Star Wars: The Old Republic – Not Failing Isn’t Always A Guarantee of Success

We’re on the downhill run to Star Wars: The Old Republic’s launch. Soon the hype will be over and the hard part – delivering MMO services to paying customers – begins. I saw a report that stated industry analysts saw SWOR as a “little risk of failure” title. In some ways this is because if you are an industry analyst, this is the safe thing to do. SWOR is Star Wars. SWOR is BioWare. SWOR is EA’s biggest project. Suggesting that this is actually a risky mix wouldn’t win you any industry fans.

But as we go into the pre-launch countdown, I’m still very confident that just because SWOR is a low risk of failing doesn’t mean it has a high chance of success, especially the kind of success EA wants from this title. (Shameless plug to the previous 5 key reasons I saw SWOR as a high risk title).

Why I Disagree With Michael Pachter Specifically

The lead source in the article was Wedbush Morgan analyst Michael Pachter. He gets a lot of press as a financial analyst of the computer games market, but he as his detractors as well. A few statements he makes in the article about SWOR strike me as, well, questionable.

A chart showing upwards profits in front of increasing piles of coins.

This is the aim, but involving a lot more than just pocket change.

The main one sits around his claim that LucasArts can take 35% of the revenue and SWOR can be massively profitable for EA:

“On an ongoing basis, they will split revenue from running the subscription business. My best guess is that they will attract 1.5 million subscribers paying around $15 a month, so they should generate around $270 million in revenue. If LucasArts gets 35 per cent and if EA incurs around 35 per cent operating expense, they make 30 per cent, or around $80 million per year, in profit. That’s not bad.”

I’ll come back to the subscription revenue math in a moment, but here’s the question in my mind: without LucasArts’ royalty payment, would SWOR really be making a 65% profit margin? According to the sources I can find, World of Warcraft (WOW) has a current profit margin of over 40%, maybe as high as 50%.  WOW’s had a long time to build up a huge player base and doesn’t have development debts to pay back. SWOR’s just starting out.

Maybe I’m missing something in the percentages – and I fully believe that LucasArts will be collecting something like 30% of the game revenue in royalties – but to think that from very early on SWOR will be ultra-profitable despite a third of revenue heading out the door sounds pollyanna-ish to me.

There was a very interesting comment there about EA and LucasArts splitting the money:

“The revenue split is around 35 per cent to LucasArts after EA earns back their investment. That means EA keeps most of the revenue from disc sales (they have marketing expenses and need to staff up the server farms), so they should earn a nice profit there.”

If correct, in order for LucasArts to start earning royalties, EA has to earn back SWOR’s development budget. That’s a massive concession from LucasArts.

EA makes a phone call to LucasArts through the miracle of stock images.

"Hey LucasArts, it's EA. Sure, we'd love to pay you some money for using your little Star Wars IP in our game, but only after we get the first US$100m. Sound good? Yeah, yeah. Great - give your wife my regards, heh. Laters."

LucasArts is used to playing the money game in Hollywood, where even Darth Vader doesn’t get his full residuals. Although the analysts in the article applaud EA on its deal-making abilities, LucasArts has been playing longer and harder. So I wonder if the assertion is correct and, if it is, what the sting in the tail is. Perhaps it is that 35% royalty on revenue going on forever.

The actual development budget for SWOR is one that has had a variety of very big numbers associated with it, from US$100m all the way to US$300m. That US$100 actually comes from Pachter again in a separate set of comments, split by US$80m in development and US$20m in marketing (which includes “total manufacturing, marketing and distribution spending”). Although I think that the US$80 in development costs sounds low, what strikes me is that EA spending only US$20m on all SWOR-related marketing activities worldwide sounds REALLY lowball. Pachter thought that EA would spend US$45m – US$50m on marketing Battlefield 3, and SWOR is actually a bigger project (again, their biggest ever) to EA. Valve spent US$10m in 2008 marketing Left 4 Dead in the US alone.

A photo showing clutter in Times Square

Best of luck finding space to book in some SWTOR ads here at Xmas if you haven't planned ahead.

