Is Unity ($U) burning down?

Unity Software, Inc ($U) creates and operates an interactive real-time 3D content platform. Its platform provides software solutions to create, run and monetize interactive content for mobile phones, tablets, PCs, consoles, and augmented and virtual reality devices. If you play video games on any of these devices, there is a very high likelihood that the developer used Unity to build the game. The only other player in this market is Epic Games' Unreal Engine.

Unity recently announced a major change to their pricing model that is causing quite a stir within the gaming industry. A lot of Unity's success can be attributed to the early support by indie game developer community and the rise of iOS and Android as gaming devices.

But first, let me share a story of the first time I visited Unity's offices in San Francisco.

I had my first foray in the gaming industry in 2011. At the time, I was part of a business development team that served Google's new and emerging products. Back then, Google didn't really acknowledge the gaming industry as a "serious customer." My former manager and I were involved in a lot of Google's early gaming initiatives at the time.

I initially built relationships with indie game developers. Julie, an European indie game developer, was visiting San Francisco and wanted to visit the Unity office in North Beach. I tagged along with her.

I met a lot of the personnel across marketing, sales and engineers. The last person I met stood out from the rest. He was tall with short ash blonde hair, and he smartly dressed in tailored slacks, shirt and sport coat.

In his Danish accent, he introduced himself as David.

I ended up having dinner with the Unity crew at a local Italian restaurant nearby. David and I sat together at the end of the table.

David asked me a lot of questions, and he intently listened to my responses. We talked about our first games and our interests. We both recently made San Francisco our home. We shared our latest restaurant finds and differences between living in California compared to our hometowns. He made me feel comfortable, and it was easy to talk to him. Hours flew by.

At the end of dinner, it occurred to me that I never really knew what David's role was within Unity. I finally asked him as we were leaving the restaurant.

He chuckled and responded, "I'm the CEO and co-founder." 😅

Despite my total noob move, David continued to be a great mentor, collaborator and friend to this day. At every gaming industry event, David was shaking hands and earnestly talking to every game developer no matter how small they were. The same goes for his co-founders and the rest of the Unity team. They embodied their mission of democratizing creation for the game developer - especially for those that didn't have the resources to build their own tools.

On September 12th, Unity announced they're changing their fees and faced huge blowback from the game developer community upon announcement. The negative response was so bad that Unity issued an apology on September 17 and will be making changes to the policy.

Why did Unity make this change to begin with? Let's check their numbers.

Revenue has been on uptrend.

Net income has seen no improvement, and it's getting worse.

Basically, shareholders are subsidizing Unity's operations. Even though Unity is the market leader for game development technology, it can't turn a profit. Unity's current license-fee model is clearly not sustainable.

What's surprising is that Unity chosen to model their Runtime Fee model as a CPI (cost per install) pricing scheme rather than follow Epic's revenue share pricing model.

Why did Unity choose the Runtime Fee model?

If you think about what games could cause Unity to lose money, they fulfill most of the criteria below:

High volume
Low revenue per user
Most monetization through ads rather than in-app purchases

Free-to-play mobile hypercasual games check all three boxes.

How can Unity make money on these games? Pushing these game developers to use the Unity Ads network in exchange for not being charged the Runtime fees.

Applovin, the dominant mobile marketing platform, was clearly not happy especially after Unity's CEO rejected their acquisition offer last year. AppLovin's CEO even published his take on the Unity's pricing change on the company's blog.

How should game studios think about this?

Unity's pricing announcement is just another reminder to evaluate third party platform and technology risks. Many game studios are revisiting their technology stack. As development timelines can be highly variable, game developers are especially sensitive to any sudden, unpredictable changes to their budgets or revenue projections. The 3-month notice and retroactive policy proposed by Unity really threw the industry in a loop

If you're a game studio just starting development, it may be worth evaluating alternatives like Unreal or Godot.

If you're a game studio deep in development, it may be worth revisiting your production and marketing budgets and revenue projections. If you choose to build on another game engine, you will be effectively starting all over again.

Is $U a stock worth investing?

Disclaimer: I recently exited a small position (<$5K) in $U.

I really do hope Unity finds a more sustainable business model, because it would be a tragedy if they don't exist.

Unity just issued an update saying they're revisiting this policy, so I'm hopefully the ecosystem can align on a viable path forward. Until then, I prefer to wait until Unity provides an update on the matter and improvements to their net income.

If you're in the game industry, I would love to hear what you think.