Unity IPO aims to fuel growth across gaming and beyond

Unity Software Inc. is set to list on the New York Stock Exchange this month, following its S-1 filing two weeks ago. The 16-year-old tech company is universally known within the gaming industry and largely unknown outside of it. But Unity has been expanding beyond gaming, pouring hundreds of millions of dollars into a massive bet to be an underlying platform for humanity’s future in a world where interactive 3D media stretches from our entertainment experiences and consumer applications to office and manufacturing workflows. 

Much of the press about Unity’s S-1 filing mischaracterizes the business. Unity is easily misunderstood because most people who aren’t (game) developers don’t know what a game engine actually does, because Unity has numerous revenue streams, and because Unity and the competitor it is most compared to — Epic Games — only partially overlap in their businesses.

Last year, I wrote an in-depth guide to Unity’s founding and rise in popularity, interviewing more than 20 top executives in San Francisco and Copenhagen, plus many other professionals in the industry. In this two-part guide to get up to speed on the company, I’ll explain Unity’s business, where it is positioned in the market, what its R&D is focused on and how game engines are eating the world as they gain adoption across other industries.

In part two, I’ll analyze Unity’s financials, explain how the company has positioned itself in the S-1 to earn a higher valuation and outline both the bear and bull cases for its future.

For those in the gaming industry who are familiar with Unity, the S-1 might surprise you in a few regards. The Asset Store is a much smaller business that you might think, Unity is more of an enterprise software company than a self-service platform for indie devs and advertising solutions appear to make up the largest segment of Unity’s revenue.

Bear and bull cases for Unity’s IPO

What is a game engine?

Unity’s origin is as a game engine, software that is similar to Adobe Photoshop, but used instead for editing games and creating interactive 3D content. Users import digital assets (often from Autodesk’s Maya) and add logic to guide each asset’s behavior, character interactions, physics, lighting and countless other factors that create fully interactive games. Creators then export the final product to one or more of the 20 platforms Unity supports, such as Apple iOS and Google Android, Xbox and PlayStation, Oculus Quest and Microsoft HoloLens, etc.

In this regard, Unity is more comparable to Adobe and Autodesk than to game studios or publishers like Electronic Arts and Zynga.

What are Unity’s lines of business?

Since John Riccitiello took over as CEO from co-founder David Helgason in 2014, Unity has expanded beyond its game engine and has organized activities into two divisions: Create Solutions (i.e., tools for content creation) and Operate Solutions (i.e., tools for managing and monetizing content). There are seven noteworthy revenue streams overall:

Create Solutions (29% of H1 2020 revenue)

• The Unity platform: The core game engine, which operates on a freemium subscription model. Individuals, small teams and students use it for free, whereas more established game studios and enterprises in other industries pay (via the Unity Plus, Unity Pro and Unity Enterprise premium tiers).
• Engine extensions: A growing portfolio of tools and extensions of the core engine purpose-built for specific industries and use cases. These include MARS for VR development, Reflect for architecture and construction use with BIM assets, Pixyz for importing CAD data, Cinemachine for virtual production of films and ArtEngine for automated art creation.
• Professional services: Hands-on, specialized consulting for enterprise customers using Unity’s engine and other products. Unity expanded its consulting capacity further in April with a $55 million acquisition of Finger Food Studios, a 200-person team in Vancouver that builds interactive media projects for corporate clients using Unity.

Aside from these three product categories, Unity is reporting another group of content creation offerings separately in the S-1 as “Strategic Partnerships & Other” (which accounts for further 9% of revenue):

• Strategic Partnerships: Major tech companies pay Unity via a mix of structures (flat-fee, revenue-share and royalties) for Unity to create and maintain integrations with their software and/or hardware. Since Unity is the most popular platform to build games with, ensuring Unity integrates well with Oculus or with the Play Store is very important to Facebook and Google, respectively, for example.
• Unity Asset Store: Unity’s marketplace for artists and developers to buy and sell digital assets like a spooky forest or the physics to guide characters’ joint movements for use in their content so they don’t each have to design and code1 every single thing from scratch. It is commonly used, though larger game studios often use Asset Store assets just for initial prototyping of game ideas.

