New Year, New Steam Sale

Cross post from Substack

I keep receiving emails that Star Wars Squadron is only $2.50. Wild! I love Star Wars, and when I was a kid I loved flying around all the planes and stuff.

But why such a big special? And why are lots of computer games on a big sale now?

I mean surely this is the time when demand is high (a lot of people are on holiday) and computer games are a durable good (you pay up front, and then consume them over time).

As a result, this must be the time when people are most willing to pay for it – and the incentive to discount must be pretty weak because if you sell a game to someone now, you can’t sell it to them again in the future.

So let’s have a think about why this may be going on – and I promise not to talk about tacit collusion this time. Instead lets talk price discrimination.

A tale of three consumers

Imagine we have three people who all get excited when they see the following image.

One of these people is a 16 year old from a high income family, and a social network of friends in a similar position. Access to a new game depends largely on payment by your parents due to the need of a credit card – even if you’ve gone off to earn the money yourself.

In terms of time you have plenty of time to play games where you would otherwise be practicing hand stands and breaking windows. As a result, such purchases tend to occur when you are able to access them as an external gift – such as during a birthday or at a game launch when you can point out your mates have gotten it.

In this situation, your demand does not really vary with prices, and you are exceptionally impatient about having the game at release.

Another person is a 21 year old university student with fairly strong credit constraints. Although your time is a bit more constrained than at 16, you still do have a variable amount of leisure time – focused specifically at study breaks. Furthermore, others that you will play with are available at similar times – so individuals will coordinate on games.

This combination of factors means that demand can vary quite sharply with price, as groups of students coordinate on different games on the basis of their price.

Finally you have a 35 year old professional with a family, significant work commitments, and some disposable income. Their network is also similar people. Work and child requirements are not so coordinated, and as a result there is less coordination between people about playing together.

Furthermore, you have very limited free time – which means that you don’t really expect to get too much value from a game, as you doubt you’ll have much time to play it. However, you do have significantly more income.

This type of consumer has relatively low price elasticity … but for a game that is multiplayer focused also has a much much lower value for the game.

All three of these individuals would enjoy playing the game – but they differ in the opportunity costs they face from doing so.

• 16 yos: Material resources are available at fixed times, and plenty of time. So the opportunity cost is associated with the specific time of purchase (a form of limited material resources).
• 21 yos: Have limited material resources, but plenty of time. As a result, the key opportunity cost is other things they could spend money on.
• 35 yos: Have material resources, but no time. As a result, the opportunity cost is more associated with not having time available.

Price discrimination and our Steam sale

Our firm is selling a piece of software online. The marginal cost of doing so is close to zero.

As a result, in a perfectly competitive industry the price would collapse to zero. However, such an industry wouldn’t be sustainable – as no-one would make these games. So some amount of market power exists which generates the revenue to cover fixed costs as well.

We know that the game seller is setting marginal revenue equal to marginal cost – to sell an extra unit they have to cut the price to everyone, and they do this until the “extra dollars” they get become zero.

If they had to set the price and leave it, then we can look at our three groups to figure out the price:

1. If we only sell to 16 year olds we can set the price pretty high!
2. If we include the 21 year olds we run into the issue they can’t pay as much – so we have to sell at a lower price for both.
3. If we include the 35 year olds, then they aren’t willing to pay much at all – so we have to set the price very low to cover all of them.

So the seller will compare marginal revenue and cost, and determine what group is the marginal group. They will only sell to that group and the groups willing to pay more, and the groups with a lower willingness to pay will not receive the product.

Lets picture that the price was $50, and it was only sold to 16 year olds in this instance.

This is “inefficient”. Why? Because it costs $0 to provide the game, people like the 35 year olds do have a small positive value from the game, and yet there is no transaction between the game seller and the 35 year old!

Ohhh no, lost gains from trade!!

So why not charge them less based on the age on their passport? Well we can’t age discriminate. Steam offering different prices based on a persons age would lead to manipulation and is illegal.

But instead we can achieve this by changing prices through TIME – based on when the game is released, and when it is discounted.

A $2.50 sale after Christmas – when the 35 year old is on leave from work, everyone else is getting gifts, and they have had some fun playing with their kids toys – is pretty appealing. If the retailer has already saturated the 16 year old and 21 year old markets, then they are really just servicing 35 year olds when they do this sale.

When the game was released it was $50. The game was advertised, and in some places sold with, a joystick. A lot of 16 year olds love spinning their ship around and around to annoy their friends when playing with them (speaking from experience) – so there is significant value from buying at release when there are a lot of people to do this to, friends and people online. This was in October 2020.

In the three years inbetween, there were plenty of sales – as well as a lot of negative reviews regarding bugs and a lacklustre story. Whether these things matter I don’t know, as I’ve never played or watched the game, but for our price sensitive 21 year olds it will have taken a number of school holiday sales to convince them to give it a go. $20 or $30 sales may have worked for this group.

If this is a correct description of the market, through time based price discrimination the retailer can charge 16 year olds who want the game at launch $50, our 21 year olds who are willing to delay $20, and the relatively disinterested 35 year olds $2.50 – providing the game to a set of different groups who value it, and making the highest profit.

Now we can’t just randomly set the prices lower at different dates as it is a durable good. If everyone knows it will be $2.50 on a certain day, then why would they pay $50!

• It is uncertain if, and when, the game will become $2.50 – hell it took 3 years!
• People may value having the game early – or more specifically, coordinating when they have it to play with other people. The people who value games in this way will pay more for receiving the game at an earlier date.

As a result, the ability to price discriminate is limited by the ability for a high paying type (16 year olds) to tag themselves as a different type (i.e. a 35 year old). If the $2.50 sale was one month after release, the 16 and 21 year olds would likely delay the purchase by a month.

But look at when the $2.50 sale has occurred – three years after game release, at the start of January, after Christmas when middle aged people who don’t commonly buy games are sitting around thinking about their youth.

Great time to convince them to drop half the price of a coffee on something they will never open or use … after customers that were willing to pay a bit more have already paid.