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Valve has just started the PC games race to zero

By on March 3, 2014

Valve has just announced that developers will now be in charge of their own pricing on Steam. They can run sales, offer discounts and promote their games without talking a Valve representative. This is the beginning of PC games prices drifting downwards, with an endpoint of zero. Here’s why.

The marginal cost argument

In Chapter 3 of The Curve, I set out the economic arguments for why a digital product will tend towards a cost of zero over time. Broadly put, an economist named Joseph Bertrand established that, all things being equal, in a competitive market, the cost of a product falls over time to the marginal cost, driven predominantly by competition.

Let’s imagine a shoe factory supplying shoes to one small town. Leaving aside the cost of the factory, the land and the equipment, the cost to make a pair of shoes is $1. Every extra pair of shoes made costs an extra dollar. Factory A decides to sell its shoes at $5.

An entrepreneur sees that there is an opportunity to make $4 for every $1 he invests in a pair of shoes. He borrows money to build a factory and buy equipment to make shoes. He wants to make sure that he gets some market share, so he decides to sell his shoes for $4, meaning that he only makes $3. His shoes are now 20% cheaper than his rivals. He gets all the customers. So Factory A cuts its prices to stay competitive to $3. The entrepreneur custs his prices to $2 and so on and so on until, according to Bertrand Competition, prices stabilise when they can no longer afford to make one pair of shoes, the marginal cost, in this case, $1.

In the world of digital, the marginal cost is zero, or as close to zero as makes no odds. On iOS and Android, the AppStores swallow the distribution bandwidth costs, which means that the marginal cost is actually zero for many developers. In the world of PC, this is not yet true, but bandwidth costs keep falling, and the marginal cost, if not zero, is pretty small.

There is an issue with Bertrand Competition: it excludes the impact of marketing; it assumes that one pair of shoes is as good as another pair of shoes; it doesn’t factor in the cost of comparison, or the cost of switching, all of which are real. But what it does say is that the thing that drives the cost of products down, particularly in the case of digital products with low marginal costs, is competition, not piracy. And by removing itself from the pricing process on Steam, Valve has just made its platform hyper-competitive.

The hardware argument

Free is the dominant price point on mobile platforms. Why? Because the two main players don’t care much about making money from the sale of software, or even In-App Purchases (IAPs).

The Appstore is less than 1% of Apple’s revenue. Apple has become one of the most valuable companies in the world on the strength of making high-margin, well-designed, highly-desirable hardware. One of the things that makes its hardware desirable is that there are over a million apps available for the platform, many of them for free, that extend the capabilities of the phone in a way that Apple might never have imagined. Steve Jobs wanted to enable the free price point for mobile apps because he hypothesised that having a competitive market of entrepreneurs striving to make their software work on his device would drive the desirability of his hardware. Boy, was he right.

Google didn’t create Android to sell software. It built Android to create an economic moat. Google was dominant in the desktop and makes the majority of its revenue from advertising. It identified the very real threat that Internet usage and search was going to migrate to mobile and it needed to ensure that it did not get left behind. Android was its response.

In the case of both iOS and Android, keeping prices high for software would have been in direct opposition to the core businesses of Apple (hardware) and Google (search-related advertising). The only reason that ebooks are not yet free is that Amazon’s core business is retail, not hardware. If Amazon believed it could make more money selling Kindles than selling ebooks, ebooks would be free. Console games are not going free because the business model of Sony and Microsoft is to subsidise the hardware and make their money back on the software. In this model, subsidising the hardware and taking the risk of free-upfront games seems too high for incumbents.

Which brings me to Steam. The Steambox is a competitor to consoles, created by Valve. It is supposed to provide an out-of-the-box PC gaming experience, although it struggles to compete on either price or on marketing with the consoles. It doesn’t seem as if Steam is keen to subsidise the costs of the box, not to the level that Microsoft and Sony are.

But what if Steam’s USP was thousands or tens of thousands of games for free? What if it competed with consoles by taking the Steve Jobs’ approach of an open platform with the price set by developers (and hence likely to tend to free, according to Bertrand Competition). What if Steam *wants* the PC market to go to free because it will be a powerful competitive weapon as it battles the console manufacturers.

Then I would expect Steam to open Steam to many more developers (Greenlight), to make games available fast (Early Access) and to give the market control over pricing (developers set their own sales).

Which looks just like what is happening.

The new business model argument

image

But Steam is a retailer, you might cry. It makes its money from the 30% cut it takes from selling games in digital boxes.

Sort of.

Steam is also a successful free-to-play channel. It was an early experimenter with the business model in the West, with Team Fortress 2 staying consistently at the top of its own F2P charts. SuperDataResearch estimated that Team Fortress 2 made $139 million

in In-App Purchases in 2013 alone. Other games like Stronghold Kingdoms from independent UK studio Firefly have been consistently high in Steam’s F2P charts. (Disclaimer: I have worked on Stronghold Kingdoms since its inception).

Valve makes money from the In-App Purchases discovered through its platform. It also makes money from selling games upfront. If customers are becoming more comfortable downloading games for free than paying for them upfront, Valve can make money either way.

That doesn’t mean I expect Valve to stop supporting paid games, in the same way that I don’t expect Apple or Google to do so. I do mean that Valve seems likely to open the market to more developers, to more experimentation and to more price points to see what works for consumers and businesses alike.

