The online gaming industry : the relationship between pricing mechanisms used by game developers and the online gaming communities : what is the impact of DLCs (downloadable content) and micro-transactions on the commun

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The online gaming industry. The relationship between pricing

mechanisms used by game developers and the online gaming

communities.

What is the impact of DLCs (downloadable content) and

micro-transactions on the community and what are the factors

influencing the player's willingness to pay?

Name: Bogdan Berbece

Student ID: 10824421

Date: Final version, 29th June, 2015

Program: MSc in Business Administration

Track: Entrepreneurship and Innovation

Institution: University of Amsterdam

Supervisors: Dr. Roel Van der Voort and Dr. Tsvi Vinig

KEYWORDS: micro-transactions, DLCs, free-to-play, subscription, packaged games, willingness to pay, lock-in, competition, interaction, virtual goods, eSports, flow state, platforms, addiction, business model

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Statement of originality

This document is written by Student Bogdan Berbece who

declares to take full responsibility for the contents of this

document.

I declare that the text and the work presented in this document

is original and that no sources other than those mentioned in the

text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for

the supervision of completion of the work, not for the contents.

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1. Foreword and acknowledgements

This piece of research was written as part of the Business Administration Masters of Science program of the University of Amsterdam, specializing in Entrepreneurship and Innovation at the Faculty of Economics and Business Studies (FEB). The topic of the thesis revolves around the relationship between online gaming platforms and game developers, and online gaming platforms and the gaming communities. The focus lies on the impact that DLCs (downloadable content) and micro-transactions could potentially have on the game developers and the online gaming community. Besides its theoretical relevance, the paper also tries to provide practical information for the game developers, in order to help them make better informed decisions when thinking which approach to follow when choosing the best viable pricing strategy for their products and services.

Since I can remember, computer games have been part of my upbringing and have shaped my development throughout the years. Although the academic field of entrepreneurship and innovation came as a novelty to me during my studies in Amsterdam, being able to link a lifelong passion with my academic aspirations has helped me acquire vast knowledge on a topic that I love and that I believe is of great importance nowadays.

I would like to thank Dr. Roel Van der Voort, the leading supervisor of this piece of research for his constant involvement and guidance throughout the whole process. Furthermore, I would like to express my appreciation for Dr. Tsvi Vinig, the second reader of this research.

In addition, I would like to thank all the interview participants from the online gaming community (professional players, professional casters, team representatives and managers) that have spent their time and consideration throughout the interviews. Furthermore, I would like to express my gratitude to the 290 respondents to the online questionnaire which immensely helped the research.

Lastly, I would like to express my appreciation towards my friends and family, who have been alongside me, throughout the whole process of conceiving this research paper.

The ideas expressed in this thesis are those of the author, and do not automatically reflect the views and beliefs of the business organizations that are part of this phenomenon.

Amsterdam, 29th of June, 2015 Bogdan Berbece.

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2. Abstract

The gaming industry has seen a fast changing environment during the past decade. This has put a great pressure on gaming developers to shift their business strategies from selling their products in a tangible form through retailers, through offering them in a digital format through their own, or separately developed gaming platforms. This shift has brought changes in the way companies engage with the platform operators and the gaming community as a whole. Nowadays, the community plays a crucial role in the development of the industry. Amateur and professional gamers have become the foremost important customers of game developers, and are shaping the way in which the products are offered to the market and the characteristics of these products. Companies need to adapt to this shifting tide and place a great emphasis on what the market desires, and how their products need to cater to the needs of the end users.

The research utilizes a mixed methods approach. Through semi-structured interviews with game casters, production managers, professional players and professional team managers that aimed to identify the characteristics of the games typology and the benefits and downfalls of free-to-play versus pay-to-play games, a conceptual model was established. Afterwards, the importance of characteristics such as satisfaction and willingness to pay were tested through surveys among several types of participants in the market.

The data collected through the semi-structured interviews gave a holistic approach to the gaming environment, but several limitations need to be considered based on the methodology followed. The surveys also provide an in-depth understanding of what people's expectations are in terms of pricing mechanisms used by game developers, but its scope may be limited and generalization might be hard to established due to the diversity and heterogeneous choice of participants.

We are positive that this piece of research does indeed help build on the existing online gaming literature, which, at this point in time is relatively scarce and divergent, and also provides valuable insight into this emerging and constantly changing field.

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3. Introduction and Research Questions

Rapid development in science and technology, intensive global competition, new and advanced methods in organizational structure and many other factors have emphasized the urgent need for organizations, whoever their business targets, to constantly innovate and be more entrepreneurial in order to survive and therefore prosper (Dess, Lumpkin and Mckee, 1999). Although a general trend, it strongly applies to the gaming industry and highlights the need for companies (game developers, platform providers, event organizers) to stay one step ahead and anticipate the trends that are changing this environment at a very fast pace.

As early as the 1990's, the phenomenon of computer gaming started to emerge through the introduction and development of dedicating gaming consoles such as Sony's Playstation, Sega's DreamCast and Nintendo's Super Nintendo. Through the appearance of these platforms, world known characters such as Sonic the Hedgehog or Super Mario Brothers started to emerge and shortly became embedded in the gaming culture worldwide. Despite the vast expansion of this phenomenon, little attention has been given to this phenomenon in the academic research area. Most of the research up to date has been focusing on the demographics of the individuals that decide to spend their leisure times in these fictional environments. Furthermore, most of the research has concentrated around the potential negative impacts that online and offline gaming may have on the upbringing of individuals (Griffiths and Davies, 2003). It has been argued that playing violent games may have a negative effect on the psychological development of youngsters (Griffiths, 1995). According to Griffiths and Davies, 2003, games have developed along two individual branches. Firstly they present an overview of standalone games. These types of games do not immerse the player into the online environment and therefore players do not seek to engage in a teaming behaviour. Secondly, there is the case of Massive Multiplayer Online Role-Playing Games (MMORPG) which offer the players a different experience. The world in which the characters that are brought to life are very sophisticated, detailed, and are constantly evolving, but have no final point. The nature of these types of games offers a three-dimensional environment populated with thousands of characters that interact with each other, and are able to perform an unlimited number of tasks. As an example, as early as 2002, Sony's Everquest game totalled a number of over 400,000 active players on its 44 servers that were running 24/7 (Sony Online, 2002). As years past and technological and digital advancements have started to be more and more present in our daily lives, the gaming scene has undergone a shift in its offering. According to Electronic Art's (EA)

