My last blog I had a throw-away comment indicating that the publisher complaint of used games being equivalent to a lost sale is fictitious. My first commenter questioned that assertion.Jblaq said:
I love reading your blogs. There's always a bunch of data/facts to backup your opinions. That is why I'm curious about this, "For publishers afraid of lost sales revenue due to used game sales, which is a fiction, by the way..."
I don't have facts either way, but if Gamestop sells the same game 3+ times and they only paid the publisher once, wouldn't that be lost revenue?
First of all, thanks for the kind words. I enjoy writing these, but it is always better when people enjoy reading
them. I want to make sure I have high-quality stuff so thanks for calling me out on a point where I did not give enough background. In my defense, it was a long post already, but this is a worthy topic. Today, then, as I have more space, let us dig in deeper to the economics. Are the publishers complaining about GameStop right? If not, time for me to show my work.
To start I am going to build from the ground up and spend some time covering some economic theory.
Supply and Demand Curve
There are a few things to note about a supply/demand curve. The simplest concept is that where supply and demand intersect is the transactional price. The price moves if the curves move. The second thing to note is that the curves are, in fact, curved, despite my image above being simplified into straight lines. Demand is never a straight line, and supply rarely is either. In order to talk about this it will help to have a real world example.
Today I am founding a company: Electronic Widgets. Widgets are the wave of the future and I know how to make them. I set up a production plant and start cranking out widgets as fast as I can. How much should I charge? How much can I charge?
Here we get to start making assumptions. Assumption #1. As founder of Electronic Widgets, I want to make money; lots of money. Most of the science of economics is based on assumptions like this. We assume that consumers are rational, that companies want to maximize profits, and that, a widget is a widget. Real life is never that tidy, but we make these assumptions anyway because we have to and because they are a good starting point.
If I want to maximize profits, I should sell my first widget off the line for $1,000,000,000,000,000,[...]000,000,000.00. Or something like that. It is unique in the world, the first widget ever. The price may be ludicrous, but remember this widget is a life changer. Is there one person in the world willing to pay that much? If yes, then that is what I should charge. My supply is 1, far to the left of the graph. That demand line is curving upwards. As quantity available goes down, the price people are willing to pay can increase exponentially.
Electronic Widgets have sold our first widget, and we are rolling in the cash. I can take a little dive in my money bin.
Three cubic acres of money. But we want more because we want to maximize profits. And there are more people out there who still want widgets. Time to make more.
This time the price is not going to be so high. There already is one, so the uniqueness factor goes away. And we already soaked the richest man in the world for all of his money. But it is still worth it to make the widget because even if it only sells for half as much as the first one did, that is still a ton of money and most of it profit.
Eventually, we keep rolling out the widgets, and following an S-curve
of adaptation our revenues start to drop. We remain profitable, but it is not as ridiculous as it once was. There just are not enough people that far on the demand curve to support the price--so the price falls.
But wait, there is a problem. One of the reasons why our profitability is taking hit is not just the lack of consumer demand, but also our competition. UbiWidget saw how we soaked the richest man in the world and they want a piece of that action. They know how to make widgets too, and because widgets in simple economics are indistinguishable, when they start making them, we are competing with each other for market share. We each are pushing supply along the curve faster and trying to reach the end point faster so that more of our widgets get bought than the other guy's.
Eventually, this reaches an equilibrium point. Most of the demand is met and there is enough slack in the system that both my Electronic Widgets and UbiWidgets get to make what is called normal profits. It is enough that everyone stays in business, but no one is really happy about it.
One place that this breaks down as an analogy is that widgets are not always widgets. My Electronic Widgets might well be superior. Or more commonly, UbiWidget is selling a substantially similar, but functionally different product that we can call a Wodget. Because we are selling different products our supply curves do not interact with each other in the manner noted, at least not as much.
Another, larger, place that games break the model when it comes to classic supply and demand economics is that widgets are physical things that we create in a factory. Software is ethereal. It does not exist in the physical world, except through how it interacts with it. It is also theoretically infinitely reproducible. That may not be precisely true for a disc print in a box on a shelf at GameStop, but it definitely is for a digital copy.
The economics of a product with infinite supply are not well understood. What is the price of air?
Economics ascribes zero value to priceless things, on either end of the spectrum. Developers work hard to make the software and deserve to charge money to recoup their investment. Coders and artists deserve wages. The product that they create is not valueless (air) because it can be made over infinitely at no additional cost. This is a problem with post-scarcity economics. For what it is worth, this is a very important question for the next 50 years because as more and more of our economy and economic activity, particularly in the “first-world” is dependent on the production of and use of software, portions of our economy are going post-scarcity. It is likely to be a disruption to the economics of our time as profound, or more, as the Industrial Revolution. This disruption will likely continue until we can get to a fully post-scarcity society, which seems a pipe dream still, or until we define a new paradigm of an economic system. Something like Whuffie
, perhaps. But a legal band-aid, like copyright
, is not going to fix this one.
Wait a minute, did he just say "Whuppie?"
