The Games Middleware Investment Opportunity

April 14, 2011

This article was first published on www.gamesindustry.biz on 14th April 2011.

“Middleware?” I hear you cry. “Isn’t that the really boring stuff that game developers don’t want to do?”

And that’s the point.

The reason I like middleware is because it is the really boring stuff that game developers don’t want to do. And before anyone gets hot under the collar, I actually don’t think it is boring stuff either.

Let’s start by defining what we mean by middleware.

There are any number of dictionary definitions for middleware: “software that occupies a position in a hierarchy between the operating system and the applications, whose task is to ensure that software from a variety of sources will work together correctly” (Oxford), “software that mediates between an application program and a network” (Webster) etc.  In relation to games, middleware typically means a games engine, providing tools for rendering (2D or 3D), animation, physics, collision detection/reaction, artificial intelligence, sound, networking, streaming and so on.

For our purposes, what we mean by middleware is anything which makes it possible to develop, manage and commercialise games. Simple.

Actually before the rise of online and mobile games, middleware did look like a relatively simple part of the market. But today the middleware market has become more diverse and fragmented, which together with high growth in online and mobile games has created a great opportunity for the company that gets it right.

Before we look at the games middleware market, let’s take a look at middleware investment in general.

The good thing about middleware companies is that they are selling shovels, rather than panning for gold. This sounds quite dull, but from an investment point of view can be brilliant.

Investors like diversification of risk and portfolio management, which sounds more complicated than it is. Diversification is simply a way of ensuring that you aren’t placing all your eggs in one basket. If you’re a consumer-facing games company like Electronic Arts or Bigpoint, you diversify by having a portfolio of games and a portfolio of distribution. But this doesn’t completely diversify game-by-game investment risk, which in itself means that any one games company is inherently less diversified than the entire games market.

But if you’re a middleware company, then investing in you is essentially investing in the games market itself. If your solution becomes dominant in your part of the market, then from an investor’s point of view it doesn’t matter if any one game (or any one games company) client fails, because there are thousands of other games and game companies that will succeed who can buy your middleware too. It sounds harsh, but from an investment point of view it deals with one part of risk management.

If your middleware company happens to also be aimed at a large, high growth part of the market like online and mobile games, then investing in a middleware company looks like a good diversified investment in growth.

The bad thing about investing in middleware companies is that there is no such thing as a free lunch. So even though middleware sounds like a dream ticket, it is not without risk.

A rather direct VC friend puts it simply, “great technology without a business model is worthless.” This is to say that the road is littered with the corpses of investors in middleware companies that produced great technology for which there wasn’t a market, or which didn’t become the dominant middleware solution in their sector. So if you do invest in middleware, you need to feel confident that your company could become one of the dominant players.

The games middleware market

Now let’s look at companies in the different middleware sectors, with a particular focus on those serving online and mobile games companies. It is worth keeping in mind that some sectors and companies overlap strongly with others.

Development

Unity Technologies is the sort of company that most people think of when you say games middleware. David Helgason and his strong team make a proprietary 3D content development solution called Unity, which is an integrated development environment intended to make it easier and cheaper for content developers to create and deploy 3D content for online, mobile and console games and virtual worlds. Unity based content is deployed via the web to supported browsers and devices such as PC, Mac, Wii and iOS/Android platforms. Competitors include Adobe Director, Dassault’s 3DVIA Virtools, GarageGames’ Torque and Conitec’s Gamestudio. The company is backed by Sequoia amongst others, and given the company’s potential and Sequoia’s track record, this looks like a pretty smart investment.

Monetization

Some see this space as the holy grail of games middleware, helping developers to make money out of online and mobile games. Having survived the “scamville” episode of late 2009, the monetization space seems to be thriving.

Jambool (now owned by Google) operates the virtual goods monetization platform Social Gold, which enables online game and virtual world developers to create and manage white-labeled virtual currency for in-app payments and analytics. Vikas Reza and Reza Hussein leveraged their significant experience in the payments space at Amazon, so had a real head start when they launched Social Gold in 2008. Backed with $6M investment by Charles River, Madrona and Bay Partners, investors made a tidy return when Jambool was acquired by Google in Q3 2010 (for what TechCrunch reported as around $70M). Competitors include Playspan, LiveGamer, Radium One/Social’s gWallet and SponsorPay.

Analytics

Analytics are something that no self-respecting online or mobile games developer can do without. Even a brilliant veteran game developer like Steve Meretsky (now at Playdom), will tell you how detailed analysis of every element of social games strongly informs social game design to focus on how best to acquire, develop and retain players.

So it’s no surprise that companies like Kontangent are on investors’ minds, as investment in analytics in data rich environments can be a great way to make money (just ask Bloomberg’s Michael Bloomberg or SAS’s Jim Goodnight). Kontangent is a social analytics platform for application developers, delivering social behavioral analysis and data visualization “analytics as a service” for social application developers and platforms such as Perfect World, PopCap, EA and BigFish. They also analyse big numbers: 1,000+ social applications, 100M+ monthly active users (“MAU”) and 10,000+ messages per second.  Founded by Jeff Tseng and Albert Lai, Kontagent has received backing of around $6M from ALTOS, Maverick and Facebook.

