Business Model Report on Valve Corporation

Group Structure (members): 

Group Chairman
Masayuki Otsuka

Chief Executive Officer
Lee Wee Chen

Class-Code: F4

 

Background of Valve Corporation

Valve Corporation, (also known as Valve Software or simply as Valve), is an American video game development and digital distribution company based in Bellevue, Washington, United States. Founded in 1996 by former Microsoft employees Gabe Newell and Mike Harrington, Valve became famous from its critically acclaimed Half-Life series, (the first game released in November 1998). It is also well known for its social-distribution network Steam^TM and for developing the Source engine, which has been used in every Valve game since its introduction in 2004.

Since Valve Corporation's debut, it has expanded both in scope and commercial value. From its beginnings as a video game development company, it gradually shifted its focus to the online game distribution market by creating the Steam^TM platform, becoming the dominant digital distribution company in the world.

Prior to Steam^TM, Valve had problems releasing updates for their online games, such as Counter-Strike, wherein a patch would result in the disconnection of the larger part of the online user base for several days. They decided to make a platform which would update games automatically, and implement better anti-piracy and anti-cheat measures. After Valve approached and was turned down by several companies including Microsoft and Yahoo!, Valve began development of the platform which was eventually known as Steam^TM in 2002.

When Steam^TM was first made available for download in 2002, its primary function was streamlining the patching process common in online computer games. Gradually, Valve began negotiating contracts with several publishers and independent developers to release their products on Steam. In 2005, the first third-party games began to appear on Steam^TM. Valve also announced that Steam^TM was starting to be profitable. Although digital distribution was still no match to retail in terms of sales volume, profit margins for Valve and developers were far bigger on Steam^TM than at retail.

In 2007, big developer-publishers such as id Software, Eidos Interactive and Capcom started to distribute their games on Steam^TM. In May 2007, 13 million accounts had been created on Steam^TM, and 150 games were for sale on the platform. As of August 2012, there are over 1800 games available through Steam^TM, and 54 million active user accounts. The concurrent users’ peak was 5 million on January 2, 2012. Although Valve never releases sales figures, Stardock, former owner of competing platform Impulse, estimated in 2009 that Steam^TM had a 70% share of the digital distribution market for video games.

 

Analysis of the 8 key elements of Valve Corporation’s e-business model

Valve Corporation is a “Pure play”, B2C business model and can be summarized as follows:

1.       Value Proposition:

Valve markets Steam^TM to the consumer as “The ultimate entertainment platform”. Valve Corporation’s online value proposition can be summarized into four main points; the ability to allow instant access to games, the presence of an online gaming community, allowing users to create and share contents, and providing entertainment “anywhere”.

Instant access to games: Steam^TM guarantees instant access to more than 1,800 game titles and allows users to enjoy exclusive deals, automatic game updates and other great perks. Using Steam^TM, consumers can easily browse though over a thousand game titles in the comfort of their homes (saving travelling time and costs); something which the consumer cannot experience under the traditional “brick and mortar” business environment.

 

Online gaming community: The Steam^TM platform allows its 54 million active users to connect with each other allowing users to meet new people, join game groups, form clans, and chat in-game. This creates an effective gamers’ community (users providing reviews on game titles, sharing game walkthroughs, discuss about game strategies, etc), giving its users a unique gaming-cum-networking experience; which the users will not be able to experience in traditional online gaming systems.

Create and share content: Allows consumers to send gifts to their friends, trade items and even create new content for games in the Steam^TM workshop. Being able to send gifts through Steam^TM saves the consumer the trouble of having the “physical copy” of the game shipped to their loved ones, saving time and avoiding high postage costs in the process. Additionally, the fact that Steam^TM workshop enables consumers to create new content for games gives them the freedom to customize various aspects of the game to their liking. 

Providing entertainment “anywhere”: Unlike games sold in the traditional disc format, digital copies of games purchased from Steam^TM can be accessed from any personal computers with internet access. With just a click on the mouse and a valid Steam^TM account, users can download and install games they have previously purchased anywhere and anytime without the need for a physical disc. This gives them the freedom to play their games whenever they want to. Users can also be updated with the latest sale and news of games through multiple platforms, including PCs, Mac, mobile devices, or even their television.

