Unity Technologies recently reported better than expected earnings for the fourth quarter ended December 31. It reported revenues rose 39% to $220.3 million, but the company still reported a loss from operations of $80.8 million, wider than its loss of $48.6 million a year earlier.
But Unity’s new investors (the company went public at a $13 billion valuation in September) are largely OK with this. The stock fell after the report, but Unity is still trading at a healthy $34.5 billion valuation. Part of the reason that people are bullish on Unity is that it has a market share lead, as its game engine is used in more than half of all mobile games compared to rivals Cocos and Unreal. In its recent history, Unity has been emphasizing market share over profits in its recent strategy. So long as it has access to capital, that strategy has worked.
I talked this over with Kim Jabal, chief financial officer at Unity, after the earnings report. We talked about the concerns of investors — from the COVID-19 situation to the Identifier for Advertisers (IDFA), where Apple has chosen to focus on user privacy over targeted advertising. The latter will likely Unity’s advertising revenues, which are a big source of revenue. Overall, Unity has benefited from the enthusiasm for games during the pandemic as players try to distract themselves from reality during lockdown. Unity’s mission is to turn everybody into game developers, and that’s where it has been investing a lot of its resources.
Jabal said that Unity is targeting full-year revenue of $950 million to $970 million in 2021, compared to $772 million in 2020.
Here’s an edited transcript of our interview.
GamesBeat: Did you feel like there was a point of emphasis during the analyst call, things everyone was watching for?
Kim Jabal: As we expected, it was [the Identifier for Advertisers, where Apple has chosen to focus on user privacy over targeted advertising] IDFA and COVID. There was interest in the fact that we’ve–I don’t want to say “committed,” but we’ve shared our forecast for a 30 percent growth rate going forward, which did attract some attention. Not a lot of companies make that statement as far as longer term growth rate. Investors were happy to see that.
The piece that caused some confusion is, how can you grow at 30 percent and then report guidance in the higher 20s? The answer to that is, we had a one-time tailwind from COVID in 2020, so our growth rate in 2020 was higher than we might have normally expected. In 2021, we have this one-time impact from IDFA that we’re estimating at $30 million, which is impacting the overall year-over-year growth rate. That’s why we still feel confident that our underlying growth rate is in the 30 percent range.
GamesBeat: How do you arrive at something that precise?
Jabal: It’s two things. First of all, it is an estimate. It’s an art and a science, for sure, and that’s why we said “approximately.” But the one thing I will say that is interesting, on the create side of our business, a lot of that revenue is from larger customers. It’s more of an enterprise sales motion, where we have deals getting signed. There’s recurring revenue. When we do our forecasting on the create side, we have some analytics, and then we have customer by customer pipeline. On the operate side, it’s much more like my Google days, where we have visibility into revenue on an hourly and daily basis. It’s a very different type of revenue forecasting, and there’s a lot more science in the forecast.
When it comes to thinking about how IDFA is going to impact us, we have a detailed forecasting model for our business, and it looks at things like–what percent of impressions are coming from iOS versus Android? For us it’s well under half that are coming from iOS. That helps us to size the impact. Then we look at, for example, the learnings we had in GDPR. GDPR was a very similar situation where users in Europe are prompted, “Do you want to allow targeted ads or not?” We have data from that. We’ve done testing on our own as well, small user tests on what the opt-in rate might be. That’s one of the drivers here. What percentage of users will opt in or opt out of ad tracking?
We look at country by country. We look at the historic and current opt-out rate. We look at the adoption rates of our current contextual ad products. One thing that’s not always understood–we already have a product, and we’ve had it for years, that does contextual advertising and doesn’t rely on IDFA. We have a lot of data from that product. Keep in mind, a meaningful portion of our advertising revenue is using that contextual-based product. For all these reasons, we have good visibility into how this will impact us.
The two variables that we just can’t be 100 percent certain on–one is that opt-in rate, so we’ve been conservative in our estimates there in terms of what percentage of users are going to opt out of the personalized tracking. The other is the market share gains we could achieve. We do believe that the depth and breadth of our data, which is very specific to game player behavior, is deeper and broader. We noted that there were 5 billion downloads per month of apps made with or monetized by Unity. The scale and the type of that data is very differentiated versus our competitors in the advertising space. We do feel that, in the medium to long term, we could very well gain market share. We didn’t bake that into our guidance or our estimates.
GamesBeat: That particular part, where are you getting it from? Who are the types of competitors?
Jabal: Our biggest competitors are Google and Facebook. Facebook has announced that they may drop their Audience Network completely. We don’t think they’ll do that. They have a lot of resources. They’re not just going to give up all that business. But the fact that they even announced that they may completely get out of it suggests that perhaps, and we don’t know for sure, they’re not as well-positioned as we are. We’ve been planning for this for years.
