epic-games-business-model

Inside The Epic Games Empire And Business Model

Epic Games is a gaming company, that develops, publishes, and distributes games. It comprises the Unreal Engine, making money through licensing agreements with developers and creators. Its games (like Fortnite) mostly follow a free-to-play model on PC and an in-app purchase model on the digital marketplace. And its storefront Epic Games Store takes a 12% cut on games’ sales.

Glance at Epic Games

The story of Epic Games started decades before, the launch of the game, that would become one of the most successful games of our times (Fortnite). Not only because of the engagement and success of the game itself. But for the fact that it changed the whole gaming industry.

From the content format (how the game is scripted and played) to the distribution model (how the game is made accessible to people) to the revenue model (how the company monetizes it). Thus, creating a new business model for gaming.

The beginnings of the game developer turned billionaire

Born in 1970, Tim Sweeney grew up in suburban Potomac, Maryland. His first video game, when he was nine or ten, was the arcade game, Space Invaders, and a Nintendo shooter called Space Firebird.

From there it started his fascination with video games. So much so, that from an early age, he started to tear those apart, to understand how they were made and programmed.

While, as a kid (by the 1980s) he owned an Atari 2600, he called it “lousy machine” as the experience was not as close to that of cabinets games.

To be sure, Sweeney was fascinated by games, but not as much as a player than he was as a programmer. He loved to understand the intricacies beyond them. Indeed, he never finished more than two games by the time he was an adult.

As a nerdy, smart kid, he didn’t fit in any particular group, and while Tim would not be fond of remembering those years, this was also the time where he got the chance to learn as much as he could about programming.

Indeed, when he was 11, traveling to California. He visited the startup that his older brother had created, he had the chance to play along with an IBM PC. That was a life changing experience to him, as he learned to program in BASIC and realized the immediateness of computing.

Where in the physical world, he had to wait months or years before building a full prototype of something (like a go-cart which he had tried to build as a kid) with computers he noted, how by using the right code, he could have them do exactly what he wanted.

From there – as his brother had bought to Sweeney’s father and Apple II – it became the computer where Tim evolved as a game developer. As a kid, he could understand the intricacies of programming very quickly.

One game that really captured Sweeney’s attention, was Adventure, on the Apple II. From there, again, his interest wasn’t much in just playing the game, but rather replicating the code.

As Sweeney recalls it took him about a month to understand how to program the basics of a game similar to Adventure. Yet he was hooked and by age 15 he would become a great programmer, able to replicate and even improve on other people’s code.

While he would later enroll as a mechanical engineer, at the University of Maryland, in reality, Sweeney’s always thought about programming. However, given the limitation of the Apple II game development ecosystem, at the time, he didn’t think of it as a potential business (he never released the games he had developed) until an IBM computer changed it all.

After graduation, his father bought him a 286-class IBM computer. IBM gaming ecosystem at the time was booming and Sweeney’s for the first time realized he could build a business around it.

ZZT: a game that helped code a game

As he realized the potential to building games for the IBM ecosystem, he started to code the text editor, that would enable him to build a game in the first place.

Yet, as he was going through this process, he thought of the text editor, as a game itself. Capitalizing on his experience in learning the code behind Adventure, on the Apple II, he built the text editor, following that style. This would eventually become Epic Games’ philosophy (both development tool builder and gaming company).

The interesting thing is ZZT was both a text editor than a game. ZZT served as the foundation for what would later become Epic Games’ core philosophy. Not only ZZT was the embryonal stage of what would later become game engines, but it was also open.

Sweeney let anyone to use ZZT editing tools, to build their own games. As Sweeney would later recall, his whole strategy, which would become Epic Games’ strategy, later on, was all about developing the tools first, and then from those tools building up games.

And those tools would be made available to anyone, which was the core open philosophy of Epic Games. In the gaming industry, mostly locked in, and tied to the hardware this would become “game-changing” decades after.

Creating software for Sweeney had gone from an individual endeavor, of a nerdy kid, sitting in his bedroom, to a way to share this code into the world, to gather feedback from there.

A businessman by age 15

As he grew up, Sweeney not only appreciated the gaming world, as it enabled him to build interesting stuff and releasing it into the world. He also understood that as a business person, he could earn much more than a wage earner. He learned that as he was working in an hardware store, and no matter how effort he was putting into it, he would always earn four bucks an hour.

So he figured, that by buying a tractor, to mowing Potomac’s mansion’s lawns, he could exponentially increase his earnings, and tie that to the increased effort. So he turned this business understanding to gaming.

Finally in business

As Sweeney’s had released ZZT into the world, he realized he could sell it to build a business. At the time (in the early 1990s), beyond the traditional model, where you could buy games from stores. An alternative model, was the shareware, or the ability to offer the software of the game in several ways (perhaps in Adware it would be released with advertising rendering as a monetizaition strategy).

