Games as services, video games

Disabusing digital distribution delusions: the industry’s digital holy grail myth

October 2005

Digital distribution has long promised but consistently failed to revolutionise the traditional computer and video games supply and value chains. The disintermediation of retailers, distributors and even publishers which promised to allow content developers to sell directly to consumers was always seen as the inevitable consequence of the internet revolution. This argument looks good in theory but, in practice, is deeply flawed.

While the digital distribution of core games (rather than casual games which are excluded from this argument) will generate some lucrative niche opportunities, it will not materially impact retailers or distributors at least until the next, next-gen (i.e. PS4, Xbox720) nor will it generate meaningful revenues for publishers relative to retail sales. I also believe that digital distribution will not enable most independent developers to move to a direct sale business model, at least not for a long time. Here’s why.

Digital distribution can be achieved in two ways: via complete game downloads and streaming (AKA Games on Demand or “GoD”). Despite the first digital distribution services being established over 6 years ago, their markets have failed to gain any significant momentum or mass. According to Screen Digest’s recently released Digital Distribution of Games report which looks at both markets, core game downloads are expected to generate $48m in the West during 2005 whilst the GoD market is forecast to reach just $28m. Combined, they represent less than 0.5% of total retail games software sales in the West and are not expected to exceed 2% even by 2010.

The core GoD market remains hampered by technological, marketing, industry support and user experience hurdles, issues that have existed from the dawn of application streaming and for which only partial solution appears to exist. The download market, on the other hand, is both proven and offers far greater opportunity. However, it is constrained by platform limitations.

Both Sony and Microsoft have indicated that they do not expect to support complete game downloads (other than casual games) for PS3 and Xbox 360 and expect to focus on the successful incremental downloads (levels, maps etc.) model established with Xbox Live. Furthermore, Microsoft’s decision to join Sony in making its hard drive an optional extra for its next-gen console impairs the potential of the incremental downloads by curtailing its addressable market.

The digital distribution market is therefore largely based around the PC, a platform that has been in decline for the last five years as user numbers and per-player purchases continue to decline. Despite this, the vast majority of the $289m Screen Digest expects to be generated by core games downloads in 2010 comes via the PC.

At first glance, Valve’s distribution service, Steam (the current market leader), appears a rare example of successful disintermediation but in fact retail sales of Half-Life 2 have dwarfed download sales. Steam is a highly risky (albeit commercially successful) enterprise which has faced the realities of trying to sell direct to consumers including publisher and retailer hostility, costly infrastructure and customer support, and the addition of different types of third parties into the value chain such as billing, hosting, and distribution specialists.

Few developers have the outright ownership of successful IP, cash resources and willingness to emulate Valve. Most would therefore have to go through third parties who already have operational distribution infrastructure. It is somewhat ironic therefore that while digital distribution certainly disintermediates in some areas it also adds often costly intermediaries in others.

This explains why Macrovision recently paid $34m cash for digital download specialist Trymedia. Trymedia offers a complete download solution to content owners but also serves more customer-facing third parties such as web sites and e-tailers (clients include IGN/Direct2Drive, AOL and Yahoo). And it is these new intermediaries that represent the bulk of the current market and, unfortunately for content owners, are expected to remain the largest generators of download revenue by 2010.

The mass-market digital distribution of games will come and will present fantastic opportunities for content owners. Just not for a while…

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