Playing For Keeps
OK, you know video games are big business. And you have probably heard they can not only make as much money as a blockbuster movie, but if they are released in tandem with one, can do ever better. That’s about half true – most comparisons don’t factor in Hollywood’s downstream revenue from DVD retail and rental, and overstate video game numbers by leaving in hardware sales. But even still – it’s a hefty dollar sign, and if you happen to be a media company without a shiny new games development division, the big question on your mind has got to be – what now?
According to DFC Intelligence, the industry turns over $24.5 billion annually, and is dominated by Sony, Nintendo, Electronic Arts and Microsoft. Beyond these top four, the market remains highly fragmented and is characterised by independent publishers who survive on the occasional surprise hit.
Curiously, each of the four majors differs profoundly in their approach to the market. Sony, which is the largest in terms of revenue, has used console gaming to reinforce its position into the consumer home entertainment market, and to also take advantage of cross promotional tie-ins with its film releases. Microsoft, keen to expand its influence beyond the desktop, has similar aspirations on using a broadband connected gaming console to be the new gateway into the home. Nintendo, which is actually the most profitable of the four, has a long history of securing high royalties from developers and harvesting the value of its game franchises by re-releasing older titles on new mobile platforms. Finally, Electronic Arts, which is the only player among the top four that does not manufacture its own hardware platform - has built scale through acquisition and a focus on acquiring licenses to lucrative sports franchises.
The scale of the players involved is understandable when you consider that the development budgets of a major game release have grown dramatically. Typically, games are usually in the US$3m-$10m range, with US$40m at the top end, while movies tend to cost between US$10-40m and US$130m at the top end. However, the gap in production costs between games and movies is narrowing as artwork, coding, licensing and marketing costs begin to spiral dramatically.
Although like movies, sales figures for the top games are generally roughly proportional to their relative development costs - a notable exception last year was Electronic Art’s Madden 2005 which grossed $120M in sales, but based on an existing code development and captured audience base, cost relatively little to make and promote.
Most entertainment media companies today who produce movies or publish best selling books, make money from video games through third party licensing. Nevertheless, with the exception of Sony, most of these companies have limited control and visibility over the actual production process, reducing the benefits of integration. There is no doubt that being able to originate and exploit your own content franchises is a huge advantage, as it both lowers your licensing costs and allows you to benefit from cross marketing.
Sony, for example was able to leverage the release of their Spiderman movie sequel, to promote an associated video game, and then later, bundle a mobile version of the DVD to help sell its new portable gaming system. Movie studios, such as 20th Century Fox, can still benefit from gaming sales through licensing deals, but they potentially lose some of the strategic benefits of total integration. Complications and expensive legal disputes can also arise where there are multiple sources of rights - for example, the Lord of the Rings movie, the Tolkien novel, and the board game.
Developing an in-house game development function, however, is highly risky for entertainment companies. Microsoft’s successful launch of its XBOX division, required not only huge financial commitment, but also harnessed internal company experience with complex code development and retail distribution. The acquisition route is less risky, but currently lacks a plethora of suitable targets. With an $18 billion capitalisation, Electronic Arts would be a tough beast for even the largest media empire to swallow. There are a number of smaller targets – including Take Two, THQ, Capcom and Midway – which vary from between US$0.6m and US$1.6bn in size. Each of these, however, has tradeoffs and complications for an acquirer depending on their relationships and focus. One emerging target may be Japanese developer NAMCO which are pushing harder into the North American market, and could benefit from a US media player acquisition.
The current configuration of the game industry has a lot to do with retail market power, which may change as new direct distribution channels mature. Well over half of all marketing dollars spent in the gaming world are in co-op dollars or marketing development funds, used by publishers to secure retail shelf space.
Eventually, online distribution of game software may allow entertainment companies to be in a better position to bypass publishers, and exploit their license rights by outsourcing technical production but retaining control over marketing and cross promotion. However, with the console wars about to go to the next level with the imminent release of Sony’s Playstation 3 and Microsoft’s XBOX 2, the time for Hollywood’s dealmakers to release their own sequel may already be up.
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