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8 COO, Peter Moore (2014), just like the music industry's transition to the digital, the gaming industry must, before it is too late, embrace the 'creative destruction' as this is what consumer tastes and requirements are at the moment. Games are no longer a product that is being published and then discarded as an area of interest for the company, but are rapidly becoming a 'live operation' (Brightman, 2014). Companies now require highly diversified infrastructure with customer service and global billing. The industry has completely shifted in a way that gamers require global networks running live, and their games have to be available at all times. According to Brightman (2014), the change can also be noted in terms of marketing targets. He believes that gaming companies should focus more on the use of digital channels rather than traditional TV ads that used to work in the past. To further strengthen the argument that we are in the middle of a shift, according to Statt (2015), in 2014, half of EA's revenue came from selling games and add-ons through online platforms. The company's CFO Blake Jorgensen (2015) stated that the company is strongly supporting the idea of selling their products online and continues to shift its business model to more and more live services.

In this piece of research, we attempted to gain a deeper understanding regarding what has pushed gaming developers to adapt to this shift in preferences, looking at the types of offerings that are currently available in the market. Micro-transactions are the core of our analysis and therefore, through interviews conducted with business professionals of the field, we used an inductive approach to devise the conceptual model, and through the questionnaires we deductively tested the main characteristics that we thought were of great importance. The objectives of the thesis were therefore:

- to understand how the preferences in online gaming have shifted during the past years and how the gaming developers have responded in this regard

- to analyze the pricing models and the lock-in mechanisms that these models subject their customers to

- to recognize the importance of DLCs and micro-transactions and to understand the community's preferences in connection to these concepts

The main research question that we looked to answer was:

- What is the relationship in terms of business and pricing models between online game developers and the communities?

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9 We divided the matter in subsequent questions:

- What is the impact of DLCs and micro-transactions on game developers and the community? - What is the community's perception on these types of pricing mechanisms and what are the characteristics that enable their success?

3.1 Theoretical relevance

According to Blackburn et al. (2011), online gaming is a multi-billion industry that is tapped by population on a world-wide level. Boyd (2004) argues that through online interaction, people meet and create linkages that enrich and add diversity to their lives, blow off steam, chat about matters of the world and thus make sense of the environment that impacts them. Interaction also comes from the steps that a player takes in order to further his existence in the game. he purpose is to achieve goals, with the help of operators that provide feedback. As stated by Crawford (1982), problem solving theory offers a framework that guides the players' actions and is based on the following three pillars: goals, operators and feedback. Goals are considered the targets that each individual sets for himself, based on its character's capabilities, the time that he or she can put into the game and the willingness to do it. The operator is simply the means that allows the individual to attain the goals. Finally, feedback is the response that the game provides based on the player's capability to interact with its operators.

Moving to a more macro level, every player is part of a community that will, to some extent, impact the gaming experience, and the way the developers decide to interfere within the game. With more than 304 million users of the internet in early 2002, and an average annual growth of 23%, the internet is considered to be not only the greatest invention of our generation, but its impact changed the direction of the world we live in (Plant, 2004). In 2014, figures showed that 59% of Americans play some type of

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10 online games, either mobile, computer or console, and those numbers can only grow in the years to come (ESA, 2014).

Development of online communities has been a highly debated topic in the literature. Several researchers (Plant (2004), Jensz and Martens (2005), Steinkuehler (2005), Becker, Chernihov, Shavitt and Zilberman (2012), Holstrom (2001)), have tried to exemplify how do these tight communities impact the livelihood of an individual. Also, their research has focused more on the social and behavioral aspect of being part of such communities and less on the financial incentives.

This research paper looks to fill in the gap concerning the potential impact that business models in the online gaming industry can have on the community's willingness to play and pay. It will closely analyze the contribution that DLCs and micro-transactions offer, and the community's preferences regarding these types of instruments. At the same time, the research focuses on the characteristics that these individuals possess and what traits may be correlated with the willingness to play a pay-to-play game, or purchase an in-game feature that enhances the gaming experience. It must also be noted that the research will be conducted mainly based on the games that are offered through online gaming platforms such as: Valve Corporation's Steam platform (Dota2, 10,861,987 active accounts (Blog.dota2.com, 2015)), Blizzard Entertainment's Battle.net platform (World of Warcraft, more than 10 million active subscribers (Grubb, 2015)) and Riot Games League of Legends game (27 million active users (PC Gamer, 2015)) due to the availability of the participants and their willingness to cooperate.

3.2 Practical relevance

Our work offers a current image of the online gaming market both from the perspective of the game developers and the community. It examines the impact of DLCs and micro-transactions on the customer's experience and on the strategic directions of the organizations. Its main purpose is to offer an understanding of how these instruments impact the gaming experience and what are the types of players that prefer or dislike this particular approach.

Through conducting semi-structured interviews, the broad state of the industry was examined. Participants were people actively engaged with the phenomenon and not amateur players that expect nothing more than just pleasure when engaging in this activity. They assessed the market in terms of its development during previous years, tendencies in people's preferences, lock-in mechanisms, and the impact of using DLCs and micro-transactions as a pricing strategy.

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11 The questionnaire was designed to help us understand whether our propositions can be tested, and looked into player's preferences when choosing what games to play, their social status, their willingness to pay in order to reap the benefits of this experience, and overall their satisfaction levels.

The results of this exploratory study can be considered as a starting point for game developers and online gaming platform owners, as to better understand who their market is, what are their customers' preferences, how can they alter their offerings based on the feedback provided, and most importantly, should there be a change in their pricing models and strategies? These findings might also shed light on the levels of satisfaction that people who engage in this sort of activities can deduct, and also try to find plausible correlations between their social and economic status and their willingness to pay in order to continue to reap the benefits of these virtual worlds.

