Epic Games



In the podcast Acquired, hosts Ben Gilbert and David Rosenthal discuss the evolving landscape of the gaming industry, particularly focusing on Epic Games, creators of Fortnite and the Unreal Engine. They highlight Epic's journey from a startup to a technology powerhouse that revolutionized game development and distribution. The episode delves into Epic's strategic decisions, such as their partnership with Tencent, the transition to a games-as-a-service model, and the contentious battle with Apple over App Store fees. They explore how Epic's Unreal Engine, with its low marginal cost and high inertia, became a critical tool for developers, enabling a wide range of creative endeavors beyond gaming, including the production of the TV series "The Mandalorian." The discussion also touches on the implications of Epic's fight with Apple for the industry, developers, and consumers, debating the potential outcomes and the balance between value creation and capture.

Summary Notes

Background and Introductions

  • Ben Gilbert and David Rosenthal introduce themselves and their roles.
  • Ben is the co-founder of Pioneer Square Labs, a startup studio and early-stage venture fund, with a background in founding companies and product management.
  • David is a long-time venture capitalist, now an independent angel investor and advisor to startups, with a focus on the venture and investing side of the industry.

"I am the co-founder of Pioneer Square Labs in Seattle. We are a startup studio and early-stage venture fund, and my background is primarily in founding companies and product management." "And I have been a longtime venture capitalist. I'm currently an independent angel investor and advisor to startups based in San Francisco."

The quotes introduce Ben and David's professional backgrounds and their expertise in the startup and venture capital industries. Ben's experience lies in company founding and product management, while David's is in venture capital and advising startups.

Acquired Podcast: Season Seven, Episode Three

  • Ben and David host the Acquired podcast, which delves into stories of technology companies.
  • The episode discusses Epic Games, creators of Fortnite and the Unreal game engine.
  • Fortnite is highlighted as a cultural phenomenon, especially among Gen Z, and a major competitor to big companies like Apple and Facebook.
  • Epic Games is also noted for its connection with Tencent, a significant player in the tech industry.

"Today we talk about Epic Games, makers of Fortnite and the Unreal game engine. You probably know of them since Fortnite is an absolute international phenomenon, the most played game in the world."

The quote emphasizes the significance of Epic Games in the gaming industry, particularly with its popular game Fortnite and its game development tool, the Unreal game engine.

Acquired Limited Partners Program

  • The Acquired Limited Partners program offers deeper insights into company building and investing.
  • It includes LP shows, monthly calls, a book club, and author discussions.
  • The program is named after limited partners in venture firms, who provide the capital that enables ventures to operate.

"You should join the community of Acquired Limited Partners. You'll get access to the LP show where we dive deeper into the fundamentals of company building and investing."

The quote invites listeners to join the Acquired Limited Partners program to gain a more in-depth understanding of company building and venture capital investing.

Sponsorship: Pilot

  • Pilot is a company providing accounting, tax, and bookkeeping services for startups and growth companies.
  • It is the largest startup-focused accounting firm in the US.
  • Ben and David endorse Pilot, highlighting its ability to handle a company's entire financial stack.

"Pilot is the one team for all of your company's accounting, tax and bookkeeping needs, and in fact now is the largest startup focused accounting firm in the US."

The quote introduces Pilot as a comprehensive financial services provider for startups, emphasizing its significant presence in the industry.

Epic Games Research and Acknowledgments

  • The episode's research includes contributions from various sources.
  • Special thanks are given to Matthew Ball and Jacob Novak for their primer on Epic, Kotaku's interview with Tim Sweeney, and the podcast Wizard and the Bruiser.
  • Listener recommendations and shared resources within the Acquired community are also acknowledged.

"Three in particular I wanted to call out though. One is Matthew Ball and Jacob Novak, who wrote just an awesome six part primer on Epic and all the dynamics around the company."

The quote acknowledges the valuable insights provided by Matthew Ball and Jacob Novak on Epic Games, which contributed to the research for the podcast episode.

Tim Sweeney and Epic Games' Origins

  • Tim Sweeney, founder and CEO of Epic Games, grew up with a passion for tinkering and business.
  • He started programming at a young age and created his first game, ZZT.
  • Sweeney's early business ventures included a lawn mowing service and computer consulting.
  • He founded Potomac Computer Systems, which later became Epic MegaGames.
  • Sweeney developed Unreal Engine, a game engine that revolutionized the gaming industry.

