Structuring a Game Development Deal

An old friend of mine, Daniel Marks, recently suggested I write a blog entry on different ways publishers and other IP holders could structure deals with game developers. Given this suggestion, I wanted to look at the many ways to create mutually beneficial deals. Before talking about deal structures, I want to stress that I intentionally used the phrase “mutually beneficial” not as a throwaway but as the only way to work with developers. If you create a deal that is not sustainable or simply bad for the developer, you will almost certainly end up with a bad product or no product. The developer may agree because of cash flow issues but once a better deal is available, you will find yourself without a team. Even if you avoid that pitfall, having an unhappy developer is a recipe for creating a game everyone is unhappy with.

First, let’s start with the traditional deal structures, flat fee contract work and a recoupable development fee against future royalties. In the former case, a developer prepares a budget for a project based on their expected hours, their labor and materials cost and a degree of profit. They are then paid the fee over various milestones (i.e. first playable, alpha, beta, launch). If the publisher changes the requirements or scope of the game, the cost is adjusted to reflect the new scope. Once the product is delivered, no further money is owed to the developer. With a recoupable advance, the developer is still compensated for the costs of creating the game (or a portion of these costs) but also receives a share of the revenue the game generates. The recoupable development fee is still paid in milestones as with the flat fee structure. The developer is likely to take a lower development fee because it has long-term potential to make more. Royalties normally range from as low as 5% (when it is a proven IP or concept and little innovation is required of the developer) to 25-35%. A key benefit of the flat fee approach is that the Publisher knows exactly how much the project will cost. For the developer, they are guaranteed a profit they are comfortable with. In the latter approach, the developer is more incentived to create a product that will resonate well with the market. The publisher, however, could be left with a large liability if the game is a hit.

An increasingly popular model for creating games is co-production. In this model the developer will bear some or all of the development costs in exchange for a larger share of the revenue. The exact ration depends on how much of the costs the developer is willing to bear and how valuable the assets provided by the Publisher (or Licensor) are. A base case would be a company provides a very strong IP (for example a major movie), the developer creates a social mobile app at its expense, and the two parties split revenue evenly. This model works particularly well when a Publisher or Licensor has a very strong IP or strong distribution channel. Thus, the developer can estimate the return they would have for financing (or partially financing) the project. I have seen many successful implementations of this model by traditional entertainment companies looking to move into the online or social gaming world, where they don’t want to finance a game but have an IP that works well in the space. Thus, they are able to monetize their IP better than simply licensing it or not having it exploited at all. For the developer, it is an opportunity to get a higher return than just a small profit on a flat fee basis or a relatively small royalty.

There are also variants on all of these models. Although I cannot cover them all, I will throw out some options to get you thinking. In a flat fee model, there can still be incentives for success (defined by the publisher). If the game is finished early, there could be a bonus. If revenue exceeds certain thresholds, bonuses can be paid. In an advanced royalty model, the royalty structure could be tiered so as sales grow the royalty rate decreases (or increases) to limit the publishers exposure or to provide more incentive to the developer to create a hit. Also, a portion rather than the entire development fee might be recoupable, so the developer can start earning royalties sooner. With a co-production model, the revenue share can shift based on performance or based on marketing efforts by the Licensor. As I mentioned, there are thousands of permutations, the important thing is finding a model that gets all parties focused on the same goal.

One other issue in structuring agreements is how to deal with issues specific to social gaming. Currently, very little social game development is out-sourced, largely due to the complexities and demands of running a game once it is live. Milestone payments in getting a game to launch do not deal with the real issue of how to compensate developers to maintain a live game. As the social gaming industry matures, however, I am seeing more and more developers and publishers proposing creative ways to use the external development model to scale their businesses. A couple of models that I feel are most likely to create that mutually beneficial nirvana are committing to a monthly payment and a retainer plus royalty model. With the monthly payment option, the game publisher would determine how many engineers/artists/designers are needed to support the game, then pay a developer a fixed monthly fee to keep this personnel dedicated to the project. In the latter case, the publisher would pay a monthly retainer but also a portion of the games revenue (anything from 1 to 50 percent). The retainer allows the developer to dedicate resources to the project while the royalty incentives them to keep the game strong.

Finally, international rights can be an important tool in structuring a development deal. A developer might retain rights to a game outside of North American in exchange for a lower development fee. The developer could then syndicate those rights to third party or publish it themselves. Many publishers and license holders are focused on specific markets, by picking up rights to markets that they do not value highly, the developer can generate a higher return on the project without any cost to the publisher/licensor.

As I mentioned at the beginning of this post, the most important element of structuring a deal is finding a structure that is mutually beneficial and aligns everyone’s interest. There are many ways to get to this end result, just be creative and be fair.

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