Sweeney’s opted for the prevailing model, which consisted of releasing the software in pieces. With the first piece released for free, and it served to hook up users. From there, he would then prompt users to pay later on. He finally started his gaming company.

This model wasn’t new. And according to several accounts, this model was officially born (at least its official name) in 1982, when Andrew Fluegelman created a communications program called PC-TALK. Fluegelman released the software by asking users to pay for it, only if they thought it was worth it.

For the nascent software industry, that way of doing business seemed a shared idea. Indeed, at the same time, in Washington State, another programmer, named Jim Button, created EASY-FILE. Button, similarly to Fluegelman released the software for free. And he asked users to either share the program or give a donation if they liked it.

This was the birth of software-enabled business models.

The shareware model, and the birth of software-based business models

By 1982, Fluegelman and Button met each other (through another user who noticed how they used a similar marketing and distribution model) and they agreed upon a set of joined actions to standardize their business models (like referencing each other’s program and by setting a voluntary donation at $25).

Though, they slightly changed the name for each model. Fluegelman called its model “Freeware,” Button, instead called it “user supported software.”

The concept of shareware still at the embryonic stage, would become a standard in a few years. As other programmers and entrepreneurs started to adopt this model, it consolidated. Perhaps, Bob Wallace, a former Microsoft employee, founded QuickSoft, and it offered it with a similar model.

In an in-depth article of IntoWorld in the 1980s, entitled “Software For A Donation” the protagonists of the shareware (then popularized as freeware) model were proposed as alternatives to large players, who were not interested in that sort of model.

While those companies never turned into multi-billion-dollar companies, they did show an alternative model for gaming. It would still take a few decades for this model to fully become viable.

The birth of Epic MegaGames

At age 21, Sweeney finally launched his company, Epic MegaGames, which started to commercialize ZZT with a shareware model. Sweeney would build its first business thanks to that, and he started to make as much as $100 per day. Yet, he realized how limited was the audience for that sort of game, with limited graphics.

It was only later, when he would work on Jill of the Jungle, that Sweeney’s started to think in graphical terms. At the same time, he realized that while he was good at programming, he lacked the skills as a designer. Thus, he started to recruit people, that would help him with creative aspects of building the game.

sweeney-epicmegagames
Tim Sweeney looking for programmers to join his company Epic MegaGames

As Sweeney built the team of four people that would release Jill of the Jungle, orders skyrocketed. From a few orders per day to up to 20-30 orders. Not bad for a kid who was still in college.

Attracting talent to build the next generations of Epic Games

After the hit of Jill of the Jungle, Sweeney’s refined his business understanding of the gaming industry, while at the same time tried to attract more talented people (one of them would be Cliff Bleszinski that will eventually build another hit game, “Gears of War”).

By that time, the Epic Games template was getting refined. Throughout the 1990s. Sweeney’s approach consisted of developing foundational technology to build those games in the first place. That would become the Unreal Engine (this was developed by Sweeney, as the software-development environment designed for programmers to build video games).

On top of the Unreal Engine, the game Unreal would be built upon. Unreal was a success. Not only from a critics standpoint. It was also a huge hit with gamers.

The Epic Games template was ready

By 1995, as the Epic Games business template got shaped. It comprised three key elements:

  • The engine or platform/framework on which the game would be developed. This platform-driven approach enabled Epic Games to license its own tech stack and make enough money to sustain the business. Thus, using those resources to build great games, later on. In addition, by being involved in tool development, and not just gaming development, Epic Games’ team built a deeper understanding of the industry, and mastery of its own tools.
  • The creative side, that with James Schmalz (the creative behind Unreal) and Cliff Bleszinski (the creative behind Gears of War) built Epic Games first hits, before Fortnite.
  • And its distribution model. The games developed by Epic Games would be eventually distributed with a free-to-play model (this would become the standard for Fortnite’s Battle Royal). In short, players can join and play for free, and they could buy ancillary products and customizations).

Unreal Engine: ZZT vision becoming a reality and the development standard for gaming

As the next Unreal Engines got released, it would be licensed from small to large corporations. And many of the games present on Microsoft’s Xbox and Sony’s PlayStation were developed either through Unreal Engine or by Epic Games on top of it.

From Sweeney’s first editor, ZZT, the evolution was impressive. And yet the vision behind it was not so far away. As Sweeney had the ambition to create both the tools (at the time it was only an editor) to build games, beyond the games themselves.

