The following was an application of a framework (“8 sources of competitive advantage”) I learnt from my favorite class in business school. I wrote this as a personal exercise one month after I joined Riot Games, back in August 2011. It was intended as a quick review of Riot’s company strategy.
Reading it today, I definitely get a “I was wet behind the ears back then” vibe; but the framework itself I regard as a classic, and intend to reference in an upcoming post – hence posting this.
Executive Summary
Riot’s current strategy can be summarized as:
- Free to play, gaming-as-a-service business model
aligns product development with revenue generation
- Traditional competitors such as EA are not well-aligned on this, and shrink-wrapped software sales model is outdated
- Direct distribution to own the customer and capture value
- Constantly pushing for bigger market presence
and economies of scale
- Tencent relationship helps greatly in this regard, as China is one of the biggest online gaming markets
- Vertical integration – we develop the game as well as the online platform
Major challenges I see:
- The free-to-play model can be replicated. Many competitors are already catching on
- There is nothing inherently unique about what we are doing (the other bullet points above). Valve has built Steam into a major distribution platform in North America; many companies have bigger market presence / scale. It seems we have been successful so far simply because we were the first to try the free-to-play biz model on a hardcore game, and we leveraged an existing community-created game franchise (the DotA map on Warcraft3)
Sources of Competitive Advantage In-depth
Brand
I recently read The Curse of the Mogul, and I tend to agree with the author that in the media industry context, brand is usually overhyped especially when the products are “discrete” titles (hit-driven business). To the extent that Riot can build successful game franchises (such as Call of Duty or Warcraft), brand can have an effect on initial traction with consumers; overall however it is hard to see consumers developing loyalty to the company as opposed to the specific game. And relative to some of the major incumbents, especially Blizzard and Valve, Riot definitely does not enjoy an advantage in brand.
That being said, Riot has gone out of its way to accommodate players and listen to the community. We take pride in our community our interaction, and believe we show a human face which makes our brand distinctive. I’m not sure how this will change as we continue to grow – it is easy for a company of 20 people to be very personal with its customers, but hard for a 500 person company.
IP
One type of IP that has value, which I’ve already mentioned above, is the creation of successful content franchises such as Call of Duty. Such content enjoys copyright protection and has demonstrated to have value in terms of driving consumer purchases. The most successful franchises such as Super Mario Brothers have enduring economic value and can generate decades of cash flow.
Another type of IP that has economic value is proprietary technology, such as a 3d engine. Some studios such as Valve generate revenue by licensing their engines. To my knowledge Riot has primarily focused on leveraging off-the-shelf technology (with some proprietary development on top of open-source software), so I don’t think the company has any advantage in this regard. And in a broader sense there seems to be enough choices for developers (I need to research this further), so it is unlikely any company can develop a significant competitive advantage by owning such IP.
Another form of IP may be creative talent – i.e. the ability to come up with ideas for games that have commercial appeal. However human assets can be bought, so I don’t think this can be a competitive advantage for any one company over an extended period of time.
Market presence / distribution
In The Curse of the Mogul the author argued that EA came to prominence by building up a superior distribution channel. However, with the advent of online distribution, the barriers to entry in distribution have been significantly lowered for all players. Riot Games itself has now completely bypassed the traditional physical distribution channels (although the product was at one time available as shrink-wrapped software at GameStop).
Overall, there is still competitive advantage to be gained through controlling a strong distribution, usually in the form of an online service with a large user base. Valve has demonstrated the value of its Steam service, and has repositioned the company’s entire business model (from originally a developer to now a distributor). However barriers to entry are continuously eroding with cloud services providers (e.g. Amazon) making it easier and easier to launch web services. Riot’s own success proves that it does not take too much time / resources to build up a highly demanded, directly distributed service.
Economies of scale
Economies of scale do play an important role in web services. Google enjoys a major cost advantage due to the large scale of its infrastructure. In online game services, Blizzard gains both engineering experience (IP) and a cost advantage due to the scale of World of Warcraft. However, the rise of web services providers like Amazon may again be reducing the relative economies of scale of any particular vendor, again reducing barriers to entry in this regard.
In the high performance gaming sector that Riot competes in, companies still need to own and build out their own server infrastructure, often with a lot of proprietary technology developed. This means that this will continue to be an area where a company can gain some competitive advantage.
Economies of scope
Economies of scope exists both across different sub-markets of gaming (the different platforms – console, PC, handheld, mobile) and at a macro level across related markets (movie tie-ins, merchandising, e-sports related revenues if any, etc.) For the first kind, it is common to see a title released for both PC and console, so there seems to be a lot of overlap in the underlying development assets; while economies of scope from developing for both mobile / handheld and a bigger screen (PC / console) seems to be very limited because of the dramatic difference in technical capabilities and playing experience.
For the second kind, it seems that few video-game companies have created a lasting model to extend its games to other product categories such as movies and merchandising. LucasArts comes to mind as probably the only company with clear gaming and film content synergy, and that also originated in film first.
Network effects
Network effects are a major and well-documented source of competitive advantage for players in the video-game industry. Console platform owners profit from the two-sided market of developers and consumers. For each game, the developer also tries to create same-side network effects – more players playing means even more players wanting to play.
With the arrival of the social web and the rise of digital distribution, developers increasingly have the potential to become platforms themselves, in a couple of different ways: the first as exemplified by Valve’s Steam service, is a new digital distribution platform; the second as exemplified by Zynga, is an advertising medium for advertisers thanks to Zynga’s massive (and well profiled) user-base.
As everyone recognizes the value of network effects, we can foresee fierce competition to build up and own it. One main strategic challenge for Zynga and many other social gaming companies is exactly over this – whether they own their network effects, or does Facebook retain ultimate power over the consumers. And for the distribution platforms, we can also foresee a fragmented landscape, if not only because of the underlying hardware fragmentation (consoles, PCs, mobile etc.) and the respective hardware platform owners’ stakes.
In the case of Riot, we try to have strong ownership over our players. One of our strengths is our community management. But I can foresee a major challenge in future when the industry moves away from the PC platform to newer platforms that have major platform owners (e.g. Apple with tablets). Then we will face similar challenges as Zynga does with Facebook over ownership of the underlying network.
Access to capital
In the console space, access to capital could pose some barriers to entry, thanks to the platform owners’ platform rules. At the other end of the spectrum, the rapidly growing mobile gaming market has almost not barriers to entry from a capital perspective. PC is somewhat in between – hobbyists can develop and distribute games via the Internet very easily, but they are competing with big budget titles from the likes of Blizzard, and a lot of games are still sold via physical retail.
Regulation
The industry is lightly regulated in general. There is a self-regulating ratings bureau (ESRB) that imposes some limitations on content, and platform owners may impose their own regulations (e.g. Nintendo’s long-term stance on games being “family-friendly”).
In certain regional markets, the situation is more hairy. In China and Korea game content needs to pass government approval, and is prime ground for corporate sabotage (blocking out a competitor via the government). Riot’s connection with Tencent helps greatly in this regard, but it only applies to the China market.