Gabe Newell: Its interesting to touch on a number of pricing and service issues, because it will help convey the complexity of what were seeing in the entertainment space, and theres probably also going to be lessons in it for other people trying to create value on the Internet.
One thing that we have learned is that piracy is not a pricing issue. Its a service issue. The easiest way to stop piracy is not by putting antipiracy technology to work. Its by giving those people a service thats better than what theyre receiving from the pirates. For example, Russia. You say, oh, were going to enter Russia, people say, youre doomed, theyll pirate everything in Russia. Russia now outside of Germany is our largest continental European market.
Ed Fries: Thats incredible. Thats in dollars?
Newell: Thats in dollars, yes. Whenever I talk about how much money we make its always dollar-denominated. All of our products are sold in local currency. But the point was, the people who are telling you that Russians pirate everything are the people who wait six months to localize their product into Russia.
So that, as far as were concerned, is asked and answered. It doesnt take much in terms of providing a better service to make pirates a non-issue.
Now we did something where we decided to look at price elasticity. Without making announcements, we varied the price of one of our products. We have Steam so we can watch user behavior in real time. That gives us a useful tool for making experiments which you cant really do through a lot of other distribution mechanisms. What we saw was that pricing was perfectly elastic. In other words, our gross revenue would remain constant. We thought, hooray, we understand this really well. Theres no way to use price to increase or decrease the size of your business.
But then we did this different experiment where we did a sale. The sale is a highly promoted event that has ancillary media like comic books and movies associated with it. We do a 75 percent price reduction, our Counter-Strike experience tells us that our gross revenue would remain constant. Instead what we saw was our gross revenue increased by a factor of 40. Not 40 percent, but a factor of 40. Which is completely not predicted by our previous experience with silent price variation.
Then we decided that all we were really doing was time-shifting revenue. We were moving sales forward from the future. Then when we analyzed that we saw two things that were very surprising. Promotions on the digital channel increased sales at retail at the same time, and increased sales after the sale was finished, which falsified the temporal shifting and channel cannibalization arguments. Essentially, your audience, the people who bought the game, were more effective than traditional promotional tools. So we tried a third-party product to see if we had some artificial home-field advantage. We saw the same pricing phenomenon. Twenty-five percent, 50 percent and 75 percent very reliably generate different increases in gross revenue.