In many ways, the video gaming industry has never looked more promising: smartphones and tablets have massively expanded the addressable market; wearables (including virtual and augmented reality devices) are enabling new interaction models and experiences; and user generated content allows studios to add depth and re-playability at little-to-no cost. In 2013, the industry generated more than $65 billion in revenue – representing a nearly 30% increase in only 5 years and totaling 82% more than the global box office and 3.2 times the size of the recorded music industry. Despite this, brand-name studios – including some of the most celebrated and commercially successful ones – continue to hemorrhage or shut down entirely.
Mobile is only a part of the reason why. Over the past decade, the video game industry has been fundamentally upended:
Led by the Nintendo Wii, the seventh generation of video gaming was the first to really achieve mass market adoption. As the console base proliferated, the industry benefited from a nearly 350% increase in annual unit sales – from under 150M in 2006 to 630M only four years later. Yet, this trend abruptly reversed itself in 2010 – and industry volumes have since fallen to fewer than 460M units. Over this same period, we’ve seen an even greater reduction in industry output: 48% fewer (non-mobile) games were released in 2012 than in 2008 (accurate estimates for 2013 could not be sourced). See-sawing demand and competition typically challenges industry economics, but in fact, these trends have provided the industry with a shockingly consistent increase in average unit sales per game:
In theory, this should have driven industry stability – but over this same period,
studios have had to contend with exponential increases in ‘tablestake’ investment costs. In the early 1990s, game development required only a handful of programmers, designers and artists. However, the sophistication of modern gaming engines and ever-rising graphical standards have driven this figure into the hundreds. Some blockbusters, such as Call of Duty and Assassin’s Creed IV, have even exceeded 1,000 (with each team member having a total annual cost of roughly $100,000). Once-modest marketing expenditures have also grown to rival those of major motion pictures. All in, 2013’s Grand Theft Auto V is believed to cost nearly $265M – placing payback sales volume at roughly 10M units (25x average sale volumes). Though GTAV is an outlier, few studios can still afford to develop 2-3 ‘average’ blockbuster titles per year – and a single failure can be ruinous. Furthermore, these titles still need to compete against the likes of Assassin’s Creed and Grand Theft Auto for finite consumer spend.
The normal recourse for this cost creep is raising prices, which remain largely unchanged from the early 90s. In fact, prices have actually eroded by 38% over the past twenty years after accounting for inflation. As a result, today’s studios feel pressure on both the top and bottom lines. Increased sales per game have helped, but they’re insufficient in and of themselves. With this in mind, it shouldn’t be shocking that there has been such dramatic reduction in the number of market participants. But the gaming industry has not just more financial precarious, it has also become more complex.
Over the past five years, the traditional gaming categories, PCs and consoles, have shrunk by nearly $1.5B. During this same time, online and mobile have both doubled, generating an additional $12B and $5B in revenue per year. While mobile has primarily cannibalized time and spend from traditional gaming forms, online has had the most profound impact on veteran gaming studios. Like motion pictures, video games have evolved from a product to a recurring service:
While games used to follow the standard media product lifecycle, they’ve transitioned to a new model where the goal is to drive (and monetize) ongoing usage. Activision Blizzard’s World of Warcraft, which generates revenue through online monthly subscriptions (and soon in-game transactions too), did not reach its peak quarterly user base for nearly five years – at which point quarterly recurring revenue had increased 1,400% over its Q4 2004 release. Though this growth was supported by sequel-esque expansion packs (in Q1 2007 and Q4 2008), the franchise’s ‘Entertainment as a Service’ value is proved through its ability to both sustain and grow paying subscribers in the 26 and 22 months paid months in between releases.
The success of WoW and other EaaS games (not all of which are MMORPGs) explains many of the aforementioned trends:
- By increasing the amount of time the average player plays per game purchase, total industry unit sales are likely to drop
- The focus on developing and establishing blockbusters (which require far more depth than an average 15 hour game) drives studios to reduce the number of games they produce and increases development costs per game
- To meet lofty payback targets, publishers amp up initial marketing costs
- To sustain user engagement, marketing and promotion expenses (tournaments, advertising, developer programs etc.) long after a game’s initial release
What’s more, studios need a far greater skillset than ever before:
Until recently, game production was straightforward: a studio would design, build, test and perfect a game – there was a “ship and forget” mentality, to use industry terminology. Unfortunately for many, the Entertainment as a Service world is far more complex: Studios/publishers must manage customer relations, foster user generated content and experiences, design and oversee complex in-game economies (which may generate up to 100% of the game’s revenue), provide ongoing patches and bug support and so on. Even the classic skillset of game development is strained: Guild Wars 2 developer ArenaNet has pursued a 2 week content release cycle in order to drive user engagement. Whether the game is even getting paid for these “services” depends on the game; many users expect it for free after paying for $60 of content. As a result, many games have team supporting for at least a couple months after release. In addition, games that were unable to achieve the necessary user scale are often made free-to-play in hopes of increasing engagement and in-game commerce – further challenging industry economics.
There simply aren’t many studios with the skillset, IP and balance sheet to compete in this new market. As a result, we’ve seen a dramatic thinning of the “middle layer” of studios. The largest studios (such as EA, Bungie, Rockstar) will continue to survive, as will niche developers and lean mobile shops. However, we’re likely to see mid-market players continue to exit (which will drive further reductions in industry output).
For all its promise, non-mobile game developers face a harsher reality than ever before. Though consolidation will drive back office synergies and some increased talent utilization, it will not resolve the aforementioned issues. Premier developers, such as Activision or Rockstar, would no doubt love to increase prices. Yet, this would inevitably initiate price-based competition in an industry already moving to free-to-play models in order to maximize the total userbase.
To survive, studios need to acknowledge the reality that content creation, curation and consumption is being democratized. For many executives in the media & entertainment industry, this concept is anathema; they believe that their veteran experience and instinct can pick ‘winning’ game concepts and turn them into blockbusters. Even if and when this is true, the final game will fall short of its potential if it remains tightly controlled. To quote Gabe Newell, Co-Founder and Managing Director of Valve: “Games are essentially going to be nodes in a connected economy where the vast majority of digital goods & services are user created vs. created by companies… Our users have already outstripped us spectacularly… They’re an order of magnitude more productive.” How can a studio fight back spiraling development, marketing and support costs? It doesn’t. It outsources them to users.