Welcome to Master the Meta, a newsletter focused on the business of video games.

This is the first of many company deep dives Master the Meta will publish going forward, and there’s no better place to start than with Epic Games, perhaps the most forward thinking business in the industry. This is my attempt to explain how the most innovative company in gaming got to where it is today, what’s next, and why it’s been able to do what others can’t.

Before diving in, let me note that since Epic Games is private there’s much we don’t know. As a result, this analysis will be far less quantitative than usual, and I’ll probably be wrong about something.

A Brief History

Epic Games is best known for Fortnite, which took the world by storm 2017, but this was very much an overnight success 26 years in the making. Like software, founder and CEO Tim Sweeney once stated he views Epic Games as an iterative entity that upgrades over time, molded by changing industry winds and keen insight. Here’s how the company got to where it is today:

Epic 1.0: Tim Sweeney kickstarted Potomac Computer Systems — originally as a computer consulting business — as a college student in 1991. He pivoted to game development pretty quickly, and ZZT was released later that year on MS-DOS. The game was a small success, so Sweeney decided to build a team, change the company’s name to Epic MegaGames, and lean further into game development.

Epic 2.0: After a few more years of developing MS-DOS games and very early Windows games, the company unveiled Unreal, a first-person shooter built on the new and proprietary Unreal game engine. This launch gave the company a renewed focus and set it on a new trajectory. Licensing the game engine provided another revenue stream, and it set the foundation for being both a gaming and technology company — an advantage that persists 20 years later. In 1999, the company moved to North Carolina and simplified its name to Epic Games, which it still uses today.

Epic 3.0: In the mid-2000s — during the heyday of PC pirating — Epic Games tackled the console market for the first time. The successful 2006 release of Gears of War was not only significantly profitable, but it was the first non-Unreal Tournament game the company developed since the 90s. This success — followed by additional Gears of War games — provided cash to acquire a couple studios. This bolstered the company’s console ambitions, and paired with the updated Unreal Engine 3, led to Epic’s mobile debut. The debut game, Infinity Blade (2010), which showcased the updated game engine’s capabilities, became the fastest grossing app on Apple’s App Store. (I remember being so excited to buy this game on my birthday using an iTunes gift card)

Epic 4.0: By the early 2010s it became clear that the industry was changing yet again — this time toward free-to-play games (FTP) and games-as-a-service (GaaS). To bring in expertise, Epic Games sold ~40% of the business to Tencent (Tim Sweeney owns most of the rest). The company then sold Gears of War to Microsoft, shifted a couple of its own titles to FTP, dabbled in VR, made access to the Unreal Engine 4 free (5% royalties kick in once products earn $3,000+ per quarter), launched the Unreal Marketplace (and took a 30% cut), and stopped being bound to any other publishers. These changes spurred executive turnover, but the company plowed forward. It was also during this time that Fortnite was (slowly) being developed to serve as a testing ground for how Epic’s tech stack could push boundaries in live, multiplayer games. The team likely knew they were building an impressive game and compelling capabilities, but there’s no way they knew just how game-changing their work would pan out to be.

Unpacking Epic 5.0

As I look over Epic Games’ first four iterations, two key lessons stand out to me:

Companies that are controlled by visionary founder-leaders have fewer problems pivoting focus to greener opportunities, especially when it means forgoing profits to reinvest in new unproven ideas. Change is often hard for companies that breathe politics and require consensus from multiple stakeholders, so lowering barriers to change means a company — like Epic Games — can not only survive but thrive in ever-changing environments. The fact that we’re talking about a fifth iteration indicates how “adaptive capacity” is one of the company’s core competitive advantages. It’s the kind of advantage that doesn’t show up on financial statements or impact a P/E ratio, but it’s an intangible that makes a world of difference over the long-term.

Across multiple decades — and no matter the industry’s composition — the intersection of gaming and technology has continued to grow in importance. Pioneering the forefront of that intersection provides a first-mover advantage on new opportunities and eventually leads to a diversified revenue stream of tools/platforms that others can benefit from. It reminds me of Amazon: infrastructure like Fulfillment by Amazon (FBA) and Amazon Web Services (AWS) serves everyone, but Amazon was and remains customer #1. Amazon built solutions — logistics/warehousing + cloud computing — to tackle its own company-specific needs and then scaled out that infrastructure for everyone else to use. Similarly, Epic Games builds foundational tools (and now platforms) that everyone can use, but — especially with the Unreal Engine — Epic itself remained customer #1. Some companies just serve gamers and some just serve developers, but serving both simultaneously breeds unique ecosystem advantages that can persist for decades. Companies that focus on just one side increasingly compete at a natural disadvantage.

