Once you’ve drilled down into your target segment and tested some of your assumptions, you now need to quantify whether that segment can be profitable. If you work for a major publisher, you have access to a professional marketing department that does this sort of thing for a living. But if you don’t, you’re not out of luck. You have an amazing tool at your disposal for free: Facebook.
Video Game Market Potential
I’ve talked a lot about value in this series. Specifically, how value creation, not money, is the focus of effective marketing. That being said, video games are a for-profit endeavor. In order to capitalize on the value you create, you need to stay in business. You can spend 18-24 months (or more) flying blind and then hope for the best. Or, you can try to quantify your odds of success up front by estimating your target video game market segment’s potential.
Top-Down or Bottom-Up, Part Deux
Much like in marketing strategy, there are two ways to analyze the revenue potential of any particular video game market segment: top-down and bottom up. However, unlike marketing strategy, only one of these methods is viable.
In the top-down method, you look at how many people are in a market segment, and say something like “There are ten million people in this market. All we need to do is convert a measly 10% of that market into paying customers and we’ll have a million unit sales.” You then multiply that number of sales by some estimated price per sale and voila, there’s your production budget.
DO NOT EVER USE THE TOP-DOWN METHOD. It’s a spurious way of thinking.
The smarter, more analytical way to analyze profitability is the bottom-up method. You start with your budget, then divide that by your intended sale price to determine the number of sales you need. You then divide that number of sales by the number of people in the market to determine the conversion rate you need in order to breakeven.
Why is Bottom-Up Better?
Because you are making a different critical assumption. In the top-down method, you are assuming a certain conversion rate and using that to determine your budget. In the bottom-up method, you are assuming a budget and then comparing that to the overall market.
Or, more simply, in the bottom-up method your assumption is about something you control (the budget). In the top-down method, your budget is determined by something you don’t (how many people buy).
Here’s how you can do a quick bottom-up analysis:
- Estimate the number of months you need
- Example: 24 months
- Multiply that time-line by your burn-rate
- Example: you have a team of 5, with a total average burn of $30k/month
- Expected salary cost for production: 24 months*$30k/month = $720k
- Divide the result by your price point
- Example: you expect to sell the game for $19.99 across all digital platforms, with each platform taking a 30% cut
- Break-even sales: $720k/($19.99*70%) = 51.5k sales
- Divide that number by the addressable market
- Example: the target segment has an estimated 500k people
- Break-even conversion rate: 51.5k/500k = 10.3%
In other words, with your projected time-line, at your projected burn-rate and estimated price-point, you need to convert 7.2% of the target segment to break even.
Dipping Into The Financial Weeds
Professional finance people will point our that this exercise ignores the time value of money, which is absolutely true. I’m skipping it because I’m guessing most indie studios don’t have a known cost of capital with which to make present value calculations. Or, if they do, the cost of capital is probably negligibly small.
But, for the sake of comprehensiveness, here’s how you would do that analysis in Excel:
- Open a new spreadsheet
- In any cell, type “=FV(X, Y, -Z)“, where:
- X is your cost of capital
- Y is the number of months of development
- -Z is your monthly burn (expressed as a cash outflow)
- For the example above, assuming a 5% cost of capital, “=FV(5%,24,-30000)” returns $1,335k*
- Divide the returned value by your price point, less the platform holder’s cut:
- $1,335k/($19.99*70%) =95.4k sales
- Divide that quotient by the overall segment to determine your breakeven conversion rate
- 95.4k/500k = 19.08%
In other words, if your cost of capital is 5% (the average indie studio’s cost of capital is likely much lower), you need to convert 19.08% of the market to breakeven from an opportunity cost stand point.
Facebook is Your Friend: Estimating a Video Game Market Segment
If you work for or have a contract with a big corporation like Activision or EA, you have a marketing department that can (or at least, should be able to) estimate the size of any categorical segment. If you’re an indie, there are still tools that are readily at your disposal. And one of the easiest is tied to something you probably use everyday: Facebook.
- Log into Facebook
- Click the drop down menu on the right and select “Create Ads”
- Under “Campaign”, select Awareness. Facebook will ask you to create an account if you haven’t done so previously. Don’t worry about this step. Nothing we’re doing here will see the light of day.
Step 4: Dial in your target market:
- Age range
- Targeting parameters:
- In the “Include” field, list the target segment’s primary interests
- Click “Narrow” and then list secondary interests someone also must satisfy to match the target segment
- Click “Exclude” and list interests that would disqualify someone from being in the target segment
Example: Rita Role-Player
Let’s find out how many people matching our Rita Role-Player buyer persona from Part 4 are on Facebook
- United States
- Role playing games
- Mass Effect
- Final Fantasy
- Narrowing Interests
- Graphic Designers
- No-Kill Shelters
- Excluding Interest
- Multiplayer Video Games
- Potential Target Size on Facebook: 1.5MM
IE, there are a million and a half Rita’s on Facebook. Using the example above, if I need 51.5k sales, that corresponds to 3.4% of the overall Rita market.
Resources that Informed and Influenced this Post
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What qualifies as a reasonable market conversion rate?
This is a difficult question to answer. The larger the target video game market segment, the lower conversion rate you would need to be profitable for any given budget. But the smaller the market, the more likely it is that you can make a product its members will love (assuming you’re doing your research), meaning you can probably secure a higher conversion rate.
Unfortunately, there’s no bright-line or rule-of-thumb, other than the lower, the better. It’s simply too subjective. So, you need to make a judgement call: does a given conversion rate sound reasonable? Is it reasonable that a game, if well made, could entice 2.4% of all of the Ritas on Facebook to buy? Is it reasonable to assume 7%? What about 10%?
You can’t empirically validate your assumption until you actually have something to sell. So the goal here is to stress test your thinking in a analytical manner. In the end, what you really want is a quantifiable rationalization for moving forward.
There are no guarantees in life, but the margin between absolute certainty and complete ignorance is pretty wide. Your goal, as a marketer, is to find ways to move as close to the former as possible.
Further Reading If You Enjoyed This Post
So, we have a strategy, a target, and a persona. We’ve also talked to the segment and learned some more about it. This means we know who our customer is and who our competition is. It’s time to figure out how to position our product so that the customer can understand why he/she wants it and how it’s different that other games on the market.
- There are two basic methods for matching budget to market, top-down and bottom-up
- In the top-down method, you assume what percentage of the market you’ll capture and use that to derive a budget
- In the bottom-up, you assume a budget and then calculate what percentage of the market you need to capture to be profitable
- Never use the top-down method
- If you don’t have access to a professional marketing department, you can use online ad tools like Facebook’s to estimate video game market size
- There is no rule-of-thumb as to what qualifies as a reasonable percentage of the market to capture; it’s a judgment call