3.3 Thesis structure

To better understand the steps we have taken in this research, the structure is as follows: the third chapter offers a broad picture of the gaming industry: where it all started, how it developed, and what seem to be the trends moving forward. Also in this part of the thesis, the research questions will be introduced. The following chapter delves into analyzing the literature review and it will focus on aspects such as the transition that has taken place in the industry from the traditional way of selling games via retail stores, to offering them in a digital manner (this is the point where instruments such as DLCs and micro-transactions have been developed and have started to play a crucial role in how the organizations market their products). Secondly, it will look at online platforms that have facilitated the fast proliferation of games and will end with looking at what aspects of game related real money transactions have been research in the literature.

Moving forward, the choice of business models and pricing strategies that companies may use (Packaged game sales, Subscription models, Free-to-play models) will be discusses and also a link will try to be established between these models and lock-in mechanisms that are used to keep users engaged. Furthermore, the 7th chapter will present the mixed methodology approach that will help us answer our propositions. The following part is devoted to the results that have emerged from the analysis.

The last part will focus on providing a synthesis of the findings in comparison with what the literature provides us, and afterwards, a conclusion will portray the potential implications of our study and show future directions of research on the topic.

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4. Literature review:

4.1 Communities

A community, as explained by the Oxford dictionary, is a group of individuals that either live in the same area or have a characteristic, or several characteristics in common (Oxforddictionaries.com, 2015). The term has also been used with a technical connotation in academia (Bell and Newby, 1971) to explain social interaction between members, geographic characteristics and common bonding (Willie, 2000). Online interaction and communities changed the way business is conducted nowadays, the role of any given individual at the workplace, and how the society functions as a whole (Plant. 2004). This was possible thanks to the deregulation of the internet that took place in 1995 (Plant, 2004).

For a traditional goods organization, online interaction required high degrees of adaptability and shifts in business models and strategies. Online interactions impact organizations' relationships both internally and externally. At the internal level, high degrees of computational skills and increased opportunities to network ensure a company can stay focused and adapt to change and at the same time remain competitive and efficient. Externally, these new channels of communication have facilitated a better relationship between businesses and their suppliers, customers, and in general the stakeholders that impact the organization (Plant, 2004).

Moving to the virtual world, Hagel and Armstrong's (1997) model divides the virtual space into four areas. Firstly, there are the communities of interest, which have an informative purpose for their audience. Secondly, communities of relationships that generally consist of forums where people can share and swap ideas. Furthermore, they talk about communities of fantasies, which are online, virtual worlds where people can communicate, interact via virtual characters, compete, evolve, and at the same time gain satisfaction and pleasure through their actions. Finally, the fourth area is tightly connected to transactions, and these mainly involve B2B and B2C communities. Our research identifies itself with the third category mentioned above.

There are several reasons behind what pushes people to engage with these virtual environments. Bekhtina (2002) argues that motivation to join these worlds mainly comes from four characteristics: firstly, curiosity and interest play an important role when deciding a player's course of action. Secondly, cognitive stimulation, and feeling that the virtual world pushes your skills and capabilities further. Thirdly, enjoyment of a different life style, which comes from the online experience, but more recently from the potential of earning a constant revenue through these types of activities (Keng, 2014) and

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13 finally, for its recreational aspect. Krotoski (2004) builds on this and argues that online games, especially massively multiplayer online role-playing games (MMORPGs) "encourage group interactions and involvement, flexibility and mastery" (Krotoski, 2004), that result in tight friendship bonds and personal empowerment. Seay et al. (2004) support these findings through their research, where they have found that 77% of the people they surveyed exchanged support and advice while being connected in these games, 77% engage in social exchange and small talk, 53% exchange personal experiences, and 69% of the respondents engage with fellow gamers outside of these virtual environments. Cole and Griffiths (2007), in their paper on social interactions in MMORPGs draw a comparison between the characteristics of the relationships people establish online versus offline. Their findings revealed that 45.6% of the persons questioned believed that their online friends are comparable with their real-life friends, although no gender differences could be established between the two groups. A small portion of the people questioned (4.8%) went further and argued that their online friends can be more trustworthy that their real-life friends, whereas 36.7% reported that online and offline friends can be equally trustworthy.

The proliferation of online communities came as a natural development in the human nature, however it must be noted that these types of communities are dynamic in nature and that research and organizations have the ability to recognize and classify them accordingly. It is an important aspect that facilitates organizations, or even individuals to acknowledge the role a certain type of community plays in the macro environment and at the same time the artifacts that come along with these communities in order to make them effective (Plant, 2004).

4.2 Culture

When talking about culture, the role of the state needs to be considered, and how studies of political economy and communication aided development (McChesney 1998; Mosco 1996). Vast literature on media productions (such as movies, games, music platforms) tackled the issues of the dynamics of the media industry, strictly from a corporate perspective (Caves 2000; Hawkins 2005; Jackel 2003). The corporations, regardless of their size and exposure, shaped the industries that focus on cultural content. According to Peichi (2008), a cultural industry needs to "form agglomerations among media companies" in order to establish thriving industry dynamics. Because there is a scarcity of discussion and analysis on the cultural industries in Asia (Peichi, 2008), the next part of the thesis will focus on this geographical

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14 area, and will try to exemplify the mechanisms that the states use to ensure the proliferation of these cultural phenomena.

The South Korean online gaming phenomenon has had a fast growth rate and has become one of the most dynamic marketplace for these types of activities. According to Wi (2006), two policies have played a crucial role in the development of online games and their expansion to the broader audience: the broadband policy of the MIC (Ministry of Information and Communication) and the Special Military Exemption policy of the MCT (Ministry of Culture and Tourism). Due to the effects of these policies, as early as 2006, the Korean gaming industry's revenues were $550 million. The increase continued, and the exports of Korean games totaled $671 million, out of which, 89% of the total games exported were to be enjoyed online (Ministry of Culture and Tourism, 2007).

Turning to Singapore's online gaming market, the government's turn to culture and arts at the beginning of the 1990s, and the scholarships that it offered to individuals wanting to follow a career in this creative industry, has ensured the fast development of companies doing business in this particular sector (Peichi, 2004).However, the success that this phenomenon has had in this particular region should as well be attributed to several socio-cultural and economic factors. Singapore and Korean developers have been able to outperform their western counterparts including Electronic Arts (EA), Nintendo and Sony, due to the fast development in Information Technology infrastructure, subsequent distribution of high internet speed networks and the booming PC bangs (also referred to as internet cafes). The increased popularity of online gaming in this regions has been closely related to the explosion of information and communication technologies that have created the necessary conditions of communication and interaction. This is mainly due to the efforts of the national governments to deploy and adopt state of the art broadband infrastructure to homes in all parts of the countries (Jin and Chee, 2008).

