(2020-09-08) Unity Is Manifesting The Metaverse

Unity is Manifesting the Metaverse (analysis of their S-1). The company's engine — which makes it easier to develop a new game — is used by 53% of the top 1,000 mobile games. Though unprofitable, Unity brought in $541M in revenue in 2019, an annual growth rate of 42%

This is a business with ambitions far beyond gaming — Unity wants to power realities.

Not only is Unity angling to be the rails for the Metaverse, the infrastructure that undergirds new worlds, but it's also a recurring revenue business selling a popular product into a rapidly growing market.

Unity's history

After a year of painful development, OTEE released its first and last game.

that failure was a blessing. Staring down the prospect of another long development slog with an uncertain outcome, the team had a revelation: We realized that we suck at making games, but that we had some sort of strange insight into tool making.

the idea of an easy to use game development platform back in 2003/04 was just like a fundamentally bad idea. Because nobody actually needed that. Everybody was so focused on big games and big teams. This is the first massive stroke of luck. Because nobody was trying to do it, there was a bit of air cover for us to stumble around, figure it out, and build a product that was eventually needed.

When 2008 arrived, Unity was ready. In March of that year, Jobs's Apple opened the doors of the App Store

the company was the first product designed to support the development of games for Apple's newest creation (iphone).

While Mac games had been an interesting beachhead, mobile was a much bigger prize.

In what Helgason described as the company's "second stage," Unity moved from offering tooling to facilitating a developer ecosystem. As part of this push, the "Asset Store" was launched in 2010, allowing developers to buy and sell artwork, audio, and other game creations.

We thought we could make money from this. But honestly, we couldn't in any scalable way. But it became an incredibly powerful way to rally the community together.

Earlier figures noted that creators of top packages could bring in north of $20K per month, with Unity estimating that more than 1K developers generated significant income through the marketplace. We imagine that figure has grown significantly over the last couple of years.

As the company scaled, establishing a viable revenue model became increasingly important

Founded in 1998, Epic Games' Unreal engine had always been a threat. But in 2014, hostilities escalated: Unreal was made free to university students. Just a few months later, it was made free to all users, full-stop. Unity responded by bringing in a pro. In late-2014, David Helgason was replaced by former Electronic Arts CEO, John Riccitiello. He remains at the helm today.

When you hit the X button or the forward button you're creating a frame that's never been seen by another human being on this planet in a sixtieth of a second. That level of performance is astonishing, and it's starting to affect industries well beyond the game industry. It's the future for how films are going to be made. It's the future for so many industries we work with.

we may be entering Unity's third act.

In the future, what began as an attempt to make GooBall a hit, could be the tool used to design cars, buildings, and bridges.

The gaming market (and beyond!)

Unity needs to focus on the room left to run.

many new use cases, including automobile and building design, online and augmented reality product configurators, autonomous driving simulation, and augmented reality workplace safety training.

Unity estimates the market size for their Create and Operate solutions to be approximately $17B, giving a current TAM of $29B between gaming and other industries.

Unity highlights Skanska, one of the world's largest construction companies, as an engaged user outside gaming: [Skanska uses] Unity for a wide range of applications, from photorealistic interior mockups to coordinated pre-fab animations, 2D and 3D logistics, model management, and 4D sequencing.

Unity also secured a strategic partnership with Autodesk.

the collaboration streamlines user workflows and eliminates friction between the two platforms.

There is something conspicuously missing from the S-1 filing: education. (schooling)

The Metaverse

We'd be remiss if we didn't discuss Unity's role as a "founder" of the Metaverse, a term coined in Neal Stephenson's Snow Crash, and further popularized by media analyst Matthew Ball.

perspective comes from Unity's nemesis, Epic Games. As mentioned in Company History, Epic is the creator of the directly competitive Unreal engine. In a conversation with the LA Times, CEO Tim Sweeney described what the Metaverse will enable

I think we're approaching the point where every company will have a real-time live 3D presence

Epic v. Apple

In mid-August, Epic updated the Fortnite iOS app to let users bypass the App Store and buy in-game currency directly from Epic, at a discount. Apple promptly banned the app

Apple has substantial flexibility to punish Epic by reducing the prominence of Epic's other games, or of any game that uses the Unreal engine.

Unity helps developers build games through "Create Solutions" and monetize via "Operate Solutions."

At the heart of Create Solutions is the Unity Engine. What's a game engine?

Unity's is one of two game engines on top of which nearly all of the world's games are built. The other is Epic's Unreal Engine. Comparing the two highlights Unity's strengths and weaknesses.

Unreal, launched in 1998, had a seven-year head start on Unity.

