The Roblox (NYSE:RBLX) public offering is imminent.

Last Thursday it filed its S-1 and, given the favorable market in 2020 for interactive entertainment, the Roblox IPO is poised to make one of the biggest splashes this year. Following its February series G raise of $150 million at a valuation of $4 billion, Roblox is now set to deliver on high expectations.

Yeah but isn’t it just a fad?

No. It is an overnight success has been 16 years in the making.

Started in 2004, it only gradually grew into what it is today. According to its filing, there are 31.1 million daily active users (DAUs) playing Roblox. By comparison, according to its court documents from its case against Apple, Fortnite has 350 million registered users and 25 million DAUs.

“About three quarters of American children ages 9 to 12 are now on the platform,”

says Roblox.

To someone unfamiliar with the industry it may seem to be simply a case of a global pandemic turbocharging a novelty. But Covid-19 served merely as an accelerant rather than a trigger because Roblox’ user base and their activity had been gaining momentum prior to 2020.

Year-over-year revenue in 2019 had grown +56% to $488 million from 2018, and for the nine months ending September 30, 2020 it grew to $587 million, up +68% from $349 million the year before. What characterizes Roblox’ success today is the gradual ascension to become a breakout hit.

Roblox didn’t invent the wheel

But it is taking the idea to the bank in at least two ways. First, the benefits of crowd-sourcing content creation are significant.

During a recent panel hosted by Protocol Gaming, Electronic Arts’ senior vice president Samantha Ryan stated that one of Electronic Arts’ studios, Maxis, generated around 5,000 pieces of individual clothing for The Sims over the past five years. Says Ryan:

“But if you look at one of our biggest UGC sites, they’ve created 39,000 pieces in that same period of time. There’s just no way as a professional development house to keep up with our players.”

Creative firms will increasingly rely on their users to provide the content that keeps their games popular. The sheer volume means that user-generated content will soon be commonplace and central to the way we think about online and digital experiences.

Second, it improves the economics of marketing.

Digitalization has brought a lot of new players to the market. Initially marketing was a breeze: people were eagerly looking for new things to do and play on their brand new devices. But that initial momentum has subsided and the costs of marketing have gone up, almost to the point of emulating the 50/50 split between development and marketing we saw in the conventional product-based business.

One obvious way to counteract the always-increasing cost of marketing in search of new users is to keep and cultivate the ones you have. Consider this: Roblox paid $42 million in sales & marketing on $589 million in revenue for the period ending September 30, 2020. By comparison, Glu Mobile spent $150 million, or 3.6x, on $399 million in revenue.

Relying on user-generated content makes a creative firm more fuel efficient.

Do try to keep up

Not too long from now all major game companies will be valued by the efficacy of their user-generated content strategies.

Following a successful Roblox IPO, we can expect publishers to have to confront the question of what user-generated content initiatives they have in the works during the next earnings rounds. Many of the legacy firms still rely on a more conventional model to develop their billion-dollar franchises. However, digitalization has facilitated a host of new innovations like online gameplay, microtransaction-based revenue models, esports tournaments, and live-streaming. Each time game companies are tasked with figuring out a way to make the most of these new market circumstances.

How is Activision Blizzard going to incorporate user-generated content in its existing titles? And how will Electronic Arts navigate the growing interest among audiences to be part of the creative process considering that it relies mostly on licensed, and therefore tightly controlled, titles for its income?

Creativity hates a vacuum and newcomers are eager to fill it

The early stage investment community has gradually been funding a myriad of titles that are similarly focused on building experiences that put user-generated content at the center.

For instance, in September this year Fortnite-maker Epic Games led a $15 million investment round in Manticore. Companies like CREY Games in Denmark and TrapLight in Finland are working on comparable projects to facilitate users to make their own games. And then there are the newly emerging firms that offer a white-label approach to user-generated content like Mod.io, which recently raised a $1 million round led by Makers Fund, and PlayerState which is part of the Ubisoft Entrepreneurs Lab Portfolio.

