Analysis

As was mentioned in the introduction, the present business model is problematic. Starbreeze can be compared to a craftsman, who gets paid for his work, but doesn’t get anything beyond that. For the company’s shareholders this is obviously unacceptable – sooner or later they need to see a return on their investment. But the present business model makes it difficult for the company to turn a profit that is anywhere near that which is acceptable in terms of return on equity. The low profit margins are the result of intense competition. Starbreeze must not only compete with other private studios, but also with the large game- and console companies in-house studios. It’s difficult to demand a premium for your work, when others are willing to do the same work for less. In order to be able to motivate a premium, the company must have a strong track record and a clearly demonstrated ability to make better games than the competitors.

The company’s bargaining position is not only weakened by competition, but even by the fact that it must get contracts in order to avoid bankruptcy. When you’re desperate for work, it’s pretty difficult to demand a premium for it. This means two things. First of all, the company will get a very small or even non-existent premium up front, instead being offered a share of the income if the game sells well, in the form of royalty. The level of sales at which the Starbreeze starts to collect royalty is however so high that there is a very great risk of not collecting any royalty at all. For Chronicles of Riddick, Starbreeze was only able to collect a million SEK (roughly a hundred thousand USD), despite good sales figures. It is still uncertain whether The Darkness will bring in any royalties whatsoever. Secondly, Starbreeze lives and dies on its reputation – good games means more companies will want to sign contracts with Starbreeze, which strengthens the company’s bargaining position. However, getting a better contract generally means getting a better royalty clause, not more money up front. So two years work can potentially mean zero profit.

Since Starbreeze is a small studio that only develops one or at most two titles at a time, and since each game takes such a long time to make, the company’s income generally takes the form of a few large payments a year, whenever a new milestone in the contract has been reached. This makes income quite difficult to predict, which is problematic from the point of view of the company’s investors. For this reason, it must be determined if there is some way for company to change its business model so that it gets a more continuous cash flow. There are a few quite small things that the company could do, which could potentially lead to the creation of a few solid cash cows for the company. There are also larger, more fundamental changes that the company could make to its business model. This analysis will begin by discussing the smaller changes, and then move on to the more large scale ones.

First of all, Starbreeze has one asset that many of its competitors lack, in the form of its own game engine. The game engine is valuable not only because of the function it fills within the company, but also because game engines are much sought after by those developers that lack ones of their own. Building your own game engine is time consuming and expensive, so this isn’t an option for many smaller developers. For this reason, most smaller developers license engines from third parties. For example, Valve corporation’s Source engine has been licensed out to a large number of developers. The market for game engines is one that Starbreeze could quite easily enter, since it already has an entirely original and state of the art engine of its own. It has the potential to generate nice profit margins, since the engine already exists and will continue to be developed by Starbreeze for its own in-house games, regardless of whether they license it out to other developers or not. These costs should therefore be considered irrelevant. The only relevant costs associated with licensing it out would therefore be the costs for marketing the engine, legal costs associated with writing licensing agreements and costs for providing technical support to licensees, which is to say, they would be probably relatively low. These costs are entirely variable and could easily be increased or decreased depending on demand, so the risk is also low. And since the relevant costs would be small, profitability could potentially be very high.

Another area which is opening up, thanks to the fact that game consoles are increasingly connected to the internet, is downloadable content, such as mini-games (casual games) and extra material for existing games, such as new levels and “skins”. These can often be put together relatively quickly and at low cost and are then sold straight to consumers via the internet. The price is set after what consumers are willing to pay, and has no real connection to the actual (fixed) development and distribution cost. Therefore, downloadable content has the potential to be a pure cash cow, even after the cuts taken by the service provider (for example Xbox Live or Steam) and license holder. This has the potential to increase both the company’s income and its sources of income, without markedly increasing costs. Small games are cheap to make so risk is limited. If Starbreeze were to start developing small casual games in addition to its larger projects, it could get more continuous cash flow, from new sources, which would decrease its dependence on the large publishers and thereby strengthen its bargaining position even when it comes to big projects. Downloadable content and casual games could also be used as a method to test new staff members and interns before allowing them to work on larger projects. So the risks associated with employment could also potentially be lower.