"By the time he was, I guess, would have been in elementary school. Both of his brothers were probably in college or out of college at that point."

The quote provides context for Tim Sweeney's early life and his independent exploration into programming and business, which eventually led to the creation of Epic Games.

Epic Games' Business Model and Growth

  • Epic Games initially focused on 2D side-scrolling games before transitioning to 3D with Unreal Engine.
  • The company adopted a shareware distribution model, allowing for wider dissemination and user engagement.
  • Unreal Engine became a significant product, attracting third-party developers who wanted to license the technology.
  • Epic Games' approach to building a scalable and extensible engine allowed for continued innovation and growth.

"I could write in just a few hours a really impressive program. It was the ultimate machine to tinker with."

The quote reflects Tim Sweeney's fascination with computers and programming, which was a driving force behind the development of Epic Games and its products.

Console Market Dynamics and Developer Challenges

  • Sony and Nintendo dominated the early console market, with Sony attracting third-party developers and Nintendo focusing on first-party titles.
  • Nintendo imposed onerous royalty terms on third-party developers, relying on their in-house games like Mario and Zelda.
  • Microsoft's entry into the console market changed the dynamics, competing with Sony for developers.
  • Developers faced challenges creating games for both PlayStation and Xbox due to the need for dual development teams.
  • Unreal Engine emerged as a solution for cross-platform development, reducing the need for separate teams.

"Nintendo's attitude has always been, we're both the best at the technology and the best at the creative gameplay."

This quote highlights Nintendo's confidence in their technology and game design, which justified their focus on first-party titles and stringent terms for third parties.

"You're going to have to build from the ground. Dual development teams."

The quote emphasizes the difficulty and resource intensity of developing games for multiple console platforms before the advent of cross-platform engines like Unreal.

Evolution of Epic Games and Unreal Engine

  • Epic Games transitioned from a game company to a technology company, focusing on the Unreal Engine.
  • The proliferation of console wars and the need for cross-platform development tools positioned Unreal as a crucial technology for game developers.
  • Epic's Unreal Engine attracted major franchises, enabling them to release games across different platforms more efficiently.

"Epic is a technology company. Like they make games and they make this game engine, which is a huge component of the game's value chain."

This quote explains Epic's shift in identity to a technology provider, where the game engine became a central part of their business strategy.

"This is what he calls Epic 3.0, where the massive proliferation of the sort of console wars allowed us a neutral third party that can dramatically bring your cost down and your efficiency up in developing a game."

The quote describes the third phase of Epic's evolution, where they leveraged the console wars to position themselves as a key player in reducing development costs and increasing efficiency for game developers.

Epic's Strategy and Gears of War Success

  • Epic aligned with Microsoft to launch Gears of War as a near-launch title for Xbox 360.
  • Gears of War's innovative gameplay and marketing partnership with Microsoft led to high margins and significant revenue.
  • The success of Gears of War highlighted the potential and pitfalls of the developer-publisher model.

"And Microsoft's effectively in this relationship, the publisher and Epic is the developer."

This quote clarifies the roles in the partnership for Gears of War, with Microsoft as the publisher handling marketing and Epic as the developer.

"They end up making epic ends up making $100 million of revenue on Gears of War. It cost them $12 million."

The quote illustrates the financial success of Gears of War, showcasing the high margins possible when a developer partners effectively with a publisher.

Transition to Games as a Service and Digital Distribution

  • Epic recognized the shift towards games as a service, with digital distribution and ongoing player engagement becoming key.
  • Riot Games' League of Legends exemplified the free-to-play model with aesthetic microtransactions, moving away from the traditional boxed software model.
  • Epic's Unreal Engine became instrumental in enabling cross-platform play and supporting the games as a service model.

"There was an increasing realization that the old model wasn't working anymore and the new model was looking increasingly like the way to go."

This quote captures the industry's shift towards a new business model focused on digital distribution and games as a service.

"If we tie up with Microsoft, we're going to be launching a new version of the Unreal Engine."

The quote indicates Epic's strategic move to align with Microsoft for the launch of a new iteration of the Unreal Engine, capitalizing on the shift to digital and service-oriented gaming.

Epic's Growth and Investment from Tencent

  • Tencent's investment in Epic Games allowed for a strategic pivot towards a platform and service model.
  • Epic sold the Gears of War franchise to Microsoft, focusing on developing the Unreal Engine as a comprehensive platform for game development and operations.
  • The Unreal Engine became free to use, with a royalty model on game revenue, encouraging widespread adoption.

