Unity: Large And Growing Opportunity
Summary
- Unity faces a huge opportunity as the importance of 3D content increases. Revenue is currently primarily generated from gaming but there is potential in other verticals like media and automotive.
- It is unknown to what extent a metaverse will develop or who will control it. Despite this, Unity is well positioned to benefit from an increasingly 3D future.
- Unity has limited direct competition due to the extremely high technical barriers to building a leading engine. There are numerous niche competitors who are well resourced though.
Unity (NYSE:U) is the developer of a leading platform for interactive 3D content. They believe that in the future most of the world's content will be real-time 3D and want to enable this future. Unity's vision is to have hundreds of millions of creators on the platform, from consumer creators to professionals in gaming and dozens of other industries. This represents a large market opportunity which will continue to grow, supported by improvements in technologies like GPUs, 5G and Artificial Intelligence (AI). Direct competition is limited due to the complexity and cost of building a leading game engine, although Unity faces a number of well-resourced niche competitors.
Market
A technologically enabled shift from asynchronous, non-interactive 2D content to real-time, interactive 3D content is currently underway. The gaming industry has been a primary beneficiary of this trend and is the fastest growing sector of the media, but other industries are increasingly being impacted as well. A virtuous cycle of software and hardware innovations are driving this growth, including GPUs, 5G networks, 4K displays, AI, cloud computing and Augmented Reality (AR) / Virtual Reality (VR) devices. The proliferation of devices like smartphones, PCs and consoles has also contributed to the growth of immersive and interactive content.
Game engines are at the heart of 3D experiences and are the foundational code upon which virtual worlds run. They manage everything from the processing of physics to visuals, audio, AI, memory and networking. In the past, many game developers would utilize their own custom-built engine, but as engines have become more advanced this has become increasingly difficult to do. The creation of content with high fidelity graphics used to require the use of disparate point solutions and large teams, as much of their time was spent building custom tools from scratch. Third-party engines provide developers with a toolkit that lowers the barriers to entry for creating high-quality 3D content. The proliferation of device types has also made engine design more difficult, as more resources must be committed to ensuring cross-platform compatibility. It is a significant benefit to be able to develop content once and have it compatible across platforms and third-party engines manage this complexity.
The majority of game makers now build and operate their games based on a third-party engine, like Unity or Epic, with only a small number of AAA studios still developing their own engines. AAA games are those that are backed by years of development and cost hundreds of millions of dollars. The major publishers, such as Activision Blizzard (ATVI) or Take-Two (TTWO), typically use proprietary engines as they have sufficient scale to justify development costs, although these engines are generally less capable than third-party engines. The importance of this may be overestimated in many applications though, as a game must succeed on game play, not just cutting-edge graphics or physics. AAA studios are engineering-centric and have large teams which often feel compelled to develop their own tools, because they can.
AAA studios are more likely to utilize a third-party engine when they face constraints like limited time and budget or the limitations of their own engine. It will become increasingly infeasible to utilize proprietary engines in the future though as graphics and physics continue to become more complex and additional capabilities like AI and networking become more advanced. Consumers want entertaining content and engine development can detract from this. As a result, customers of all sizes, including AAA studios, are increasingly looking to leverage third-party tools to accelerate the development process.
Cyberpunk 2077 is indicative of the potential problems when a studio tries to in-source nearly all aspects of a complex game. After years of hype, Cyberpunk 2077 was released with significant issues, resulting in many gamers demanding refunds. The game was built using CD Projekt's own engine and it has been noted that during game development the studio opted to develop functionality internally as much as possible rather than rely on middleware.
Hardware has historically had a large impact on the structure of the gaming industry. There are currently three core platforms for video games: consoles, PCs, and mobile devices. Game consoles are closed platforms, meaning a game publisher must receive approval from the manufacturer (e.g. Nintendo, Sony, Microsoft (MSFT)) and pay a licensing fee to release a game for the system. As a result, the sale of software is lucrative for platforms and they often sell their hardware at a loss to establish a distribution base. Google (GOOG) attempted to disrupt this model with their Stadia streaming service, although so far it has failed to live-up to the hype. Similarly Microsoft and Amazon (AMZN) offer xCloud and Luna respectively. Streaming is yet to prove it can disrupt consoles, but in the event it does the hyperscalers would be in a strong position to succeed in game engines as cross-platform compatibility would be less important.