SWOR is launching during the Christmas peak period in North America and selected countries in Europe. This isn’t the cheapest time to be buying ad space and localisation of ads costs extra. It doesn’t look like SWOR is launching with TV ads (although I may be wrong) which would keep the costs down, but US$20m to both get the game into stores and let the market know it is on shelves seems low for such an important (to EA) game. After all, if it costs $1 to get a box copy on shelves and 2m boxes are shipped, that’s 10% off the communications budget right there.

I mentioned the revenue math – let’s look at that. One item that Pachter has repeated a few times is that “EA expensed the development cost when incurred, so much of the disc sales revenue will be profit”, which to me seems sensible if it is something that EA does for all of its titles (which would then make all EA titles profitable by default, since their development cost is separately incurred and paid for) but I’m not sure they do. What makes it a curious arrangement is how that fits with the LucasArts’ arrangement, and if the box sales can simultaneously be profit for EA but still paying back development costs as far as LucasArts is concerned.

Modern accounting is a wonderful magic show.

This Is All Made Up, But Does Follow Some Kind of Logic

Sand dunes in the Moroccan desert of Northern Africa

All these figures are built on shifting sands, since things like fixed costs versus variable costs come into play so SWOR's scale becomes a key factor, or maybe EA amortises certain costs over its entire gaming product line.

Putting aside that issue for a moment, Pachter’s assuming that SWOR sells about 2m units, keeps 1.5m active accounts for year. Assuming a box cost average of $US60 per sale (collector’s editions and discounts post launch muddy the waters) and average subscription per user of $15 (although bulk discounts on sub time probably drop this figure lower) then this is about US$60m in box revenue going back to EA (retail stores take 50% or so) plus US$22.5m per month coming from subs. It’s big money.

(I’m going to ignore EA’s Origin online distribution platform, but it would give EA a much higher revenue margin per copy of SWOR sold.)

Regarding operating costs, Pachter says that “[m]ost MMOs require around 250,000 subscribers to cover the direct operating expense of the server farms” – wonder if anyone has told the MMOGs with less than 250k players that? – which pegs that expense at US$3.75m per month. This doesn’t include customer service costs (Pachter doesn’t include them, but it’s a few dollars per active subscription – let’s say $3 per account on average) and that about $1 in every sub gets eaten up dealing with credit card issues and fraud costs.

Add all that together (US$3.75m plus 1.5m x $3 plus 1.5m x $1) and you get US$9.75m per month in expenses (or operating expenses at 43% of revenue, which may still be underestimating it). So that’s US$22.5m take US$9.75m and you get US$12.75m in revenue. Nice.

Except LucasArts comes along and pockets US$7.88m as it takes 35% of revenue (!not profit!). So EA’s monthly profit is US$4.88m on subscriptions, or around $58.5m per year, plus box sales. I don’t think anyone would turn down that kind of money, but it’s a calculation that doesn’t include ongoing development costs and is based on a heap of hypotheticals, crucially that SWOR keeps 1.5m players for 12 months.

That’s a massive assumption.

Disagreeing With The Analysts More Generally

There seems to be the assumption that SWOR is too big to fail. It’s EA! BIOWARE! STAR WARS! It’s easy to take comfort in that warm embrace of big companies, known IPs and nerd love.

But history tells another story. Since 2005 there have been very few subscription-based MMOs that have launched and then grown or even maintained their active player base size from the launch period. World of Warcraft grew and grew. EvE Online flopped on launch, but managed to hold on and then grow. Lord of the Rings Online allegedly did okay, but not enough to stop it making the (risky at the time) move to F2P.

The Sedan Plowshare Crater

MMO Launches Since 2005: A Pictorial Representation

In the other corner, there are a number of MMO titles who launched and immediately nose-dived. Warhammer Online: Age of Reckoning. Age of Conan. Fallen Earth. APB. DC Universe Online. Champions Online. Final Fantasy XIV. It’s a notable list. It isn’t difficult for a MMO to launch and sell over a million boxes but end up shedding 50% to 60% of those players three months later..

Yes, each of those titles had its own issues, but my point is that it is actually very hard for a MMO to hold onto players under a subscription model. And this must be doubly a concern for SWOR given that at 1.5m it would race into second place by size within the Western MMO market, but that’s the expectation it has in order to be a success.

