Digital Economics 101
As with all of my thoughts, these are hardly original. I have read a bunch of good stuff about economics and the evolution of digital content across the web that got me thinking about these things. But I like to think that I have a knack for reading and understanding the issues, swirling all of the ideas around, and spitting out a somewhat cohesive explanation of what it all means without using big fancy words. Incidentally, this has ties to my last post about how “free” services aren’t free so it might be worth reading that too!
I’m not an economist but, as far as I know, the main law of economics is the relationship between supply, demand and value. If supply goes down, demand and value go up, etc. Digital content causes problems with this equation because it’s theoretically infinite. Since the content can be replicated perfectly over and over there is no scarcity of supply and demand can be instantly fulfilled, meaning value is zero. So: infinite supply equals zero value.
I’ve seen this point argued both ways with people in the middle saying that the supply is not actually infinite and so on. The truth is when you can replicate something as easily and perfectly as you can with anything binary, the supply is practically infinite. I also believe that the law of economics is true, meaning that digital content’s value goes to near-zero. The preachers-of-doom are right, content has lost its value. Does this mean that good content will die in favor of mass-produced, regurgitated garbage?
In the late 90s the infamous mp3 caught the music industry by surprise. The way I see it, there were two big catalysts. First, the development of the mp3 compression algorithm (I’m not sure exactly when this happened and I’m too lazy to look it up because I’m a blogger, not a journalist). Second, the steady increase in bandwidth at reasonable prices. Suddenly you could create a 10:1 compressed file of a song, at similar quality, and download it in less than 20 minutes on dialup. When DSL and Cable dropped in price it added fuel to the fire. I’ll skip the history lesson because you know what happened: Media piracy exploded via P2P networks.
Music, video game, film and other content industries freaked out and are still freaked out because the content they offer is increasingly under valued.
I felt this burn personally when I created Whirlygig for WP7. I’ll readily admit that Whirlygig is not a great game. It’s not bad, but it’s not great. And I couldn’t sell it for a dollar. After working for months on a game, pouring my sweat and soul into something, it was hard to accept that it was worth less than 1/3 of a Starbucks latte. I realized that my hard work had very little perceived value and, at the time, got pretty depressed about the future of indie game dev (which I now find ironic because I consider 2011 to be a pretty stellar year for indies).
I spoke at a mobile marketing conference in Houston in October, 2011 and, as part of my research, I looked at total volume of apps on the market. At the time iTunes had almost 500k apps, Android was nearing 250k and WP7 was working towards 50k for a nice round 800k number. I’m sure it’ll hit 1 million total apps soon. So, even without the digital music revolution, the sheer volume of choice makes the perceived value of individual apps very low because supply outweighs demand.
Industry pundits lament the demise of quality content, blah, blah, blah and indies like me either get burned out and quit or continue to do it for the love of it, without hope for financial success. The digital revolution has happened and there is no money to be made in content creation.
Or is there?
Every equation has inverse equations. If the value of digital content has dropped to zero it is a hard product to sell. But if you think of digital content as a resource and not a product it suddenly has enormous potential because it’s a FREE RAW MATERIAL.
In 1901 a blacksmith would have to put a moderate amount of labor into creating a tiny metal ring. Now there are factories in China that do nothing but churn thousands of them out a minute. The value of that tiny metal ring has dropped so much that it may as well be valueless. But Victoria Secret combines a few of those metal rings with some lace to create a $35 fancy bra . There are two important things happening here. First, Victoria Secret is creating a high-value product from low-value materials. Second, there is artificial scarcity. While all of the materials exist in abundance, the combination is unique, hard to reproduce and thus valuable.
In 2003, some smart company created a way to deliver a product that was dropping in value and create a business around delivering that content. They called their product the iTunes Store and sold individual songs digitally instead of full, physical CDs. Apple took a material that was dropping in value and wrapped it in a unique service that created value. The industrialization of music was becoming complete.
This transition has been further realized by Spotify, Pandora and other streaming services. These services do not sell you songs as a product. You don’t pay for individual songs at all…you either pay for a service or even get it for free thanks to advertising. The songs are a raw material that powers the service as opposed to a product themselves. These companies have realized that content is getting harder to sell due to the volume available. Additionally, the volume itself creates its own problems that are solved by streaming services. They create playlists and stations of like-music that combine the raw materials (songs) into unique experiences (playlists) just like clasps and fabric in a fancy bra.
