Steam's Engine

Harnessing the power of Valve's gaming network

What is more important, how much fun a game is to play, or how many people are playing it? Valve, a privately held video game company well known for its blockbuster hits, has the best of both worlds. Valve supplements its impressive digital distribution platform, Steam, with franchises such as Counter- Strike, Portal, and the Half-Life series. Analogous to Apple’s iTunes, Steam allows users to electronically purchase and download new games, chat, play online, and update content entirely with seamless digital rights management. The service has an estimated 50 million active users, compared to Xbox Live’s 40 million, and PlayStation Network’s (PSN) 90 million. Although PSN’s user base appears significant, the service contains duplicate, unused, and separate accounts for other Sony products.

By generating revenue through content-creation, the Steam network has developed far greater value per user than traditional console networks. Microsoft’s Xbox Live and Sony’s PSN generate value from monthly subscriptions and virtual content sales, whereas Steam also cultivates a core set of active users that actually create content for Steam games. This content is then sold by Valve, with the company taking a percentage of these sales and the remainder going back to the creators. In 2012, content sales accounted for 50% of Valve’s growth. Consistently adding content also extends the lifespan of Steam games, keeping them engaging for current and new Steam users. The most proficient content creators can earn up to $500,000 a year, and are often even employees of Valve’s competitors, working in their spare time.

The New Engine

Valve recently unveiled the first iteration of its new console, the Steam Box, at the consumer electronics show (CES) in Las Vegas. The prototype, the “Steam Piston”, is the first of its kind – most easily described as a scaled-down personal computer utilizing a modular chipset, allowing for yearly hardware updates, and operating on a Linux-based operating system. These features are marketed towards “hard-core” gamers who appreciate open-source customization and hardware upgradability. Hardcore gamers, however, generally own multiple consoles and high-end PC’s that run Steam. Reasons for this demographic to potentially purchase a scaled down version of something they already have are unclear and this raises major questions about Valve’s decision to launch a console.

Valve has been successful utilizing this strategy in the past. This success means Valve is financially strong, which may be a source of confidence for expanding its offering to gamers. In response to a $1B takeover bid from Electronic Arts in 2012, Co-Founder Gabe Newell estimated the company’s worth at $1.5B. Furthermore, Forbes estimated Valve’s value to be between $2-4B, and projected Valve’s 2011 revenues to be $600-$800M. However, this valuation still leaves Valve at half the size of Electronic Arts, and an eighth the size of Activision – its main competitors. In addition, both of these competitors generate over $4B in revenue. Valve is in a dangerous position: it has enough credit to sit at the table but only enough cash to make a few bets.2

To develop the Piston, Valve partnered with computer manufacturer Xi3; however, after several months the partnership recently fell apart. Xi3 wants its next generation of computers to be “more than just a Steam Box” particularly, Xi3 wants to release the Steam Box with Windows. Linux is not widely supported by major video game manufacturers as they mainly create content for Windows. For this reason, Valve’s console model is being criticized as a locked-down PC that essentially occupies the same market position as high-end PCs – a market Valve already dominates. Now, the first “prototype” of the Steam Box, developed in cooperation with Xi3, no longer belongs to Valve. If Valve released a Steam Box it would compete against all the major consoles, Xi3’s new offering, and directly against Steam’s traditional PC offering.

Building Pressure

Using traditional metrics, it’s difficult to determine Valve’s reasoning for this seemingly counterintuitive strategy. One must recognize that Valve employs a very unique corporate strategy, one whose inspiration is driven by altering the very nature of gaming and the video game industry. Valve’s product release patterns and strategic positioning demonstrate it is willing to sacrifice near-term profits to improve the gaming experience. Far more than any other company, Valve listens to and then develops for its growing consumer base. Accordingly, the Steam Box’s rollout must uniquely navigate the value chain and competitive landscape to achieve widespread acceptance without sacrificing this consumer relationship.

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Content creation versus traditional subscription

Valve’s past decisions are easier to understand when taking into account its unique motives. Consider a not-for-profit organization: their goal is to effect the maximum change in its cause, without damaging its own livelihood. Valve gives away Steam subscriptions and titles for free, allows users to release modified versions of its games, and takes time to produce the highest quality games as opposed to releasing lesser titles yearly. At the cost of potential profits, Valve has taken these actions to better the video game industry, to promote creative content, and to generate exciting new content. So while Valve’s revenues show it is decidedly for-profit, these not-for-profit tactics are what have made Valve so popular with gamers. It is these not-for-profit tactics that it must continue to use.

