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Friday 10 February 2012

Developing metrics for free-to-play products

In my previous post, I outlined a few ways in which a "sales funnel" KPI model changes between different businesses, and argued that it really doesn't serve a free-to-play business well. Today, I'll summarize a few ways in which a free-to-play model can be measured effectively.

Free-to-play is a games industry term, but the model is a bit more general. In effect, this model is one where a free product or service exists not only as a trial step on the way to converting a paying customer, but can serve both the user as well as the business without a direct customer relationship, for example by increasing the scale of the service, making more content available. From a revenue standpoint, a free-to-play service is structured to sell small add-ons or premium services to the users on repeat basis - in the games space, typically in individual transactions ranging from a few cents to a couple of dollars in value.

As I wrote in the previous article, it's this repeated small transaction feature which makes conversion funnels of limited value to free-to-play models. Profitable business depends on building customer value over a longer lifetime (LTV), and thus retention and repeat purchase become more important attributes and measurements. Here is where things become interesting, and common methodologies diverge between platforms.

Facebook games have standardized on measuring number and growth of daily active users (DAU), engagement rate (measured as % of monthly users on average day, ie DAU/MAU), and the average daily revenue per user (ARPDAU). These are good metrics, primarily because they are very simple to define, measure and compare. However, they also have significant weaknesses. DAU/MAU is hard to interpret as it pushed up by high retention but down by high growth, yet both are desirable. Digital Chocolate's Trip Hawkins has written numerous posts about this, I recommend reading them. ARPDAU, on the other hand, hides a very subtle, but crucially important fact regarding the business - because there is no standard price point, LTV will range from zero to possibly very high values, and an average value will bear no reflection on either the median nor the mode value. This is, of course, the Long Tail like Pareto distribution in action. Why does this matter? Well, because without understanding the impact of the extreme ends of the LTV range to the total, investments will be impossible to target, implications of changes impossible to predict, as Soren Johnson describes in an anecdote about Battlefield Heroes ("Trust the Community?").

Another way of structuring the metrics is to look at measured cohort lifetimes, sizes and lifetime values. Typically, cohorts will be defined by their registration/install/join date. This practice is very instructive and permits in-depth analysis and conclusions on performance improvement: are the people who first joined our service or installed our product last week more or less likely to stay active and turn into paying users than the people four weeks ago? Did our changes to the product help? Assuming you trust that later cohorts will behave similarly to earlier ones, you can also use the earlier cohorts' overall and long term performance to predict future performance of currently new users. The weakness of this model relates to the rapidly increasing number of metrics, as every performance indicator is repeated for every cohort. Aggregation becomes crucial. Should you aggregate data older than a few months all-in-one? Does your business exhibit seasonality, so that you should compare this New Year cohort to the one last year, rather than to the one from December? In addition, we have not yet done anything here to address the fallacy of averages.

The average problem can be tackled to some degree by further increasing the number of cohorts over some other feature than the join date, such as the source by which they arrived, their geographic location, or some demographic data we may have of them. This will let us understand that French gamers will spend more money than those from Mexico, or that Facebook users are less likely to buy business services than those from LinkedIn. This information comes at a further cost in ballooning the number of metrics, and will ultimately require automating significant parts of the comparison analysis, sorting data to top-and-bottom percentiles, and highlighting changes in cohort behavior.

Up until now, all the metrics discussed have been simple aggregations of per-user data into predefined break-down segments. While I've introduced a few metrics which can take some practice to learn to read, the implementations of these measurements are relatively trivial - only the comparison automation and highlight summaries might require non-trivial development work. Engineering investments may already be fairly substantial, depending on the traffic numbers and the amount of collected data, but the work is fairly straightforward. In the next installation, I will discuss what happens when we start to break the aggregates down using something else than pre-determined cohort features.

Tuesday 7 February 2012

Metrics, funnels, KPIs - a comparative introduction

I know, I know - startup metrics have been preached about for years by luminaries like Mark Suster, Dave McClure, Eric Ries and many, many others. The field is full of great companies and tools like KISSmetrics, ChartBeat, Google Analytics, to name but three (and do a great disservice to many others). Companies like Facebook and Zynga collect and analyze oodles (that's a technical term) of data on their traffic, customers and products, and have built multi-billion dollar business on metrics. Surely everything is done already, and everyone not only knows that metrics matter, but also how to select the right metrics and implement a robust metrics process? There's nothing to see here, move along... or is there?

Metrics depend on your business as much as your business depends on them. No, more, in fact. It is possible (though hard) to build a decent, if not awesome business purely on intuition, but it is not possible to define metrics without understanding the business. Applying the wrong metrics is a disaster waiting to happen. In fact, in some ways this makes building a robust metrics platform more difficult than building the product it's supposed to measure. Metrics can't exist ahead of the product, but are needed from the beginning. Sure, with experience you will learn to pick plausible candidates for KPIs, and may even have tools ready for applying them to new products, but details change, and sometimes, with those details, the quality of the metrics changes dramatically. This is obviously true between industries like retail vs entertainment, but it's also true between companies working in the same industry.

This is a big part of why metrics aren't a solution to lack of direction. They can be a part of a solution in that well-chosen metrics will make progress or lack of it obvious, and may even provide clear, actionable targets for developing the business. Someone still needs to have an idea of what to do, and that insight feeds back into all parts: product, operations, measurement. I've never liked the phrase "metrics driven business" for this reason. Metrics don't do any driving. They're the instrumentation to tell you whether you're still on a road or what your speed is. You still have to decide whether that's the right road to be on, and whether you should be moving faster, or perhaps at times slower.