Naturally, Epic 5.0 — 2017 through the near-future — builds on these lessons and takes it up a notch.

It goes without saying that Epic Game’s current iteration was catalyzed by Fortnite, which amassed 250+ million registered players, created insane buzz, and generated billions in revenue. The company caught lightning and is impressively redistributing that energy and capital to accelerate its ambitions for the future.

In order to best understand how important Epic 5.0 is (and what it ideally leads to), let’s break apart the pillars that make up Epic Games today… and then examine how they work together.

Video Games: Using Fornite to Push Boundaries

Fortnite is the company’s sole game right now, but it’s moved mountains — both for Epic Games and the industry as a whole. Here’s why Fortnite was so successful:

The initial “Save the World” concept didn’t take off as planned, so the game pivoted into Battle Royale at the right time, riding a massive tailwind. It also made itself distinct through unique gameplay mechanics like building.

Fortnite was at the forefront of free-to-play and cross-play, meaning anybody could play with anyone. Most other similar games had neither.

Gameplay itself was praised, attracting top players and personalities who essentially marketed the game on streams and YouTube for months on end.

It’s a social experience, a place to hang out and have fun with friends, which accelerated the game’s network effect.

Your avatar can be most anything, and it sticks with you through all games and game modes. The game puts individuality front-and-center in a fun way — skins, emotes, etc. — which drove a frenzy of spending.

Fortnite also popularized the Battle Pass concept, which incentivizes greater engagement and spending from the most engaged players.

It’s a place where anything can happen. Therefore, Fortnite doesn’t have lore or a story, but it’s able to use special events to reinvigorate buzz and engagement. In many cases, it partnered with the world’s biggest personalities and brands to do things no game has ever done before: Marshmello, Star Wars, and more.

The game regularly updates throughout seasons (and now chapters) — new weapons, abilities, locations, etc. — which keeps players from getting bored.

Esports is good marketing and deepens engagement with the most competitive players.

Creative Mode captures a different audience with different tastes. It sets the foundation for many new gaming experiences that are community-built.

In other words, it wasn’t any one thing that made Fortnite successful. It was successful because Epic was able to engineer something complex using the best of what was possible in 2017 while creating a foundation to push boundaries in the future.

In some ways the team made wise decisions that anyone could’ve: battle royale, monetization tactics, approach to narrative (or a lack thereof), esports. But more importantly the company decided to invest where others weren’t: significant resources dedicated to ongoing new features/content, building the best live ops team in the industry, improving the Unreal Engine (which translates to upgrades in the game), prioritizing creator tools to scale user-generated content (UGC), and more.

Here’s the kicker. Yes, Fortnite hit a “local maxima” in terms of DAUs, viewers, and therefore revenue; however, as soon as other companies try to catch up with what Epic Games has achieved, Fortnite will have likely “leveled up” again. We’ve already seen this in some regards. Apex Legends competes as a great battle royale game, but as soon as it got started Fortnite doubled down on live events that Respawn couldn’t even think to match. Again, that’s just the beginning. By the time other games capture even more of Fortnite’s key lessons, Fortnite will have likely moved on from even being just a game. Fortnite is on the cusp of turning its game into a platform — not to mention kickstarting a competitive ecosystem — a feat that will surely leave 99% of other publishers in the dust, unsure of how to even compete. Of course, it’s a massive industry that can support multiple winners — Fortnite at its peak “only” represented ~2% of total game industry sales — but these moves ensure Epic Game’s ceiling is a lot higher than other companies.

Unreal Engine + The Epic Games Store: The Battle for Developers

The Unreal Engine and the Epic Games Store are two distinct pillars of Epic’s business, but they serve a conjoined purpose: to win over the hearts and minds of developers.

The 21st century is the century of digital builders, and developers’ influence on business is only growing. Therefore, catering to developers is increasingly as important as catering to the end users. Fortunately, Epic Games figured this out before the 21st century even hit.

What’s unfortunate is despite the fact that developers are innovating on the way we learn, work, shop, and play, there remain obstacles. The largest obstacle is the fact that all parties want a cut, and gatekeepers — storefronts, worst of all — take advantage of their near-monopolistic positioning to charge exorbitant fees.

Epic Games made the audacious decision to use its Fortnite profits to go to war against Steam and subsidize a more developer-friendly take-rate. In December 2018, the company launched the Epic Games Store (EGS), a website + launcher meant to break Steam’s monopolistic grip on PC storefronts. Like all two-sided networks, it needs to serve both sides (players and developers) and solve the inevitable chicken-and-egg challenge.

