More on Video Games, from a Disruptive Innovation Perspective

I have been reading Christensen’s theories on disruption. Some key themes of disruption are: 1) making a technology cheaper and more accessible, and 2) solving a problem that’s previously under-treated, or addresses a slightly different audience. Competing against non-consumption is a key theme as well.

So disruption is about creating value and diffusing it throughout society. You want things to be both cheaper and available to more people.

This also echoes “Crossing the Chasm”, where a technology leaps across the exclusive purview of early adopters and visionaries, and into the mainstream.

Disruption typically requires three things that are internally consistent and reinforce each other:

• An enabling technology
• A new business model
• A new value network (value chain) of disruptive players. Creating this often requires one strong company to vertically integrate the value chain and force industry changes.

From an investment perspective, picking winners means spotting industry trend changes, understanding the technologies and new business models that enable these changes, and then investing in a company that is part of the new value network of disruptors.

For practice, I'm trying to think through the video game landscape and apply these concepts. 

Video games - changes I’m observing

Two changes come to mind immediately:

• First, the value proposition and target audience of video games is changing, from teenage and college dudes in the basement shooting strangers, to a more inclusive (both adults and children, male and female) social experience.
• Second, costs have gone down dramatically. The proliferation of simple, low cost mobile games means people are conditioned to only paying a few dollars for games, if at all.

These fit the themes of disruption – a broader audience, lower cost access, and address problems that were previously unsolved (social needs instead of pure adrenaline rush).

The next questions are "what's technologies and business models fit with these changes", and "who's part of the disrupting value chain?"

(Apologies - the next couple sections are a bit messy because it's a bit of brainstorming)

Enabling Technologies and New Business Models

1. Enabling technologies- 

Internet is an obvious enabler that allows players to go online and shoot at random strangers, or team up with friends and strategize. This increased the social component of video games.

Network technologies continue to evolve. First, with CDNs (Fortnite uses Akamai), and now with full streaming (Google Stadia).

Another one I can think of is Nvidia’s ray-tracing chips. This seems to me a complementary technology for CDNs, where the ray-tracing capability can be done not at huge data centers, not at consumer’s homes, but at more remote (“edge” if you will) locations within CDNs.

2. Business Models

Free to Play (F2P) a revenue model that’s here to stay. This could be F2P with advertising, or F2P with microtransactions (loot boxes, battle passes, skins…etc).

Distribution is another obvious one. We went from buying game at physical retail stores, to downloading games at home, to now full on streaming.

Fortnite is potentially pioneering a whole new business model. With unique in game events like concerts, Fortnite real value could be as a “gamified” online gathering place that monetizes by selling tickets to events.

Value Networks - who’s part of the disruptive chain?

Now it's time to find parts of the value chain that benefits from these enabling technologies and (relatively new) business models. 

Let’s go from upstream to downstream.

• Hardware.  As mentioned earlier NVDA’s ray tracing chips could be used to bring top quality to mass market.
• Consoles are being disrupted by F2P model as well as streaming, so makers like Nintendo, Sony, and Microsoft will have to rely on their game development skills.

• Game Developers and Publishers.  
• Developers that grew up with low cost mobile games will fit well with the F2P paradigm. Zynga and ATVI’s King are examples. 
• Publishers with strong experience in online multi-player games have advantage.

• Streaming networks like Twitch, communication apps like Discord, or even Reddit amplify the social value of playing video games.

How to invest – Tencent and ATVI

Unfortunately much of this is uninvestible. I'd love to invest in Epic Games, or Twitch, but they are owned by Tencent and Amazon, respectively. Both are so big that the impact of Fortnite/Twitch would be negligible. 

I do like Tencent itself though. The company is integrated along games, social, and payments. That’s three competencies that define the future video game world. No wonder they saw the potential of Fortnite before it happened! They also have a stake in Garena’s Free Fire.

Activision Blizzard (ATVI) is one that I have a small position in. Their games like Overwatch will be disrupted by F2P model, but they do have the resources to overcome disruption if management tread wisely.

Fending off disruption requires disrupting yourself, and separate the new business into an autonomous entity. ATVI (like EA) already does that. Activision is a different studio from Blizzard, which is separate from King. King is quite familiar with F2P model. So I do think ATVI has the skills to thrive in the new world. But we’ll see.

Video Games as Social Networks, and How EA Misses the Point

The market has been treating Electronic Arts (EA) and Activision Blizzard (ATVI) stocks rather harshly. A big part of it is the emergence of Fortnite, a free-to-play (F2P) battle royale game that’s taken the world by storm, and helped its creator generate $3bn in profit.

Investors who are long EA are counting on its new battle royale game, Apex Legends, to fend off this competitive threat.

Unfortunately, this type of thinking misses the point.