Today the Unreal Engine comprises a set of tools for developers:

LevelEditor_Windows.png
As pointed out on the Unreal Engine technical documentation, the Level Editor helps to construct your gameplay levels. Generally speaking, it is where you define the play space for your game by adding different types of Actors and Geometry (Source: docs.unrealengine.com).
MaterialEditor_Windows.png
The Material Editor is where you can create (or edit existing) Materials which are assets that can be applied to a mesh to control its visual look.

Other key editors comprise:

  • Blueprint Editor.
  • Behavior Tree Editor.
  • Persona Editor.
  • Cascade Editor.
  • Niagara Editor.
  • UMG UI Editor.
  • Matinee Editor.
  • And more.

The massive hits transforming Epic Games into a decacorn

By 2006, Epic Games would launch Gear of Wars, which would build the basis to create one of the most popular games of all time, Fortnite.

There are several components that would make Fortnite successful, both as a cultural hit, and an innovative business model.

Before we get to the overall Epic Games business model, let’s look at how the whole gaming industry is organized, at business level.

Understanding the gaming industry and its distribution models

gaming-industry
The gaming industry, part of the entertainment industry, is comprised of three main types of players. From game engines, which help developers build their games. To publishing gaming houses. And gaming consoles. While the prevailing business model for decades has been that of selling the console at cost, and make money on games. Digital games changed the way games are distributed and sold, and it opened up the way to free-to-play models.

Within the gaming industry there a few key players to take into account:

  • Developers: while there are a few major development houses that control a good chunk of the market (perhaps Tencent Games, Sony Interactive Entertainment, Microsoft’s Xbox Game Studios, Epic Games, and a few more), there are many others smaller and independent developers and studios.
  • Publishers: publishing games houses either have their own development studios, or they license game production to the studios. Beyond smaller and independent publishers, also the game publishing industry is pretty much skewed toward a few large players like EA Sports (publisher of FIFA), Activision Blizzard, and a few more. In addition, gaming console companies like Nintendo, Sony, and Microsoft have their own development and publishing arms.
  • Platforms: in terms of platforms (the physical or digital places where the games will be available), we have primarily PCs, gaming console, and mobile/tablet. Each of those platforms has a different logic.

Based on the three key types of platforms for gaming, each will have its own distribution, and monetization logic:

  • PCs: while in part, PCs follow a similar logic to a gaming console, where the game could be bought and played. PCs also have different distribution logic. As they are not tied to gaming console manufacturers, other emerging companies, like Epic Games, could experiment with new distribution and monetization models with built-in virality (like free-to-play), which was one of the key contributors for Fortnite’s success. At the same time, before Epic Games launched its own Storefront in 2018, the largest player controlling gaming access from PCs was Steam, a storefront built by a company called Valve.
  • Mobile/tablets: for a full experience on those devices, the games will need to pass through the digital marketplaces owned by companies like Apple or Google, thus working with a revenue split with those marketplaces, and by following the monetization logics there. For instance, in Epic Game’s case, Fortnite is available for free on both iPhone and iPad, with in-app purchases (gamers can buy V-Bucks, which is the Fortnite’s virtual currency perhaps to personalize the appearance of the game’s characters).
  • Gaming consoles: on a gaming console, the logic is the old one. The game will either be bought through a traditional brick and mortar retail gaming location. Or it can be downloaded (bought) digitally through the console. In both cases, the game will have a cost, and royalties will be split with the gaming console manufacturers. While games like Fortnite can be downloaded for free via the gaming consoles, the experience might be still limited (for instance, gaming consoles for long-time didn’t allow cross-platform gamers, and they adapted over time due to the massive popularity of Fortnite).

Another look at the Epic Games template and flywheel

Building a big community, made of gamers, creators, and programmers has represented the killer commercial application for Epic Games.

With the games developed through the Unreal Engine and the tools built along the way, to build those games in the first place, Epic Games could serve anyone, and at the same time use that toolbox to attract creators and developers and build and publish its own games.

  • Game engine: on the game engine side, by releasing the tools for creators and programmers, Epic Games made it possible to improve those over the years. Indeed, by making those tools available, creators and programmers started to use them in ways that Epic Games could have not thought about. And that helped them improve their owns tools (which they would later use to build games like Fortnite). Initially, the Unreal Engine licensing served also as the financial basis, to sustain the development of new games.
  • Developers/Creators: as Epic Games build and released tools for creators, it tapped into a much deeper understanding of that ecosystem thus giving them the freedom to creators to build their own games. This would serve as the basis to release many games over the years, which also led to Fortnite.
  • Streaming and gamers: as streaming became fully viable throughout the 2010s, also the game streaming became widely popular. And with that, the free-to-play mode of Fortnite’s Battle Royale was a player-versus-player (for up to 100 players) sparked virality and made it a sensation.