Operate Solutions (62% of H1 2020 revenue)

• Advertising: Via the 2014 acquisition of Applifier, Unity launched an in-game advertising network for mobile games. This expanded substantially with the Unified Auction, a simultaneous auction that helps games get the highest bid from among potential advertisers. Unity is now one of the world’s largest mobile ad networks, serving 23 billion ads per month. Unity also has a dynamic monetization tool that makes real-time assessments of whether it is optimal to serve an ad, prompt an in-app purchase or do nothing to maximize each player’s lifetime value. While the Unity IAP feature enables developers to manage in-app purchases (IAP), Unity does not take a cut of IAP revenue at this time.
• Live Services: A portfolio of cloud-based solutions for game developers to better manage and optimize their user acquisition, player matchmaking, server hosting and identification of bugs. This portfolio has primarily been assembled through acquisitions like Multiplay (cloud game server hosting and matchmaking), Vivox (cloud-hosted system for voice and text chat between players in games), and deltaDNA (player segmentation for campaigns to improve engagement, monetization and retention). There is also Unity Simulate for training AI models in virtual recreations of the real world (or testing games for bugs). Live Services products have usage-based pricing, with an initial amount of usage free.

Unity versus Unreal, versus others

Unity is compared most frequently to Epic Games, the company behind the other leading game engine, Unreal. Below is a quick overview of the products and services that differentiate each company. The cost of switching game engines is meaningful in that developers are typically specialized in one or the other and can take months to gain high proficiency in another, but some teams do vary the engine they use for different projects. Moving an existing game (or other project) over to a new game engine is a major undertaking that requires extensive rebuilding.

Epic Games

Epic has three main businesses: game development, the Epic Games Store, and the Unreal Engine. Epic’s core is in developing its own games and the vast majority of Epic’s $4.2 billion in 2019 revenue came from that (principally, from Fortnite). The Epic Games Store is a consumer-facing marketplace for gamers to purchase and download games; game developers pay Epic a 12.5% cut of their sales.

In those two areas of business, Unity and Epic don’t compete. While much of the press about Unity’s IPO frames Epic’s current conflict with Apple as an opportunity for Unity, it is largely irrelevant. A court order prevented Apple from blocking iOS apps made with Unreal in retaliation for Epic trying to skirt Apple’s 30% cut of in-app purchases in Fortnite. Unity doesn’t have any of its own apps in the App Store and doesn’t have a consumer-facing store for games. It’s already the default choice of game engine for anyone building a game for iOS or Android, and it’s not feasible to switch the engine of an existing game, so Epic’s conflict does not create much of a new market opening.

Let’s compare the Unity and Unreal engines:

Origins: Unreal was Epic’s proprietary engine for the 1998 game Unreal and was licensed to other PC and console studios and became its own business as a result of its popularity. Unity launched as an engine for indie developers building Mac games, an underserved niche, and expanded to other emerging market segments considered irrelevant by the core gaming industry: small indie studios, mobile developers, AR & VR games. Unity exploded in global popularity as the main engine for mobile games.

Programming Language: Based in the C++ programming language, Unreal requires more extensive programming than Unity (which requires programming in C#) but enables more customization, which in turn enables higher performance.

Core Markets: Unreal is much more popular among PC and console game developers; it is oriented toward bigger, high-performance projects by professionals. That said, it is establishing itself firmly in AR and VR and proved with Fortnite it can take a console and PC game cross-platform to mobile. Unity dominates in mobile games — now the largest (and fastest growing) segment of the gaming industry — where it has over 50% market share and where Unreal is not a common alternative. Unity has kept the largest market share in AR and VR content, at over 60%.

Ease of Authoring: Neither engine is easy for a complete novice, but both are fairly straightforward to navigate if you have basic coding abilities and put the time into experimenting and watching tutorials. Unity has prioritized ease of use since its early days, with a mission of democratizing game development that was so concentrated among large studios with large budgets, and ease of authoring remains a key R&D focus. This is why Unity is the common choice in educational environments and by individuals and small teams creating casual mobile games. Unity lets you see but not edit the engine’s source code unless you pay for an enterprise subscription; this protects developers from catastrophic mistakes but limits customization. Unreal isn’t dramatically more complex but, as a generalization, it requires more lines of code and technical skill. It is open source code so can be completely customized. Unreal has a visual scripting tool called Blueprint to conduct some development without needing to code; it’s respected and often used by designers though not a no-code solution to developing a complex, high-performance game (no one offers that). Unity recently rolled out its own visual scripting solution for free called Bolt.

Pricing: While Unity’s engine operates on a freemium subscription model (then has a portfolio of other product offerings), Unreal operates on a revenue-share, taking 5% of a game’s revenue. Both have separately negotiated pricing for companies outside of gaming that aren’t publicly disclosed.