The solution for developers is simple on paper. The EGS only takes a 12% cut versus the 30% cut Steam takes. Plus, if a developer uses the Unreal Engine, the typical 5% royalty rate gets absorbed by the EGS’s 12% cut. In essence, fees fall roughly two-thirds, from 35% to 12%. Switching to the EGS is a no-brainer if — and that’s a big if — the platform has a competitive player base.

Epic addressed the player side of the equation with a bang; after all, the PC Fortnite audience itself has tens of millions of players. The company followed that up with weekly free games and ongoing exclusives (I’d love to see how how much they’re spending on all this). Naturally, the EGS’s feature set remains lacking compared to Steam, but that should change in time. And even if Steam lowers its rates to obliterate the EGS, that would be considered a win:

It’s ideally a win for developers either way. If Steam reduces its take-rate rate, fantastic! If Steam holds out and the EGS steadily chips away at Steam’s market share, that’s great too. In the long-run, the game theory favors creators. This is especially true on PC where there isn’t an inherent “app store” monopoly like there is on console and mobile.

So how is it going so far? Epic recently shared this infographic:

A few reactions:

108 million customers is a lot, and launching across the world as quickly as they did is impressive. That’s a win, but it doesn’t say much about engaged active users.

Third party sales are critical, and $251 million of third-party sales isn’t a bad start. I suspect the team had higher goals — a 12% cut is only ~$30 million — but breaking consumers’ spending habits — especially when they already boast collections of games elsewhere — is challenging.

Epic probably hasn’t whacked Steam as hard and as quickly as it hoped for, but Steam is starting to feel a pinch. The pace of new releases has slowed, and average revenue per game is falling. As smaller studios see less success on Steam, it makes Epic’s exclusivity offers look more appealing.

It’s important to remember that this is just year one. The EGS’s momentum in 2020 will be just as crucial. The two key metrics to judge performance (and market share) will be growth in monthly active users and money spent on third party games.

If I’m Epic Games, I’m racing to add games and features that make the EGS more competitive, hunting for reasonable tentpole exclusives that move the needle on player acquisition/engagement, thinking up ways to reward players for sticking with the EGS (especially when buying non-exclusives), and perhaps working with Tencent to get their other partners/investments to switch over.

As for Unreal, the game engine market has always been competitive and probably always will be (especially as larger tech companies dive in), but business continues to grow. Unreal, which is known for high-fidelity graphics, looks to have captured ~13% market share in 2017-18, although it may have inched a bit higher in 2019 (would love to see data on this). Unreal was initially designed for PC and has had trouble catching up with Unity on mobile, but Fortnite’s success helps in three key ways. One, the fact that the most popular game in the world is built on Unreal is good marketing. Two, Fortnite’s success allows more money to be reinvested into development, especially development that targets next-gen interfaces (like AR/VR, where its adoption lags Unity’s) and entertainment markets beyond gaming. And, three, like with the EGS, Epic could afford to lower the take-rate on the Unreal Marketplace to 12% from 30% (which is where Unity is still at). Getting teams to switch game engines is tough, but hopefully these moves help Unreal better capture new developers and teams who are just getting started.

Just like with the EGS, lowering take-rates and reinvesting more heavily into Unreal is audacious. These changes don’t guarantee significantly higher market share, but it’s still wise to lean into an ecosystem approach, where the different business pillars support each other.

Building an Ecosystem

Epic 5.0 is currently known as the Fortnite era, but it’s really about Epic’s transcendence beyond any one game or any one technology.

At its very core, Epic 5.0 is about forgoing profits in order to build a forward-thinking ecosystem. But even that is stating it too simply.

It’s about busting monopolies.

It’s about empowering creators of all types.

It’s about pushing the boundaries of shared digital experiences.

And most importantly…

It’s about setting a foundation to drive the next major internet evolution: the metaverse.

We haven’t seen the end of Epic 5.0. Fortnite isn’t yet a platform. Epic’s low-code development tools have room for improvement. The EGS needs to solidify its place and hit breakeven. And Unreal needs to segue into the upcoming VR/AR era.

There’s much more to come.

Epic 6.0, 7.0, 8.0...

Epic Games is clear about its motivations. The team wants to build a metaverse, and they want to ensure that that power and responsibility don’t exclusively fall into the wrong hands.

What does metaverse really mean? Well, it’s complicated and frankly no one quite knows. Sci-fi writers have portrayed their guesses for decades, and if you want a comprehensive take, read Matthew Ball’s recent write-up. My take is fairly simple.