It is my expectation that free, driven by the iron laws of competition, economics and technology, will win out.

That may be a meaningful competitive advantage as Valve tries to make the Steambox work.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com

91 Comments

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  10. trans

    April 16, 2014 at 5:42 pm

    Did you even read the article?

  11. Anthony

    April 16, 2014 at 5:38 pm

    Differentiation is the way to compete with free. If you can’t compete with free then you just flat out can’t compete. Games are not a commodity market.

  12. trans

    April 16, 2014 at 5:36 pm

    The intent is to discourage game makers from using “this is free” to get you in the door when in truth it is not free. If all games had to cost at least a dollar, then it would at least even the playing field some. As it stands, game makers are feeling the pressure to move to in-app purchases b/c there is no way to compete against “free”.

  13. Anthony

    April 16, 2014 at 5:30 pm

    The larger distribution channels bring with them a measure of discoverability. There is also a not insignificant segment of the PC games market that won’t bother with a game if its not on steam.

  14. Anthony

    April 16, 2014 at 5:29 pm

    Why is that necessary when you could have the same effect personally if you could just filter for games that cost at least $1? Does a free game being on steam really hurt you in any way if you can filter away all the free games?

  15. Anthony

    April 16, 2014 at 5:28 pm

    I think you are arguing with people who don’t understand the concept of marginal cost.

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  19. Nicholas Lovell

    March 14, 2014 at 11:27 am

    I don’t agree. Competition is the driver, not piracy.

  20. bib

    March 14, 2014 at 10:50 am

    No , excessive piracy and idiotic unmaintainable business plans are to blame.

    Its really that simple , you can tell yourself its a digital revolution but tbh its just its easier to pirate than to buy mostly that is the problem.

  21. Biib

    March 14, 2014 at 10:48 am

    This whole article is just wrong on so many levels.

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  33. HoneyGoat

    March 7, 2014 at 9:02 pm

    2nd sentence ‘Without talking [to] a Valve rep.’

    Forgot the ‘to’

  34. furthur

    March 7, 2014 at 8:31 pm

    you accidentally a word in the second sentence fyi

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  37. Krid O'Caign

    March 6, 2014 at 11:06 pm

    There’s theory, and there’s practice.
    In theory, there are plenty of ways to monetize a game which are perfectly ethical and socially acceptable.
    In practice, the “free” products that flood the app stores are by and large engaging in behavior that ranges from unethical to abhorrent and illegal.

    Lets take micro-transactions for example: You have some products which do not have a strong negative effect on consumers, such as Team Fortress 2.
    In the case of TF2 the impact of micro-transactions on the customers is complex, but can be summarized as being a wash overall, with no net ethical concerns or damage to goodwill beyond that common to any attempt at novel monetization.
    Even so, there are many consumers who have abandoned the product as a result. Their complaints depress public opinion of Valve’s, which in turn decreases the average goodwill held for the company. Valve has turned a significant profit, but as a result every gamble they take has a marginally higher risk.
    The lower goodwill means customers will be less likely to assume risks, and by way of example this means the upcoming steambox will have slightly less early adopter demand. I don’t expect this effect is going to have more than a minor effect, but there is a real cost here.

    Then you have Dead Space 3, where micro-transactions were not handled unethically, but were a very poor fit for the product. This resulted in significant lost sales – if a game is being retailed at standard AAA pricing then attempting to further monetize it will inevitably be seen as attempting to double-dip in the customer’s wallet. Customers saw it as anti-consumer behavior, and how the customers see things is only metric for anti-consumer behavior that’s worth using.

    … And then there’s Smurf’s Village. The game which exploited the interplay of young children and Apple’s credential cacheing to rack up untold thousands of dollars in illegitimate purchases. That was extraordinarily both unethical and anti-consumer, violated the laws of many jurisdictions, and prompted changes to both how app stores function and the laws regarding their use.
    While notable in scope and brand recognition, the targeting of young children and attempts to avoid informed consent continue to plague the micro-transaction F2P model and carved a space in consumer opinions of the system.

    Selling ads seems benign on the surface, except that targeted ads are significantly more profitable and thus tracking and spying on users is strongly encouraged. This ties in to the larger issue of datamining and user privacy. Unlike with micro-transactions there is no direct financial trail between the consumer and the developer, which makes tracking bad actors and holding them accountable significantly more difficult.

    A some F2P apps have monetized by using the consumer’s CPU/GPU for computation (typically Bitcoins), but the users are almost never informed of this. There is potential here, but transparency is required and informed consent requires the user understand to what they are agreeing. These sorts of methods are generally too technical for users to understand, which would inhibit adoption.

    Then there are F2P monetization methods which are outright illegal – identity theft, silent phone calls to 900 numbers, etc… This isn’t a baseless concern; these are monetization tactics which are occasionally found in F2P shovelware, typically when walled gardens decide to lower the barrier to entry.
    This has the effect of reducing demand for F2P products.

    Piracy is your product competing with itself. I would say that is quite relevant to competition.

  38. Nicholas Lovell

    March 6, 2014 at 10:08 pm

    I love that response. It’s marvellous.

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  40. anon

    March 6, 2014 at 5:44 pm

    I was going to re-post the whole thing, but decided to just link to his Twitter comment instead.

    http://www.twitlonger.com/show/n_1s0qu3u

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