Smart game developers have leveraged this. SpryFox‘ created Realm of the Mad God (RotMG) and Triple Town, that leverage the exploding Free-To-Play (F2P) business model. In Triple Town you have a limited amount of turns that slowly recharge over time. If you run out of turns you can wait or buy more turns with real money. In RotMG you are limited to a single character at a time unless you buy more slots. You can also pay for cosmetic and other upgrades. League of Legends, TeamFortress 2 and countless other well-known games have similar models. Note that this is very different than in-game ads. In game ads generate some revenue but the model overall is not sustainable long term for any but the highest-downloaded games. Additionally, it doesn’t really view the game as a raw material for a higher-level experience, it’s just a billboard for a different product that someone else is selling.
So F2P has circumvented the infinite availability by creating a scarcity of supply. You can play TripleTown for free and it’s a good game (this is a key point, more on this in a bit) but then you run out of supply (turns) after the demand has been generated (when the gamer has been pulled into the game flow). Suddenly the product has value. Even better, it creates a reliable revenue stream for the developer that enables them to add even more content and charge for that too. The game becomes a self-sustaining platform by managing its own supply and demand. But Triple Town’s model works because it is a good game at its core. The turn threshold is just long enough to get gamers into the flow but short enough that it runs out before you’re satisfied and the game is good enough that you want to keep going. So, even as I make the point that the value of content is dropping and that content has become a raw material, you have to have GOOD raw material to build a product on top of it. Weak content has no value as a product or a resource.
But I don’t think these events define the future of the industry. I personally do not like the F2P model in most cases. While I enjoy TripleTown, RotMG, League of Legends and other F2P games, they have gotten a minimum of cash from me (maybe $1). I paid the game price for SWTOR and the monthly fee to play. I also bought Skyrim and often buy indie games on Steam. I like to pay up front or at least know the fixed cost of a media experience. New indie markets are springing up and some indies are making it really big. Some people are content to stream music, pay for a service, and never actually own songs. I prefer to own my collection. Everybody has their own preference: mainstream markets, niche markets, F2P and other evolving models will coexist.
The point is that content creators need to understand the economics of the market. I think we all see and understand the what of the business models that rise around us but do we understand the why of it? Do we know which pie will give us the best exposure and the biggest slice? I discovered this the hard way when I worked hard on Whirlygig and realized that only close friends and fellow devs were really willing to purchase the game and mostly out of the goodness of their hearts. The thing I still believe is core to any of these models: you have to create good content. Triple Town’s model wouldn’t work if the game didn’t really suck you in, gamers would hit the barrier and simply walk away. I personally hope to make Whirlygig better and integrate things that will keep people playing and maybe even find a way to make it financially worth it.
We content creators wear a lot of hats as we produce, market and deliver our content. It’s time to put on your economist hat and find the business model that will earn your shining content the revenue it deserves.
 I didn’t use the example of bras to be juvenile, I read about a Chinese factory that does nothing but create the metal rings used in bras in this National Geo Article and have found it fascinating every since.
 Here’s why ad-supported games are not viable long term:
- Advertisers (usually brands or retailers) have a product to sell.
- Advertisers will never spend more on ads than they make in sales and prefer that cost to be a predictable ratio.
- Thus Advertisers prefer to pay for revenue-share on sales (exactly predictable) or clicks (fairly predictable)
- Since the Advertiser drives the market they only buy impressions at high volume, for low cost.
- New ad markets usually subsidize the impression payouts to get Publishers (developers, website owners, etc) to integrate their ads and have big enough impression blocks to drive deals with Advertisers.
- Once the market matures, the Ad Market and Advertisers can forecast sales driven by impressions and stable prices are negotiated
- Now that the Ad Market has predictable income they relax the payout subsidies and ad payouts drop for Publishers
- The Publisher payout starts as a percentage of the Net Sales price of the Advertiser’s product and gets further cut by the Ad Market’s take
So, armed with the above knowledge, think about how likely that in-game ad is to actually drive a sale of an Advertiser’s product. Not likely. Eventually Advertisers will pull out of in-game marketing unless it either drives sales hard or gets really, really cheap. I have purchased ads as an Advertiser long enough to see this happen in several new web markets and I don’t think mobile will be any different.
 Note that Whirlygig doesn’t have a trial mode, which probably would have greatly increased the number of purchases. That being said, my research for the Houston talk drove home the point that the conversion rate (conversion rate = purchases / trials) for games is much, much lower than the conversion rates that online retailers and other businesses enjoy. All of the research I have done indicates that it’s easier to get someone to pay a dollar for a cup of coffee than for an app.