Again, we’re singularly focused–for now, at least. This business will evolve to other verticals. But for now we’re almost entirely focused on mobile and on gaming. The strength in that area I believe is a differentiator in terms of our ability to leverage the data we have in a way that’s respectful to user privacy. We’re not collecting personal information. We’re collecting what kinds of games you like to play, what is your behavior in that game, and therefore what is the best targeted ad for you.
GamesBeat: When you talk about preparing for years, do you think there was a certain writing on the wall that everyone could see? People caring more about privacy. There’s targeted advertising, there’s privacy, and there’s this tug of war between them. It feels that targeted advertising may have gone too far.
Jabal: Maybe? It’s hard to say. What will be interesting, and we saw this with GDPR, is that sometimes users opt out, and then they realize they’re still getting ads. This will not reduce the number of ads you see. And now they’re just completely irrelevant. Particularly when you think about gaming. Gaming, you want to see a game you might want to play. If you enjoy games, as an end user, if you have to look at an ad anyway, it may as well be one for a game you might want to play. It’ll be interesting to see–in GDPR we did see some users opt out and then come back in.
The other thing that could happen–advertisers are not going to reduce their spend. This is their lifeline. Most of our advertising is cost per install. It’s very measurable. They’re paying on an install basis, so the ROI is very clear to them on their spend. Back in my days at Google when we launched the cost per click model, it was a revolution versus CPM, because you could clearly and carefully track your ROI.
Advertisers still need to get customers. The question is, do they start spending more? Do publishers put more ads in there? Do they open up more ad inventory? From a user perspective, what would you rather have? Untargeted ads, and even more of them, or targeted ads?
GamesBeat: There’s also the part about, would you rather get stuff for free, or would you rather pay for it?
Jabal: Correct. That part is interesting. I doubt it, though. I don’t think there will be a shift to more paid games. But that could be one thing that happens. Or more in-app purchases perhaps.
GamesBeat: As far as ways for Unity to monetize, advertising is a big part of it, but are there other things that you have hopes for when it comes to improved monetization?
Jabal: Within monetization we’re always improving our algorithms and the way we deliver value to our customers. We announced our game growth program. This is, again, a use of our data, where we can tell from an early stage, based on the adoption patterns and usage patterns within a game, which games are likely to be successful. We can partner with small game developers to help them succeed, to help fund their acquisition activities. There’s a lot of innovation within monetization.
More broadly, within operate solutions, we have hosting. We have orchestration products. We have voice services. We have analytics tools. That platform continues to grow. We’ll continue to build out the products and features and services. We have cloud content delivery. All of operate solutions is primarily gaming for now, but there are plenty of opportunities outside gaming as well. We announced this product called Forma, which you can use for real time 3D rendering in online product sales, car configurators, things like that. Those need to be hosted in the cloud. There’s a huge opportunity for our hosting and orchestration products, our multiplayer products on the gaming side, that’s just getting started. Lots of opportunity within operate to build on what we have on the create side.
The other part that’s unique to Unity is, we’ve embedded a lot of these right in the game editor. When you’re building a game, you can click into hosting and into monetization and design those from the beginning into your game. That’s pretty powerful, because it not only helps you to maximize your lifetime player value by building that into your game design, but it’s just easy. Game makers, a lot of them, don’t want to deal with the underlying technology of their monetization. They want to create cool games. It makes the whole process of developing and publishing a game easier for our customers.
GamesBeat: How do you look at the overall competitive dynamic, with Epic coming down from the high end and Unity going up from the low end? What else is there to that competitive picture?
Jabal: We’re glad to have competition. But our real competition is actually businesses that still have their own home-grown tech. They’re building and maintaining their own technology. You saw our market share of the top 1,000 games. We have 71 percent. The next chunk of market share is China. Epic has a very small percentage of mobile. In other areas, like console and PC, we have very large market share there as well.
They have a big name because of Fortnite, and they’re a great business. We respect what they do. They do compete. In verticals we do see them. They’re going after automotive and film. We see them in those areas. But I personally like our positioning in that our sole mission in life is to make creators and developers more successful.
GamesBeat: Perhaps the question here is, your mission is to work on behalf of gamers, but in some ways–how does that mission affect your relationships with the platforms? You enable games to cross so many platforms. Sometimes that’s not in the interests of the platforms themselves. It’s an interesting relationship, where to serve gamers and serve game developers, you have to balance that against the interests of the platforms, which are not necessarily identical.
Jabal: First and foremost, our focus is mostly developers, not end users, although we’re starting to think about opportunities on the consumer side for consumer creators. But our primary focus is creators, people who create interesting content. All of the platform players I think acknowledge that developers–there aren’t many developers that are only going to develop for one platform. If you have a mobile game, you can’t say, “I’m going to only be an Android game.” Even PC and console, as you see, there’s such a proliferation and a want from consumers to be able to play games on different platforms. You can play with friends on mobile and console. That trend, I cannot imagine that’s going away. The platform players, whether it’s Google or Apple or Xbox, I think they acknowledge that this is a multiplatform world.