If Starbreeze wishes to strengthen its bargaining position in relation to the publishers then Starbreeze must become a brand that the consumer is conscious of. The Starbreeze logo should in itself be seen by consumers as a mark of quality. The studios that are consistently able to make good games generally get a very loyal core of customers. These help the studio to spread its message and act as un-paid marketers for the company. As an example, one could mention Black Isle, which was able to turn itself in to a strong brand thanks to games such as Baldur’s Gate, Fallout and Planescape: Torment. Another example is Bethesda Softworks, thanks to its “Elder Scrolls” series of games. Bethesda has a forum on its site where fans can discuss its games and get access to new information about coming titles, which they then proceed to spread widely. This helps to build hype for coming games. The forum also helps to build loyalty to the company, and gives the company access to a group of people who are very interested in its games, and with whom it can discuss various ideas that it has. The company’s existing and coming games are also constantly kept alive in the minds of a group of people who are very active in the gaming community.

A third company which has been able to turn itself in to a strong brand thanks to good games is Bioware, which became widely known thanks to a few role playing games set in the Star Wars universe. Thanks to these, Bioware got a reputation as a good developer of science fiction role playing games. This has allowed Bioware to dump the Star Wars license and instead develop its own IP in the form of Mass Effect, which is similar to Star Wars, but gives Bioware much nicer profit margins, since it doesn’t have to pay any licensing fees to a third party. It has been able to dump Star Wars for the simple reason that Bioware has become such a strong brand in itself. Developing a game in an original setting also increases the value of the company, because of how valuable IP’s can be. As an example of how much IP’s can be worth, it could be mentioned that Paradox Entertainment, with less than ten employees and no physical assets, has a stock market valuation of 20 million dollars (more than 2 million dollars per employee), entirely thanks to the value of Conan the barbarian and the other IP’s that it owns.

What is then the content of all this? Starbreeze needs to work on its brand, and must create a core of loyal customers who can act as ambassadors for the company. A stronger own brand would strengthen the company’s bargaining position and increase the possibilities for launching new game brands. In recent years it has become quite common for successful games to be turned in to movies, so just owning an original IP can be a lucrative business in itself. Some examples of games which have become or are in the process of becoming motion pictures are Final Fantasy, Resident Evil, Doom, Far Cry and Halo.

We will now move on to the more large scale changes to the company’s business model which could be worth considering. The most obvious alternative to the present model is to stop developing games on contract for other companies, and instead finance and develop games on its own. This would potentially lead to much larger profits, since the company would get a much larger share of the income from the game, but would also potentially mean much larger losses, since the company would have to finance everything itself (or rather, with the help of the bank and the share holders). Considering that it currently costs around ten million dollars to make a game, a single flop would likely be enough for the company to be forced in to liquidation. What the company must the consider is whether it is worth the risk. One way to minimize risk might be to license a known IP from another company, as Funcom as done with its upcoming MMO, Conan: Hyborian Adventures. But this would lead to lower profit margins and a missed chance to create an own valuable IP. One game was enough for Fallout, Half-Life and Halo to become well known and very valuable IP’s (although follow-up games have of course added to the strength of all of these brands). For example, Bethesda recently acquired the Fallout license from Interplay for five million dollars, even though it is years since anything was last done with the Fallout brand.

The risk is not small, but a successful launch of its own game, especially one in its own setting, would increase the company’s ability to create value for its owners, and thereby its value, enormously. With the present business model the profit margins are tiny because so many different actors all have to get their slice of the cake. An unsuccessful launch would however likely lead to the company’s destruction. Perhaps this can best be seen as an issue of timing – if the company decides to go its own way too early then it is destroyed, but if it waits too long and goes its own way too late, then it has missed out on a lot of potential value creation.

Another subject which is fundamental to the company’s ability to create value is the employees. The employees are the primary cost factor for the company, and they are also the factor which determines how good the games it makes are. For these reasons it is important to find the right people and also to find the right ways to motivate them to do their very best. One problem for the company is the localization in Uppsala. Although there are plenty of well educated Swedes who would love to work for Starbreeze, most of these lack the experience that the company seeks. And foreigners with the right competence are difficult to attract, since there are also studios in more exciting places like San Francisco and London out to grab them.

One possible solution to this would be for the company to move its offices somewhere more attractive. But in that case Starbreeze should have moved a few years ago, when it only had twenty employees, instead of now, when it has upwards of seventy. The more employees the company has, the more difficult and painful a move will be. The company would also risk losing key people, who have been with Starbreeze from the start and are central to its success.

The difficulty in attracting staff means that Starbreeze must offer very competitive wages and other bonuses, such as a share of the income from its games. This decreases short term profitability, while at the same time being absolutely necessary for long term success. Wage costs can therefore not be pressed or rationalised, and since wages are the single major cost for the company, it is practically impossible to cut overall costs and in this way push up profitability. Therefore it is on the income side that change must happen.

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