"We're going to refocus the entire company around this vision of the future."

This quote signifies Epic's decision to concentrate on building a platform that supports the evolving landscape of the gaming industry.

"Epic stops charging a licensing fee for the Unreal engine makes it completely free to use and develop on."

The quote explains the shift in Epic's business model for the Unreal Engine, aiming to remove barriers to entry for developers and stimulate innovation.

Fortnite's Unprecedented Success

  • Fortnite, initially a separate project within Epic, pivoted to a battle royale mode in response to the success of PUBG.
  • Fortnite Battle Royale achieved rapid growth, becoming a cultural phenomenon and significantly boosting Epic's revenue.
  • Epic continued to innovate with Fortnite, introducing creator modes and launching the Epic Game Store to compete with platforms like Steam.

"Within two weeks, they get 10 million active players."

This quote demonstrates the explosive growth of Fortnite Battle Royale, highlighting its immediate impact on the gaming market.

"Epic raises their first non strategic capital raise... at a $15 billion valuation."

The quote reflects the immense valuation jump for Epic following Fortnite's success, attracting significant investment interest.

Direct-to-Customer Channel Advantage

  • Epic Games recognized the value of direct customer relationships established through their online store.
  • Leveraging this direct channel allows for bypassing traditional retail and maintaining closer customer connections.
  • Epic's approach undercuts traditional distribution models, providing a competitive edge.

"We had the advantage of never needing to be in your store and always going direct. So now we have this direct channel to all these customers. Like, we should leverage that."

The quote emphasizes the strategic advantage Epic Games gained by not relying on physical stores and instead using direct online distribution to engage with customers and leverage that relationship for marketing and sales.

Epic Games Store Launch Strategy

  • The store launched with only a 12% cut of revenue, significantly undercutting Valve's Steam platform by 18%.
  • Developers using the Unreal Engine benefit by having the 5% engine royalty included in the 12% store fee.
  • Epic Games offers a comprehensive package: engine, live ops, distribution, and payment processing for a maximum fee of 12%.

"They launched the store with a 12% cut of revenue, so they undercut Valve by 18%. And then the kicker is, if you build your game on the Unreal engine, the 5% revenue fee gets baked into the 12%."

This quote details Epic Games' competitive pricing strategy for their store, offering a lower revenue cut and additional savings for Unreal Engine users, positioning themselves as a more attractive platform for game developers.

Cost-Plus Pricing Model

  • Epic Games' pricing model is based on a cost-plus approach, aiming for efficiency rather than high profit margins.
  • Tim Sweeney, CEO of Epic Games, believes in covering operational costs plus a modest profit margin, contrasting with the industry's higher fees.
  • Epic Games avoids double-charging developers using their full stack of services.

"That 12%, the way that Tim talks about it, is basically a cost plus pricing model where he says, look, I think it's going to take five, 7% to run the store, and we don't need to make more than 5%."

The quote explains Epic Games' philosophy behind their pricing strategy, which is to cover operational costs and maintain a reasonable profit margin, differentiating themselves from competitors with higher fees.

Epic's Challenge to Google and Apple

  • Epic Games challenged Google by bypassing the Play Store and prompting users to sideload Fortnite, highlighting the open Android platform's limitations.
  • The company later listed Fortnite on the Google Play Store due to security warnings and user experience issues with sideloading.
  • Epic Games' actions against Google and Apple's app store policies sparked broader industry debates on platform fees and openness.

"We're not going to go through Google Play anymore because Android, you have this nice open platform, you brag about it being an open platform. We are going to have people download the Apk where they're just going to sideload and install the app directly."

The quote captures Epic Games' initial move to challenge Google's Play Store dominance and promote an alternative method for installing Fortnite, which ultimately led to a reconsideration due to user experience concerns.

Epic vs. Apple and Google: The App Store Battle

  • Epic Games introduced a direct payment option in Fortnite to avoid app store fees, leading to delisting by Apple and Google.
  • Apple threatened to ban Epic's developer account, affecting Unreal Engine distribution on iOS and Mac.
  • The legal battle highlighted tensions over app store policies and developer freedoms.

"Epic pushes a new version of Fortnite to the iOS App Store and the Google Play Store that offers a permanent discount on vbucks, the in-game currency in Fortnite, if you buy directly from Epic."