Breaking down Epic Games’ revenue model

By 2018, Epic Games made over $5.6 billion in revenues. By 2019, revenues would slow down to $4.2 billion, and its profit margins tightened as the company reinvested a substantial part of its resources in its Unreal Engine, Fortnite, but also to launch its own Epic Games Stores. Therefore, Epic Games makes money through:

  • Games: perhaps Fortnite Battle Royal, while free-to-play it makes money by enabling customization and the acquisition of V-Bucks (the Fortnite’s digital currency) to personalize game’s characters.
  • Unreal Engine licensing: as we’ll see the Unreal Engine, while free for development, it collects a royalty fee for publishing, and it’s not free for off-of the shelf projects.
  • Storefront: Epic Games launched its Store also in an attempt probably to contrast Steam’s (the other key storefront for games) reduced revenue share rates. That is why Epic Games promises to keep the 88% share to the developer as a permanent rate. De facto using Epic’s 12% share to cover the operating costs of the store and still making a profit.

In addition to generating revenues through those streams, Epic Games also secured several funding rounds. In 2012, Tencent bought over 40% of capital from Epic Games, and by August 2020, Epic Games secured another $1.78 billion round, in which also Sony Corp, participated with a $250 million stake.

This valued the company at over $17 billion.

Free-to-play model: flipping the gaming revenue model upside down

Where Microsoft sold the console at cost and made money by selling games. Fortnite made the game free, and upsold products within the game.

Known as freemium in the software world, it has worked wonder to distribute the game to a vast audience. Yet Fortnite wasn’t just a traditional freemium model, which we usually find in the software world. It had three modes of consumptions, which helped shape its overall business model:

  • Save the World, premium model: built as a player vs environment game, is structured as a mission-based game. Contrary to the Battle Royal mode, which is the one that enabled Fortnite success, Save the World is available at $14.99.
  • Battle Royale, free-to-play model: built as a Player versus Player, or PvP, game mode this free-to-play game sparked virality and made Fortnite the success it is today. This game mode enabled up to 100 players, to play in several formats, alone, in duos, squads, and more. The built-in group dynamics, and the fact it was freely available, helped sparkle the Epic Games’ ecosystem. And it is also lucrative for the company, as gamers can buy V-Bucks (Fortnite’s virtual currency) to customize their characters or else.
  • Creative mode: in the Creative mode, players gain access to a private island, where they can design the whole thing as they want and invite others. This mode is pretty interesting as it enables not only gamers but also creators or aspiring so to build their own gaming environment.

Epic Games Store: taking over the PCs gaming platform

epic-games-store
Epic Games Storefront, working both as a website and game launcher (Image Source: Epic Games).

The primary storefront and digital channel for gaming on PCs have been for years, Steam, a storefront, operated by Valve. Yet, by 2018, Epic Games launched its own storefront, called Epic Games Stores, which might have helped Epic Games make $680 million by 2019.

Its revenue-split model is quite straighforward:

epic-games-storefront-revenue-split
Epic Games Revenue Split (Source: Epic Games)

Epic Games’ Unreal Engine revenue model

The Unreal Engine – a suite of creation tools for developers – comprises three main types of licensing depending on the creator’s use:

  • License Agreement for Publishing: a free to use license comprising a 5% royalties when the developer monetizes the game and the lifetime gross revenues from that product exceeds $1,000,000 USD. 
  • License Agreement for Creators: This license is free to use and 100% royalty-free; it can be used by creators for internal or free projects, but not for publishing off-the-shelf offerings (which will get otherwise in the first tier).
  • Custom licenses: Tailored licenses for creators.

Key takeaways from Epic Games story and business model

  • Epic Games template would be shaped over the years, and its core philosophy moved around both creating the tools enabling programmers to build games, and using those same tools to develop games.
  • Over the years Epic Games launched its gaming engine, Unreal, together with the homonym game, which showed the power of the toolbox created by the company.
  • As Unreal Engine became one of the most used development frameworks for gamers, it also attracted creators. Epic Games would make money both from licensing its gaming engine and using those resources to build its own games.
  • Epic Games distribution model was shaped over the years and it leveraged on making a part/or gaming mode (like Fortnite’s Battle Royale) for free, to leverage on a separate distribution channel (like PCs) that goes beyond the locked-in logic of gaming consoles, manufactured by two key players (Sony and Microsoft).
  • The free-to-play gaming mode, where players could also team up, sparked its virality, enabled Fortnite to become a streaming sensation, and in turn build the sort of gaming ecosystem that made it a success.
  • Epic Games was valued over $17 billion by August 2020, and it comprised three primary revenue streams: Unreal Engine Licensing and Publishing Royalties, Games like Fortnite, with primary a free-to-play model, and its storefront.

Read also: How Much Money Has Fortnite Made?, Gaming Industry, EA Sports Business Model.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here