# A loook at the subscription revenue model

Steel yourselves: This post is a little long.

Much has been made of the riskiness of Zenimax Online’s decision [4] to have a subscription-based revenue model for Elder Scrolls Online, whose release is expected early next year. Naysayers point out that almost every company to publish a subscription-based MMO in the past few years has converted to F2P within a year or two (or less). The poor or sub-par initial performance of games like SWTOR, The Secret World, and Lord of the Rings Online, and other subscription MMOs is still fresh in our minds, as is their subsequent success upon conversion to F2P or freemium. Despite the shadows cast by these case-studies, I believe that subscriptions can be a robust – even first-best – revenue model, under certain conditions. At the very least, some critiques leveled at subscriptions rest on shaky economic reasoning. My goal in this post is to respond to three criticisms that I have seen forwarded against game subscriptions, in general. Many of these criticisms can be found in posts and articles in Gamasutra in the past year. [1][2][3]

These criticisms are as follows:

1.  Subscriptions incentivize players to rush through content as quickly as possible so that they will not have to pay again next month. [1][3]
2. As a consequence of 1), keeping players engaged requires a steady release of content, which is expensive to produce, and again gobbled up in just a month’s time. [1][3]
3. Subscriptions prevent game companies from being able to price discriminate – that is, everyone pays the same price for access, rather than being charged for how much they value that access. [2]

These are not all the criticisms I’ve read, but they are of a class that draw conclusions about the demand side of subscriptions that I think are suspect.

What’s a subscription?

Just to make sure we’re all on the same page, ESO’s planned revenue model – as far as we know so far – is as follows: The customer pays in advance for unlimited access to the game for a fixed number of months. Typically, the charge is $15 per month, with quantity discounts offered if the customer pays for three, six, or twelve months in advance. For example, a customer paying for three months in advance would only pay$14 per month ($42 total, a 7% discount), if she paid for six months in advance then it would cost her$13 per month ($144 total, a 13% discount), and so on. Do subscriptions encourage players to rush through content? The answer is that some – but not all – game players will rush through content in a subscription game. The reason is that a large number of players have neither the time nor the flexible schedule necessary to effectively rush through that content. A subscription game’s average audience is in its early- and mid-30s, and on average, that same demographic is married (or co-habiting), working full-time, and has kids.[5] In other words, it is a group without a lot of free time, and which is minimally able to re-allocate a significant number of hours from other commitments in order to play games. So it is more correct to say that subscriptions incentivize certain segments of the player population – the segments with flexible schedules and lots of free time – to rush through content. Still, those certain segments are important for revenues. Aren’t they going to depart quickly? And isn’t that a reason that subscriptions are a poor revenue model? This brings me to the second question: Do subscriptions require a steady infusion of expensive content to keep players engaged? I’ll address this in two parts. First, the question should not be “Was this content expensive to produce;” rather, it should be “Did this content generate enough revenues to make it profitable?” For a subscription service, the profits are obtained from the number of subscriptions to the service relative to the cost of providing content to get players to subscribe. In other words, it doesn’t matter whether or not it was expensive to produce the content. It only matters whether the number of subscribers justifies the production costs. If the content is poor quality, or not much is provided, then not enough players will pay for enough subscription time to cover it. So providing bad content, or not enough of it, is expensive, indeed! But providing good content in high enough quality will generally be a profitable venture. Second, we need to ask who, exactly, needs newer content in order to stay engaged. Here it’s important to have a clear idea of how players decide whether or not to pay for an extra month of access. So let’s digress for a moment: Digression: How much did that subscription really cost? You might think that you’ve paid$15 for your month of access to your favorite MMO. And you have. But more importantly, you’ve paid $15 for the time you expect to play that month. That means if you plan to play 30 hours in a month, you’ve paid$0.50 per hour of play time. More generally, if you pay for M months of unlimited access at a price of PM, and during that time you expect to play H hours, then your expected cost per hour of play is given by:

$c=\frac{P_MM}{H}$

That means that no matter what kind of content you’re experiencing – new, old, high quality, or low quality – you’re paying c to spend an hour playing the game. Players will play a game until the value of an additional hour of play (call it v) falls below c. Then they will quit.

The number of months of subscription the player pays for will then reflect the number of months where v ≥ c, given the constraint on the number of hours a player can play in a month, as well as the price of a month of play.