The metaverse is a simplified term for the next era of the internet that offers More^5:

More experiences. Things to watch, play, and work on — in ways both individual and social.

More immersion. Various technologies — mobile, AR, VR, etc. — will offer gateways to participate, and these technologies will further separate the physical and digital worlds.

More creation. The metaverse will grow organically, and, much like the traditional internet, various tools will allow everyone to contribute. In a best case scenario, these tools are open-sourced, encourage decentralization, and leverage next-gen internet protocols.

More rewards. Digital work — creating digital goods and services, or performing digital tasks — will be rewarded with digital dollars. The percentage of people who get paid for digital work will steadily grow.

More freedom. The digital world lacks physical geography and therefore lowers barriers to participate. Ideally, the metaverse creates a more even playing field.

Of course, there’s no magic “on” button, and no company can put a patent on the metaverse (although someone will probably try!). So there will be challenges over the decades in which the metaverse organically grows. Where will (and won’t) things interoperate? Will there be a rift between the East and West? How can you support 1,000x more participants in the same game or experience? It will take hard work from lots of different parties, and Epic Games wants a seat at the table.

Also, I hope it’s clear that many of the trends people are hyped up about — AR, VR, cloud gaming, digital currencies, etc. — are all individual building blocks that make the metaverse possible.

In some ways, Fortnite itself — especially a year or two from now — is an early stage metaverse. After all, you can take your one character through lots of different experiences with lots of different people. Other games like Minecraft, Roblox, and Grand Theft Online also share similar qualities. These games could last the test of time or fizzle out, but their intent and spirit will absolutely carry forward.

This is where the intersection of gaming and technology becomes useful again. On the creative side, it’s impossible to plan 2-3 years out. There’s no way to know what will be feasible or what the zeitgeist will be. However, from the technical side, even if you don’t know when exactly technical breakthroughs will occur, it’s pretty clear what the technical hold-ups are and what needs to be improved on. The benefit of having both sides under the same roof is that as the technical side finds new solutions, the creative side can start thinking about what’s possible far earlier (and with more internal help) than pure creative companies. The same advantage that made Epic 2.0-5.0 possible could very well play out in iterations 6.0+.

Epic will continue to push the boundaries on what’s possible in games, perhaps even changing the definition of what a game can be. They’ll make it easier for anyone to be a creator, which in turn will allow Epic to host more content — games and beyond — on its proprietary platforms. And the platform approach solidifies an ecosystem that works equally hard to serve creators and consumers, two sides of the same coin. The big question is where will pushing the boundaries take us? What new experiences will be unlocked? How will we consume them? Who will Epic go up against to solidify its footing in this brave new world?

I’m excited to find out. Of course, despite Epic’s proven track record of forward thinking, there are plenty of risks to solve for. How to keep Fortnite fresh. How to make the EGS sticky. How to succeed as paradigms shift. How to partner and acquire to accelerate technical and creative ambitions. How to stay a step ahead of competitors — publishers, Steam, Unity, and one day the tech giants like Facebook — which are more numerous and bigger than in Epic’s past. Not everything will work, but not everything needs to. In general, I like Epic’s odds.

Take Notes

Other companies shouldn’t let these lessons pass them by. As I mentioned in “The Path to Titan,” the gaming industry will increasingly consolidate around ecosystems, but there will remain successful gaming companies at every tier, because there’s a near-endless appetite for outstanding games. There’s nothing wrong with staying focused on a niche, but Epic Games has shown it’s possible to transcend. Having a popular game helps, but it’s much more than that. The world is more malleable than most people and companies think, and I’m convinced others can rise up and make a dent in how the gaming industry functions.

I work with David Gardner, a brilliant investor who’s known for saying, “make your portfolio reflect your best vision for our future.” Investors are smart to heed those words, but I’d like to propose a similar variant for companies: “make your roadmap reflect your best vision for our future.” Your purpose statement should distill why you exist, your vision statement should capture a forward-thinking strategy that encourages ambition, and — specific to this industry — your roadmap should reflect tactics that go beyond just making games: investments in new technologies, business model tests, more ambitious hires, partnerships that offer unique advantages, and more. Just like Epic Games thinks and plans in terms of company eras/iterations, so should other companies.

Fortnite is both the culmination of years worth of work and just the tip of the iceberg. That one game can be so much more, and future games can be bigger and better than Fortnite. That’s bullish for Epic Games as well as anyone else who’s willing to listen, learn, and push the boundaries.

Aaron Bush (@aaronbush100)

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