This article documents my learning and I will try to take you on a journey while I study Sandbox VR. Sandbox VR is probably the hottest VR startup right now and they were able to raise a $68m Series A, led by a16z in early 2019 and another $11m in a party round in October 2019.
I’m trying to structure this post as a learning experience because I’m really critical of the business model right now. However, I want to understand why a16z invested in it and question my opinion of the business. So I will first analyze the business itself and then check what a16z and SandboxVR write about the business.
Business model
They are an Escape Room clone, but instead of solving a puzzle, you play a VR game with your friends
As mentioned in the introduction (and as the name suggests :D), SandboxVR aims to build a business in the emerging virtual reality market. To be more precise, they do not plan to sell VR headsets or games to consumers at home. Instead, they are building an experience for groups around premium VR equipment. So what does this mean?
Basically, they are an escape room clone, but instead of solving a puzzle, you play a VR game with your friends. Currently, groups of 2–6 people can rent a room at one of SandboxVR’s offline locations, equipped with VR headsets and motion trackers, and play one of five different games. The target groups are birthday parties and all kinds of corporate and team events.
What surprises me is that according to their website, a group has only 20–25 minutes of active playtime (+15min setup and training & +15min debriefing and video highlights), but it costs about ~40 USD per person (depending on location). This seems like terrible user experience, but according to their reviews I found on the internet, most customers are extremely satisfied with their experience.
There are currently ten different locations. Four of them are in Asia and six in the USA, with two more to be opened in the USA soon. For the future, SandboxVR plans to have most of the locations operated by franchisees, but I don’t know what the current split between franchisees and SandboxVR owned locations is.
It costs the franchisee 360.000 USD to open a franchise. SandboxVR also takes a fee per game, starting at 3.1 USD per player. In addition, the franchisees have to pay 4% (probably of the revenues) for royalties and 1% for brand development.
My initial thought was that the company would have difficulty making games worth playing, but as it seems, most of the customers enjoy playing them. So this point is basically disproved.
The second concern I have is that SandboxVR will not generate enough revenue from the franchise system to justify high VC valuations. So let’s do some maths:
Their website states that the average franchise company generates ~1.1 million USD in revenue annually. Since they take 5% of that, that’s about $55,000 per franchisee. Dividing the total revenue by the ~40 USD that a player generates, the average franchise can be expected to have about 27,500 customers per year. This is 27,500*3.1=85,250 USD for SandboxVR. If we add it up, SandboxVR makes about 140,000 USD per franchisee. This is good, but we have a start-up that is currently worth hundreds of millions, and even if SandboxVR owns all 10 offline sites itself, it would only make about 11 million USD per year.
In addition, the revenue generated by “launch costs” for new franchisees of $360,000 is divided as follows: $50,000 franchise fee, $290,000 hardware and development fee and $20,000 launch marketing. Assuming that the VR Premium Gear costs a lot and is covered by a portion of the hardware and development fee, SandboxVR is under enormous pressure to engage new franchisees to subsidize their development costs for new games (in terms of margin; they are obviously liquid at the moment). But let’s just say that at the moment they receive $250,000 per new franchisee. Even if they open 20 new franchises this year, this would only generate about $5 million in “launch costs” revenue. And these 20 franchisees would generate approximately $2.8 million in revenue through fees and costs per game if we apply the current metrics.
If you look at these metrics, SandboxVR can definitely become a successful business, but to be a hit with VCs, they have to reach an incredible scale, and I only see them scaling by opening new locations. To open these amounts of new locations quickly, they need the help (and capital) of a lot of franchisees. However, as shopping malls and city centers die, rent will be quite affordable and the development of new games will become a less significant cost with a growing number of franchisees. So I clearly see a way to (high) profitability.
SandboxVR about their business
After sharing my initial thoughts, let’s take a look at what SandboxVR claims to make them a great company.
Thesis 1:
SandboxVR’s first argument for buying a franchise company relates more to the product itself than to the company. They basically say that the product will improve naturally when better VR technology becomes available.
That’s true, but they seem to have a good product even without an improvement in technology, if you listen to their reviews. On the other hand, a great product is not all you need for a successful business. The finances must also fit. I don’t have definitive information on this, but the financial figures I’ve looked at above don’t indicate high scalability through existing stores.
Thesis 2:
This is the statement I have to struggle with most. SandboxVR wants to build IP rights to distinguish itself from other me-too companies, which is understandably and undeniably the right step. But when I look at the product (let’s remember: 20 minutes playtime for 40 dollars) at the moment, I don’t see most customers returning often. Apart from the price, most games right now look more like mini-games that are fun to play but don’t trigger the need to play them frequently, through compelling storytelling or a steep learning curve. Even if you assume that only 10% of customers come at least once a month, that seems very daring. It also doesn’t really make sense to create games with a deep story and interesting characters, because even if you play it weekly, you only have 80 minutes of game time per month. That’s never enough to create a story that’s interesting enough to pay $160.
Maybe they build something similar to a series where you play a new episode every week and the customers have to pay a certain amount upfront. But again, with only 20 minutes of play, I don’t see them developing storylines. Instead, I expect them to stick more to mini-games, which are easier for other companies to copy.
Also, I don’t see anyone (not even weekly customers) paying much for character customization. BUT let’s not forget that they can build a healthy business without regular customers as long as the rooms have a high occupancy rate and they reach a sufficient scale.
Thesis 3:
Another selling point for them is that they capture everything that happens in the game and create highlight videos from it. This allows the customers to spread free content marketing in addition to the classic word of mouth, which is certainly happening as most customers are extremely satisfied with their experience and want to tell everyone else about the new hot things in town.
This is a point that I agree with wholeheartedly. If customers are happy to share their social media experience, it’s a great way to increase brand awareness and should enable cost-effective marketing.
Scenarios for the future
In conclusion, I must say that my opinion about the business has shifted a little. The business as I see it now is a retail business that creates a differentiator through technology. The reason why I see it as a retail store to a large extent is, similar to escape rooms, that SandboxVR can only really scale by opening new locations. And anyone with sufficient funding can do that. But unlike escape rooms, the entry barrier is quite high because without good games the experience will be pretty bad and making good games is something that costs time and money. Since the product is already well-received by its core customers and will improve in the coming years, I am convinced that its popularity in the future will be similar to that of escape rooms. Provided that this is true, I can imagine two different scenarios for the future:
Scenario 1 (escape rooms):
In the first scenario, we will end up with a market similar to that for escape rooms. Many different and independent VR-Room owners will each operate one or a few locations where customers will have access to the same games in each VR-Room. Independent publishers have developed popular games that they license to VR-Room companies. Therefore these companies are not dependent on developing games themselves, but still have access to popular titles, while the developer can concentrate 100% on his craft — creating games.
Scenario 2 (fast-food chains):
A second possible scenario would be that a few companies similar to SandboxVR dominate the market and have several locations in each major city. They would have created or acquired extremely popular games and IP rights, giving them an advantage over other me-too businesses and smaller shops. Initially, a lot of money will go into me-too stores but later the market will be consolidated, leaving only a few big brands. Thanks, to the high number of franchisees, the franchisor generates enough revenue to justify high VC-valuations.
