Unity's pricing changes are trying to solve too many problems at once

The changes announced by Unity to its engine price last week prompted an immediate and overwhelmingly negative reaction from game developers outraged that new fees were being introduced at short notice, levied on top of existing charges, implemented retroactively, and failed to take into account numerous apparently unintended impacts.

Unity has since made a series of adjustments and concessions in response to the outcry, while sticking with the core of the plan. But why has Unity decided to make such fundamental changes so suddenly, and how has it stumbled so badly on implementing them?

The answer is that the company has found itself backed into a corner financially thanks to a combination of overspending and bad luck, and has seemingly tried to both solve an immediate financial crunch and adjust its long-term strategic priorities in one fell swoop. With priorities muddled, this was always going to be a tough balance to achieve, so it’s little surprise that things have not gone according to plan, though Unity may yet achieve at least some of its goals.

Unity’s profitability struggles are not new

The fundamental strategic problem with Unity’s game engine business is lack of scalability. Its current game engine pricing is not exactly flat, but it scales only to a limited degree. Studios pay per seat, with larger organizations paying a higher fee per seat. So bigger companies do pay more to use Unity, but in practice they do not pay a great deal relative to their total revenue.

Unity itself claims that 70% of the top 1,000 mobile game studios use its engine. But Unity’s Create solutions earned just $716m (not all of which is game engine revenue) in 2022, compared to $161bn in total mobile games revenue. Crucially, Unity’s model does not allow it to tap into the success of the biggest hit games made using its engine—unlike Unreal Engine, which charges a 5% revenue share.

This is not a new development. Unity has never been profitable and it spends significantly more developing its engine than it earns from fees. Yet Unity has nonetheless consistently attracted outside investment, not least earning more than $1.3bn from its IPO in 2020. The company was at one point valued at more than $50bn, which could not have happened if investors didn’t believe that the company had—or would eventually create—a scalable business model.

Until recently, it appeared that this model would be to accept relatively modest game engine revenue and cross-subsidize development of the engine from other, more profitable business lines. The rapid growth of Unity’s advertising business in recent years seemed to vindicate this strategy, which the company doubled down on with the acquisition of rival ad network IronSource last year.

Around the same time, Unity officially launched Unity Gaming Services, a portfolio of backend and LiveOps services, mostly priced on a scalable pay-per-use model. These business lines do in fact generate more revenue than core development tools. According to Omdia’s Games Tech Market Forecast, games companies spent $10.9bn on operations technology and $6.4bn on monetization solutions in 2022, compared to $2.9bn on development tools.

Figure 1: Games companies spend far more on operations and monetization than core development tools

Source: Omdia Games Tech Market Forecast 2023

However, the recent downturn in the digital advertising market has hit Unity’s ad business—a particularly severe blow given the $4.4bn spent acquiring IronSource. With investor capital drying up, Unity scrambled to shore up profitability through a price hike and several rounds of layoffs.

But compared to those stopgap measures, this latest move is a more fundamental shift. It suggests that Unity no longer believes that advertising and services alone can deliver sufficient long-term profitability, and so engine revenue will now need to scale more aggressively. But by introducing the new fees at short notice, making them additional to existing charges, and applying them retroactively to existing games, the move seems simultaneously designed to shore up the company’s short-term finances. That lack of clarity of purpose is fundamental to what went wrong.

Short-term imperatives take priority

So why the abrupt change of course from Unity? It’s not at all clear that there was anything wrong with its original long-term strategy. The ad market (and indeed the mobile games market in general) is currently experiencing some turbulence, but the future growth prospects for in-game advertising still look fairly bright.

Unity’s ad business is far from a bust. Nor is its services business. While it will take time to scale, Omdia expects robust growth in the market for backend services like multiplayer services, content management, and analytics that Unity is targeting. Omdia forecasts stronger growth over the next five years in both backend services and advertising than the engines and rendering segment.

Figure 2: Advertising and backend services are still more lucrative growth opportunities

Source: Omdia Games Tech Market Forecast 2023

What instead seems to have driven these changes are short-term financial imperatives. Unity simply cannot continue to lose money at the rate that it has been doing. IronSource, which was profitable at the time the acquisition was agreed, was meant to shore things up, but is now only adding to Unity’s financial woes. As a result, Unity has been driven to a gambit to simultaneously bring in a large revenue boost, starting from January 1, 2024, and reassure investors about the company’s long-run growth prospects.

