Games go online and on sale: the audience grows, but at what price?
Deloitte predicts that in 2011 the global computer and video games industry will continue growing but from a more diverse set of revenue streams. The industry is forecast to generate $52 billion in software revenues in 2011, 6 percent higher than in 2010, while hardware is predicted to generate only $13 billion, a decline of 19 percent1.
An increasingly large percentage of games revenue is likely to come from monthly subscriptions, peripherals, fees for services and in-game purchases and advertising in the free-to-play (F2P) and ‘Freemium’ markets. Deloitte forecasts that the total revenue from these relatively new sources could be as high as $10 billion, or 16 percent of total games revenues, by the end of 2012, and over time could represent 50 percent of all revenues for the industry.
The existing PC and console games business is confronting various challenges. Increased software piracy has had a profound effect on sales over the past few years, costing the industry billions2. Meanwhile, the higher costs and lengthening development times for high-end games has made game development riskier (publishers need blockbusters) and has reduced profits across the industry as whole3. For PC game developers and publishers, more and more computing devices are being sold – but many of them are smartphones, tablets and netbooks that do not have the hardware to support conventional high-end games.
Console revenues and profits tend to be highly cyclical as both hardware and software purchases are linked to the console upgrade cycle4. Five years have passed since the current generation of consoles was released; the result will likely be relatively flat growth in 2011. Moreover, there are some concerns that the console refresh cycle, which has averaged five years for almost two decades, is about to lengthen into a 10-year cycle, as existing games are not yet putting stress on the hardware capabilities of existing consoles. This would delay the next expansion phase. Console makers hope to bridge the gap by introducing add-on features such as motion control, camera peripherals and 3D.
Three major technological drivers – powerful portable devices such as smartphones, ubiquitous network connectivity, and social gaming – are transforming the industry and creating new sources of revenue. As these new revenue streams emerge, the industry should see growth that is both more stable and more profitable. Also, the global audience of gamers will likely continue to expand rapidly, primarily due to an increase in casual gamers on consoles, web and social networks, and most recently smartphones and tablets. However, worldwide games revenues are forecast to grow more slowly than the number of gamers: revenue per gamer is expected to fall.
Only a few years ago, very few gamers were connecting to the Internet for any reason. But today, an estimated 53-78 percent of gamers (depending on their console) in the US use a connected console to play multi-player online games, download new content and converse with other players while gaming. Connected consoles are also used as PC substitutes for applications such as streaming video5. The benefits to the gamer of a connected machine are enormous – but the benefits to the games industry are even greater: the arrival of connected gaming has not only slowed the growth of piracy, but actually reversed it, especially in geographies where piracy was particularly high6.
As more of their customer base gets connected, games publishers are likely to see expanding contributions from revenue sources that aren’t entirely new, but are becoming increasingly important: micro payments from selling additional levels, characters and costumes; online stores; and, possibly, real-time ads placed in games (although this has not been a big market so far)7. Also, some high end games are being sold as monthly online subscriptions. The cloud gaming market (or GaaS, gaming as a service) is still nascent but could become a significant revenue source for companies that have customers with fast Internet connections – even people with relatively low-powered netbooks or small, cheap thin-client devices that can be connected to TVs should be able to enjoy console-like experiences8.
The fastest growing games segment will probably continue to be free-to-play (F2P) and ‘Freemium’ games. These games are typically based on a revenue model where basic game play is free, but a premium is charged for add-ons that enhance the game experience such as extra levels, accelerated progress and special in-game accessories such as weapons, supplies and costumes (micropayments). Many subscription games are converting to F2P and seeing their revenues increase by 100 percent or more9. Total F2P revenues in 2009 were about $2 billion10; in 2011, that number could reach $5 billion.
The upshot of all these trends is that the gaming industry will likely see smoother revenue streams, higher revenues and profitability, and massive user growth. The existing market of core gamers isn’t about to go away, but the mix of people who play games is likely to shift in many ways: age, gender and income, among others.
