On July 27, 2018, the Battle Royale video game and global phenomenon “Fortnite” celebrated its first birthday. In that first year, Fortnite and game developer Epic Games shattered records and their peers’ expectations, not exactly coming out of left field, but arriving as an underdog in an industry already ripe with shooter games.

Between its release in July 2017 and May 2018, Fortnite amassed an audience of 125 million players and netted $1.2 billion dollars in revenue, reports research firm SuperData. When the Fortnite App launched to the iPhone on April 1, it reportedly made $2 million a day from players on Apple Inc.’s  AAPL, +2.48% iOS. By the end of 2019, the game is expected to generate $2 billion in total, making Epic Games worth $5 billion to $8 billion, according to the Bloomberg Billionaires Index.

While other games have netted $1 billion in their first year after launch, Fortnite was the first to do it by releasing their game for free. Whether the multiplayer shooting game is here to stay or has captivated the gaming world momentarily, one thing is clear: following the release of Fortnite, the gaming industry must respond to the free-to-play model.

What is Fortnite?

Fortnite is a multi-platform video game, meaning it can be played on the computer, mobile devices, or consoles, including Sony’s  SNE, +0.40% PS4, Microsoft’s MSFT +0.65%  Xbox One, and Nintendo’s OTC:NTDOY -0.09% Switch. In the Battle Royale game mode, 100 players drop onto a storm-torn island and survive, fight, or build their way through a shrinking map to be the last one standing. While many popular shooting games, including Activision Blizzard’s ATVI +1.47% “Call of Duty” franchise, attempt to mimic reality with graphic violence, Fortnite sets itself apart with its inclination towards comic mischief and customizable whimsy.

Although players are competing for the coveted “Victory Royale,” they are also given the option to team up with one another. As Jefferies analyst Timothy O’Shea put it, Fortnite “is a social experience at heart, encouraging friends to play together.”

But Fortnite fans not only play together — they also watch together. On March 14, a game of Fortnite pulled in 630,000 concurrent viewers on Twitch TV, Amazon’s AMZN +1.89% YouTube-like service for watching competitive video game streams, shattering the previous record of 388,000. Fortnite has since amassed almost 30 million viewers, nearly doubling the streaming service’s runner-up, League of Legends, owned by the Chinese internet company Tencent Holdings OTH:TCEHY -0.93%. (Tencent Holdings also purchased 40% of Epic Games, Fortnite’s parent company, in 2013.)

The game is played, watched, and talked about obsessively by teenagers, rappers, athletes and celebrities alike — which is exactly what allows Fortnite to make money, despite being free-to-play.

Photo: courtesy of Epic Games' Twitter @EpicGames

How Does Fortnite Make Money?

As of August 2018, Fortnite had become the highest grossing video game on consoles, according to a study conducted by SuperData. However, while most console releases make money from selling a hard copy or digital version of the game itself, Fortnite’s revenue comes entirely from microtransactions.

In Fortnite, players have the option to spend money on in-game currency, called “V bucks,” which can be used to make in-game purchases. Although “Bonus Deals” incentivize players to purchase higher quantities of the in-game currency, the exchange rate is roughly 1 USD to 100 V-Bucks.

The key to Fortnite’s business model is that players cannot use V-bucks to buy anything that will actually affect their performance in the game, which has proven disastrous in the past. Instead, the currency is used to purchase cosmetic skins, dances, and pre-released game modes for their characters, which range from 200 to 2,000 V-bucks ($2 to $20).

(Photo: screenshot taken by writer, September 27, 2018.) 

Many accessories in the Fortnite shop are available on a limited-time basis, prompting players to purchase coveted items before they disappear from the virtual store.

"On the revenue side, [Fortnite has] done something that's really unique, which is come up with a perception of exclusivity," said Michael Pachter, an analyst at Wedbush Securities. "If you see another player in a leopard skin and go to the store and see it's no longer available, you think, Shoot, I've got to move on it next time."

This is where the social aspect of Fortnite intersects with its finances. In a study of 1,000 Fortnite players by LendEDU, nearly 69 percent made in-game purchases, averaging $84.67 each. All of that commerce translates into some of the highest rates of revenue-per-user in the industry and operating margins north of 50 percent, according to analysts.

(Photo: screenshot taken by writer, September 27, 2018.) 

How Has Free-to-Play Affected the Gaming Industry?

In May, Fortnite generated $318 million in revenue for North Carolina-based Epic Games, according to SuperData, beating out Electronic Arts' "FIFA 18" and Blizzard Activision's "Call of Duty: WWII," which charge for downloads and offer in-game purchases.

However, according to BTIG analyst Brandon Ross, Fortnite may end up benefiting its competition because it has drawn new players into a genre that previously struggled to expand beyond its core audience.

“There is a need in the space for innovation in the shooter genre,” said Ross, adding that Fortnite’s cartoonish style demonstrated that there is a demand from non-gamers and more casual gamers. “There were people who wanted to be a part of what was going on in gaming,” he said, and “just needed the barriers to entry to be removed.

Even so, Fortnite became a national and global phenomenon so quickly that industry leaders, such as Take-Two Interactive Inc. TTWO, +0.35% and Electronic Arts Inc. EA, +0.74%, have not released anything in the way of competition — at least not yet.

Earlier this month, Blizzard Activision announced the development of a Fortnite-style, Battle Royale game mode for its newest release, “Call of Duty: Black Ops 4.” While the video game giant appears to be following in Fortnite’s footsteps, it is sticking to a familiar business model: “Call of Duty” will cost $59.99 and offer in-game purchases.

However, according to Piper Jaffray analyst Michael Olson, that move may just pay off.

Last week, Olson set an $88 price target for Activision Blizzard after reviewing positive responses to the game mode. That’s about 7% above current levels, suggesting that Fortnite’s success may have more to do with its innovative game mode than its business model.  

“What do you get when you take the largest annual gaming franchise on Earth and combine it with the most popular new game mode?" Olson asks. "We believe the answer is earnings per share upside."

Thursday, September 27 marked the beginning of Season 6 of competitive Fortnite play. For players, this means the arrival of new skins, new dances, and new features. For Epic Games, it likely means millions in microtransactions.