Proprietary engines

Many large gaming companies, especially in the PC and console categories, continue to use their own proprietary game engines built in-house. It is a large, ongoing investment to maintain a proprietary engine, which is why a growing number of these companies are switching to Unreal or Unity so they can focus more resources on content creation and tap into the large talent pools that already have mastery in each one.

Other Engines

Other game engines to note are Cocos2D (an open source framework by Chukong Technologies that has a particular following among mobile developers in China, Japan, and South Korea), CryEngine by Crytek (popular for first-person shooters with high visual fidelity), and Amazon’s Lumberyard (which was built off CryEngine and doesn’t seem to have widespread adoption, or command much respect, among the many developers and executives I’ve spoken to).

For amateur game developers without programming skills, YoYo Games’ GameMaker Studio and Scirra’s Construct are both commonly used to build simple 2D games (Construct is used for HTML5 games in particular); users typically move on to Unity or Unreal as they gain more skill.

There remain a long list of niche game engines in the market since every studio needs to use one and those who build their own often license it if their games aren’t commercial successes or they see an underserved niche among studios creating similar games. That said, it’s become very tough to compete with the robust offerings of the industry standards — Unity and Unreal — and tough to recruit developers to work with a niche engine.

UGC Platforms

User-generated content platforms for creating and playing games like Roblox (or new entrants like Manticore’s Core and Facebook Horizon) don’t compete with Unity — at least for the foreseeable future — because they are dramatically simplified platforms for creating games within a closed ecosystem with dramatically more limited monetization opportunity. The only game developers these will pull away from Unity are hobbyists on Unity’s free tier.

I’ve written extensively on how UGC-based game platforms are central to the next paradigm of social media, anchored within gaming-centric virtual worlds. But based on the overall gaming market growth and the diversity of game types, these platforms can continue to soar in popularity without being a competitive threat to the traditional studios who pay Unity for its engine, ad network, or cloud products.

What’s at the forefront of Unity’s technical innovation?

DOTS

For the last three years, Unity has been creating its “data oriented technology stack,” or DOTS, and gradually rolling it out in modules across the engine.

Unity’s engine centers on programming in C# code which is easier to learn and more time-saving than C++ since it is a slightly higher level programming language. Simplification comes with the trade off of less ability to customize instruction by directly interacting with memory. C++, which is the standard for Unreal, enables that level of customization to achieve better performance but requires writing a lot more code and having more technical skill.

DOTS is an effort to not just resolve that discrepancy but achieve dramatically faster performance. Many of the most popular programming languages in use today are “object-oriented,” a paradigm that groups characteristics of an object together so, for example, an object of the type “human” has weight and height attached. This is easier for the way humans think and solve problems. Unity takes advantage of the ability to add annotations to C# code and claims a proprietary breakthrough in understanding how to recompile object-oriented code into “data-oriented” code, which is optimized for how computers work (in this example, say all heights together and all weights together). This is orders of magnitude faster in processing the request at the lowest level languages that provide 1s-and-0s instructions to the processor.

This level of efficiency should, on one hand, allow highly-complex games and simulations with cutting-edge graphics to run quickly on GPU-enabled devices, while, on the other hand, allowing simpler games to be so small in file size they can run within messenger apps on the lowest quality smartphones and even on the screens of smart fridges.

Unity is bringing DOTS to different components of its engine one step at a time and users can opt whether or not to use DOTS for each component of their project. The company’s Megacity demo (below) shows DOTS enabling a sci-fi city with hundreds of thousands of assets rendered in real-time, from the blades spinning on the air conditioners in every apartment building to flying car traffic responding to the player’s movements.

Graphics

The forefront of graphics technology is in enabling ray tracing (a lighting effect mimicking the real-life behavior of light reflecting off different surfaces) at a fast enough rendering speed so games and other interactive content can be photorealistic (i.e. you can’t tell it’s not the real world). It’s already possible to achieve this in certain contexts but takes substantial processing power to render. Its initial use is for content that is not rendered in real-time, like films. Here are videos by both Unity and Unreal demonstrating ray tracing used to make a digital version of a BMW look nearly identical to video of a real car:

To support ray-tracing and other cutting-edge graphics, Unity released its High Definition Render Pipeline in 2018. It gives developers more powerful graphics rendering for GPU devices to achieve high visual fidelity in console and PC games plus non-gaming uses like industrial simulations. (By comparison, its Universal Render Pipeline optimizes content for lower-end hardware like mobile phones.)