Along the expansion of ICT infrastructure and capabilities, and the growth in numbers of people playing online games, concerns started to emerge to whether this type of activity would end up eclipsing other activities. Gamers from these regions have "repeatedly made the headlines with reports of their perceived level of pathological use of games" (Jin and Chee, 2008). The controversy materialized due to the potential of online games to disrupt the traditional social and cultural activities that people use to include in their daily activities and so, the discussion of addictiveness started to emerge (Jeon, 2004). Lee (2006) argues that it was at that point in time that people realized that gaming is not purely to be treated as a fun and relaxing activity, but has paved the way to new channels of communication, human relations, and has started to become an important part of people's lives.

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15 4.3 Addiction

With the increase of individuals who engage in Massively Multiplayer Online Role-Playing Games (MMORPGs), literature that focused on how addictive this phenomenon is, started to emerge. Games such as World of Warcraft and Lineage 2 have been at the forefront of this movement and have managed to captivate the attention of millions. More recently, games such as Dota2 or League of Legends, although not in the category of MMORPGs, started to catch ground and are now considered more than ever able to attract the online gaming masses.

It must be noted that most of the research conducted on this area tends to only highlight the negative aspects that may come with spending long hours within these virtual worlds (May, 1994; Griffiths and Hunt, 1998). However, more recently, studies have started to put more emphasis on the benefits that human interaction, the creation of strong bonds and a constant sense of belongingness may bring to players (Griffiths, 2003). Although the purpose of this thesis is not to look into the benefits or drawbacks of playing online games, the idea of "addiction" is strongly linked with the lock-in mechanisms that we will tackle later on in this research.

Chappel et al. (2006) found that in accordance with Griffiths et al. (2004) study, players find the social and cooperative nature of such games, coupled with the possibility to create new friendships both within and outside the virtual world is what drives people to continue playing these types of games. The level of addictiveness may also vary according to peoples' personalities and the sensations that they seek when engaging in these virtual worlds (Griffiths and Dancaster, 1995).

Through their research, Kuss, Louws and Wiers (2012) point out that the consequences of playing online games differ in individuals who play MMORPGs and those that choose some other form of online entertainment. Their study is in line with the literature that argues that MMORPG players are more likely to experience problems, due to the characteristics of these games. The feeling that the experience is never-ending, coupled with "variable reinforcement schedules" (Skinner, 1969) may pose a significant threat to players. In terms of addictive behavior, the National Research Council (1999) compares this type of effect to the online gambling experience. Turning back to the idea that different types of psychological profiles influences the effects that online games have on different individuals, Mehroof and Griffiths (2010) found significant relationships between addiction and traits of aggressive behavior, sensation seeking, anxiety and depression and neuroticism. Boredom and the clever designed reward mechanisms that are part of a character's journey in these virtual worlds, are triggers of the types of behaviors mentioned above (Mehroof and Griffiths, 2010). Ko et al. (2009) go further with the research

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16 and find that the activities of 6 brain areas are directly correlated with the urge to play online games, when their subjects were shown pictures from their favorite gaming environments.

On the other side of the spectrum, David and Wiemer-Hastings (2005), although agree that MMORPG players do indeed spend more time connected to the games than other types of players, argue that spending time in these virtual worlds may simply be an alternative way of social entertainment. Their research shows that players do not look for self-confidence within the games, and there is no point of labeling them addicted or anti-social, as MMORPG players simply have a different perspective on social life.

4.4 Platforms

As ICT capabilities and the internet have started to be a pregnant part of our everyday livelihoods, the gaming industry had to adapt in this regard. In the past, and still to a very small degree today, game developers offered their products in a physical format through retail stores. Sensing the need to adapt to a changing business environment and to the community's demands, developers are now offering their products in an online downloadable format through these so called online gaming platforms. Valve's Steam platform, E.A's Origin platform or Blizzard's Battle.net platforms are just a few of these types of 'game libraries' that offer their customers an in depth gaming experience. It offers them the possibility to access all their favorite games from these integrated platforms, and at the same time keep up with future offerings or even engage and have a saying in how future products should look like. For the purpose of the research, based on the game (Dota 2) that is going to be at the forefront of this paper, the paper will focus on Valve's Steam platform. Every player that subscribes to this platform has a personal page that can be accessed publicly, alongside a webpage from which he can access his games library (Becker et al. 2012). As it has become a community in a sense, users tend to connect with each other. Users that have a high number of connections are inclined to connect with other users that share the same characteristic. This feature is called assortativity as depicted in the work of Becker et al.(2012). In 2012, when Becker et al. (2012) conducted their research, the platform was comprised of 1824 active games. The following figure (Figure 2) shows the distribution of players based on the number of games available. The majority of the games have up to 10,000 active players, whereas only 26 games have more than a million users (which at that point in time was equivalent to 12.5% of all active accounts) (Becker et al. 2012).

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17 Since 2012, things have only been on an ascending trend for Valve's Steam. In September 2014, the number of steam users has doubled compared to the same period two years before (Peel, 2015). According to Saed (2015), today, there are more than 125 million active Steam users, that engage in more than 4500 games, and generate over 400 million pieces of content for the community (items, groups, events). These impressive figures are also supported by the proliferation of the eSports phenomenon. eSports are computer games sporting events, where professional teams play against eachother, either at a LAN event or online from the comfort of their homes. As an example, the biggest LAN event in the history of eSports is Dota2's The International that started in 2011. The prize pool for that year totalled $1 million . Since then it has constantly grown. In 2012, the total prize pool was $1,6 million. One year afterwards, it almost doubled to $2.9 million. Until 2013, all the prize pools were from partner sponsorships and from Valve itself. In 2014, the community was involved through a croudfunding campaign that managed to raise $10 million (Peel, 2015). This year, through the same strategy, four months before the start of the tournament in August, $7.2 million have been raised (Dota2.prizetrac.kr, 2015). Although it may not be impressive when comparing eSports with traditional

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18 sports, these figures heavily support the idea that online gaming has been increasing at great pace during the previous years.

