two ways how subscription-based businesses can retain their users. The first one is a dirty little secret of this revenue model.
There is certain inertia built in the core of the subscription business model. Companies love subscription services because they seem to be providing a more stable source of revenue than any monetization model that is based on occasional purchases. Simply put, the company charges each user a fixed amount of money each month regardless of whether he consumes the content or even engages with the service.
This of course hinges on an assumption that users once subscribed will stay subscribed in perpetuity regardless of whether they actually use the service or not. This is a fair assumption. Most people will not bother to cancel a service that they are not using very much. Opting out of the service you have been subscribed to requires overcoming natural mental inertia. It is similar to overcoming the natural inertia of making an occasional purchase. However, in the former case inertia works to the company’s advantage, in the latter against it.
This works only if the cumulative price that the user pays per month for this and additional similar services is low enough. If the total monthly spending rises over a certain threshold, players seem to change their behavior. Savvy users are switching between Netflix, HBO, etc., turning their subscriptions on and off on a monthly basis, binge-watching the content.
Companies are well aware of this problem and are developing strategies to combat it. HBO is already offering a 50% lifetime discount that is valid only if the user doesn’t interrupt his subscription ever. This is already a hefty discount. I don’t have insight into their user behavior data, but I am sure that they are willing to roll with it because numbers make sense to them. This would imply that an average user is subscribed to HBO for less than six months in a year. Otherwise, this strategy of user retention will start to work against the company’s other objective, the growth of the revenue.
The other way of retaining users goes back to the core of any business. It is about providing value for your customers. Content is the king. From the user’s perspective, the best way to keep them is by providing value for their money. In practical terms, this means a greater amount and better quality of the content that you offer. This applies to TV shows, movies, music, or games. Of course, this will inevitably lead to an increase in the company’s production cost. Inevitably as competition grows more fierce, the companies will be spending more and more money to produce new content.
According to some reports, Netflix alone will spend $17 Billion on production in the fiscal year 2021.
Again obviously this goes against the other objective, i.e., the revenue growth, as these expenses start eating into profit margins.
Building a value proposition for potential users is also a part of revenue growth. You will attract new users more quickly if they perceive the value of your offer.
If a company is also an IP holder and producer of content, this task might seem easy. However, this can be a problem for a company that makes a transition from other monetization models to subscriptions. In order for a subscription to work, the company needs to make available its complete portfolio (especially its flagship IPs) for a fixed monthly price.
This is a problem if the revenue generated by individual items in the portfolio is greater than what would be generated via subscription over the same period. Consider a gaming company that makes a profit of 50 dollars per average player per year for each of games A, B, C, and D. In total this makes up to 200 dollars. If the said company switches to the subscription model and makes games A, B, C, and D available to all users for a fixed price of 10 dollars per month this amounts to only 120 dollars per year. In other words, the company would be making 80 dollars per year less than it would otherwise. Here lies a Catch 22 of this model. In order for a subscription to be attractive to users, it should offer more value than the purchase of individual content.
This is the problem that established traditional big names in the gaming business, such as EA, Ubisoft, Bethesda, etc., are facing when it comes to subscription services.
Finally, a company can always try to grow its revenue by hiking up the price of its service. This is a valid approach. However, this doesn’t allow the company to break away from the inherent limitations of the business model. The revenue ceiling will simply be pushed to another level.
Hiking up the prices goes directly against the building of the value proposition. It can thus be detrimental to user retention. In order to offset this, the company might resort to offering larger more, and better content, in turn increasing the production cost and eating into the profit margin. Another Catch 22!
Some companies have been experimenting with augmenting their subscription revenue with ad-based income. Ad-based business doesn’t suffer from the same fundamental limiting factors. There is no upper limit for the amount of money a company can charge for an ad placed in the strategic place. See for example astronomic sums spent on Super Bowl ads.
Adding advertisements to your content again goes directly against the value proposition of many of these companies. This is especially relevant to gaming since the subscription has been offered to players specifically as a way of avoiding ads and IAP monetization.
On the other hand, ads have been a part of the magazine and cable TV business model for decades and haven’t been able to save them from inevitable doom.
Navigating this conundrum is what makes the subscription business model so difficult. Some companies such as Netflix have been able to so far escape this trap, although the speed by which they have been adding new users has been slowing since early 2020. Other attempts have already run into headwinds. This is the reason why Apple is bundling Arcade with other services.
As always there will be winners and losers, so get your popcorn ready.
- Subscription Economy by Zuora
- Netflix revenue growth by Statista
- Netflix production spending in FY2021
- Apple Arcade Can’t Compete with Free
- Cost of Super Bowl ads