Fortnite is not about battle royale, nor is it about F2P. The disruptive part of Fortnite is turning traditional shoot-them-up games into a lively social experience, while broadening the audience beyond hardcore gamers.

All aspects of Fortnite’s designs, from graphics to game play to monetization model, fit together tightly to create that social experience.

Apex Legends on the other hand, merely copies Fortnite’s revenue model (free to play) and game mode (battle royale), without matching it to relevant product features.


Fortnite is more than a Battle Royale!

You don’t have to look very far to see that Fortnite is much more than a video game. It’s a social phenomenon:

• Athletes from basketball players to boxers have been celebrating with Fortnite dances
• Creatives like Carlton tried to sue Fortnite for its dances
• Carlos Santana had to smash a TV because his teammates were playing Fortnite during baseball games!

Why people play video games

Let’s take a step back and think about why people play video games. Common reasons include:

• Fill time
• For entertainment – this could be adrenaline rush or going through a story like in role playing games
• Get a sense of achievement - whether it’s solving puzzles or beating a stage boss
• Social needs – so they can interact with friends, or make friends through the game

The early generations of video games, say Super Mario, focuses more on the first three. There is a social component (kids talk about it in school or invite friends over to play), but in in general, game improvements are based on better graphics and fancier game play mechanics.

Then the internet came along, and we have multi-player online games such as Warcraft or Counterstrike, and all the sudden these games have more of a social component. Now you have to pick your teammates, strategize game plans, coordinate a time with your friends to storm some fortress. No one wants to let their team down, and the games are sticker because of that.

This is network effect in action. More players in the game means it’s more likely that my friends play, and the more my friends play, the more likely I’m going to play.

But a social network goes beyond simple interactions. In true social circles, people want ways to express their individualities, as well as build social status. Social circles also offer unique shared experiences that binds people together.


Fortnite as social network

This brings us to Fortnite. It has multiple elements of a social network - not just team play, but status signaling and shared experiences:

• Peer interactions 
• Play because your friends play - can’t let your teammates down!
• Or you can play with random strangers
• Shared experiences that people can talk about
• The Rocket launch in 2018
• Concert in Feb 2019
• But also ways to provide and signal social status 
• Game dominance = Bragging rights
• Your avatar can have its own unique attire (“skins”), including limited edition ones.
• Emotes/dances – these are great ways to express your individuality and sense of humour. Because earning these requires in-game achievements, they are bragging rights as well.

How Fortnite’s game features and monetization model both fit with this social function

Just saying “we want to build a social experience” won’t make it happen. Successful satisfaction of customer needs requires a suitable integration of product features and monetization schemes. And this is where Fortnite really shines. 

F2P totally makes sense given Fortnite’s “video game as social network” feel. To build a social network you want to minimize access barrier and maximize number of players. What’s more accessible than free?

To reinforce that accessibility, Fortnite’s cartoonish graphics broaden the audience to include kids and females. The game’s building mechanics also broaden the player base beyond just shooter fans. It drew in a class of gamers who likes solving puzzles.

In terms of monetization, Fortnite chose to monetize by selling skins/emotes/dances. These have no bearings on your competitiveness in the game itself, but are ways to express individuality and bragging rights.

Again, game features are fully consistent with monetization. The cartoonish graphics are aligned with silly dances, while 3rd person perspective (camera behind your character) means you can see the fancy clothes that you bought.


Now compare that to Apex Legends

Apex has copied two elements of Fortnite, the battle royale, and the F2P. But it fails to optimize game features to monetization while creating a social experience. As a result, this is just another game.

This article has a good comparison of Fortnite versus Apex Legend. Pay attention to various elements of the game (graphics, game play, perspective), and its implication.

• Perspective. Apex is also F2P and try to monetize by selling skins. But this is a first person shooter, so you only see the gun. This isn’t much incentive to dress up your avatars!
• Game play. Apex is more of a shooter, it doesn’t have the building mechanics, so gun skill is king. This limits access to a more niche group of players, and creates less of a diverse community.
• Graphics: Apex has more realistic renderings. While this is “better” graphics, it clearly caters to more of a mature audience, and will not work as well with humorous dances. This limits monetization through emotes.
• In-game events. So far I’m not aware of any.

Apex just put out its first Battle Pass (monetization). Not surprisingly, the feedbacks are disappointing across the board.


Conclusion

A disruptive business model has hit the video game industry, and it’s not about battle royale.

In Fortnite, Epic has found a way to do F2P to the tune of $3bn profit a year. That formula is to embrace the social network elements of a video game, complete with rare in-game events to encourage buzz, and with monetization tied to personal expressions.

Incumbents like ATVI and EA have to respond, but EA’s response via Apex Legends makes me wonder if they even “get it”. They seem stuck in the “let’s make the best shooter game we can and give it awesome graphics” mindset.

They better get it soon. Because Fortnite is here to stay.