4.5 The business behind the games

Now that we have seen the massive investments that are made in the online gaming industry, our focus will turn to the developer's business models and strategies that facilitate these kind of investments. Vast research has been done in this area and several researchers have focused on understanding the different types of revenue models that have been used to ensure the constant growth of this phenomenon.

Jackson (2007) argues that a couple of years back, creating a virtual world meant starting from scratch, which involved massive costs. Those days have however passed, and companies such as BigWorld Technologies, World Forge and Multiverse offer 'tool kits' that allow developers to craft their own virtual realities. This phenomenon emerged at the same time as the transition was made from retail sales of packaged products to offering them in a digital format. In his article, published by Forrester Research, Jackson (2007) points out that this transition has paved the way to hybrid business models such as subscription based models, micro-transactions, advertising and marketing and media franchises. However, his research also cautions that potential risks may arise when engaging in these types of revenue models. Firstly, high costs that result from constant maintenance of the platforms, addition of new content and keeping the community engaged may pose serious threats. Secondly, the levels of risk are considerably high. In this regard, retaining critical mass is essential. Also, when giving the players the opportunity to engage in real-money transactions, hacking may pose a real threat to the well-being of these worlds. Finally, there is the possibility of high churn rates. Players may retain their subscriptions for a limited number of years, but may decide to switch to newer and improved experiences, before the developers have had the chance to recoup their investments.

With this constant changing environment, just as Jackson (2007) pointed out, new and innovative revenue streams need to be thought of. Lee (2013), through his research, comes up with his own version and adds to previous literature by tapping into the free-to-play model. His research focuses on aspects such as virtual goods, freemium services and advertisement to advocate in favor of this model as becoming more and more prominent in the online gaming scene. His research also turns to electronic sports (eSports) which he believes heavily help the expansion of the gaming phenomenon through the

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19 creation of new jobs (professional casters, professional players, statisticians) and also engaging the broader community through streaming and the promotion of events.

Chang (2009) advocates that the gaming scene has undergone a shift from gaming 1.0 to gaming 2.0. With this shift, hybrid revenue models have emerged, which can potentially revive traditional media industries. Gaming 1.0 refers to the traditional method of getting the games o the audience. Packaged products offered through retail stores, which implied high costs from developers and carried high levels of risk in terms of covering these costs. Gaming 2.0 on the other hand, brought frictionless, ubiquitous, social and service oriented games. Through platforms such as Facebook, Android and iOS, we have now entered the "Renaissance Era of Indie Gaming" (Chang, 2009). Frictionless distribution channels are of great importance as they facilitate the accessibility of content and the opportunity to try out new games without investing large amounts of money. Chang (2009) argues that in today's market, the 85/15/2 model applies. 85% of the people engaging in online gaming are only social gamers and prefer playing without engaging in micro-transactions. 10% to 15% only spend modest amounts of money to drive their gaming experience further, and only 1% to 3% spend large sums of money for premium content. Through these new business models, when talking about online gaming, researchers refer to them as 'Games-as-a-service'. This means that game developers need not only to come up with captivating content, but at the same time create an ongoing relationship with their audience (Chang, 2009). Furthermore, based on similar research, many aspects that we see nowadays coming to life in online gaming can be thought of as paving the way for other industries to transition to. Music, broadcasting, television, or even journalism have started shifting their focus from offering products to services, what has gotten to be known as 'Media-as-a-service' (Chang, 2009).

4.6 Lock-in mechanisms

Choi and Kim (2004) argue that people constantly engage with the same game over a long period of time due to their loyalty to a certain brand. In marketing research, loyalty is described as the repeated tendency of the customers to use a specific product or service, without having the urge to switch to substitute products or services (Kotler and Armstrong, 1989). Therefore, the higher the loyalty towards a certain brand, the more time an individual is willing to play that specific game. The research of Choi and Kim (2004), focused on the aspect of customer experience as the primary lock-in mechanism that developers use to keep the people engaged. Csikszentmihalyi and Csikszentmihalyi (1988) argue that during the playing time, individuals enter into a state of flow. This state means that the player is

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20 interested in engaging with the game, curious about what it could offer him, and also maintains a state of focus without letting distractions come between him or her and the virtual world. According to flow theory, participants seek ways in which they can constantly maintain the state (Csikszentmihalyi, 1990). As earlier discussed, interaction plays a crucial role when managing these environments. Game developers are constantly trying to come up with new ways to increase players' interaction (Leqinsky, 2000 and Gillespie, 1997). Interaction can be divided into two aspects: player to the system interaction and player-to-player interaction, and both need to be maintained at a high level to ensure a positive customer experience (Cummins, 2002). In order for player-to-player interaction to take place, developers need to provide communication channels and tools. Based on these characteristics and the traits depicted in Figure 2 , Choi and Kim (2004) use the following model to highlight the features that lead to customer loyalty and to the effect of lock-in.

Source: Choi and Kim (2004) As stated by Pontzen (2008), the knowledge that an individual acquires during the play time of an online game (especially MMORPGs) and the system-related skills are incompatible with other games, which open the way to creating lock-in. Also, the existence of items and values that a character acquires while playing a certain game, and their un-transferable characteristics further increase the lock-in effect. Castranova (2005) argues that migrating to a different game also imposes high switching costs for an individual, loss of social status, reputation, and the progress in terms of knowledge gained which has to be re-acquired in the new world. Turning back to the interaction that these virtual worlds offer, lock-in also appears when 'fighting' for bind on pick-up items that require high degrees of collaboration between participants (Pontzen, 2008).

