Loss leaders of the pack | This Week in Business

Call me old fashioned, but I generally believe that a successful business should make money.

That's why it sometimes surprises me to read about incredible buzz and valuations around companies like Roblox and Unity, both of which posted their earnings this week and neither of which actually make money.

STAT | $17.5 billion - The value of AppLovin's proposed non-binding deal to merge with engine-maker Unity in an all-stock deal that would give AppLovin shareholders 51% voting control over the combined company. It would also require Unity to back out of its own planned acquisition of IronSource.

Unity has been around since 2004 and has never had a profitable quarter. It added to that streak this week with the posting of its second quarter earning results.

STAT | $1.3 billion - Unity's lifetime accumulated deficit as of December 31, 2021.

STAT | $204 million - Unity's net losses last quarter.

Now I'm not entirely clueless here. I understand the value of losing money in the short term to drive growth and position the company better for the long term. Unity said in its latest annual report that it has 3.9 billion people playing content made with Unity's offerings every single month. Those games and other offerings collectively averaged 5 billion downloads a month.

That's a massive market, and given expectations of continued growth in gaming, if Unity can cement itself as cornerstone of the future world of game development, the company could end up posting profits that far outweigh what it has already lost.

So sure, I see how a company making itself an indispensable, dominant force in a major market — and you can just read that as "creating a potentially illegal anti-competitive advantage for itself" — can go a couple decades without being overly fussed about turning a profit.

I mean, it is weird that someone would build a business that takes more than half a professional career to even start turning a profit over a three-month span, much less making up for all the money burned getting to that point. But what the heck, when you get paid eight figures for running the show and make bank on an IPO first and then entertain an acquisition at a premium before showing that profitability is even possible, the company's near- and mid-term financial well-being can take a back seat.

Well, not entirely, of course. Unity still cares enough about its bottom line that it laid off hundreds of people in June "to realign some of our resources to better drive focus and support our long-term growth."

It has also in the past taken government and defense contracts over the objections and concerns of its employees, and did so again this week.

When it comes to paying workers or acting on matters of conscience, Unity is a business and has to be financially responsible. When it comes to everything else that keeps the company in the red year-in and year-out? I guess you gotta spend money to lose money, right?

There's a path to profitability by growing big first and worrying about profit later, but it usually involves degrading the service and squeezing people

Some of the expenditures that Unity has been making — a long string of acquisitions and stock-based compensation expenses, for example — can be curbed, but only at the risk of losing the advantages they provided in the first place.

But this isn't exactly an unprecedented approach in tech. Grow big first and worry about profit later. YouTube, Twitter, Facebook… There are more than enough examples of companies that have tried this, and some have profited handsomely as a result. There's a path to profitability with this strategy, even if it typically involves degrading the service you're offering users and squeezing people a bit.

But what if you're already squeezing people and still drowning in red ink?

STAT | $984 million - Roblox's lifetime accumulated deficit as of December 31, 2021.

STAT | $176 million - Roblox's net losses last quarter.

Like Unity, Roblox was founded in 2004.

Like Unity, Roblox has never had a profitable quarter.

Unlike Unity, Roblox is not trying to corner a well-defined sector of an industry we can assume will still be around 20 years from now, like "game development." It is instead trying to corner an offshoot it has created: Roblox game development.

Roblox game development relies on tools it has created rather than accomodating standards common to the rest of the industry. The nature of the service cuts off possibilities for multiplatform development, limits the control the developer has over their relationship with the customer, and offers a deeply unfavorable cut of revenues: developers on Roblox get a 24.5% share of revenues earned, and that money is stuck within a Roblox ecosystem designed to erode it further or have it given right back to buy featured placement in the service.

I think Roblox is big enough to support a handful of professional developer operations like that — Adopt Me developer Uplift Games had grown to 40 people last year — but the terms of building a business inside Roblox are too onerous for it to be an attractive option for many, I expect.

Also unlike Unity, Roblox does not seem to have a market to monopolize. I feel safe saying there will always be myriad other options for playing, creating, and sharing game content. Roblox investors may buy into it being the metaverse, but the blurry vision of a metaverse people are currently chasing — Ready Player One in a shopping mall plastered with ads — is a) not necessarily a thing people actually want, b) an insult to life itself, and c) not something Roblox is well-positioned to dominate even if you disagree on a) and b).

If there actually is a metaverse market — and if such a thing can be dominated at all — I would think the breakthrough more likely to be made by companies with deeper pockets (Facebook), more marketable and trusted names (Lego and Epic Games), or people who would burn the planet to ashes for a nickel (anything blockchain).

I kid, I kid. I expect every blockchain metaverse to fail spectacularly.

Right now Roblox has a large online community that does the hard work of creation as well as the expensive work of buying things

Right now Roblox has a large online community that does the hard work of creation as well as the expensive work of buying things. Roblox plays the middle man for the community, taking a cut of each transaction and subsequent cuts of everything else that happens on the platform. That's a neat trick and a good way to build a games business off the creative work of others, but it only works as long as that community sticks around.

Unfortunately for Roblox, its key demographic is children — 49% of daily active users last year were under 13 — and children are known for growing out of interests faster than a corporation of any size can reasonably be expected to keep up with. Roblox seems to know this, too.