The majority of game sales now occur digitally and the major platforms control this through their proprietary stores (e.g. the PlayStation store, Nintendo Online). These stores also manage additional sales and generally take a 30% commission on all one-off transactions and a 30% commission on subscriptions in the first year, which drops to 15% in subsequent years. Stores also act as a social network so that friends do not need to reconnect in each game, which can help to make a platform stickier. Digital stores are an important part of the gaming ecosystem, although probably do not present a threat to game engine developers.
In the past games were monetized through an upfront sale or on a pay per use basis but gaming business models have evolved to include advertising and in-app purchases. While they may still utilize an upfront fee, the biggest games now typically rely largely on on-going revenue (downloadable content, ad impressions, etc.). There are a range of additional tools (e.g. ad network) required to support these alternative types of monetization, which are often supplied by third-party engines.
Game engines also have rapidly expanding use cases outside of the gaming industry, with new use cases including automobile and building design, online and augmented reality product configurators, autonomous driving simulation and augmented reality workplace safety training. Architects, designers and project partners use real-time 3D to simultaneously contribute to the planning and development of a building with rapid, cost-effective iteration.
In film, real-time 3D technology allows a creator to edit and review a scene instantly, rather than waiting days for server farms to fully render a digital scene. Game engines could be the future of both animation and live action, as illustrated by The Lion King and The Mandalorian, which were almost exclusively shot using Unity and Unreal respectively. These emerging use cases represent a significant growth opportunity for game engines.
The idea of ubiquitous 3D content can be extended to a concept of a Metaverse (a persistent shared virtual space on the internet). At its most extreme this concept would be like the virtual reality simulation, OASIS, in the Ready Player One movie. Unity's CEO believes that a nascent version of the Metaverse is already here, but will become increasingly dominated by real-time 3D in the future. Interoperability between experiences is necessary to achieve this though and will require standardization, interconnectivity and collaboration between companies. 3D engines could well be at the core of this but large companies like NVIDIA (NVDA), Apple (AAPL), Google, Facebook (FB) and Microsoft have all presented their own case for being important contributors to the Metaverse.
3D content has helped to expand gaming from a 15 billion USD industry 20 years ago to one with over 2.5 billion gamers generating in excess of 140 billion USD in annual revenue today. Unity estimate that their gaming market opportunity in 2019 is approximately 12 billion USD across over 15 million potential creators. They believe the market opportunity from other industries is approximately 17 billion USD based on an estimate of the number of software developers, architects and designers that could be served by game engines.
Table 1: Unity Estimated 2019 Total Addressable Market
(Source: Created by author using data from Unity)
Unity believe they can expand their market opportunity by:
- Creating new gaming solutions like assisted artistry workflows and higher performance rendering capabilities
- Providing solutions for AR & VR applications
- Further expanding into other industries which can be benefited by 3D content
Unity have stated that their expansion opportunities are potentially multiple times larger than their current market.
Competitors
Epic
Unity's main competitor is Epic, with their Unreal Engine. Unreal was initially designed for the PC market, to support development on hardware that varied significantly across vendors. In recent years Epic's success has been driven by Fortnite, an enormously popular game that was built on the Unreal Engine.
Unreal is generally considered best for visually rich games, especially multiplayer ones played on consoles and PCs, making it the top choice amongst AAA studios. As an example, eight of thirteen launch titles for Microsoft's newest console are Unreal-based. Unity is easier to use than Unreal and lighter but also more technically limited, which is reflective of its beginnings in mobile gaming. Unity is generally considered a superior development platform for mobile and excels in VR and AR.
Unreal's licensing terms mean that in some cases technology or tools built by a developer are freely licensed back to Unreal. The engine therefore benefits from the work of thousands of developers, while proprietary publisher engines may only have a few hundred developers working on them. It is not hard to imagine this being a point of controversy for customers though, as it is quite exploitative and their work can be leveraged by Epic and competitors. Unreal's engineering team also benefits from a large amount of user data which can be used to inform development and investment. Unity's focus on the low-end of the market gives them access to significantly larger volumes of data though and puts them at an advantage to Epic in this area.
Unreal is a code-based platform but includes an integrated visual scripter called Blueprints. Epic also offer TwinMotion, which is icon based and focused on visualization / renders. There is also Fortnite Creative Mode which provides pre-fabricated assets and heavily simplified tools for game making. This is similar to Unity's strategy of increasing the number of users by lowering the barriers to entry.
Epic has made a number of acquisitions in recent years to add to their platform's capabilities, including the creation of realistic digital humans and environments. These acquisitions appear focused on expanding Unreal's use outside of gaming and include:
Cubic Motion (2020) - platform for capturing more realistic facial animations.