The games industry appears to be following in the footsteps of the enterprise software market. Two decades ago, 90 percent of enterprise software revenues were one-time license sales – analogous to buying a game disc – and there were virtually no follow-on revenues or service fees. Today, many software companies derive more than half of their revenues from services and subscriptions, and license fees are much less critical.
Although this change was disruptive to the industry, most enterprise software companies found that after the transformation they were still able to grow profitably while enjoying less revenue volatility. The games industry might be able to learn from their experience, leveraging best practices from the enterprise software industry while developing new best practices of its own.
The F2P/Freemium revenue model is interesting and potentially lucrative. However, it could pose a serious disruptive threat to existing console hardware and software manufacturers if they respond too slowly. The new model will likely give rise to new competitors; also, it might reduce the perceived value of all games11.
The growing number of non-console and non-PC games and gamers suggests that companies focused on traditional console and PC hardware sales may need to diversify. We are already seeing high-end graphics chip manufacturers use their technology in non-gaming markets12. Also, the peripheral market seems to be shifting from single-purpose accessories (musical instruments, etc.) to multi-purpose peripherals that provide image recognition and motion capture. Peripheral manufacturers and game developers alike may need to adapt to this market shift.
1World Video Games Market: Data and Forecasts 2010-2014, IDATE, 2 June 2010:http://www.idate.org/en/Research-store/Collection/Market-Data-Reports_23/World-Video-Games-Market_515.html
2One study suggests $41.5B for portable game piracy alone. Japan’s Computer Entertainment Supplier’s Association report dated 4 June 2010 cited in Slashdot, 8 June 2010:http://games.slashdot.org/article.pl?sid=10/06/08/057245and http://www.cesa.or.jp/news/1393/51/(in Japanese)
3Homefront Studio: Rising dev costs post greatest challenge to games industry, Interview with Zack Wilson of Homefront/THQ, 14 September, 2010:http://www.nowgamer.com/news/4226/thq-studio-dev-costs-biggest-industry-issue
4Xbox birthday signals death of 5-year console cycle, CNET News, 29 November 2010:http://news.cnet.com/8301-13772_3-20023926-52.html
5PlayStation 3 is "most connected" console in US, The Diffusion Group Research, 12 April 2010:http://tdgresearch.com/blogs/press-releases/archive/2010/04/06/sony-ps3-most-connected-game-console.aspx
6An article titled ‘Game Hacking 101’ which is sample chapter from the book ‘Exploiting Online Games: Cheating Massively Distributed Systems’ published by Addison-Wesley Professional, InformIT, 21 November 2007:http://www.informit.com/articles/article.aspx?p=1074291
7Microsoft redeploys Massive technology, Microsoft website, 20 October 2010:http://community.microsoftadvertising.com/blogs/advertising/archive/2010/10/20/microsoft-redeploys-massive-technology.aspx
8Cloud gaming means sky's the limit for any PC, Guardian, 24 November 2010:http://www.guardian.co.uk/technology/2010/nov/24/cloud-gaming-pc-onlive-gaikaiAlthough the issue is complex: some think that GaaS is being pushed out by F2P, while others who went from subscription to F2P are now going back to subscriptions.
9Lord of the Rings Online Revenue Doubles Since Going F2P, MMO Hut, October 2010:http://mmohut.com/news/lord-of-the-rings-online-revenue-doubles-since-going-f2p
10A blog on ‘Top Moneymaking Online Games Of 2009’, Forbes, 10 June 2010:http://blogs.forbes.com/velocity/2010/06/10/top-moneymaking-online-games-of-2009/
11EA: Free-to-play will threaten console business, News at GameSpot, 5 November 2010:http://www.gamespot.com/news/6283592.html
12Nvidia describes 10 teraflops processor, EE Times Europe, 18 November 2010:http://eetimes.eu/en/nvidia-describes-10-teraflops-processor.html?cmp_id=7&news_id=222904640&vID=209