 

2.       Revenue Model:

Valve Corporation derives its revenue using a sales-cum-subscription revenue model. This can be further broken down and elaborated as shown below:

Sales revenue: Valve Corporation’s sales revenue is derived from the sale of the games it developed and also from its role as a major channel for distributing games. Despite its transition into a digital distribution company, Valve Corporation continues to develop new digital games, resulting in the release of wildly popular titles such as “Left 4 Dead”,” Counter-Strike: Global Offensive”, and  “Dota 2” which have contributed substantially to its sales revenue. Other than selling games it has developed, Valve Corporation’s main source of revenue comes from the distribution of third party games on its Steam^TM platform.  Valve Corporation works closely with major and freelance game publishers/ developers and helps them distribute and advertise their products on its platform for a one-off listing fee and royalties.

Subscription revenue: Besides its main role in developing and distributing games, Valve Corporation collaborates closely with cyber cafes by providing its catalogue of games in exchange for a yearly subscription fee. This is made possible through its Steam^TM network and Valve Corporation adds further value to this service by rendering technical support, organizing tournaments to boost the profile of the respective cyber cafes and helping to advertise games that these cafes carry.

Besides the above mentioned main revenue models, Valve Corporation has adopted several other retailing strategies to increase its revenue. One of these retailing strategies would be the practice of holding “online sale” events for its products a few times a year to boost sales. They would also have certain weekends for consumers to try out full versions of certain game titles. These events help Valve to increase the sales of its titles (especially older titles) as discounts of up to 75% are offered and it proved to be effective in attracting more consumers to adopt its network. Being a “pure play” retailer also allows Valve to tap on a niche market by offering older and less popular games as part of the “Long tail” retailing strategy as it will cost Valve almost nothing to make these titles available.

 

3.       Market Opportunity:

There are a number of inherent market opportunities in the case of Valve Corporation’s development of Steam^TM. Firstly, when Valve Corporation first started developing Steam^TM before 2002, the online gaming sector which they were originally targeting was still in its infancy stage. As such, being one of the pioneers of online game developers, they could capture quite a huge market share, as evident from the popularity of its first games such as Half-Life and Counter-Strike. This created a loyal gamers’ base that would tend to support future game releases by Valve Corporation, and form the base on which Steam^TM would capitalize on for beta-testing and development.

Also, since the online gaming sector were in the early stages of development, there were ample space for growth and it meant only that more consumers would participate in online gaming. This also implies more demand for games to be produced by developers, and there is a high chance that Valve Corporation would end up distributing a large proportion of the games being developed due to the large initial market share acquired by them. This is evident from the fact that 80% of the online sales for the game ‘The Witcher 2: Assassins of Kings’ were done on the Steam^TM platform. Given that Valve also intends to venture outside the gaming industry, there are definitely more opportunities in other markets for them to capitalize on.

 

4.       Competitive Environment:

To analyze Valve Corporation’s competitive environment, Porter's five forces analysis will be used by breaking up the analysis of its competitive environment into the five forces:

Intensity of competitive rivalry (Threat of direct competitors): Major direct competitors include Impulse, Gamers Gate. These competitors are also in the digital distribution business for personal computer games and provide services and game titles that are very similar to what Valve Corporation provides.

Threat of substitute products or services (Threat of indirect competitors): For indirect competitors, GameFly serves to be its main indirect competitor as it is an online video game rental subscription service that specializes in providing games for game consoles and handheld game consoles, including personal computer games. The service that GameFly provides might draw some of Valve’s customer away as these customers might feel that renting a game might give them a greater value than buying it. (Due to the fact that gamers seldom “replay” a game that they have completed and it is cheaper to rental rather than purchase a game.)

Another indirect competitor would be Microsoft through its popular gaming console, X-box. The X-box is an indirect competitor as its online gaming platform, X-box Live, offers something similar to Valve’s online distribution platform (Steam^TM), but only for games on the X-box system. However, there are certain game titles that are offered on both PC and console platforms, and given the growing console gaming market, this poses a threat to Valve’s sales figures. Also, due to Microsoft’s sheer size in the market, there is a potential threat of Microsoft enticing developers to develop games exclusively on the X-box platform by giving them various incentives. This leads to lesser choice for PC gamers and there is a threat on them migrating to console gaming, further impacting Valve’s sales.