3Lateral (2019) - game studio focused on designing more realistic computer-generated human characters.
Quixel (2019) - created an asset library of real world imagery that can be used in films or video games.
The Unreal Engine is used extensively outside of gaming with most of Disney's (DIS) The Mandalorian filmed using the Unreal Engine. Unreal also runs much of Disney's Star Wars: Galaxy's Edge theme park attraction. Disney has always been focused on monetizing IP across multiple channels and a 3D engine is an excellent way of transferring locations, objects and characters across experiences.
Figure 1: Disney's Intellectual Property Monetization
(Source: hbr)
Sony Music is also building a technology team for Unreal-based concerts, which could be considered surprising given that Sony Music's sister company Sony Interactive Entertainment has its own gaming platform (PlayStation) and numerous proprietary engines.
The Unreal Engine is monetized primarily through a commission on revenue (typically 5%), although this can also generally be bought out upfront. In 2020 Epic announced it would waive the licensing fee for a game's first 1 million USD in revenue. Most games never gross over 1 million USD and hence will no longer generate any revenue for Epic. This appears to be an attack on Unity as Unity is the most widely deployed engine for small / mobile games and deploys a flat "per seat" fee for its engine. It will be interesting to see if this helps Epic to gain traction among smaller users and win some of Unity's customers. Epic also announced a new initiative to publish the games of independent developers in 2020. They are offering to fund up to 100% of development costs and in return split profits evenly after those costs have been recouped. Developers would retain creative control and ownership of the IP.
Fortnite is one of the most popular non-mobile only games in terms of monthly active users, with roughly 60-80 million users compared to 110-150 million for Roblox and Minecraft. Fortnite's total playtime is the largest though. In April 2020, it amassed more than 3.2 billion hours of play, compared to ~2 billion each for Roblox (RBLX) and Minecraft. Fortnite is often considered more than a game though, sometimes playing a role as a social network or a place to hang out. In support of this multi-functionality Epic offers Battle Royale, Party Island (social) and Creative Mode (similar to Minecraft). In 2019 Epic purchased the social video hangout service Houseparty, which was a fortuitous acquisition given Houseparty's surge in popularity during COVID. Houseparty is a social app focused on video chat and it is likely that the acquisition was made in support of Fortnite. Fortnite's popularity has also made it a channel for consumer marketing, brand building and multi-media franchise experiences.
Fortnite could be the beginning of a Metaverse, but there are still significant technological limitations. Unreal is unable to support thousands, let alone millions of people participating in a shared experience with their own individual characters. When large live events with millions of attendees have been held in Fortnite it has actually been tens of thousands of instances, capped at under a hundred users.
Outside of Fortnite and the Unreal Engine Epic also offers a store, a game studio and publishing and online services. Epic Games decided to launch its own PC and Android store in late 2019 by leveraging Fortnite and this is probably at the heart of Epic's dispute with Apple. To help grow the store Epic bought exclusive distribution rights to a number of top games. Epic takes 12% commission on in-store sales and in the event the publisher's game uses Unreal, the Unreal licensing fee (typically 5%) if waived. This means that Epic's revenue may be as little as 7% of sales, probably barely above costs. While the Epic Games Store offers developers larger profits it has frustrated end users. The store also expands Epic's ability to collect user data, which can be used to inform investments and allow Epic to:
- substantially grow the number of active users in its player network
- grow the size of the Epic ID player/social graph
- increase the total Epic-related playtime, data, and spend per Fortnite user
Epic Online Services helps Epic to build a persistent user base that transcends platform boundaries. Online Services locks customers into the Epic ecosystem and provides developers with access to the full Fortnite player base and social connections.
Figure 2: Epic's Intellectual Property Monetization
(Source: matthewball)
Epic is a much larger company than Unity but much of their success is currently built on the back of Fortnite. The vast majority of Epic's revenue comes from Fortnite and the company's strategic moves really need to be viewed through the lens of how they impact Fortnite. It is estimated that Epic generated approximately 5.1 billion USD revenue in 2020, aided significantly by increased usage of Fortnite during COVID lockdowns.
Table 2: Epic Financial Performance
(Source: Created by author using data from Epic)
Ignoring the anomalous past 12 months, usage and revenue for Fortnite appear to be in decline. Epic believe Fortnite has saturated its core market, with 65 million MAUs in 2019 and an ARPU of 28.3 USD. Despite weak financial performance over the past few years, Epic continues to increase their headcount fairly aggressively, some of which comes from acquisitions.
