With an IronSource deal pending, CEO John Riccitiello talks about the future of Unity, its history of losses, and buying back stock in the wake of layoffs
Many people still think of Unity as simply a game engine maker, which is a technically accurate description but risks giving people a slanted impression of the company's business.
The Create Solutions part of Unity -- which contains the basic tools needed to make a game -- is actually a smaller piece of the company's pie than Operate Solutions -- which focuses more on engagement, monetization, and user acquisition. And it has been that way for some time.
This has created some tension for developers who would prefer to think of gaming more as an art than a business, tension that has been aggravated by the announced plans for Unity to merge with app monetization platform IronSource, as well as remarks by Unity CEO John Riccitiello about the mental faculties of developers who didn't concern themselves with monetization. (He later apologized for those comments.)
Speaking with GamesIndustry.biz, Riccitiello tries to reassure developers that the company's scales aren't tipping so far towards monetization and away from creation. Even though Operate Solutions has often doubled the revenue of Create Solutions during reporting periods in recent years and IronSource might be assumed to exacerbate that, Riccitiello says the two sides of the company's business are expected to be "roughly evenly balanced" going forward.
"I get that some developers think it's just about creation, but anyone that's been through the labyrinth of complexity that is publishing and operating a live game knows there's way more to it than that"
He says that the Create side of the business is "where the vast majority of our resources are allocated," adding that it has been growing faster than Operate's revenues this year. (For the second fiscal quarter of the year, Create revenues were up 66% year-over-year to $121 million, while Operate Solutions revenues were down 13% to $159 million.)
As for IronSource widening the gap, Riccitiello says a big part of IronSource's business is in publishing functions that don't fit neatly with the Operate side of the business.
"We feel that's a little more of a tool that a creator would use to get their game out there – not exclusively an ad network, but it's on behalf of them," Riccitiello says. "We see that and other services they [offer] as being more connected to the Create side of the house."
And regardless of the need to attribute revenue to either Create or Operate on paper, Riccitiello doesn't see the division as cleanly split as one being where a game is made and the other being where it is monetized. The Operate side covers in-app purchases and advertising, he says, but it also offers tools for hosting, matchmaking, and chat filtering to address toxic users.
"I get that some developers think it's just about creation, but anyone that's been through the labyrinth of complexity that is publishing and operating a live game knows there's way more to it than that," Riccitiello says. "So we view our mission and vision in life as being about helping them create and address headlong that next complexity of operating and dealing with all the issues from hosting to voice to multiplayer matchmaking to analytics and, when appropriate, to monetization."
He adds, "Part of the vision behind IronSource is they have some tools on the publishing side that give a developer better feedback than they would get through A-B testing or other forms of testing that are out there, so it's designed to help them make a product people would love more. And they can use or not use it."
Is the focus on games at all?
Unity client Vectual has re-created Paris in the game engine for city-planning purposes
That could address developer concerns about Unity focusing more on monetization than creation, but what about the company focusing more on things that aren't games at all?
In its second quarter earnings report, Unity said one of its key wins of the quarter was "accelerating out business outside of games across industries and geographies," noting clients like defense contractor CACI and auto manufacturer Mercedes-Benz. The company said that revenue coming from non-gaming companies accounted for 40% of its revenue in the quarter, up from 33% just six months earlier.
Riccitiello notes that Unreal Engine maker Epic Games isn't solely focused on games either, having just announced a partnership with Autodesk to ramp up its services to the architecture, engineering, and construction industry. He adds that there's a lot of demand for simulation work from other industries – protein folding, nuclear fusion, traffic management – that gets developed elsewhere but can then be reincorporated into games to make their worlds more dynamic.
"Over and over again, what we're learning and experiencing is that what we do outside of gaming makes us better at [gaming tasks]"
"Yes, we have businesses outside of gaming," Riccitiello says. "Yes, they generate revenue. Yes, that makes us a healthier company so we can invest more in gaming when we want to. But it also advances our understanding of technology so we can make an ever-better game engine."
He likens it to professional athletes doing cardio to improve their performance in their primary sport.
"Over and over again, what we're learning and experiencing is that what we do outside of gaming makes us better at rendering," Riccitiello says. "It makes us better at physics, better at lighting, UI and UX, better at workflows for creators trying to solve particular problems. Those things help the game industry.
"I too imagine a world where maybe a company like ours or Epic, when we do things outside of gaming, might be, if you will, focused less on gaming. But that would be a little bit like saying Rafael Nadal is focused less on tennis if he chooses to work out and strength train or whatever he might do to improve his physical performance. It's really not the right way to think about it."
Stock price woes
Unity's share price has taken a beating in the past year (Chart created by Yahoo Finance)
When we speak, Unity stock is trading around $32, down about 84% from its $210 peak in November, and nearly 40% down from its IPO of September 2020. Many companies throughout the gaming space have seen declines in the past year, but given the degree of Unity's drop, we ask Riccitiello what he thinks is going on.
"I'm not a stock market analyst, but I do spend a lot of time talking to investors," Riccitiello says. "One of the things to know is that game industry and technology companies have traded very differently."
Game companies, he says, typically trade at a price such that their enterprise value (cumulative price of all outstanding shares with debt and cash on hand taken into account) is five or six times their annual revenues. At its November peak, Unity was trading at an enterprise value about 50 times its revenues.
"I don't know why we traded that high, and I don't always know why we trade this low"
"I don't know why we traded that high, and I don't always know why we trade this low," Riccitiello says. "But we're not a games company. We trade along with a basket of other tech companies, and against the companies we went public with, believe it or not we've outperformed by a significant amount."