Optimization

Optimization services optimize games performance across multiple platforms, and have often been provided by teams rather than tools in the past. There are now some interesting software solution plays, one of which I met at GDC last month.

Umbra Software provides performance optimization middleware that cuts down CPU and GPU processing time by optimizing rendering, content streaming, AI and game logic. By determining what is visible and what is not, the load can be taken off everything else to increase frame rates. So far the technology is used by Bioware, Sony, CCP, Unity and ArenaNet, and this class of tools can only increase in value as online and mobile games become increasingly complex and demanding.

Delivery

Online and mobile games can generate high and “spiky” player volumes, particularly where played across regions and countries where peak playing times either overlap or leave large quiet periods in player volume. As player volumes can also accelerate rapidly when a game goes viral, particularly for social games, ensuring that games are hosted securely, reliably and in a scalable way becomes particularly important. While many companies still manage their own hosting, cloud based serving has become an important part of how connected games companies operate.

Amazon Web Services (“AWS”) provides an infrastructure web services platform in the cloud for many businesses including games, delivering on-demand back end servers and services which are spun up or down based on realtime demand. So from a flexibility and pricing point of view, the model fits well with how the market itself works. Used by companies like Playfish, AWS is carving out a valuable position in the global games market. Competitors include companies like Rackspace, Google and Microsoft, although their offerings differ somewhat.

Marketing/distribution

Online and mobile games marketing and distribution are provided by many different companies, from Facebook, Apple’s App Store/Game Center, Bigfish, Spil Games and literally thousands of other distribution channels. Managing this complexity can be extremely challenging for games companies to handle internally (although some like Bigpoint seem to manage pretty well), so companies like Tapjoy and Flurry have emerged to fill the gap. Many companies are working hard in the space, so it will be interesting to see how those independent of the primary distribution or development platforms position themselves in the long term.

Amongst other things, Tapjoy acts as a distribution platform for social games, mobile games, MMOs, and virtual worlds, with games companies paying for the promotion of their games through Tapjoy’s network. Having changed significantly since what was Offerpal acquired Tapjoy, clients like DeNA, Zynga, Disney and Glu work with the company in a valuable part of the market where the network effect should only improve margins as it grows. As a truly scalable business model, you can see why Interwest, North Bridge and D.E. Shaw invested $21M in January 2011.

Payment

Payment platforms are literally where the money is, and business models are built around high volumes and high security. Again some companies manage literally hundreds of global payment providers internally, but there is a market for payment services competing directly with the big boys like Paypal.

Playspan serves publishers and developers of digital media, online games, mobile apps and social networks with payments and monetization for virtual currency, virtual goods, and subscriptions. The company’s solution enables payments via 85 payment methods in 180 countries, so is fairly comprehensive for most games companies. Playspan (the core of which was founded by a 12 year old in 2006, although his father is the CEO) took over $46M in funding from Menlo, STIC International and Novel TMT and serves clients including Ubisoft, Facebook, Disney and Viacom. Visa clearly saw the value, buying Playspan for $190M in February 2011.

Security

Security is a big deal in online and mobile games, and while the big boys like Tencent handle this sort of thing at world class levels themselves, it is an area where specialist service providers offer both technology and consulting services. Security solutions cover piracy (both games and game engines), theft and cheating in online and mobile games, with the protection of both games companies and their players the main priority.

Secureplay (part of IT GlobalSecure) provides standalone off the shelf games security packages and consulting services, while players such as Valve incorporate Valve Anti-Cheat as a component of the Steam platform.

The middleware opportunity

Today's online/mobile game middleware market

With so many subsectors, and the risk of any one company not becoming the dominant long term player in its own sector, you could be forgiven for thinking that games middleware presents a diversification problem of its own. How do you pick where to invest? Yet the fragmentation of sectors and companies present an opportunity in itself.

Today nobody offers a completely integrated middleware solution. Clients must instead manage multiple relationships, multiple APIs and handle the integration themselves, creating an unnecessary layer of complexity and cost between them and the market. Fine if you are a middleware provider, not so great if you are a middleware customer.

Integration, together with bundled pricing to lower costs, is one of the biggest opportunities in the games middleware market today. A number of companies are thinking about how to achieve this in the next 12-18 months from different angles, and it is only a matter of time before someone pulls the trigger to invest in and acquire the different components to make it work. And they wouldn’t even need to cover the field, just offer enough best of breed components in the most profitable subsectors to become the dominant provider.

For those who think about this from a production perspective, middleware (excluding development itself) is often integrated after much of the development is complete. At the point when tools and technology address most post-development challenges, the question becomes whether the major platforms will provide their own solutions, or whether an independent integrated player can emerge to take the field.

Someone could become the Oracle of games middleware, and when you’re serving a market as large and high growth as online/mobile games, that sound anything but boring.