But such a fundamental shift in business model just cannot be executed this hastily. If a pricing restructure really was needed, it should have been implemented with plenty of notice, ideally grandfathering in existing customers (or at least existing projects) on the previous terms. But of course a planned and gradual transition would take many years to bear fruit. Unity argues that, legally, it is not in breach of contract by radically reshaping its price structure at short notice. But its customers still reasonably see this as a breach of trust: they did not sign up on this basis.

And this has only been compounded further by a failure to fully think through the consequences of the new pricing model. The choice of per-install pricing rather than a revenue share, which has triggered such backlash, was ironically probably intended as a concession to sweeten the pill. In theory, this model should scale less aggressively than a revenue share, as the fee will only be applied once per player rather than continuing to tap into ongoing revenue from in-app purchases.

But whatever the big-picture logic, it quickly becomes clear on closer analysis that the idea is riddled with flaws and inequities. A flat fee per install inherently imposes wildly different cost levels depending on a game’s business model. Games with high upfront prices pay far less, as do those that manage to generate a lot of recurring revenue per install, whereas games hoping to rely on high sales at low price are hit much harder. For F2P games, it raises the risk of developers actually losing money if many players install a game without paying. And what about reinstalls, bundles, and subscription services? And how was any of this going to be measured anyway?

A series of concessions, “clarifications”, and walk-backs in the days after the initial announcement made clear that Unity simply hadn’t considered many of these questions at all. Unity’s founder and former CEO, Dave Helgason admitted that the company had “missed a bunch of important ‘corner’ cases.” With Unity now planning to cap fees at 4% of revenue, it has effectively ended up with a sub-optimal version of a revenue share while generating a huge amount of ill will along the way.

Developers question the cost of lock-in

It’s important to remember, however, that game development discourse is disproportionately dominated by small indie and solo developers who are freer to speak publicly than those who work at bigger studios. In reality, however, the vast majority of the industry, and vast majority of individual developers and decision-makers, work at large studios making either F2P mobile or AAA games.

The outcry among indie developers is significant, even from a purely business perspective—consider how much development knowledge and innovation filters up from the indie sector. But it risks distracting from the much less visible decisions being made at the big studios.

And this decision was never going to be popular with large studios. They were the intended target of this pricing change which in intention—if not actual design—was meant to force them to pay much more than they do at present. There is no reason to doubt the sincerity of Unity’s repeated statements arguing that the changes were intended only to impact their biggest customers. Smaller users simply don’t generate enough revenue to be worth squeezing. A better-designed fee structure might have better shielded indies, but hitting the big players was the whole point of the exercise.

The key question for Unity now is, will their key customers accept this change? In the short term, they will have little choice. Existing games will not be pulled from sale, and projects deep in development will not be scrapped. But the changes will certainly be prompting re-evaluations about the choice of engine for new projects. In this respect, the loss of trust could be even more damaging than the price increases themselves, as studios will be uncertain whether they can plan future projects with the new pricing in mind, or if they might be hit by further price increases down the road.

Figure 3: Unity’s share price has remained stable through the controversy

Source: NYSE

The potential for long-term erosion of Unity’s position resulting from these changes should not be underestimated. While its market share will not collapse, at the margin it will undoubtedly lose some customers. There will also likely be damage to Unity’s services business, despite the new pricing being designed with discounts to incentivize use of these services. But how keen will Unity’s customers now be to lock themselves even further into its platform?

More broadly, Unity currently has a powerful grip on an ecosystem which extends from university game development courses focused on Unity, through to tools, plugins, and assets built exclusively for Unity. All of these stakeholders will now be re-evaluating the wisdom of their dependence on Unity, and looking to diversify, whether to Unreal, to rapidly emerging open-source alternative Godot, or to a fully engine-agnostic stance.

Unity’s goal of increasing short-term revenue will almost certainly be achieved. Through the controversy, Unity’s share price has remained more or less steady (it has taken a modest dip but is still trading about where it was a month ago), suggesting that investors are sanguine. There will be no immediate meltdown. But the simultaneous goal of boosting the company’s long-term prospects looks far less likely to be achieved. The damage to Unity’s reputation, and the increased awareness of the risks of overdependence to its platform, will ultimately end up costing far more than the revenues the new fees will bring in.