QUOTE | "A large number of our users are under the age of 13. This demographic may be less brand loyal and more likely to follow trends, including viral trends, than other demographics. These and other factors may lead users to switch to another entertainment option rapidly..." - Roblox warns investors about one of numerous risk factors in its latest annual report filed with the SEC.

On top of that, many of the users trying to make a buck as creators in this complex system are literal children. Take every lopsided power dynamic between a giant publicly traded gaming platform and an indie developer, then consider that many places wouldn't trust that indie developer in question to buy spray paint, much less grasp Roblox's byzantine monetization scheme well enough to make an informed business decision.

It's not tough to paint Roblox's business model as exploitative, and that's reason enough to take a dim view of the company. The fact that so many of the people involved are children ramps the concern up considerably.

Morally, I think that's where the calculations end. But emotionally, Roblox's ongoing unprofitability adds insult to injury.

It's one thing to see a company taking advantage of people just to make a buck. That's at least understandable, if still reprehensible. But there's something extra perverse about a company that exploits its users and partners and still loses money, like a mugger so incompetent that stealing your wallet somehow leaves you both poorer in the process.

The rest of the week in review

QUOTE | "It wouldn't surprise me that our results would be a bit softer than I'd like for as long as we're in a slower period, and my own view is we're in a slower period now. I don't the question is if we'll be in a recession; I think we're in a recessionary environment right now." - Take-Two chairman and CEO Strauss Zelnick says the company's performance has already been hurt by the wider economic downturn, in particular its recurrent consumer spending.

STAT | 1 - The number of new releases in the UK July Top 20 game sales chart. That was Xenoblade Chronicles 3, which debuted at 13.

STAT | $39.2 million - The amount Nexon lost on its crypto investments last quarter. (Fortunately for Nexon, its earnings report ended positive thanks to its actual games and foreign currency trends.)

QUOTE | "Our purchase of bitcoin reflects a disciplined strategy for protecting shareholder value and for maintaining the purchasing power of our cash assets. In the current economic environment, we believe bitcoin offers long-term stability and liquidity while maintaining the value of our cash for future investments." - Nexon president and CEO Owen Mahoney in April of 2021, announcing that the MapleStory publisher had just purchased $100 million in bitcoin for about $58,226 per bitcoin. Cryptocurrency prices have plunged in recent months, and bitcoin is trading as low as $22,800 this week.

STAT | "Sony has surpassed Microsoft in terms of console sales and installed base, having sold more than twice as many [systems as] Xbox in the last generation." - In an attempt to help smooth through its acquisition of Activision Blizzard, Microsoft gives a Brazilian regulator more insight into Xbox hardware sales figures than it has given shareholders in the last seven years.

QUOTE | "Microsoft would be able to speak directly to PlayStation's own fanbase on its own console, putting Sony in an impossible position of either rejecting its console’s most popular game, or accepting what could amount to a huge Game Pass ad disguised as a first-person shooter." - Our own Chris Dring, writing about how the pending Microsoft acquisition of Activision Blizzard could hurt Sony whether Call of Duty stays on PlayStation or not.

QUOTE | "We love the Loyal Samoyed, but regrettably we erred in our process and have removed this imagery from the game. We apologize for the misstep." - Activision Blizzard apologizes for plagiarizing a concept artist's work without permission or compensation. I was going to say the publisher took the dog out back and shot it as a tasteless joke, but it occurred to me that shooting the dog was kind of inherent to making it a Call of Duty skin in the first place.

QUOTE | "Maybe with an infinite magic box that can create everything, the most interesting thing in the world is not a god damn M16." - Whitethorn Games CEO and founder Matthew White is eager to see more diverse offerings in the AAA space.

QUOTE | "I've talked quite openly about how I wasn't a fan of having Lara [Croft's] father be a big plotline in Rise of the Tomb Raider. But that was dictated from on high and I had to find peace with it to do my job. But you've got to be prepared for taking advice and direction from people who are good at their jobs, but aren't necessarily experienced in story." - Rhianna Pratchett reminds aspiring game writers that they won't always get the final word on story in a two-part feature on the history of the field and advice on succeeding in it.

QUOTE | "In this context, I don't think it's a bad start at all for Netflix. The challenge will be continuing to ramp up its release schedule and provide ongoing support for the games side of the business, as well as publishing engaging titles that aren't available elsewhere on mobile." - Sensor Tower's Craig Chapple believes a recent report that less than 1% of Netflix subscribers have actually checked out the platform's slate of mobile games isn't terribly concerning.

QUOTE | "Campbell's Chunky Stadium." - The venue for the next Madden Championship Series as EA announced it sold the "virtual naming rights" to the soup maker as it confirmed a multi-year esports exclusivity deal with the NFL.

QUOTE | "We have formally ended our relationship with Square Enix." - Battalion 1944 developer Bulkhead Interactive confirms that it is no longer associated with Square Enix, a company that bought a 20% stake in the studio back in 2018. It is the latest example of Square Enix withdrawing from Western game development, following the company's sale of Crystal Dynamics, Square Enix Montreal, and Eidos Montreal to Embracer Group.