Next-gen authoring

Unity’s Research Labs team is focused on the next generation of authoring tools, particularly in an era of AR or VR headsets being widely adopted. One component of this is the vision for a future where nontechnical people could develop 3D content with Unity solely through hand gestures and voice commands. In 2016, Unity released an early concept video for this project (something I demo-ed at Unity headquarters in SF last year):

Game engines are eating the world

The term “game engine” limits the scope of what Unity and Unreal are already used for. They are interactive 3D engines used for practically any type of digital content you can imagine. The core engine is used for virtual production of films to autonomous vehicle training simulations to car configurators on auto websites to interactive renderings of buildings.

Both of these engines have long been used outside gaming by people repurposing them and over the last five years Unity and Unreal have made expanding use of their engines in other industries a top priority. They are primarily focused on large- and mid-size companies in 1) architecture, engineering, and construction, 2) automotive and heavy manufacturing, and 3) cinematic video.

In films and TV commercials, game engines are used for virtual production. The settings, whether animated or scanned from real-world environments, are set up as virtual environments (like those of a video game) where virtual characters interact and the camera view can be changed instantaneously. Human actors are captured through sets that are surrounded by the virtual environment on screens. The director and VFX team can change the surroundings, the time of day, etc. in real-time to find the perfect shot.

There are a vast scope of commercial uses for Unity since assets can be imported from CAD, BIM, and other formats and since Unity gives you the ability to build a whole world and simulate changes in real-time. There are four main use cases for Unity’s engine beyond entertainment experiences:

1. Design & Planning: have teams work on interactive 3D models of their product simultaneously (in VR, AR, or on screens) from offices around the world and attach metadata to every component about its materials, pricing, etc. The Hong Kong International airport used Unity to create a digital twin of the terminals connected to Internet of Things (IoT) data, informing them of passenger flow, maintenance issues, and more in real-time.
2. Training, Sales & Marketing: use interactive 3D content so staff or customers can engage with: a) photorealistic renderings of industrial products; b) VR trainings for risky construction situations; c) online car configurators that render custom designs in real-time; or d) an architect’s plan for new office space with every asset within the project filled with metadata and responsive to interaction, changes in lighting, etc. 
3. Simulation: generate training data for machine learning algorithms using virtual recreations of real-world environments (like for autonomous vehicles in San Francisco) and running thousands of instances in each batch. Unity Simulation customers include Google’s DeepMind and Unity teamed up with LG to create a simulation module specific to autonomous vehicles.
4. Human Machine Interfaces (interactive screens): create interactive displays for in-vehicle infotainment systems and AR heads up displays, as showcased by Unity’s 2018 collaboration with electric car startup Byton.

Unity’s ambitions beyond gaming ultimately touch every facet of life. In his 2015 internal memo in favor of acquiring Unity, Facebook CEO Mark Zuckerberg wrote “VR / AR will be the next major computing platform after mobile.” Unity is currently in a powerful position as the key platform for developing VR / AR content and distributing it across different operating systems and devices. Zuckerberg saw Unity as the natural platform off which to build “key platform services” in the mixed reality ecosystem like an “avatar / content marketplace and app distribution store”.

If Unity maintains its position as the leading platform for building all types of mixed reality applications into the era when mixed reality is our main digital medium, it stands to be one of the most important technology companies in the world. It would be the engine everyone across industries turns to for creating applications, with dramatically larger TAM and monetization potential for the core engine than is currently the case. It could expand up the stack, per Zuckerberg’s argument, into consumer-facing functions that exist across apps, like identify, app distribution, and payments. Its advertising product is already in position to extend into augmented reality ads within apps built with Unity. This could make it the largest ad network in the AR era.

This grand vision is still far away though. First, the company’s expansion beyond gaming is still early in gaining traction and customers generally need a lot of consulting support. You’ll notice other coverage of Unity over the last few years all tends to mention the same case studies of use outside gaming; there just aren’t that many than have been rolled out by large companies. Unity is still in the stage of gaining name recognition and educating these markets about what its engine can do. There are promising proof points of its value but market penetration is small.

Second, the era of AR as “the next major computing platform after mobile” seems easily a decade away, during which time existing and yet-to-be-founded tech giants will also advance their positions in different parts of the AR tech, authoring, and services stack. Apple, Facebook, Google, and Microsoft are collaborators with Unity right now but any of them could decide to compete with their own AR-focused engine (and if any of them acquire Unity, the others will almost certainly do so because of the loss of Unity’s neutral position between them).

Read Part 2 to break down Unity’s current financial position, how its positioning itself in the S-1 to achieve a higher valuation, and what both the bear and bull cases are for its future.