What to do, then? Well, understanding the differences helps. Lets start with a commonly applied metrics model, the sales funnel.

In a business-to-business, face to face sales driven business, a traditional funnel may begin with identifying potential customer opportunity, then measuring the number of contacts, leads, proposals, negotiations, orders, deliveries and invoices. A well managed business will focus on qualified customers and look for repeat transactions, as the cost per opportunity will likely be lower, and the revenue per order may be higher, leading to greater profitability. They will also look at the success rate between the steps of the funnel, trying to improve the probability of developing an opportunity into a first order.

This model is often adapted to retail: advertising, foot traffic, product presentation, purchase decision. For some businesses that's it - others will need to manage the delivery of the product, and may see further opportunities in service, cross-sales, or otherwise. Online retail businesses measure every step in much greater detail, simply because it is easier to do so. Large retail chains emulate that measurement with very sophisticated foot traffic measurement systems. But even in its simplest form, while the shape is similar, the steps of the funnel are very different.

Online businesses have developed a variety of business models, among which two large categories are very common: advertising and freemium.

The advertising-funded two sided market model is two different funnels: a visibility - traffic - engaged traffic - repeat traffic page view model, and a more traditional sales funnel for the advertisers, though even that one has been, through automation, turned to look more like an online retail model than what advertising industry is used to. This model is further enhanced by traffic segmentation and intent analysis, allowing targeted advertising and a real-time direct marketing product, the sales funnel of which is even less familiar to the sales funnel I described at the beginning.

Freemium isn't even one business model: a B2B service with a tiered product offering and a free time- or feature-limited trial product may ultimately use the traditional sales model, only so that the opportunity to prospect part of the model is fully automated. Often it's entirely automated to the point a customer never needs to (or perhaps even wants to, assuming a simple enough product) talk to a sales rep. Still, the basic structure holds: some of the prospective leads turn into customers, and carry the business forward. Free service, be it for trial only or for the starter-level segment, is a marketing cost and a leads-qualifier, enabling a smaller sales force.

On the other hand, the free-plus-microtransactions model, one which we pioneered with Habbo Hotel, and has since been used to great success by many, including Zynga, can certainly be described as a funnel, but to measure it with one requires significant violence to many details. The most important of these is that because individual transactions are typically of very low value, building a profitable business on top of a model which aims for, and measures one sale per customer is practically impossible. This class of business doesn't just benefit from repeat customers, it requires them. Hence, a free-plus (or, as it is called in the games industry, free-to-play) business model must replace counting a "new customer" metric or measuring individual transaction value with the measurement of customer lifetime value. Not just measuring it on average, but trying to predict it individually - both to try to develop 0- or low-value users (oh, how I hate the word) to higher value by giving them better value or experience, and by identifying the high value customers to serve and pamper them to the best of the company's ability (within reason and profitability, of course). And once you switch the way you value revenue, you really need to switch the way you measure things pre-revenue.

Funnels change. There are business models where funnels really can't provide the most instructive KPIs, even though they still may be conceptually helpful in describing the business. As this post is getting long, more on the details of KPIs of free-to-play in the next episode.

Wednesday 6 July 2011

Zynga's ARPU doubling? Not quite

Apparently today the pundits and analysts around have come up to reviewing Zynga's ARPU figures from their S-1 filing (Inside Social Games, Eric von Coelin). Something seemed fishy in these calculations, and since I'm home for a day, I had the opportunity to review the filing figures on a computer, rather than just a tablet. Yep, people, you're comparing apples to oranges. Zynga's monetization rate is improving, but it's nowhere as dramatic as you're making it look. Did you already forget, they defer revenue? You can't compare GAAP deferred revenue to non-deferred DAU/MAU figures! Use the bookings data instead.

This is what the S-1 filing states about the difference:

"Bookings is a non-GAAP financial measure that we define as the total amount of revenue from the sale of virtual goods in our online games and from advertising that would have been recognized in a period if we recognized all revenue immediately at the time of the sale. We record the sale of virtual goods as deferred revenue and then recognize that revenue over the estimated average life of the purchased virtual goods or as the virtual goods are consumed. Advertising revenue consisting of certain branded virtual goods and sponsorships is also deferred and recognized over the estimated average life of the branded virtual good, similar to online game revenue. Bookings is calculated as revenue recognized in a period plus the change in deferred revenue during the period. For additional discussion of the estimated average life of virtual goods, see the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Revenue Recognition.”

Zynga is of the opinion that bookings more accurately represents their current sales activities, and I fully agree. After all, this is not subscription business we're talking of! If you're as hard-core geek about these things as I tend to be, the description of when a booking turns into revenue is discussed on pages 62-63 of the filing: 

"Durable virtual goods, such as tractors in FarmVille, represent virtual goods that are accessible to the player over an extended period of time. We recognize revenue from the sale of durable virtual goods ratably over the estimated average playing period of paying players for the applicable game, which represents our best estimate of the average life of our durable virtual goods"

That deferring means that during periods of rapid growth, ARPU monetization appears to decline, while on the other hand periods of flat or declining traffic would seem to improve ARPU, due to the recognition of earlier deferred revenue against current, not earlier userbase. 

With these covered, what are the actual sales figures? The average daily Bookings to DAU rate is somewhat higher than the Revenue to DAU rate, at $0.051 (B) in Q1 of this year vs $0.042 (R). Both seem to have plateau'd on that level since growing from a year-ago $0.030 (B) / $0.017 (R). Respectable, but not earth-shattering -- and the growth, while impressive, isn't quite "more than doubled".