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21 4.7 Virtual goods

Virtual goods are features that can be purchased in-game by a player in order to further increase his or her satisfaction with the virtual world. Nojima's (2007) research focuses on virtual goods sales as revenue models for MMORPGs, in contrast to traditional means of offering games (subscription or packaged sales). Through conducting surveys, the research tries to understand what is the player's motivation to engage in such transactions, and what drives them to want to grasp more from a game than the standard offering. The framework used builds on Yee's (2005) research on motivation to play MMORPGs who found characteristics such as advancement in the game, competition, socializing, relationship building, teamwork, discovery and customization to be some of the key factors that drive people to play these types of games. Lehdonvirta (2005) goes a step forward and builds on Nojima's findings to try and understand what prompts people to purchase virtual goods with real money. The motivators that come from the research are hierarchical advancement, competitive advancement, keeping up with fellow players, the opportunity to explore new content that is not available to everyone, customization and finally self-expression. Oh and Ryu (2007) take a different approach in their research and look into the aspects that game developers need to consider when deciding whether or not to use virtual goods as their primary revenue model. Based on their findings, developers should try to strike a balance between the types of items that can be purchased with real money and the items that can be earned through game-play. They argue that there needs to be a constant synergy between the two, so players will not be swayed away from a game that they believe has unreasonable expectations. Furthermore, the goods that can be bought should be given permanently to users only if they do not offer an in-game advantage over other players that do not engaged in real money transactions. To conclude, a balance should always be in place in order to ensure that the economy of a virtual world is not destabilized by the purchases of virtual goods. Oh and Ryu (2007) ask for caution when devising a business strategy that focuses solely on real money transactions. They point out that cosmetic items that can be purchase have no negative effect on the economy of the virtual environment, but functional items that have the capability to alter player's experiences in the online world, may in the long run be damaging to the game creator if not properly implemented.

5. Business Models

Micro-transactions are the core of this piece of research. Based on the description of the business models, and the literature review, the next stage of the paper will focus on better understanding the concept of micro-transactions in relation to the types of offerings that game

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22 developers decide to employ. As Kromand (2015) argued, although the model of micro-transactions has been introduced both for single-player and multi-player games, their success has emerged in the latter type of offering. Peterson (2014) stated that in 2012, 75% of the people that were playing Activisions's Call of Duty never engaged in the single-player missions. He argues that multiplayer has really damaged the single-player experience. According to Christofer Sundberg, the creative director of Avalanche Studios, "Microtransactions, subscriptions and other biz models will be the next generation of games" (Davison, 2013). But what are micro-transactions? These type of revenue model has come into existence once the gaming industry shifted from offering their products through retail stores to offering them online. Through this change, game developers understood that their consumers no longer desire a single product, but an experience. They desire an environment that is not bounded by the finality of a game, but can offer them a constant experience, an opportunity to grow and to further develop their skills, online relationships, and feel that their game understanding is on an ascending path. The existence of this model was only possible with the introduction of subscription based and free-to-play gaming. Also, the proliferation of these types of tools started when online gaming, rather than offline gaming started to emerge. As developers are trying to offer an experience and keep their customers engaged, micro-transactions can come in different forms and shapes. They can be purely cosmetic, they can offer an edge in the game, open up new opportunities, increase one's impact and notoriety in the community and also give the player a sense of accomplishment. The views towards weather micro-transactions benefit the online gaming world or are slowly destroying it are very disperse, but their introduction has definitely changed the way we gamers see the business behind it.

5.1 Packaged game sales:

As the gaming industry evolved, game developers have broadened their opportunities to extract revenues from their customers. At the moment, there are three business models that hold a monopoly in these virtual worlds: packaged game sales, subscription based and micro-transaction based games (National Research Council, 2010). Van Dreunen (2011) went further in his study of the US market and added the arcade as the starting point when discussing revenue models. The model behind arcade games was charging people a coin in order to play for a finite (relatively short) period of time. Although not large sums of money were invested by players in these types of games, the incumbent game developers benefited from high barriers to entry and large economies of scale (Van Dreunen, 2011). According to Play Meter (2011), the gross margins that these types of games managed to get in the past

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23 have shrunk dramatically during the era of digitization and the internet. The average gross revenue over a period of one week for a single machine has gone down from $129 in 2005 to $69 in 2009.

Packaged game sales started as early as the 1980s when the Game Boy was introduced. It then evolved into games being sold on CD's that were compatible with a multitude of platforms such as Microsoft's Xbox, Sony's Play-station and personal computers. Out of the three models introduced above, it is the most traditional one, and the one that has been around for the longest period of time (Lee, 2013). The idea behind this type of offering is simple; the players pay the initial fee upfront and afterwards own the right of the content and obtain the service in perpetuity (Lee, 2013). In terms of what are the venues that distribute these products, retailers like Metro, Asda, Amazon, Cex are examples of outlets that besides other products sell video games as well. Normally, a retail demands around 20% of the price that an item is to be put up for sale. The following table summarized by Pachter (2009) depicts the margins of different types of software that are sold through retail shops.

Table 1: Sample Gross Margin Calculation Source: Pachter, 2009

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24 In the packaged games model, the retailer has full control over its value chain as they are the ones interacting directly with the end user. This allows them to have vast influence on the overall allocation of revenues. A retailer may choose not to market products that are rated with violent, or mature content, if it decides it is not in line with the existent offering. Pachter (2009) argues that in the US, because of the high level of concentration in this part of the value chain - where companies such as GameStop, Wal-Mart, Target and Best Buy hold over 75% of the retail market share - game developers feel clustered by these giant organizations through which they need to sell their products. Another problem that arises is that retailers guide their businesses around organized inventory cycles, which may pose serious problems to developers who often have to commit to specific deadlines. This is strongly related with the retailer's strict rules in terms of in-store placement and the time allowed for a product to have a premium placement within the shop. Finally, retailers such as Cex or GameStop, also sell second-hand products. By doing this, they allow their customers to sell, trade or swap their games for a significantly lower price. The benefits for the retailer are obvious, as customers increase their loyalty towards a certain brand, increase their visits to those specific locations, or sway entirely from purchasing new products. On the other hand, game developers have nothing to gain from these transactions, or may even be at a loss if one of their products satisfies more than one user as was initially intended.

According to Orland (2011), in 2010, 73% of the games produced were sold through retailers, but the number has constantly declined from the peak period in 2006 when it was 81%. Furthermore, the overall revenue for the industry in 2011 has dropped 5% for the same period, one year before (Orland, 2011). This helps to show that there is a high possibility that this particular model may become obsolete in the foreseeable future or at least not be in the position to compete with alternative business models.