Unity's initial focus on the Mac was a classic example of low-end disruption. The company captured the long-tail of game developers who didn't need the richness that Unreal offered to AAA developers and, in exchange, made it much easier to develop simple games.

To a certain extent, Unreal and Unity can still be understood in these terms. Unreal is the tool for the top of the market, Unity for the bottom.

Intriguingly, Riot Games — owned by Tencent, the same company that owns 40% of Epic — announced its building League of Legends: Wild Rift on Unity to better reach mobile users.

Unity is increasingly moving into Unreal's territory, upgrading its engine.

As it works towards powering the Metaverse, Unity is serving more VR and AR games and experiences

Niantic built AR smash hit Pokemon Go on Unity

All to say, Unity is still the easiest way for developers to build games on any platform, from 2D web and mobile games, to 3D console games, to VR and AR. While its graphics aren't yet on par with Unreal's, and may never be, capturing the long-tail of developers remains a strong position from which to build.

In building solutions for game developers, Epic and Unity have built the world's most powerful rendering engines, which can be used in many applications.

Unity highlights its work with Volvo to design, manufacture, and sell cars

Filmmakers can use Unity to create new worlds and virtual characters without building expensive sets or needing to outfit actors with motion capture suits. Disney, for example, used Unity to shoot The Lion King.

Architects and engineers use Unity to design buildings and plan for complex scenarios. The Hong Kong International Airport team built a "digital twin" that allowed them to plan for a wide range of scenarios, including the impact of a delayed flight on a terminal's traffic flow.

SHoP Architects used Unity for everything from acoustic simulation to status tracking to on-site construction documentation in the design and construction of 9 DeKalb, which will be the tallest structure in Brooklyn when it's completed.

Operate: Helping developers manage and monetize

Operate helps developers manage what comes next.

Unity Ads help games monetize by plugging into an ad network. Developers can either show ads in their game or acquire new players by advertising in others.

Unity In-App Purchases (IAP)

While Epic serves high-end game developers who have teams of people working on making a game financially successful, Unity focuses on the long-tail of hobbyist web and mobile developers, necessitating a business-in-a-box offering.

Both Create and Operate contribute to the bottom-line, with the former providing recurring revenue. The latter gives the company a way to profit from the "winners" built on the platform.

Unity's Create Solutions enable customers to develop interactive, real-time 2D and 3D games and applications. Revenue is generated primarily through an upfront subscription cost, typically purchased on 1-3 year terms

the company sells four-tiers of access: Personal, Plus, Pro, and Enterprise.

The Personal plan is free, as are Student plans. The company recognizes the importance of a bottoms-up sales motion and the power of product evangelists. Subsequent tiers are priced at $399, $1,800, and $2,400 per year, per seat.

Operate: Usage and revenue share

Beyond aligning the company's incentives with customers, there are other benefits to this approach.

While 450 reviews on Glassdoor give Riccittiello an average approval rating of 91%, there is a dark asterisk to that figure. Last year, Riccittiello was sued for sexual harassment by former VP of Global Talent Acquisition, Anne Evans

In February of 2019, an internal email surfaced from the year following the Oculus purchase

Under the codename "One," Mark Zuckerberg suggests buying Unity.

There's little detail available on how far down the path Facebook and Unity went. But reading Zuckerberg's email, it's evident how important he considered Unity to the company's plan.

Dollar-Based Net Expansion Rate (DBNER)

is all revenue generated over the current period from a defined set of customers divided by all revenue generated in the prior period from that same set of customers. If you have a customer spend $100 with you one year and spend $110 the next, their DBNER is 110%.

Take 2018, for example. The revenue from customers that Unity acquired in 2018 increased from $21.4M as of December 31, 2018, to $57.0M a year later. That represented an overall expansion of 266%.

The average expansion for public SaaS companies is around 117%. With Unity's DBNER increasing from 122% to 142% over the past several quarters, they sit comfortably above several public software peers.

If we want to pick at anything, Unity doesn't quite tick the "Rule of 40" box — a popular SaaS benchmark that suggests a company's combined growth rate and profitability rate should surpass 40 — thanks to its lack of profitability.

Unreal's bet is that the biggest hits will be AAA titles with splashy upfront marketing campaigns. Unity's bet is that there's a long tail of potential games, with the newest and most interesting concepts skewing towards mobile.

Both Unity and Unreal run a separate risk: the risk that they're building for the wrong platform, and that games as a meta platform will be the winning model. The best example of this today is Roblox, a game that lets players create games-within-a-game

why is Unity going public now?

Time spent playing video games has increased by 45% during COVID-19. In addition to driving revenue in the short-term — Unity makes money when people spend time and money in their games — the digitization of everything has opened people's eyes to the possibility of a Metaverse.