Returning to the Question

If you come and go from a game based on whether there is new, expensive content to complete, then you play the game for a lot less time than people who are happy to return to daily questing and mat farming once they’ve completed the latest raid. That means you’re paying a higher c than the other cohort. And if you’re paying more per hour, then a developer is justified in providing you with expensive, higher-quality content. In other words, players who demand the more expensive content the most are compensating developers for it.

Moreover, we can infer that people who pay higher values of c are, on average, willing to pay more for their play time. The converse is also true: people who pay a lower c have a lower willingness to pay for their play time. So the question is, who’s leaving this game once the expensive content is consumed? I’d argue that it’s the people that don’t have a lot of flexibility in their schedule. Their time is worth more, which means lower quality and older content is relatively less valuable to them compared to the more flexible cohort. In other words, the segment that is rushing through the new, expensive content is more likely to stay once that content is finished.

To summarize what I’ve said so far: People who can’t rush through content are forced to subscribe for more months in order to experience that content. However, those same people usually have a higher opportunity cost for their playtime. Thus content quality matters for this group. As content quality falls over playtime, players with a high opportunity cost of time will start to exit. The overall effect on subscription months is ambiguous, but high-quality content is an effective way to keep these players.

Conversely, players who can rush through content will subscribe for fewer months. However, this effect is mitigated by their comparatively lower opportunity cost of time, making lower quality content relatively more attractive. Again, the overall effect is ambiguous, but quantity of content matters relatively more for keeping these players (compared to quality).

So yes: Subscription games need more content, but not because people rush through the game. Rather, they need it to keep players who can’t rush through the game.

Do subscriptions prevent developers from price discriminating?

Let’s first just be clear what price discrimination means. Price discrimination is the practice of charging customers different prices for the same, or very nearly the same, product. If a firm is price discriminating, it means it is capturing additional value from its consumers and converting that into revenues. The video game industry price discriminates all the time by, for example, selling standard and “deluxe” editions of games and consoles. Players that have higher valuations of what is essentially the same product can be induced to pay more for it. Price discrimination is quite frequent in the F2P market, especially in single-player games where players are unable to verify whether they are paying the same price as everyone else for a particular virtual good. F2P games also discriminate between more and less devoted players.

What about unlimited access subscriptions? Are they price discriminatory? 100% yes, and extraordinarily so! The reason goes back to the concept of cost per hour, above. Remember that while a player might pay $15 for a month of access, the actual cost per hour, c, depends on how many hours she actually plays. Thus a player who plays one hour in a month is paying$15 for that hour, while a player who plays 50 hours is paying just $0.30 for that same hour. The company has captured the higher value that the first player places on her play time. A non-discriminatory alternative to unlimited access is the pay per hour scheme that was common for MUDs back in the early 1990s, when they were hosted on services like Sierra Online. In those games, you paid as much as you valued your time in the game, and no more. The switch to unlimited access subscriptions, beginning with Ultima Online and Meridian 59 has been misconstrued as a failure to capture consumer value. In fact, it is an excellent way to capture that value. If the game was pay-per-hour, and the price per hour was$1, then we just gave up $14 from the player who was willing to pay$15 for that same hour.

Discussion

The ability to price discriminate depends on many things, but in the game market the single most important determinant is market power. Games that dominate a particular market (such as WoW’s domination of AAA MMOs) are able to capture more value from consumers precisely because consumers face very high switching costs. Moving to SW:TOR from WoW, for example, requires dropping a social network, buying a new game, learning a new combat system and lore, and so on. By contrast, it is comparatively easy to leave SW:TOR (or another MMO) for WoW because the switching costs of doing so are low in a world where the WoW-style is foundational, and especially if you already have a social network in WoW.

The failure of other recent subscription MMOs has been misattributed to their revenue structure, while ignoring at least three factors: game quality relative to the dominant competitor (Blizzard’s WoW), the high switching costs for players to move away from the dominant competitor into the new competitor’s game (due to social network effects), and the fact that the dominant competitor is successful, in part, because its dominance gives it the ability to price discriminate. It is therefore able to capitalize on players differentiated valuations of the game in a way that upstarts could not.

I’ve tried to address and inject some subtlety into the argument over subscriptions. By no means am I claiming that subscriptions guarantee success, nor that all games can be best monetized through subscriptions, nor that subscriptions should not be mixed with other revenue enhancers. However, the choice of subscription as a revenue model over another can be justified by the market structure that a company is competing in. In particular, with WoW now on the wane, there may be an exceptional opportunity for ESO to take WoW’s place – and appropriate its advantageous position in the market – by  providing a high-quality game backed by a venerable IP.

References