He acknowledges that's cold comfort for investors, but adds that it has been an exceptionally difficult year for the stock market in general.
"I have all the faith in the world that the world's economy is going to come charging back and stocks are going to rise, but peak to trough, if you look at hundreds of tech companies, you'll see we're in the middle of the pack," Riccitiello says. "And if you look at us relative to companies who went public in the six months before us and six months after, we're actually out-performing the average. So to compare us to a game company is tempting, but we don't make games so it's really the wrong compare. We're a blend of software-as-a-service and ratable revenue business."
Turning the corner to profitability
Unity has yet to enjoy a profitable quarter, despite having been founded in 2004. Although Riccitiello has only been at the helm since 2014, we still feel that's enough time to ask him about the strategy behind running at a loss for such a long stretch.
He begins by noting how common a phenomenon that is, saying only about 10% of the companies that had IPOs around the time of Unity had been profitable.
"Very few companies are profitable when they report 40% growth, as we did throughout 2021 and 2019," Riccitiello says. "It's because you're hiring to support heavy, heavy growth. Financial markets understand that and they anticipate companies in extreme growth phase to be unprofitable and then over time to get more and more profitable, break even, and then grow profitability, which is precisely what we described in our S-1 [pre-IPO filing] and precisely what we've done.
"We were a perpetual license business that released a product every four or five years… So the product didn't get better very often"
"If you go back to my first days at Unity, here's a way to think about it," Riccitiello says. "We were a perpetual license business that released a product every four or five years… So the product didn't get better very often. It was a great product and well-loved by indies, and we had precisely zero titles in the top 500. So most important games at that time were not built in Unity."
Riccitiello says that under his watch, Unity moved to a software-as-a-service model and doubled its R&D spending in gaming every year for four years, for a total increase of 16 times its annual R&D spending over that span. He also launched Unity's ad business to create a second revenue stream to help offset losses from investment in the Create side, and moved the company into new industries.
"We pretty much followed that pattern because we think it's the right one to best serve our market in a world where we think gaming would become the world's leading form of media, which it has, and where real-time 3D would have a strong, self-reinforcing advantage for the game industry as we moved outside the game industry," Riccitiello says.
He says Unity's market share has gone from the low teens to over 70% as a result of the moves, and gone from "pretty non-existent" on consoles to between 30% and 70%, depending on the platform in question.
He asks, "Should you be profitable? Well we could be, but we wouldn't be serving the industry in the ways we do now. Our market shares wouldn't have increased. But when you say market share, what I see is thousands of developers that are in this industry when they weren't before, and we're enabling them.
"My sense is if the game industry participants could want for anything, it's that we would continue to invest ahead of our revenue growth because that benefits the game industry. And we have done that for many years, although we are coming to a point where we're getting big enough where the revenue growth is such that it offsets the R&D and we can get to breakeven and profitability."
He says the company has told investors it plans to post profits in 2023, and it could possibly reach that goal sooner than expected.
Layoffs and stock buybacks
Finally we ask about June's reported layoffs of about 4% of the company, or about 200 employees. He is quick to note that those employees were given the chance to apply for other job openings at the company, and said three-quarters of the impacted employees wound up staying on in a new capacity.
"We shut down some projects that weren't working in order to focus more on the things we needed to do," pointing to a series of blogs laying out the company's roadmap for the future.
"If you think about a resource allocation, it can happen that 100% of what you plan to do doesn't work," he says. "It's a little like skiing. If you don't fall now and then, you're probably not getting better because you're not trying new things to improve. We felt about 4% of what we were working on was not effectively getting us where we needed to go."
He also says Unity's rate of attrition is much lower than the wider tech industry, with an average tenure of six or seven years at the company.
"I wouldn't hold any company to the standard that everything that must work and no job must end," Riccitiello says. "That's a bit like the federal government and it ends up with bloatocracy, and I don't want to be a giant behemoth. I want us to be sharp and smart and focused on things that help our customers the best."
In light of the layoffs, we ask about the decision to launch a $2.5 billion share buyback just a month later, in conjunction with the IronSource deal.
Riccitiello stresses that the two actions were unrelated.
"We announced a major merger. The company we acquired has a lot of cash. We have a lot of cash. We have investors very keen to not see our share count be diluted"
"We laid off a net of 1% through reallocation," he says. "To imagine that as being abnormal in the scheme of anything, especially when you're headlong into a recession, would be anything but real. Real is thousands and thousands of well-run companies make adjustments like this in order to serve the better purpose of its customers and frankly, the better purpose of the people who work at the company. So I really believe that's true.
"The second issue is that we announced a major merger. The company we acquired has a lot of cash. We have a lot of cash. We have investors very keen to not see our share count be diluted. It's an all-stock deal, and the shares owned by our employees would have been diluted 26.5% through the merger, which is a lot. We found ourselves in a position to buy back a significant portion of the shares issued so it's down in the teens and not in the 20s.
"We didn't cut 1% of jobs because we were trying to make a P&L. We did it because we were focusing our energy. Like with lots of things – your parents when they ask you to eat your vegetables – they're not doing it to punish you. They're doing it to facilitate your better and more nutritious self. There's another, more real story in that. Here the real story is pretty simple. We did the things a good company does to manage and meet the needs of its customers."
He continues, "It's always a dilutive thing to merger with another big company. We wanted to minimize that dilution in part because Unity employees all own stock, and we want to make sure that investment they have in our stock that was granted through compensation programs is more valuable and the M&A deal we've done is less dilutive. Yes, they're all in a string of things, and there's always going to be a string of things, and it's always easy through narrative to find a false understanding and false story. God knows the world's full of them."