5.2 Subscription based model

Since the buying habits of consumers are constantly shifting to more simple and hassle-free experiences, a large number of companies have shifted their focus to subscription based models (Longanecker, 2015). This transition has emerged alongside the idea of software-as-a-service (SaaS). When people decide to purchase a piece of software, irrespective of its purpose, they desire constant support, a worthwhile experience, and need to feel that in the eventuality that a problem occurs, there is always somebody they can turn to in order to seek help. Alongside the increasing proliferation of subscription based models, caution needs to be exerted. As an example, Blockbuster, the giant US based company, failed

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25 to notice that a change was bound to happen, and that its consumers were in search of a different type of offering and therefore fell into the trap of inertia.

When deciding to follow this pricing mechanism, companies need to understand their price metrics. Price metrics measure the willingness of the customers to pay for a service, and the associated value that they perceive as fair for the amount of money invested. These types of metrics are a very powerful lever for products that are offered through a subscription because there are many metrics possible for a single kind of subscription business (Yamamoto and Sharma, 2015).

Charging consumers a monthly fee has become a viable monetization model for a variety of industries that are customer centric. The video game industry makes no exception, and in its desire to keep their customers engaged over long periods of time, the subscription based model was introduced. This phenomenon can be mostly observed in massive multiplayer online role-playing games (MMORPGs). The first MMO, was launched in 1984 and was called Islands of Kesami. It required players to pay $12 per hour of game-play. In that same year, two students from the University of Essex released a commercial version of their multi-user dungeon game and Mark Jacobs founded a company that would later on be known as Mythic Entertainment, and released Aradath, the MMO that cost players $40 a month to play (Van Dreunen, 2011). Due to the success of this model, other companies started to follow which put pressure on existing prices. Quantum Link, the precursor of AOL began to charge $10 per hour for the graphic-based online platform that it owned. Shortly after, GE's Information Services division released a service called GEnie that cost $6 per hour. As the internet started to catch ground in the 1990s, these companies started to change their subscription models from charging their customers on an hourly basis to asking for monthly subscriptions. This has set a new standard for MMORPGs and the way their developers monetized their services (Van Dreunen, 2011). In 1997, Origin System's Ultima Online managed to total over 100,000 subscribers, charging each of them $10 a month. Shortly after, giants such as Sony and Microsoft released successful names such as EverQuest (1999) and Asheron's Call (1999) (Van Dreunen, 2011). In 2004, Blizzard Activision released their soon to be market leader World of Warcraft game which reached 500,000 active subscribers by the end of the year. By 2010, still as the market leader, the game totalled up more than 3 million active accounts in the US and brought a constant annual revenue of $500,000 (Van Dreunen, 2011). Seeing that there was a high potential for this model to disrupt the traditional packaged model, casual game companies started to play with the idea of introducing products that would require their customers to pay monthly fees. Companies such as Big Fish or PlayFirst began offering subscriptions to their clients in order to lock them in. With expenses

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26 around $6 a month for their users, Big Fish managed to generate more than $120 million in revenues in 2010 (Chang, 2010).

For a time being, subscription based models were very popular due to them creating the constant and steady income for game developers to continue to produce new content. Slowly, tides have turned with the introduction of new gaming platforms and devices, which shifted people's gaming preferences. Platforms such as Valve's Steam, EA's Origin, or devices such as Apple's Iphone or the phones running on Android software and the lack of time that we all feel, have made people more conscientious about the time they can spend playing games. This has led developers to come up with new products that would only require a fraction of the time MMORPG's require, but offer the same level of satisfaction. With the release of these new products, new pricing models needed to be implemented as people would not have paid monthly subscriptions just to casually play a game during a lunch break. This is when the free-to-play model emerged.

5.3 Free-to-play model:

Due to the fierce competition in the gaming scene, most of the game developers and publishers have adopted or switched their focus to a free-to-play model in order to attract bigger masses of players. In addition, the constant increase in social-media games that are offered through social-media platforms has boosted the popularity of this type of offering as the developers look to increase their user pools and thus be able to charge incremental amounts of money for additional services. The popularity also stems from the fact that casual gamers are less willing to commit to paying monthly fees in order to play a game or even pay upfront for a service that they may or may not use in the foreseeable future. The introduction of the free-to-play model has also been linked to the game designs that have recently emerged. For most of the games that are played online, the game design is highly dependent on the existence of other individuals with whom to play. Without having a competitive environment, players lose their interests for these virtual worlds. In MMORPGs for example, players can enjoy the benefits of the game when playing alone, but only in the initial stages of their character's evolution. In the later parts of the game, the activities can only be completed with groups of players that range between 5 to 100 (Debeauvals, 2012). As a consequence, developers need to be constantly looking to retain the players.

In free-to-play games, the revenue is generated through real-money transactions. This means that players buy in-game features with real money in order to further their gaming experience (Lee, 2013).

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27 These items are called virtual goods, and can be of different sorts: functional items, access granting items, temporary abilities, or vanity items (Van Dreunen, 2011). The beauty behind this model lies on the fact that once such an item is created, it can be replicated 'ad infinitum' at virtually no additional cost. The production process of these virtual goods allows regular updates, changes in inventory and even special items during peak season. Another key benefit of this model is that the purchasing patterns are a lot less seasonal (Van Dreunen, 2010). In the packaged game model, a holiday season implies that computer games companies have to spend a lot of money on marketing campaigns and strategies in order to persuade their audience to spend money on their games. Having a relatively low average cost in comparison to packaged games, virtual items alleviate this dependence on the cyclicity of the season. As mentioned in the literature review, this model requires game developers and publishers to be more active in their engagement with the customers. Many of the developers that used to build packaged products find themselves with more work than they used to (up to sixty percent of the necessary resources) after the launch of the product (Van Dreunen, 2010). More time involved after the creation of the games means that companies need to reorganize their production schedules and the way they allocate their resources. Also, as the retailer has been taken out of the equation, the game producers need to play this role, thus having to deal with payment method preferences, distribution and also customer service (Van Dreunen, 2011). Opinions are dispersed when it comes to whether free-to-play models will make traditional subscription and packaged games models obsolete. According to Nintendo's US CEO Satoru Iwata, there is no either-or situation between free-to-play games and packaged games. There are specific games that are designed to be sold as packaged bundles, and certain games that would not work if offered in any different form than free-to-play. He also argues that due to consumers who still highly appreciate packaged games, there will be no complete transition to free-to-play games (Holt, 2015). On the other hand, Peterson (2014) suggests that free-to-free-to-play models should 'go away'. He argues that game developers that employ such a model need to have their products supported by advertisements and should follow Pandora's model. He also advocates that developers are 'just stupid' when offering their products for free, as they accept something less than what they deserve, and they should come up with better pricing strategies to offer their products.