Threat of new competition: The threat of new competition can be determined by taking account into several factors. The one of these factors would be the barriers of entry into the online gaming distribution market. For Valve’s case, the barriers of entry are high due to the technological requirements in creating an effective online distribution platform. This requires the employment of info communication technology experts and hundreds of hours of testing to ensure that the system created are reliable and able to handle a large volume of transactions. Thus, it ensures that only big companies have the expertise and financial resources to enter the market.

Another factor that would determine the level of the threat of new competition is customer loyalty. As Valve is an established brand with Steam^TM being around since 2002, it is highly likely that the consumers would trust Valve due to its proven reliability in the delivery and maintenance of games. This is further supported by the fact that, as of 2009, Steam^TM had a 70% share of the digital distribution market for video games. Thus, it makes it hard for any new competitors to break into the market with the kind of customer loyalty Valve commands.

Thus, judging from the above mentioned factors, it can be concluded that Valve Corporation is unlikely to face any significant threat from new competitors.

Bargaining power of suppliers: In the case of the online game distribution business, the suppliers would mainly be the game publishers. Major game publishers include Bethesda Softworks, Activision, Rockstar Games, Electronic Arts, Square Enix, 2K Games, Namco, LucasArts and Sega and it would be essential to hold on to as many of these publishers as possible in other to make Steam^TM an attractive platform for consumers to purchase games from.  However, Valve does face several challenges in its bid to attract and retain these publishers. Some challenges that Valve faces include supplier switching costs, supplier competition, and strength of distribution channel.

Firstly, with regards to supplier switching costs, it can be assumed that such costs are low as the games are distributed electronically and suppliers would face almost no cost to switch to another competitor. The only cost incurred from switching would probably be the difference in gross margins that the publisher has agreed with the former and current online distributor.  Thus, in this case, the bargaining power of suppliers is actually quite strong and Valve would have to spend considerable efforts in retaining its suppliers by agreeing to take a lower cut in the gross margins.

Looking into supplier competition, as mentioned before, there are two other direct and two indirect competitors which the suppliers can switch to. Valve would have to keep an eye on its competitors so as to ensure that the packages it offers to its suppliers remain competitive.

Lastly, judging the strength of distribution, Valve’s revolutionary online distribution channel offers much advantage to its suppliers. Not only the suppliers are now able to distribute their game titles more effectively due to its 24 hours availability on Steam^TM, global reach and the “instant” delivery feature; suppliers are also able to achieve gross margins of 70% of purchase price, compared with 30% at traditional retail distribution methods. This effectively discourages suppliers from switching to other types of distribution channels.

Bargaining power of customers: In the area where the bargaining power of customers is concerned, four main factors must be considered; degree of dependency upon existing channels of distribution, buyer switching costs, buyer price sensitivity, and differential advantage (uniqueness) of industry products.

In terms of the degree of dependency upon existing channels of distribution, customers have a choice of purchasing games through traditional retail channels and are not entirely dependent on the online channel provided by Valve as the other channels are as readily available as the online channels.

For buyer switching costs, the consumers have almost zero costs when switching either to another form of channel or to another competitor. The only likely cost of switching would probably be the travelling cost (for retail channels) and the possible price difference in the products. Thus, cost wise, it is unlikely to deter the consumer from switching.

Looking at both differential advantages (uniqueness) of industry product and buyer price sensitivity, it can be seen that there is little product uniqueness to speak of as game publishers usually publish their games across different channels and competitors. This causes the consumer to be especially sensitive to the prices of the products as they can easily switch to another channel or competitor if there is a significant price difference.

Judging from the above mentioned factors, it can be concluded that the consumers have significant bargaining power over Valve under the current business model.

 

5.       Competitive Advantage:

Some of Valve’s competitive advantages include its distribution technique, first mover advantage, and its asymmetries competitive advantage.