To some investors, the cat’s already out of the bag.

They argue that there’s no way for newcomers to catch up to Roblox. As evidence they like to point out how League of Legends wasn’t just the most popular MOBA title; it was the whole damn genre.

But let’s not get ahead of ourselves.

Reading the S-1 more closely we also learn about some of the weaknesses in Roblox’ strategy. The firm admits that

“cost of revenue primarily consists of third-party payment processing fees charged by the various distribution channels.”

A big part of its growth in the last twelve months has come from an increase in mobile users. Consequently, this increases the risk associated with its mobile distribution partners. Apple and Google charge 30%, and Roblox relies for a little over half (52%) of its revenue on mobile (38% via the Apple App Store and 18% via the Google Play Store, respectively).

However, so far Roblox has shied away from openly criticizing either of its mobile retail partners like Epic Games. Conversely, a lowering of these rates will have an immediate positive effect on Roblox’ earnings.

A second risk factor is that it is a single game.

I can already hear Matt Ball say: “It’s not a game; it’s a metaverse.” He’s right, of course, but what he means is platform, specifically a “human co-experience platform.”

It consists of three equally important verticals:

1. The Roblox Client, an application that hosts users in a 3D digital world;

2. Roblox Studio, a toolset that facilitates creators to build, publish, and operate experiences and other content accessed with the Roblox Client, and;

3. Roblox Cloud, the services and infrastructure that power the human co-experience platform.

So, a metaverse, sure. But don’t forget about the parts and pieces that operate behind the scenes. In its current iteration, Roblox relies on Amazon AWS for a significant enough portion to point it out explicitly. Using its IPO money to build out a proprietary backbone (like Riot Games did, for instance) would go a long way to secure its future.

What has earned more conventional publishers their success is to gradually build a diverse content portfolio to offset risk. For firms like Roblox, and Riot Games before it, we observe a disproportionate reliance on a single franchise. That can work wonders if you’re king of the hill, but eventually it demands a diversification of efforts and revenue.

Growth of the firm is directly related to (1) its ability to grow its addressable audience, and (2) successfully monetizing its user base. With regards to the former, we can expect competitors to, eventually, start to try and claim some of Roblox’ market share. Imagine a world where Roblox is twice as large, and you’ll immediately find a whole host of offerings that seek to claim some of its success in the same way that Minecraft spawned a host of lookalikes.

Because user-generated content has so many applications for all manner of creative firms, Roblox is likely to soon diversify its revenue streams. The recent performance of Lil Nas X which gathered 33 million views shows promise for the firm to collaborate with adjacent entertainment industries and develop revenue streams around promotional events and novel online experiences. I expect Roblox to eventually push into advertising and to start operating as a two-sided platform where brands and advertisers connect with users.

Whenever a novel phenomenon presents itself we have to ask: is this a statistical outlier, or the shape of things to come? I promise to do a broader write-up shortly on user-generated content in general and discuss some of the more nefarious aspects. But for now Wall Street’s enthusiasm for Roblox’ model is justified by the company’s gradual ascension and enviable economics.

Let’s see if it can translate all this momentum into profitability.

On to this week’s update.

NEWS

Apple relents on rates

The Battle of Two Tims is starting in earnest. And Sweeney is winning.

Epic set the tone early on by forcing Apple to fight publicly. It released a satirized video that featured the tech firm in the role of the great oppressor in its own “1984”-inspired commercial. And it started a cringy albeit effective campaign around #FreeFortnite.

After a series of predictable legal set pieces including removing Fortnite from the App Store and filing countersuits, a judge threw out Apple’s claim that Epic’s action constituted “theft” and that it was deserving of extra monetary damages.

And now Apple has conceded to a reduced rate for app developers that pull in less $1 million a year.

If recent elections are any indication, it takes a special kind of tone-deafness to celebrate a concession as a victory. Rather than saying “Sorry. We’ll do better at sharing the love,” it is launching its App Store Small Business Program on January 1, 2021, which, it tells us, “comes at an important time as small and independent developers continue working to innovate and thrive during a period of unprecedented global economic challenge.”