Software breaks the supply/demand curve, but not necessarily the entire thought process behind it. Time to go back to the top. I have a new company: Electronic Games and we know that games are the wave of the future. We make a game. Why not put our first copy out for auction so that we can find the very top of the demand curve and collect that absurd number from before? Do you want to be the first to play Electronic Games’ latest title? Pay for the privilege. That has not happened yet, but I could see it happening at some point. Instead, game companies settle for a less egregious option: the collector’s edition. If you want the biggest and best Day-One package, you will pay more for it. Skipping the auction could also be a defensive technique because watching someone play a game can be a substitute for playing the game itself for some. So Electronic Games might be failing to maximize profits by not getting enough copies of the game out fast enough. If the early release window offered at auction is measured in minutes instead of days or weeks or months, it is worth a lot less. This can compress the demand curve, but it still exists.
The purpose of having a collector's edition and a regular edition is ultimately the same as an auction, just less precise. The supplier is meeting people on the demand curve at different locations. This is called stratification (or segmentation) of the market. It allows sellers to find ways for consumers who can and want to pay more for additional features to do so. This is why DLC exists as well, of course, but that is more a post hoc
answer. Some games have taken this to the extreme. You can have collector’s editions, supreme editions, extra editions, regular editions, and then for the bargain customer, the slimed down edition. Or the one that they supplement with advertising. Then finally they can sell a “Game of the Year” edition and add in all the DLC.
Time for another example. Electronic Games has had a successful launch day. Our new game, Mudden2020, was a huge hit. But that does not mean we do not still have our UbiGames rival. They saw that Mudden2020 was a hit and they say, just as before, “We can do that too!” So they set up shop and a few months later they release their new game CSN-FL ‘20 which is clearly a rip-off. Lawsuits ensue because economics never works quite so well as when there are politics involved too, but at the end of the day consumers have a choice.
The difference between Widgets and Wodgets was not as profound as the difference between Mudden and CSN-FL. Despite massive similarities, both because of laws and those lawsuits, or potential lawsuits, and because of the sheer amount of room for differences in software, the games are fundamentally different. There are gamers who love Mudden and hate CSN-FL and vice-versa. And there are even gamers who love them both and want to buy both. The supply is potentially infinite for both, and yet there is still very little direct competition because the products are sufficiently differentiated. But that does not stop me; as CEO of Electronic Games, any potential competition is too much, so I seal up an exclusive deal with the league so that Mudden will be the only official product.
Mudden2020 has been out for a few months now. Everyone who wanted it at $60 for the regular edition or $80 for the CE has bought one. They have played it to death as they watched the current season of sports-ball play out. Sales have slowed down to a trickle. It is time for a sale. Why have a sale? Because it meets that next level on the demand curve. There are still lots of people out there who might want a copy of Mudden2020 but did not have or did not want to pay $60. But they might pay $40. So for a special occasion, we can sell a copy for $40 now. We do not make as much money this way, but as with the widgets, any extra money is good, as long as it is more than it cost to make; and since our product is largely digital, it costs almost nothing to make extra copies. Everything is the sunk cost of development. In order to sell more copies we had to meet the market, nothing we do is going to make the market come to us.
One sale at Christmas was good. Two months later for the “Big Game” is around the corner, sales have been near zero since the sale, though. If they did not buy it at $80 or $60 at the beginning of the season, or on sale at $40 they really are not going to be buying it for $60 now. So it is time to have a deeper sale. Let's take it down to $30 and when the sale is done it can be permanently reduced to $40. We are almost done with production of Mudden2021 anyway and that is where we are focused. The diminishing returns from Mudden2020 are not too much of a concern. This is actually irrational from an economic perspective. If the goal is to maximize profits, then those diminishing returns should be of concern. But Electronic Games only has so much brain power to put to these questions and the few extra dollars of profit lost do not warrant as much attention as making sure the next product succeeds.
Fear my MS Paint skills
This is the status quo of gaming economics. This is why sales and discounts and then more sales are the methodologies for extracting maximum profits for a non-scarce good.
That took long enough. Now to answer the question.
Physical software brings with it a “copy” problem. It is basically the same as the piracy problem, except that physical software resale is legal and piracy is not. Jblacq is spot on in the initial analysis. And we here at Electronic Games hate resale. Someone is playing our game and we made no money on that transaction at all. That is not maximizing my
It might seem like the problem is that it is not illegal to do, like piracy. As a heartless money-grubbing corporation intent on maximizing profits, I do not see the difference between a reseller and a pirate, even if the law does. To Jblaq’s point, though, are they? The end result is that someone who gave no money to the creator is enjoying the fruits of the creation.
Dressing the part, GameStop finally shows their true colors.
The answer is, of course, no. There are two reasons why they are factually not the same, even in economic terms. The first is that in this day and age intellectual piracy is generally a zero-money thing. If I want a pirated version of a game, I do not pay anyone for it. However, resale does involve a financial transaction, from the new owner to the previous owner, with perhaps a fee for a middleman, like Gamestop. The second reason is that the first owner no longer has the game. In the sale of the physical disc (unless this is also piracy) he forfeits his right to play the game again in the future. Those are two critical distinctions that will matter a lot to our next level of economics discussion.