Valve’s online distribution channel, Steam^TM, presents consumers and suppliers an easy way to browse, purchase, and for the case of supplies, distribute its products as compared to traditional retail channels. As mentioned previously in the value proposition section, the online distribution channel offers many advantages to consumers, such as instant access to games, an online community, the ability to create and modify game content, and ability to access their games “anywhere”. Consumers also get to enjoy lower prices and the option of trying out games in “demos” and looking through reviews before deciding whether to purchase a particular game. For suppliers, distribution through Steam^TM allows the suppliers to receive a higher gross margin.

As Valve is the first firm to develop such an effective and reliable game distribution channel, it would inevitably enjoy a first mover advantage as consumers identify Valve as a trusted online game distributor, handing them the advantage of commanding brand loyalty among its customers.

Valve also enjoys asymmetries competitive advantage due to it being the largest online distribution company in the market. Using its financial capabilities, Valve is able to effectively improve its distribution channel regularly to ensure that it remains unmatched by its competitors. Valve has also built up an excellent relationship with the major game publishers as seen from the fact that the majority of the game publishers have chosen to distribute their product through Steam^TM. This gives them an edge over other competitors as it allows Steam^TM to appeal more to consumers with its larger variety of games.

 

6.       Market Strategy:

As mentioned previously under ‘Market Opportunities’, Valve Corporation initially started out developing games. Popular games led to Valve having a huge customer base to work on. They used ‘Counter-Strike’ as a test-bed for developing Steam^TM, by releasing patches through it and strengthening the anti-cheat systems. This proved popular with the customers, and through their feedback, Valve improved on the features of the Steam^TM platform and gradually introduced new features that improved the gaming experience. Customers would also recommend Steam^TM through online community forums and word-of-mouth, increasing the customer base to an even greater extent.

Developers are also enticed by the anti-piracy measures put into place by the Steam^TM platform, and they can save costs on developing Digital Rights Management (DRM) modules for their games and using Steam^TM platform’s built in features instead. Soon, big-name publishers such as id Software and Capcom also looked to Valve for online distribution of their games. Given the reputation of such publishers, this would mean that even more customers would turn to Steam^TM to purchase these games, and possibly other games through the interactive online catalogue. This would hence increase Valve’s profitability by many folds.

Valve also made public their intention to venture outside the gaming market, and they could capitalize on their reputation gained from the gaming market to gain developers’ business in the other industries they are looking at.

 

7.       Organizational Development:

Internally, Valve employs a ‘flat organizational structure’ i.e. an organizational structure with few or no levels of intervening management between staff and managers as compared to traditional organizational structures. (Also known as horizontal organization)

This form of organizational structure is acknowledged by Gabe Newell, the co-founder and president of Valve Corporation and reiterated on Valve’s website: “We’ve been boss-free since 1996. Imagine working with super smart, super talented colleagues in a free-wheeling, innovative environment—no bosses, no middle management, no bureaucracy. Just highly motivated peers coming together to make cool stuff. It’s amazing what creative people can come up with when there’s nobody there telling them what to do.”

Adopting a “flat organization structure” benefits Valve as employees are more involved in the decision making of the company, rather than closely supervised by many layers of management. This results in high morale among the employees. In turn, Valve would have greater productivity and efficiency in its processes, and employees would have a lower chance of conflicting interests should new policies be introduced in the company. In addition, this type of organizational structure also allows comments and feedback to reach all personnel involved in decisions more quickly, leading to the expected response to customer feedback becoming more rapid.

Also on Valve's career webpage, they have also indicated that they see themselves as a full-spectrum entertainment studio, and welcome passionate people with original and creative ideas to lead them to new areas for diversification. It can be seen that Valve is very open to new ideas and there are hardly any internal barriers to hinder their potential for future growth, so long the staff have the capabilities of doing so. As such, when the need to re-strategize arises, the process would be much smoother as well.

Externally, to meet the needs and demands of its customers, Valve also has an online support forum consisting of specialists to assist customers with technical and account issues, and this is vital for proper customer support as they expand their business in the future.

Other than Valve’s customers, another important aspect for Valve’s organizational development would be how the company is able to form strategic partnerships for future growth. To achieve this objective, Valve has partnered with various Operating System developers to bring the Steam^TM platform to their operating systems, like Apple’s Macintosh and iOS, Google’s Android, Linux, and Sony’s PS3 system. This further expands their market out of the PC market they originally worked on.

