Sunday, December 17, 2006

(Warning: this post doesn't have a point; it's just me thinking aloud.)

Most products have some fixed costs and some marginal costs of production. The fixed cost would be the factory; the marginal cost would be the labor, materials, transportation, packaging, marketing, etc. The price of the product usually starts out high, and competition brings it down over time to be close to the marginal cost (at least according to economic theory).

Creative products like music, novels, and movies typically have high fixed costs and low marginal costs. As technology has improved, the marginal cost of music, novels, and movies has gone down close to zero, and we now have a great deal of piracy. Software is similar to music, novels, and music, except that the marginal cost has been close to zero for a very long time, and the software industry has had to deal with the problem of piracy for longer. Economic theory suggests with good competition, the price of these products should eventually go down close to the marginal cost. For all of these products, the sellers have tied the product you really want (for example, a song) to something physical (a CD), and the physical object has a non-zero marginal cost. However, with electronic distribution, people want the music without paying for the CD, the movie without a DVD, a novel without a book, and software without the installation CDs and manuals. The marginal cost of distribution is close to zero, so in theory, the price should eventually get to zero.

The open source community sometimes argues that the price of software should be zero (to match the marginal cost), and that developers can earn money selling services and support. There's a major problem with this: the incentives are completely messed up. If a developer makes more money when more support is needed, there's an incentive to make the product require more support. Products will end up harder to use and contain less documentation. There's also no strong incentive to offer new features for free, because you're not getting paid for new versions of the software.

With MMORPGs we're seeing a lot of experimentation with software pricing. This is possible because the software is virtually useless without connecting to the service. World of Warcraft charges for the software plus for the service. They crack down on people who want to offer their own service (alternate free servers) because they make most of their money from the service they offer, and don't want competition. World of Warcraft also charges for expansions (which are rare). With Guild Wars the software is free (you can download it from their site for free), but access to different services (areas of the world) costs a fixed fee. Those services do not carry a monthly fee. With ArchLord the software costs money but there's no monthly fee. Second Life (which isn't technically a game) makes money both by renting areas of the virtual world and by selling virtual currency, which you can use to buy in-game goods and services. Games can also make money by selling in-game items, upgrades, status, etc. MMORPGs can tie the game to the service, and then charge for the service. However they are not making their software open source, because they do not want competitors to create compatible services.

Most games however do not have the option of charging for services, and it is difficult to charge for support in a consumer-level product (consumers get angry and feel that they deserve free support). So game developers are stuck with piracy, just like makers of music and movies. We want to recover the high fixed cost of developing the product, so we charge for the software, even though the marginal cost is close to zero. Consumers are more willing to buy software that comes in a physical package, so we include a box, installation CD, a manual, etc., all of which reduces sales and profits. Alas.

There is one more thing we might want to explore. Music, games, movies, etc., are all emotional experiences, and they're worth more to people when the emotions are greater. One way this works with music is to use concerts, association with movies or TV shows, branded products associated with the band, and other sorts of tie-ins. With movies, the same movie is worth more when people go watch it together at the theatre than when they watch it alone years later on network TV. A novel is more valuable when your reading club is reading it right now and you want to participate in their discussions. These products are more valuable at certain times than at others. Watching a TV show the night it airs is more valuable because I can talk to my friends about it; watching it later (with TiVo) is less valuable. What can we do with games? I think the fan sites are a big help. Frequent updates and developer involvement in forums can help too. The Movies let users upload their creations (not their games) to the site. The Sims lets you download objects created by others. Even in a single player game, you can offer something that lets people connect to each other. When they're sharing an experience, it will have more emotional value. And that is something that could reduce piracy—you're not just buying a game; you're buying access to a community.

I think piracy will always be with us, but I think the open source model is unlikely to work for games. Charging for support gives a perverse incentives to developers to make things work badly or confusingly. Charging for service might work for some types of games, and the MMORPG developers seem to be exploring the options. I think the way to approach the problem is what many game developers already do partially without realizing it: offer multiple experiences at different prices. Offer a free demo that has a substantial part of the game and no support; this matches the marginal cost of the software alone. Offer the full version without annoying copy protection (why do so many developers make their paying customers get a worse game than the pirates get??). Make a ”special edition” that appeals to the least price sensitive and most rabid fans. Offer special products (t-shirts, trinkets, etc.) that tie in to the game. Make a community site that people actually like (so that they don't go to other sites for the information they want), and make all or some of it open only to people who bought the game. Make sure the developers are involved with the community site. Change the model from selling software to selling enjoyment. Look at other businesses that do this (amusement parks, movie theatres); they sell the basic product at a lower cost and then sell extras (such as food and drinks) for a much higher price than the marginal cost of those extras. Price-sensitive customers get annoyed by this, but it works for the business because they're not just paying for a drink; they're paying extra for the enjoyment of the drink in that location.

We need to consider the entire experience of playing a game, not only the software, as a potential source of revenue, and then figure out how to best recover the high fixed costs of making the game, and also allow for a low marginal price so that we can get a large audience. We need to consider that games don't need to be played in isolation; people talking about a game with their friends or even with strangers can add to the experience. We need to consider that different people are willing to pay different amounts for the experience. It's the entire experience we're selling, not just a box with software.

1 comment:

CH_Wired_ wrote at December 30, 2006 5:20 PM

interesting thoughts