Even if there is no black and white in terms of which model is better, free-to-play models that encapsulate micro-transactions and DLCs present several important benefits compared to traditional retail channels. Firstly, they decrease the traditional dependence on seasonality. Sales of virtual goods, are better distributed throughout the period of a year than retail sales. Secondly, they take out the dependency that developers have on the retailer's production schedules and distribution channels. This

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28 in turn improves the margins of existing market leader publishers, and creates opportunities for small studios to work independently (Van Dreunen , 2009). Finally, as pointed out by Hamari (2009), having these flexible pricing mechanisms allows for "approaching perfect price discrimination" (Hamari, 2009).

5.3.1 Virtual goods

Up to this point, the research focused on explaining what micro-transactions and DLC's are, in order to better understand the concepts that are core to the purpose of this study. Micro-transactions can be described as portions of a game's content that are sold (in a low-cost form) in order to increase the attractiveness of a game, or the world in which the game is set (Statt, 2013). On the other hand, DLCs, also known as expansion packs, are features that are sold to players as bundles, that add new characteristics to a game: new worlds to explore, new opportunities and overall offer the player the chance to discover parts of the game that would be inaccessible without engaging in such transactions. This sub-chapter will look into what does an individual actually get when he purchases such new features, and the types of virtual goods that can be acquired through micro-transactions.

Although these types of pricing mechanisms have existed since the beginning of the internet, their proliferation started with the emergence of social and mobile app games. Virtual goods can be defined as the properties that the virtual worlds possess (Lee, 2013). Examples range from virtual currencies, tokens, items, or even characters (Lenhdonvirta, 2009). It must be noted that there are two types of channels when discussing virtual goods. Firstly, there is the channel that connects players within the game. An individual may decide to share an item with another player without engaging in any financial transaction. These types of trades are constantly monitored by game developers and admins, as some of these items may be protected by certain patent laws or trademark agreements. Due to these problems, developers believe that through free-to-play games these types of obstacles can be overcome. Offering the game for free, but allowing the players to decide whether or not a feature is worth paying for helps alleviate the problem of 'black market trading' which can, in extreme cases destabilize a game's environment. Secondly, there are virtual goods that are transacted between a game company and a player, which is only a one way channel from the developer to the customer. Although very prominent in free-to-play games, virtual goods have also been used to complement traditional subscription based games (Lee, 2013). Nojima (2007) argues that item-based pricing mechanisms is similar to price discrimination, where each player pays to their value experience as opposed to paying a fixed rate, or a subscription. This therefore boosts the developer's revenues by enabling the company to reap what

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29 would otherwise be consumer surplus. According to Smith (2011), the market for virtual goods totaled $2.2 billion in 2012 and was mainly due to the growth of social network applications, mobile applications and MMORPGs. Virtual goods come in many forms and shapes. Firstly, time reduction goods refer to the products that allow the user to shorten the time of an action that would have otherwise taken longer to come to fruition. This is especially used in games that are offered through social media platforms, where players would have to wait for a certain period of time until an action is completed. Without purchasing such goods, the individual's gaming experience would have to halt until the timer on that particular action expires. Secondly, there are goods that offer a functional enhancement to a character in a virtual world. These are mainly found in MMORPGs and offer players a slight edge over their opponents. They are sold through shops that are established within these virtual worlds and are designed to increase a character's "performance in terms of attire, weapons or potions" (Lee, 2013). In order to not destabilize the economy of the game, a two currency system has to be employed. Items that are less stronger and basic items can be purchased with real money, whereas stronger items can only be acquired by players with the currencies gained from game play (Lenhdonvirta, 2009). Finally, aesthetic goods have no impact on the game play, but simply satisfy a player's aesthetic tastes. Players want to distinguish themselves from other players, and therefore would engage in these types of transactions if they perceive the changes that they bring to their avatars, characters are worth the investment. Competition is one of the most important characteristics of online communities. Individuals want to feel special and are constantly looking for ways to get acceptance and credit within these virtual worlds. Aesthetic goods help them configure their avatars in ways which normal game play would not allow.

6. Conceptual model

Micro-transactions and DLCs are highly important transaction mechanisms in free-to-play models. As depicted in the literature review, these types of pricing strategies complement games that are offered in a free manner to the consumers, and therefore their usability needs to be strongly linked to several aspects that would make people engage in these sorts of transactions. Lock-in mechanisms ensure that the players remain faithful to a certain game or bundle of games. In order to obtain a high degree of lock-in, our analysis is trying to look into potential factors that may ensure an individual is willing to trade real currency for the benefits that this investment may bring to him in the virtual world. As there are two parties that are directly affected by this phenomenon, the developers and the community, our model looks into the determinants of the success of micro-transactions and DLCs from both

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30 perspectives. The propositions that follow and that will be tested serve as potential reasons why people would consider purchasing virtual goods, and what prompts them to invest in such items.

6.1 Propositions

As this piece of research is mainly qualitative in nature, a number of propositions have been derived from the conceptual model depicted above.

With the proliferation of online games, developers have constantly looked for ways to diversify their offerings and the ways in which their products get to the market. As depicted in our research, several models have been considered, and discussed. Every model has its advantages and disadvantages, but as the focal point of our research is closely aligned with micro-transactions and DLCs, free-to-play has been the chosen model which will guide the development of our propositions.

Proposition 1: The higher the customer loyalty towards a game, the higher the probability that its users will engage in micro-transactions.

The online gaming industry : the relationship between pricing mechanisms used by game developers and the online gaming communities : what is the impact of DLCs (downloadable content) and micro-transactions on the commun