So it’s like Netflix for games?

I recently listened to an old episode of the Decoder with Nilay Patel podcast featuring EVP of Gaming at Microsoft, Phil Spencer. Beyond discussing the Xbox Series X (and its predictable inventory shortages), Xbox Game Pass was also discussed at length. For those unfamiliar, Xbox Game Pass is Microsoft's Game as a Service platform or, in other words, "Netflix for Games". Although Phil hates that moniker for fear that his service seems derivative to a larger player, it really is the best analogue for communicating its value proposition.

Much like the avalanche of TV/Movie streaming services between Netflix, HBO Max, Peacock, Prime Video etc. so too does the games industry face this avalanche of on-demand, internet enabled content platforms. Xbox Game Pass is one (and the largest) but others like Ubisoft+ and Playstation Now are fighting just as righteously for precious gamer mind share.

Another contender is Electronic Arts, whose EA Play services boasts over 80 games such as Need for Speed, FIFA, and Anthem and has been in the space since 2014. However, what makes EA Play unique is that as of November 2020 the entire EA Play library can be accessed if you have an Xbox Game Pass subscription. That is to say if you subscribe to Xbox Game Pass you are entitled to the entire EA Play library of games at no extra charge.

This bundling of two GaaS services in one is not inconsequential and it's worth exploring what a deal like this could mean for Game as a Service (GaaS) going forward. With that, let's start by defining EA Play and Xbox Game Pass

More on EA Play as part of Xbox Game Pass

What is EA Play?

EA Play is a subscription service that grants you access to the following benefits:

• Access to ~80 EA games (depending on platform) to be played so long as your keep your membership active (see prices below)

• Access to first 10 hours of upcoming games or recently launched games. Progress from the 10 hours will carry over should you purchase the game.

• 10% off EA titles that aren't in the EA Play library (i.e. new games) and digital add-ons (i.e. FIFA Ultimate Team points)

It's clearly a compelling value proposition, as the total cost of the library could easily be $3,200+ USD (avg cost of $40 USD x ~80 games). Why then would EA offer a service so rich in value when they could simply charge discounted prices and still retain some revenue? I see 4 reasons.

EA Play Business Case

1️⃣Monetizes the Back Catalogue

• How many copies of FIFA 17 were sold in 2021? When FIFA 22 comes out later this year, how many copies of FIFA 21 will sell in 2023? The answer is not many. The inherently annual nature of EA's sports franchises' release calendar creates product obsolescence every 12 months. They won't generate much profit in retail space, even at discount so why not throw them into the EA Play catalogue?

• They also pad out the library to allow EA marketing to make more favorable claims in-market

  • I.e. "EA Play has over 100 games! (but 20% are old sports titles that won't see much play anyway)"

2️⃣Improves Pre-order Yield

• Pre-orders, love them or hate them, exist for a clear reason. To provide upper management clear forecasts of game sales ahead of launch. Those forecasts affect all sorts of things, from quarterly 10-Q documents for shareholders, to staffing decisions for post launch game support, to marketing budgets and everything in-between.

• That being said, pre-orders have a nasty air to them, trying to sell a product to a person who has no idea what the quality of the product is dubious in any business. People want to know what they're buying, and understandably wait on reviews from publications or friends before forking over their money.

• By providing rich 10 hour "demo's" of new games, it gives players more than enough time to understand what they would be signing up with the full game and creates a sunk cost effect where choosing not to buy a game after making 10 hours of progress becomes more difficult.

• It ultimately accomplishes the purpose of the pre-order, establishes expectations of a games success at launch, without asking people for their $60 USD up front with nothing than a spiffy CG trailer and hollow pre-order bonus.

3️⃣Reduced Demo Costs

• The last thing a team wants to do in the height of crunch season approaching launch is create a demo build for the marketing team to circulate. Like anything, those builds take time, money, and effort.

• The genius of the 10 hour demo is that it's not a unique demo build - the build being played is in fact the final game copy just with a 10 hour timer on it. It's likely easier to code a timer parameter on the game than craft an entire vertical slice for the player to play through.

• It also allows marketing to frame this as "get the full game, not some crappy demo" - genius.

4️⃣Game Subscription Trends

• Monthly subscriptions is the name of the game these days. Slow, predictable, recurring revenue has been such a proven business model these past 10 years, it's no wonder the game's industry looking to it.

• Consumer expectations have been shaped by the Netflix's and Spotify's of the world and some are starting to see their gaming experiences in the same light.

• It's unlikely that GaaS will earn the lion share EA's profit, their live services is still king (see below FY21 Q3 fiscal report) but a company as big as EA needs to have some skin in the GaaS game to meet their customers where they are.

