(Note: If you’ve successfully founded and ran a business for several years already you run a higher risk of not getting any use out of this blog post.)
Keeping The Lights On
Every company has some amount of capital and costs required to operate. Burn rate is essentially your costs per some time unit, typically expressed on a monthly basis.
Say your company has $100,000 of operating liquidity and a burn rate of $10,000 a month. In that case your company has $100,000/($10,000/month) = 10 months of operating capital, sans any profits your company may generate in the meantime.
Say your company is founded with $60,000 and its burn rate is $5,000/mo. After 12 months you’ve spent all your initial capital, but you’ve also made a profit of $30,000. Is that good?
You started with $60,000, operated for 12 months, and ended up with $90,000 (you recouped your initial $60,000 investment and profited $30,000). Assuming your burn rate is unchanged you now have 18 months of operating capital left. In 12 more months you might project that you have $90,000 – $60,000 + $90,000 = $120,000 in operating liquidity, a full 24 months of company operation!
So that’s pretty good.
But what do you do with profits other than sit on a pile of cash, assured in some future X months of operation? Well you could expand your business. Maybe your burn rate goes up to $10,000/mo but now after 12 months you expect to net $200,000 instead of $90,000. Maybe you decide to diversify and open a sister business that operates very differently from your main business. Maybe you buy low yield bonds because 1.5% is good enough for you on your excess capital. Maybe you pay off your student loans. Maybe you make a down payment on a house.
Either way this is a good scenario.
Systemic risk is something most investors have a healthy fear of. Game developers talk about this, too, hence the “indiepocalypse” craze. Systemic risk refers to risk of an entire system coming apart. Maybe games journalists get up en masse, angry at poor working conditions and pay and leave and no one replaces them. Maybe game developers do this. Maybe YouTubers and Twitchers do this.
That’d cause some upheaval.
Gamers and developers talk about this in terms of market saturation. There’s a common belief that there are just “too many” games and everyone’s going to die off. I don’t see it, personally, but it’s a possibility in the future and something to be aware of.
Risk management complications arise in trying to compute what the actual risk is and how much damage it can do to you. Systemic risk is likely to be fairly catastrophic to every business in that system. What’s the chance of it occurring this year? This month? This week? Next year?
Say you operate an indie game studio with $120,000 of capital and hand wave a guess of 1% chance the entire video games industry comes crashing down in 2017. You also determine that the worst case scenario if this occurs is you will lose $100,000. You also determine that in the 99% chance event the industry does not come crashing down you will earn a profit of $40,000.
A basic analysis might reckon that a $100,000 loss is far heavier than a $40,000 profit and it might be best to wait out 2017 and see what happens. If you drop from $120,000 to $20,000 your business might not even be viable anymore.
A slightly more complicated example: Say your studio has $120,000 of capital. You determine that you could spend $50,000 of that money to make a game and net $70,000 by the end of 2017. You believe that there is a 1% chance that the industry could tank in 2017, completely annihilating any potential revenue. Is a 1% chance of a $50,000 loss worth a 99% chance of a $20,000 profit? A simplistic analysis like the one before might say that it’s not worth even a 1% chance to swing your studio’s assets from $120,000 to $70,000. Another might be that 1% of a $50,000 loss is -$500, and 99% of $20,000 is $19,800 and it is probably worth the risk because even at $70,000 of assets your company is not completely non-viable to make future games.
More Common Happenstances
It’s harder to evaluate those sorts of risks because of the catastrophic nature and the low chances. What about costs and risks related to missing deadlines? These are common in making games, and they have a higher chance of occurring but also a much lower loss associated with their happening.
Another benefit of doing this sort of analysis is that you concretely identify what threatens your business and you can take steps to mitigate them. You feel there’s an X% chance people will kneejerk a negative response to pixel art in your game costing you $Y? Maybe you spend a little under X% * $Y making non-pixel art promotional/box art.
Aside: I’m not explicitly suggesting that’s a good solution to that specific problem. It’s just an example to demonstrate calculation of risk, potential loss, and a potential way to mitigate that loss in a cost effective manner. That said…
The platforms you support, the distributors you use, the currency exchange rates, the payment processors you employ, the languages you localize for, the art aesthetic you choose, the genre you develop in, et cetera are all potential risks. There are always costs and risks associated with doing, and not doing, anything.
Thanks for reading,