Valve have also looked to mods teams, who create custom in-game content such as levels, to expand their business. They offered the teams a game engine license and distribution over Steam^TM at a discounted rates so that they can appreciate the benefits that the Steam^TM platform brings to them, and hopefully develop more games for Steam in the future.

Valve’s partnership with schools to bring them the Steam^TM software for educational use in classrooms, under the 'Steam for Schools' program, is also worth mentioning. It involves the provision of free versions of its game titles with a customized version of the Steam^TM client for teachers to conduct workshop-style lessons with ample control over students' workstations through inbuilt authentication features. This would hopefully pique students’ interest in game development and related fields, and would contribute to the industry in the future.

 

8.       Management Team:

The main players in the formation of Valve Corporation are Gabe Newell and Mike Harrington. These people are ex-employees of Microsoft Corporation, suggesting their technical expertise in this field. This is especially true for Gabe Newell, as he played a major role in the first 3 releases of the Microsoft Windows Operating Systems. Gabe Newell’s idea of a ‘flat organizational structure’ also helps in the development of mutual respect between staff, vital to the long-term viability of the company.

Below is the list of key personnel in the current management team of Valve Corporation. Please note that one of Valve’s co-founder, Mike Harrington has dissolved his partnership with Gabe Newell in 2000 to take an extended vacation with his wife, Monica and thus, is no longer with Valve Corporation.

Gabe Logan Newell: Co-founder, President and Managing Director of Valve Corporation. Spent thirteen years working for Microsoft Corporation and played a major role in the first 3 releases of the Microsoft Windows Operating Systems. Mr Newell also served in a number of positions in the Systems, Applications, and Advanced Technology divisions during his 13 years with Microsoft. His vision, strong leadership and most importantly, his extensive technical knowledge was an important factor in Valve Corporation’s formation and rapid growth. Under his leadership, Valve Corporation grew to an estimated US$2.5 billion (2012) worth in total equity; with Steam^TM holding a 70% share of the digital distribution market for video games.

Scott Lynch: Chief Operating Officer of Valve Corporation. Prior to joining Valve, Mr Lynch served as Senior Vice President at Havas Interactive where, he created and managed the Sierra Studios business unit publishing a number of products, including Half-Life. During his 5-year tenure at Sierra, he held a number of different positions in business development, acquisitions, finance, investor relations, and product development. Before joining Sierra, Mr Lynch worked in the public accounting industry at Coopers and Lybrand where he worked in both the audit and tax departments managing a range of clients from small start-ups to Fortune 500 companies. Mr Lynch is a graduate of the University of Washington Business School with a concentration in accounting and is an inactive Certified Public Accountant in the state of Washington. Scott Lynch’s experience in both the gaming and accounting industry is his greatest asset in bringing Valve Corporation to greater heights.

Jason Holtman: Director of Business Development and Legal Affairs of Valve Corporation. Prior to joining Valve, Mr Holtman practiced law, specializing on intellectual property and technology issues. In his current role, Mr Holtman focuses on Steam^TM distribution, Steamworks integration, and game development on the Source engine. He also works with outside entities pursuing Steam^TM distribution and/or game development atop Source. Like the other key management staff, Jason Holtman’s knowledge in law and his prior experiences adds value to Valve Corporation.

Mike Dunkle: Director of Café Operations of Valve Corporation. Mike joined Valve in 2000 after spending 10 years in senior marketing and business development positions in the semiconductor test and embedded software markets. At Valve, Mike is responsible for general business development, including Source Engine licensing, Steam^TM content distribution, Asian distribution, and tournament licensing.

Doug Lombardi: Vice President of Marketing of Valve Corporation. Formally was Director for Marketing of Valve Corporation. Mr Lombardi is responsible for managing and coordinating third-party relations, marketing and press activities. He previously served in Music industry and Gaming industry. During his time in gaming, he worked on the launch of websites, magazines, and games.