Therefore, the goal of the Steam Box goes beyond profitability. Given Valve’s corporate strategy, the goal of the Steam Box is to inflict as much change as possible on the console industry. Valve is trying to implement this change by revolutionizing console technology. Using the remarkably small Xi3 is one example of how Valve is trying to perfect a console with state-of-the-art features. Further, other Steam Box models have been delayed citing technical issues, as well as delays in redesigning an ideal controller featuring biometric input. Essentially, Valve is applying its software design process to hardware; Valve is trying to create the perfect machine. However, this premise is flawed because hardware is merely a commodity and new hardware is quickly imitated. Therefore, packaging together next-generation technology is not “revolutionary” – any serious gamer can piece the parts together. Rather, this is giving hard-core gamers an alternative to their powerful PC computers, running in a living room setting. To achieve its goal and realize a positive return, Valve needs to focus on its console’s sustainable point of differentiation and superiority. This starts with the Steam network.

4Full Steam Ahead

The Steam network engages gamers unlike any other network hosted by competitors. Valve needs to focus on selling Steam, not the console. In essence, the Steam Box should be the next generation tool to access Valve’s powerful distribution network. A barrier to playing Steam games includes insufficient PC hardware; the average user’s computer is simply not powerful enough to run certain games offered by Steam. Yet these components are expensive, and if the goal of the Steam Box is to make the network accessible by supplying the hardware, a $1,000 console limits accessibility.

In order to have a real impact on the industry, the Steam Box needs to see sufficient adoption. The Steam Box needs to be compact, simple, and cheap without sacrificing performance. Steam already controls the hard-core gaming market and does not need a complicated living room PC to grow this market. Instead, the Steam Box should be easy to use, with minimal click interface, and have other features that make it accessible to the entire family. The Steam Box must also be affordable for casual users who are relatively price sensitive. Nintendo’s Wii U has recently been criticized for its $350 price tag, too high a price for its lack of valuable content. The Steam Box will certainly be as powerful as the next generation of Xbox or PlayStation consoles, but it should not be more expensive. Matching competitor consoles hardware capabilities should result in similar retail prices for the Steam Box. To achieve higher competitive value, Steam should offer free content bundled with the Steam Box. Since Valve already has a plethora of popular games, and owns a wide variety of user created content, it can give away these valuable items at no cost. When buying a Steam Box, Valve should give $300 worth of free content. This content should include both original Valve games and user created content. The inclusion of free content, hardware performance equivalent to the Xbox and PlayStation consoles, and connectivity to the best video game network will make the Steam Box the most competitive console on the market.

While it makes sense for Valve to expand its Steam network by entering the console market, Valve doesn’t necessarily need a partner to develop its console. Valve should give out all the necessary tools to make a competitive console for free. Valve still creates value for companies like HP or Dell should they enter the console market. This strategy would emulate Google’s approach with the Android OS and its manufacturing partners that created a competitive mobile phone market. Therefore, while on the surface Xi3 separating from Valve looks like a bad sign for Steam, it is actually one of the best things that could have happened. Xi3 will prove to PC manufacturers that it is possible to create and release a console that competes with Xbox and PlayStation. Xi3 will also create hype for the Steam Box – users will associate Xi3’s console with Valve despite the severed connections. Finally, whether the Xi3 console runs Linux or not – it will still run Steam, and this will undoubtedly grow the network. At the end of the day, Xi3 producing an independent console will prove that Valve does not need to produce anything itself, it merely needs to enable PC manufacturers.

In order to convince other hardware producers to begin building Steam Boxes, Valve will have to limit manufacturers’ risk. Valve should employ two strategies to limit such risk. First, Valve should offer its brand and content to promote sales of the console. Secondly, Valve can limit the number of “certified” consoles, limiting the inter-brand competition of multiple Steam consoles. To accomplish these goals, Valve should require accredited manufacturers to brand their consoles “Steam Boxes.” Companies who demonstrate an ability and willingness to develop a Steam console, and can meet key specifications including price and performance, will have their console endorsed by Valve.

In addition, Valve should offer the ability for these manufacturers to earn significant profit. Given a $300 value of free content, manufacturers can sell consoles in the $500 to $600 range. At this price, they can develop competitive consoles, and sell them at reasonable margins. In addition, Valve should offer manufacturers a percentage of revenues from content purchased on its devices. This will come out of Valve’s typical percentage and would provide enough of a profit margin to motivate new manufacturers to enter this competitive space. Securing future revenues will allow manufactures to compete at a lower price and be more competitive.

With the difficulties surrounding the Steam Box’s launch, many question the project’s feasibility. Offering the Steam brand and bundling content with the Steam Box, Valve can maximize value for manufacturers, offsetting the risk faced when building a console. By offering revenue sharing and discounted pricing, Valve creates opportunities for large returns to any company undergoing this project. Valve wants the Steam Box to create ripples throughout the video game industry. The console’s profitability is simply not a priority for the maverick video game developer. Valve’s priority needs to be the expansion of its Steam network across the industry to revolutionize gaming, and the Steam Box will be its means to do so.