This quote outlines the catalyst for the legal confrontation between Epic Games and the tech giants, as Epic introduced a direct payment method to circumvent the app stores' commission fees.

The Impact of Tech Giant Clashes on Customers

  • The conflict between Epic, Apple, and Google resulted in reduced functionality and access for Fortnite players on affected platforms.
  • Cross-platform play restrictions and season updates became collateral damage in the dispute.
  • Customer experience suffered as a result of the corporate standoff, highlighting the negative impact of such clashes on end-users.

"Epic hit back and announced that existing Fortnite instances running on Apple devices are going to lose access to the next Fortnite season and crossplay ability."

The quote describes the direct consequences for players due to the ongoing legal and policy dispute, with Epic Games announcing limitations on Fortnite gameplay for users on Apple devices, exemplifying how customers often bear the brunt of such conflicts.

Lowering the Bar to Creation and Entrepreneurship

  • Ben Thompson emphasized the importance of making it easier for individuals to create and innovate without requiring large budgets.
  • Epic and its CEO, Tim Sweeney, are focused on democratizing the creation process, enabling people to make impressive online content without Hollywood-level funding.

"The very best way you can do that is if you can lower the bar to creation and entrepreneurship. And that's what epic and Tim are really trying to do."

The quote underlines the philosophy of reducing entry barriers to creative work, suggesting that innovation can flourish when financial constraints are minimized.

Control and Independence

  • Epic's history with Microsoft over Gears of War highlights the importance of maintaining control over one's creative direction.
  • Epic's ability to publish and develop Fortnite independently allows them to have the final say in their projects.
  • Epic's capital structure, which may not be possible with a public company, enables them to engage in actions like their dispute with Apple, which may not immediately translate into value for shareholders.
  • The discussion contrasts the flexibility of being a public company, as seen with Eventbrite, with the strategic freedom afforded by private ownership and the deep pockets of VC funding.

"Being a controlling shareholder allows you to do things that you certainly could not do that may pay off compared to being a public company."

This quote emphasizes the strategic advantages of maintaining control, which can lead to decisions that may not align with short-term shareholder interests but could potentially pay off in the long run.

Game Engine Inertia

  • Game engines, like Unreal Engine, have significant inertia due to the difficulty of acquiring customers and the near impossibility of displacement once established.
  • The success of new game engines is tied to shifts in technology paradigms, such as the emergence of mobile gaming, which favored engines like Unity.
  • The discussion suggests that a significant technological shift is required to compete with established engines.

"The only way to compete with one of those products, once it has momentum behind it, is in a displacement of paradigm."

This quote highlights the challenge of displacing an established game engine and suggests that only a fundamental shift in technology can create an opportunity for new competitors.

Iteration and Compounding

  • Iteration and compounding are interlinked concepts in startups and investing.
  • Epic's methodical iterations on the Unreal Engine have compounded over time, creating substantial value beyond just financial growth.
  • The conversation likens iteration to the practical implementation of the abstract concept of compounding in investing.

"Iteration is standard dogma in startups and engineering...compounding is standard dogma in investing."

This quote draws a parallel between the principles of iteration in engineering and compounding in investing, illustrating how consistent improvements over time can lead to significant outcomes.

Crusoe and Clean Compute Cloud

  • Crusoe is a clean compute cloud provider that specializes in AI workloads and partners with Nvidia.
  • Crusoe's data centers utilize wasted, stranded, or clean energy, leading to better performance per dollar and environmental benefits.
  • The company's unique approach allows them to locate data centers in remote areas where energy is produced, unlike traditional cloud providers that need to be near internet traffic hubs.

"Crusoe's data centers are nothing but racks and racks of AI."

This quote describes the specialized nature of Crusoe's data centers, which are optimized for AI workloads and are environmentally conscious in their energy usage.

Grading the Fight with Apple

  • The hosts discuss grading Epic's fight with Apple and the potential outcomes for both companies.
  • They evaluate the financial stakes for Apple and Epic, considering App Store revenues and Fortnite's earnings on iOS.
  • The conversation explores the strategic implications for Apple if they lose access to popular content like Fortnite or if developers turn away due to the dispute.

"What should each company do?... It's very unlikely, I think, that he could have gone out after Apple in this way, because, as we'll talk about, it's likely short term value destructive, and it's not necessarily clear that it's long term value creative either."

This quote captures the complexity of Epic's decision to challenge Apple, considering the potential short-term losses and unclear long-term benefits for both companies involved in the dispute.

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