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What happened

Shares of Unity Software (NYSE: U) were plunging on Monday, down around 6.1% as of 2:15 p.m. ET.

The software company, which makes the backbone engine used by about half of the world’s console, PC, and mobile video games, has been embroiled in a controversy regarding new fees on developers it proposed last week.

Then on Sunday night, the company tweeted that it had “heard” its clients’ complaints, and that it would be “making changes” to the planned policy. Details of those changes haven’t been released.

In any case, the confusion around the new fees and what all of this may mean both for Unity’s revenues and its client loyalty led to another plunge in the stock price to start the week.

So what

Unity has traditionally worked on a “freemium” model under which game developers can use the free tier of its platform to develop certain games, while studios or developers with more resources can pay for higher tiers with more features, or use Unity’s ad-supported platform.

But last week, Unity announced a controversial new install fee policy under which it would charge a $0.20 runtime fee for every installation on games that generate over $200,000 in annual revenue on its free tier, with lower install fees for those who paid for pro and enterprise tiers, as well as lower fees for developers in lower-income emerging markets.

The move appeared to shock some developers, many of whom publicly expressed their displeasure over the weekend. And when I say “displeasure,” I mean they made statements asserting that they would be switching to other game engines.

For instance, Robert Boyd of Zeboyd Digital Entertainment said, “Unity has shown such hatred and disdain for indie developers that they can no longer be trusted. We at Zeboyd will be using a different engine in the future.”

Other developers took a more nuanced approach, but still expressed huge dissatisfaction at being “trapped” by Unity changing its fee rules for games that had already been created and released, after developers had already committed to Unity on the understanding it wouldn’t skim their revenue.

On Sunday night, Unity published a tweet on X, formerly known as Twitter, apologizing and saying the company would be tweaking its policy, and would announce how in the next couple of days:

We have heard you. We apologize for the confusion and angst the runtime fee policy we announced on Tuesday caused. We are listening, talking to our team members, community, customers, and partners, and will be making changes to the policy. We will share an update in a couple of...

— Unity (@unity) September 17, 2023

Now what

One might ask why the stock is down so much if the company has apologized (sort of) and is changing course. Well, the damage here is that Unity has already alienated a large part of its developer base — people and companies who might now give more serious thought to using alternative engines in the future, such as the Unreal engine or the open-source Godot engine.

Not only that, but if Unity changes its policy, it may miss out on revenue it was counting on as part of its business plan. While we don’t know exactly what changes Unity management will make or if they will ultimately assuage the anger of the developers, it’s possible the company will be left with the worst of both worlds: not getting as much revenue as it wants from install fees, while also leaving its developer base less than happy.

Unity posted what looked like solid growth last quarter, but that was really due to its merger with IronSource last November. On a pro forma basis, its revenue grew by a respectable, but less-than-stellar, 11%. And while its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) was $99 million, Unity still lost a hefty $193 million on the bottom line last quarter alone on a GAAP basis.

When interest rates were low, companies were able to get away with operating in loss-making, growth-at-all-costs postures. But in the new higher-rate regime, investors want to see businesses demonstrate their underlying profitability. When a company tries to “turn on” profits and runs into trouble, that can lead to investor angst about its business model.

Now that developers are rising up in protest over rate increases, it’s becoming clear that Unity might not have as much pricing power as some investors might previously have thought.

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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.

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