 

 

Opinion on Valve Corporation and its business model

Overall, we feel that Valve’s business strategy is good. It is unique, albeit a little ambitious. Valve is in a sense quite lucky, as they happened to develop Steam^TM at a time when online gaming was still in its infancy. There were plenty of opportunities to grow, and Valve capitalized on them. They also had the determination to push through even when their idea of collaboration were rejected when they approached Microsoft, Yahoo!, and RealNetworks to develop the Steam^TM client. This might actually have been a good thing for Valve as they would have a lesser share of the profits should they have collaborated with them.

Valve’s online distribution model for PC games is revolutionary in a sense that it is a radical departure from the traditional boxed retail versions that had to involve the consumer going down to a physical store to purchase the games. With Steam^TM, consumers can purchase and even try out games before committing to their purchase, right from the comfort of their own home. This is in line with the current computing trend where everything seems to be turning digital. From statistics, current retail sales however, is still larger than the digital sales of the games. Given Steam^TM’s increasing popularity among gamers, there is large room for growth as digital sales are undoubtedly set to overtake retail sales in the future. Digital sales also carry with them cost savings for the developer as there is no need for the boxes and CDs, so there are room for increased profit margins as well.

Their ‘flat organizational structure’ is radical, but is well suited in their business where game development occurs and constant, clear communication between team members is vital to their success. It also has its downfalls; since there are no hierarchy, the management would have an issue getting staff with outspoken and stubborn personalities to take in their ideas. Also, there are talented people who simply prefer to work in a traditional hierarchical organizational environment, and by insisting on this radical system, Valve might miss out on hiring these people.

Valve also plans to expand into other business areas as mentioned previously. Although this is a good idea and opens up more lines for revenue, there are risks involved. Valve needs qualified analysts to assess and research on their intended industries to expand into, to avoid pitfalls that previous e-businesses fell into and led to their failures. An example would be Boo.com where they expanded overseas faster than they can handle. They were not well versed in the countries’ laws and regulations, and lacked experience in cross-border transactions. There were also communication problems arising due to the different languages spoken. All these factors led to Boo.com’s failure, and Valve would certainly benefit by learning from its mistakes.

As companies expand, they need more capital to sustain their increased expenditures. As Valve is still a privately owned company, they run the risk of insufficient funds if they expand too quickly. Being privately owned has its perks such as more financial freedom, and the lack of the need to answer to shareholders. They can therefore operate more freely and be more efficient in their operations. However, if their growth rate cannot be sustained by their sales, they would definitely need to look for external financing. When this happens, Valve could opt for equity financing by listing the company in the stock market. Based on the current outlook, there are plenty of parties interested in Valve, and this is a good thing for them, as it means their share prices would rise in value. Valve could also approach banks for loans, but there is a need to keep an eye on the debt-to-equity ratio, as well as other ratios through ratio analysis, as too much of any one kind of financing is bad for the company.

To counter the internal dissatisfaction that may arise from public listing, which is highly likely due to the long history of being privately owned, Valve may give shares to its employees as a token of appreciation for their service to the company. This boosts their morale and make them feel recognized for their efforts, and increases their productivity, adding value to the company. This would also help in the public’s valuation of Valve’s firm value, increasing the share price.

As there are also a number of small players in the industry such as those mentioned above in ‘Competitive Environment’, Valve can consider acquiring these companies once they have the financial ability to do so. This has many benefits for Valve. One major benefit is the integration of the customer bases, which would undoubtedly bring them more sales. This also means that there are lesser competition so Valve can focus more on their business rather than worrying about its competitors stealing their market share. For big players such as EA and its Origin games store, which is something similar to Steam^TM, acquiring is not very feasible, and as such, they could consider collaborating with them and work out some kind of profit-sharing scheme to achieve a win-win situation for both parties. This would also do the gaming industry good as their synergies would help to fuel future innovations in the industry that would bring added value to the consumers.

 

Useful Links and references

 

1.       Valve Corporation website: http://www.valvesoftware.com/index.html

 

2.       Steam^TM website: http://store.steampowered.com/

 

3.       Wikipedia’s page on Steam^TM: http://en.wikipedia.org/wiki/Steam_(software) 

 

4.       Bloomberg Business week website: http://www.businessweek.com/

 

5.       UOL E-biz website: http://www.uol-ebiz.blogspot.com