What is Xbox Game Pass?

Xbox Game Pass isn't that much different from EA Play. Monthly subscription cost for a library of games (plus a hew extra bells and whistles).

Once again the subscriber is getting tremendous value for an approachable price. Sure there is a strong and growing library of games that subscribers get access to, like EA Play, but unlike EA Play's 10 hour "demo" feature, Xbox offers "Xbox Game Studio Titles the same day as release". Not to mention this service includes Xbox Live Gold which unlocks the ability for players to play multiplayer games online.

📊Xbox Game Pass Business Case

All this value creates a simple question - how on earth is this service profitable?

📈Revenue Assumptions

• As of January 2020, Xbox Game Pass boasts 18M subs - Source

• Assuming the average Monthly Recurring price across the 3 price tiers is $13 USD, with subscribers spread across the $12 and $17 price tiers.

• This leads to a monthly recurring top line revenue of $100-230M - without any costs factored into things.

📉Cost Assumptions

It's impossible to model the actual profit of the service without knowing the details of the following cost items:

• Operating expenditures needed to support the service:

  • General upkeep costs of servers

  • Marketing expenses

  • Product/Service optimizations

• Licensing Fees - Each new game added to the library is added on one of two basis

  1. Pay the developer a fixed sum for the rights to their game - a cash payout for the rights to the game to be played on Xbox Game Pass

• Pay the developer a variable rate depending on the usage of their game on the platform

• Day 1 Launches on Game Pass

  • Players using a 12$ USD/month service to play a game they otherwise would have bought at $60 USD leaves an immense amount of per product margin on the table

• Mergers & Acquisitions

• Large acquisitions such as the $7.5Bn deal to acquire Bethesda. whose back catalogue will will be brought into Xbox Game Pass

• Microsoft buys Fallout creator Bethesda for $7.5bn

• Since the acquisition has been approved by regulators on Mar 8 2021, Xbox wasted no time and added 20 Bethesda games to Xbox Game Pass. Link to full list

EA Play Inside Xbox Game Pass

Now that we've established the value proposition and business case for each service - why is this deal relevant? It's impossible to know the details of the EA Play + Xbox Game Pass Deal but regardless of the structure it still has meaningful implications.

Below are some potential deal structures and their implications. The deal may in fact pull elements from multiple deal structures in a hybrid model.

⚖️Revenue Share Agreement

For every new customer that signs up for Xbox Pass Ultimate, EA is entitled to X% of the monthly recurring revenue.

⌛Usage Based Royalty

Xbox pays EA an amount proportional to the amount the EA Play titles are played. i.e more people playing EA titles through Game pass means a richer royalty for EA.

💵Lump Sum Payment

Xbox paid EA for the rights to the EA play library in a lump sum and will pay additional sums as titles are added to the EA Play Library.

💲Is Xbox Game Pass Profitable?

A common thread I've belabored throughout this piece is the profitability of Xbox Game Pass, not how much revenue it generates, but how much margin Xbox gets to keep after all of its major cost items are accounted for including the new addition of EA Play into their product scope.

A publicly traded company at the end of the day needs to show that Xbox Game Pass generates a profit eventually - that the $7.5Bn Bethesda Acquisition and 100+ games were worth it in the end in delivering shareholder value...right?

At this time, Wall Street is reacting to hockey-stick monthly active user growth charts, not financial statements, as they should for such a new and disruptive business model. Like any growth stage product, it's all about subscriber count, growth, and Lifetime Value (LTV) of subscribers.

All of these have a firmly causal relationship to the content offered in the price point being asked of consumers. It's about the average revenue per user, not average margin per user - but for how long?

• Will Xbox Game Pass suffer the same fate as Netflix? Sheepishly raising it's price to cover it's burgeoning cost base?

• Will certain studio agreements need to ripped up because of how expensive they are for Microsoft?

• Will competing GaaS services battle for the rights to games like what's happening in the TV/Movie world?

All questions for Phil and the gang to sort out in the coming years...

🔑Key Takeaways

• Large video game companies are trying to compete with Games as a Service (GaaS) models - i.e. Netflix for games. Monthly subscription for access to a games library.

• Electronic Arts bundled their service EA Play, into Xbox's Xbox Game Pass in November 2020.

• In EA's case, EA Play's business case relies on things like monetizing their back catalogue of games to providing better forecasting abilities for upcoming games

• Both of these services offer incredible value but at the risk of very thin per user profitability given how many costs are associated with supporting the content library.

• The way the deal was structured greatly affects who ends up winning long term.

• Despite the profitability concerns, analysts and gamers are happy with the direction this is taking the games industry as a whole.