Figure 3: Epic Employee Count
(Source: Epic)
Epic remains a private company and in its most recent funding round was valued at approximately 29 billion USD. Tencent owns 40% of Epic but it is not clear if this is purely a financial investment or whether they view it more strategically.
Epic's competitive position really depends on the strength of Fortnite. They have built a business model with the Unreal Engine at the center and this could be extremely successful if they can continue to grow Fortnite and create a virtuous cycle between the different segments. On the other hand, their heavy reliance on Fortnite means that if it declines in popularity their business could become something of a house of cards.
Autodesk
Autodesk (ADSK) provides software to the architecture, engineering, construction, manufacturing, media, education and entertainment industries, with the company's historical strength being computer aided design software. Autodesk has a number of products which are complementary to Unity but the two companies could find themselves increasingly in competition as they expand.
Autodesk Maya is 3D modelling and animation software focused on the creation of in-game art. Content created in Maya can be easily exported to Unity or Unreal. Unity is looking to attract artists to their platform by adding functionality, which will place it in competition with this type of product.
Autodesk Revit is multidisciplinary building information modeling software that supports coordinated design across the project lifecycle, from conceptual design, visualization, and analysis to fabrication and construction.
Autodesk 3ds Max is a professional 3D computer graphics program for making 3D animations, models, games and images that support the media and entertainment industries.
Autodesk did have its own game engine (Stingray) at one point which came through the acquisition of Bitsquid in 2014. Stingray was offered as a game engine and to convert Revit models into interactive 3D experiences. By 2018 Autodesk had shut-down Stingray citing the popularity of Unity and the Unreal Engine as the reason. Since then, Autodesk has worked closely with Unity to enhance the functionality of their own solutions.
Blender
Blender is a free and open source 3D creation suite that supports modeling, rigging, animation, simulation, rendering, compositing and motion tracking, video editing and 2D animation. The Blender Game Engine is a discontinued component of Blender.
Adobe
Adobe (ADBE) specializes in software for the creation and publication of a wide range of content, including animation, video, motion pictures and print. There is some overlap between Adobe and Unity's businesses in the artistic area of gaming.
Amazon
Amazon licensed Crytek's CryEngine for 50 million USD and redeveloped it as the Lumberyard engine, although this has gained little traction. Lumberyard is designed to drive Amazon's AWS business and as such it is free to use for developers.
Roblox and Minecraft
Roblox and Minecraft could be considered niche competitors to Unity, but in some ways are complementary. Minecraft and Roblox offer developers a large user base, a storefront and an engine that can easily integrate various experiences. However, all of these experiences must happen inside Minecraft or Roblox. These engines have limited capabilities though and could be considered as creating familiarity with 3D content creation tools amongst future Unity users. The success of both Roblox and Minecraft is supportive of the content creation thesis.
Valve
Valve is a video game developer, publisher and digital distribution company that operates the world's largest digital gaming store (Steam). Valve launched its store for Windows in 2003 and by the time any serious competitors launched, had a 75% market share. It also offers the Source 2 engine, but it's not widely used.
Facebook has always wanted to control a computing platform, from PC to mobile and now VR. They acquired Oculus in 2014 in support of this, but progress in VR has so far been disappointing. If one company were to become dominant in AR / VR hardware it could weaken Unity's competitive position in a similar manner to Apple and iPhone app developers. Aside from this, Oculus and Unity are complementary products and their advancement should benefit each other.
Facebook is slowly making progress with Quest 2 and have announced that more than 60 titles have generated over 1 million USD revenue. This monetization potential needs to increase by several orders of magnitude to attract the necessary investment in content development though.
Facebook Horizon was recently announced as a social VR world running on the Unity engine. Horizon is a VR universe where users can build their own environments and games, explore and socialize with friends. It replaces Facebook's previous social VR experiences, Facebook Spaces and Oculus Rooms, and in comparison to those is more focused on user generated content. Horizon can be used with an Oculus Rift or Oculus Quest VR headset and two hand-held motion controllers which are required to interact with objects in the game.
Conclusion
Unity's game engine gives it access to a large and growing market. Expanding the engine user base by making Unity easier to use will be critical to the company's long-term growth. Epic is Unity's main competitor. They are a larger company with what could be considered a more advanced engine, but their business model is heavily dependent on Fortnite, which may distract them from other opportunities. Niche competitors like Autodesk and Adobe are well-resourced and are likely to provide stiff competition, particularly as Unity continues to expand outside of gaming.
This article was written by
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