If Supply is theoretically infinite, does that mean that the demand curve ceases to exist? It does not. If Supply were truly infinite, everyone would just line up at the “pay $0” side of the equation and be satisfied, because if the product is infinite, in financial terms--that is in the terms of determine who gets how much of a scarce resource--the product is valueless (air). Video games, and other infinitely reproduceable products (and yes, even air) clearly have value even when they are not scarce. The demand curve is still there because consumers want the value of the game, and they want it at differing levels based on their own situations.
Individuals, still making their own theoretically rational decisions, can value identical products differently because they have different needs and different “purchasing power.” This could be a good time to run a segue about inferior goods substitution purchases, pricing sensitivity and price elasticity, but this is already getting to be quite long, so I’ll skip it. If you are interested, be sure to let me know and I will write it up as yet another blog in a little bit.
The main point is that as gamers, we each are in our own situation and have different desires for different games at different price points. I was happy to buy Armello
at launch, something I almost never do. Similarly, even though it was not at launch as soon as I discovered that they had made Joe Dever’s Lone Wolf Console Edition
, I bought it sight-unseen. At full price. Even though it has at least one unobtainable achievement. All of those are things that would have slowed me down or stopped me from purchasing most other games with those issues. I desired these games strongly, whereas the whole point of Xpovos' blog post - Backward Compatible Sale
was that I was tempted to buy and play games I had written off before because they were too expensive. The sale comes along and lowers the price, and suddenly I am willing to drop $120 (combined). For each of those, my own position on the demand curve was lower than the price was set. Therefore no transaction occurred. In between those examples is a whole spectrum of positions I have for other games. It is actually pretty rare for people to be at exactly the same point on a demand curve. We may arrive at the same transactional point, but our reasons for doing so could be completely different.
There are a lot of things that can shift that demand curve, but they are largely external to the actual product. Maybe I win the lottery. Suddenly money itself is worth less to me than before, so it is a bit like everything
goes on sale. Or maybe I play a game and love it so now I want the sequel a lot more than I had considered previously, or just another game by the developer. The game itself hasn’t changed; just my perception of it making it more or less valuable to me in my own unique situation. One of the factors that should be reducing how much I value ant new game purchase is my existing backlog. I do not think of myself as a collector of video games so the purchase does me no good until I play it; and there is not really enough time to play the ones I have anyway. But that does not seem to be a factor for my non-rational brain.
Since the demand curve still exists even for non-scarce products, the process for maximizing profits is to steadily work down the demand curve. But publishers don't do this perfectly, if at all. And that is the reason why GameStop exists.
We have the ground rules set for if the developer is selling to us, directly or through a middle-man. But we need to talk about the individuals on the demand curve. Buyer A who buys on Day 1 and keeps it forever has the highest demand for the product. Buyer B who buys on Day 1 and then sells it to GameStop later is lower on the demand curve. He is willing to buy the game at an “inflated” price because he can get his enjoyment which he only wants for a period of time, and then sell it to recoup the portion of the price he was felt was inflated. If he could not sell the game he would not be willing to pay as much. Buyer C, who buys from B is even further down the demand curve. He was never willing to pay full price, but he still has a desire to play the game so he gets an inferior substitute good in the form of a used game at a reduced price. He subsidizes Buyer B’s demand curve with his own. Buyer D is a little lower spot on the demand curve as Buyer C, and values the substitute good differently. He waits for the first sale, because that gets him a new copy which is worth more to him, but not enough to pay full price for. Buyer D, despite being lower on the demand curve has actually given the company more money than Buyer C did. That is a failure on the part of Electronic Games.
The problem is not that the used game sale happened, it is that the developer failed to meet a potential consumer at a mutually agreeable price point. They let someone else do it, through a process known as arbitrage
and as a result, they potentially lost out on revenue. If the game developer and publisher could meet our used-game buyers at their demand curve spot they could get that sale themselves and cut out Buyer B.
They do not do this. Both because it is hard to do in practice, particularly without alienating customers, and because at the end of the day if they found some way to take Buyer B’s arbitrage margin back to themselves it just moves Buyer B further down the demand curve himself. At best they cannibalize an early sale transaction for a later sale transaction, and the publishers would rather have early sales for marketing reasons if nothing else.
Individuals partaking in the arbitrage process tend not to take significant profits away from the initial seller (Electronic Games) because if pricing is properly done initially then the arbitrage value is baked into the initial purchase decision. Therefore, GameStops profitability is not coming directly at the expense of Electronic Games, or any other publisher or developer. It might
be a lost sale unit, but not any lost revenue.
That is not always the case. If the game is horribly mispriced relative to market demand, then the opportunity for arbitrage is tremendous, and profit can be lost. That can also happen if somehow there is a supply hangup. If you get a Collector's Edition of a popular game it is possible that you can sell that for a profit yourself. If you can, it means the initial pricing was probably too low. But there is also a tremendous market force of stability. "Games cost $60
." So even if the game is worth more to consumers, if the company tries to charge more, they get accused of gouging and that bad PR is not worth the extra profit on one game, thus opening the door for yet more arbitrage.