I don’t think so.

You waited a whole year to change your fee structure to save small businesses. Covid-19 was first identified in December 2019 and the global economy began to wheeze not long after. You could have changed your rates at any time during the past twelve months while the Apple stock price almost doubled from $65 to $117 and its market cap grew from $1.2 to $2.1 trillion.

The real Achilles heel to this latest move is that Apple effectively admits that it believes in progressive taxes. If you earn more, you pay more. There’s an idea.

Playing vidya makes for more happy

According to a study of player telemetry data there is a “small positive relation between game play and well-being.” The researchers argue that despite government scrutiny of video games and its impact on global mental health, the actual “ objective behaviors of players” has been omitted from inquiry. That makes sense, of course, because historically the interest in video games from policy makers has been governed by where we are in the next election cycle.

The results are modest, but promising. What strikes me most, however, is that both EA (Plants vs. Zombies: Battle for Neighborville) and Nintendo (Animal Crossing: New Horizons) made data available. Getting a game company to part with their data is an accomplishment in itself and, apparently, feasible.

As for the well-being, I’m sure there are inconsolable curmudgeons out there who play AC:NH and stay miserable. But I wonder what would happen if we’d make studies like these standard practice for every game and assign a happiness score to titles instead? Something like: 2,000 people played this game and 87% said it made them happy. And, yes CD Projekt Red, that should include the amount of tears that were shed by the developers who were forced into crunch time. I only play free range video games.

Presentation of self in a digital environment

I’ve been doing the circuit, of sorts, following the release of my book, including a podcast with Scott Galloway, two separate talks on investing in games, and the New American Dream.

Oh, and I’ve been promoted to influencer.

First impressions on Amazon Luna

Over the past week I’ve been fiddling around with Bezos’ foray into cloud gaming.

The most positive thing I can say about it is that the tech works, kind of. It’s great to be able to play on an iPhone, and even thought it doesn’t work well with my FiOS, it runs smoothly over my cellular data plan.

The not so great: Obviously the current offering is still in beta. Headlined by Control, which is an okay title, Luna has yet to offer me something that makes my heart skip. The controller ($50) plus the mobile phone grabby thingy ($10) feel heavy and cheap. It is also necessary for most of the titles currently available.

The terrible: There are still way too many steps between me typing this sentence and me playing. One of the key selling points should be a seamless and quick transition. Unlike Stadia, which allows me to close the browser and pick back up where I left off if I return within 15 minutes, when Luna shuts down you have to reboot the whole thing. “Loading could take between 1-2 minutes,” it reads when I start Assassin’s Creed: Valhalla. Dude. I might as well download that update on my PlayStation while I’m at it.

Why is Sony torturing everyone with artificial scarcity during the PS5 release?

My daily feeds have been rammed with two related comments: (1) PS5 is amazing (or a version thereof), and (2) why can’t I buy one right now?

No, Sony does not create only a few units to frustrate everyone. It is basic economies of scale.

As it’s told to me, the first batch for launch day is the most expensive one. For one, it requires a lot of expedited shipping to get the units in thousands of stores on time. Also, there is absolutely no margin on manufacturing yet. Once you have a better sense of demand, it is easier to commit to bigger orders which allow you to buy more at once at a better price and increase the margin. Even $30 on a single unit goes a long way here. More so, it is only over time that you can reduce the complexity of the chipset. That is why the smaller, slimmer models show up later in the lifecycle, for instance.

But, but, but where’s mine?

Apparently GameStop only received two units per store, and the various online retailers seem to struggle with inoculating their sites against bots that snatch units right from under your human nose. Captcha be damned. One of my students observed that this is common practice among sites that sell sneakers but game retailers are still learning.

Look to the scalpers selling them online for double the price. That’s where your PS5 is.

PLAY/PASS

Play. Time has declared Hades Game of the Year for 2020. Congrats team @SupergiantGames

Pass. Nintendo shutting down Big House 10. You guys are lame.