I fully expect SWOR to sell over 2m boxes (including Origin sales). But unlike single player games, MMOs aren’t sprints in revenue terms – they are marathons. If SWOR sells over 2m boxes, but sees the player base shrink by 50% by the end of Q1 2012… well, ouch. Player retention is the key. Can SWOR retain its players at launch levels for the first 12 months? I’m not convinced it can.

Given that EA has indicated that SWOR will be profitable at 500k active subscribers, there probably has been some planning for that eventuality. But I’m pretty sure that scenario involves a lot of pink slips and delays in content production.

Betting Against the House

In a lot of ways, regardless of how SWOR performs, it is a huge risk for the entire MMO industry today.

Rober DeNiro in "Casino"

The house always wins. Except in SWOR's case, the house may be Facebook gaming.

If SWOR is successful, it will show that subscription-based MMOs are viable, but only if you have more money to spend than anyone else. Such an event might kick-off or revitalise some small, quirky MMOs, but a lot of people will take away the knowledge that for the recipe for modern MMO success is EA’s moneybags + BioWare’s reputation + Star Wars, which they don’t have. As such, the MMO market will generally be left to those with very deep pockets.

If SWOR isn’t successful, the risk is that all those investors (including corporate masters behind MMO companies) considering MMO projects will lose all interest and put money into the much-hotter-right-now social / casual games market. After all, if EA + BioWare + Star Wars can’t pull of a success, how can they? This sees capital dry up for the quirkier, less mainstream MMOs who may struggle to survive unless their funding is locked in. Also, if SWOR doesn’t hit its targets I can’t see EA get too eager to invest in another MMO title.

So 2012 is going to be an interesting time within the MMOsphere either way thanks to SWOR. Place your bets, ladies and gentlemen, place your bets…

5 thoughts on “Star Wars: The Old Republic – Not Failing Isn’t Always A Guarantee of Success

  1. Very good analysis. One thing though, can we really trust Pachter’s information about EA’s contract with Lucas Arts? Surely that’s a confidential document.

    At worst SWTOR may deliver an extended Tortage experience. People who played Age of Conan when it came out almost unanimously agreed that the first 20 levels, Tortage, was the best thing they’d experienced in a MMO but the game fell flat after that. SWTOR is going to be very exciting to people to level in with its iconic IP and voice-acted story but how fun will it be once we’ve seen the story? If it’s not fun, a rather cliched WoW-stype raid end game with excessive item rewards it won’t have tenacity.

    Another problem for the game is that expansions are likely to be very expensive to make. If sub numbers plummet they won’t have the revenue to develop fresh content in the style to which we will have become accustomed.

    • I did think about how reliable Pachter’s viewpoint was, but rather than just write it off, or speculate about why he was so pro-SWOR, it seemed fairer to go through and look at issues point-by-point.

      What strikes me in the reviews I’ve seen is that no-one really seems excited by SWOR’s mechanics. That’s important, because how fun the mechanics are is what will keep players subscribing in between content updates and playing different classes. If a player feels the grind at the end of one class story, they aren’t going to want to go through the same thing from scratch with another class.

      • I got in yesterday and am playing the Imperial agent. It uses the Cover mechanic.

        It’s pretty fun and there’s a certain thrill to targeting your enemy and seeing a glowy green action pose of your character kneeling behind a crate shooting it, then tapping F and rolling to that position.

        I think the issue isn’t that the mechanics are bad. It’s that they’re the same (apart from this Cover gimmick) as almost all the other MMOs. This game won’t succeed because of its mechanics but I don’t think it will fail because of them either. No one’s talking about them because there’s nothing to say. They work, they’re not original, other aspects of the game stand out more.

      • Obviously a lot of genres use the same mechanics in-game, but for MMOs I believe this can lead to the feelings of much quicker burnout. SWOR is trying to have more story narrative to keep players engaged, but given that content is level gated, it means that the mechanics are still front and centre as you go through.

        For a MMO to have short-term success, it has to be fun at lvl 1. For a MMO to have long-term success it has to be engaging at max-lvl, which for SWOR means after the story has been completed. That’s the area I’m not so confident that SWOR will be able to stand up in.

  2. Pingback: Reading the MMO Tea Leaves for 2012 | Vicarious Existence

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