That’s where our position is unique in that they trust us. They trust that Unity is that agnostic player in the middle that isn’t going to align with one platform over another. That’s a trust we’ve built up over many years.
GamesBeat: And you’ve managed to keep the peace, whereas Epic has not.
Jabal: So far I think we have, yes.
GamesBeat: The other thought I had about competition is that it looks like you view non-game designers, people who don’t make games, as competition as well. You want everyone to be able to make games.
Jabal: We’re thinking a lot about consumer creators. You see what Roblox has done. We have a long tail of users that don’t pay us creating on Unity. It’s absolutely something we’re increasingly thinking about. If our mission is to make the world better for creators–well, one thing we’ve always said is that the world is a better place with more creators in it.
There’s a heck of a lot of consumers who are becoming creators. Streamers on Twitch and all these things, they’re now creating. Even just posting to Instagram, it’s a new way for people to create. And we believe all content is going to become real-time 3D, so therefore it makes sense that over the long term, that’s an interesting opportunity for us. As the tools become more available, it will be more common. Look at modding. Once that becomes easier to do, we’ll see it more and more.
GamesBeat: There’s the market share game, but there’s also profitability. How do you make profitability more of a selling point at Unity?
Jabal: We’ve said that we’re aiming to be free cash flow positive by the end of 2023. We were free cash flow positive in Q2, Q3, and Q4 of 2020, but that was largely because of the COVID tailwinds. That said, it’s a very good proof point of where we can go. For us, it’s more a choice. It’s a matter of how much we want to keep investing in growth versus driving profitability. One of our most important initiatives in the company is very carefully managing our gross margin. With our nice high gross margins, we can both invest in growth and move toward a path to profitability. Our goal is to do both.
If you look at our operating margins last year, if you take out the COVID effect, we’re still–if you look at our guidance for next year, we’re clearly still moving on that path toward profitability. We thought carefully in 2021 about how much of those COVID savings, which we are still enjoying–travel, facilities, marketing events, we still have a lot of savings in 2021, but we decided that rather than get to free cash flow positive again next year, let’s invest in the business. Let’s invest in growth. It’s still so early for all of these opportunities, whether it’s create or operate, whether it’s gaming or other verticals. There’s so much green field open opportunity. We’re doing both.
One thing I’m excited about is, John Riccitiello, our CEO, and I are very aligned on one important thing, which is that throwing resources at things doesn’t always create growth. We believe that we need to invest, but we need to invest judiciously, and we need to look at–when we’re building out a product team, when we’re building out a new initiative, what are the resources needed to build that out? When we have an existing product, how much more resources do they need? How do we drive efficiency within the organization? He and I both believe that sometimes necessity is the mother of innovation. Constraint is not always a bad thing when it comes to resources.
GamesBeat: How do you communicate to investors that there may be some things that are difficult to understand here? You did have a quarter with more revenues, but you also had a quarter with more losses. If you’re a typical investor, that’s not something you understand.
Jabal: In terms of the quarter and our operating margins, first of all I’d always encourage investors to look at the non-GAP numbers, just because it gives you a better sense for the long-term trends. It takes out the non-cash stock-based compensation. Sometimes I do find less sophisticated investors getting confused on that.
In terms of just the quarter and the operating margin that we delivered in the quarter, again, it goes back to COVID. We had such tremendous savings in mostly Q2 and Q3, but Q1 as well. Keep in mind, our business is a third Asia, a third Europe, and a third America. When COVID hit Asia, that hit us in our Asian offices. In terms of our operating margin, if you look at the trend throughout the year, we were getting close to breaking even on the operating margin perspective in Q2 and Q3, but in Q4 we decided to invest these dollars. Back to the opportunity ahead of us, we’re investing for the future. Investors need to understand that we’re in this for the super long term. We’re always going to pick investing for long-term growth over short-term gain.
GamesBeat: Do you see a parallel to something like the early years of Facebook, communicating it that way?
Jabal: I was at Google for eight years, so I see a parallel to Google. It’s very similar. It’s one of the reasons I came to Unity. It’s a technology-driven company. Innovation is paramount. It’s a great culture in terms of engaging employees, making it a great place to work, and encouraging employees to be innovative. That’s core to any business. I don’t care what business you’re in. Being able to innovate and change with the times–I just saw a huge parallel here to Google.
John wants us to be a company of long-term consequence. He’s not in this for, “Oh great, I did my part and I’m out of here.” He’s in it for the long term. The company is in it for the long term. I saw that parallel with Google.
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