Development, Games as services, Publishing, video games

Network gaming hits the mainstream: When network gaming will overtake retail

March 2009

‘Digital’ distribution paints an enticing picture for games studios. The promise of sidelining all those middlemen – retailers, manufacturers, distributors and even publishers – is a powerful lure for games companies swimming against strong financial currents. No warehousing, no market development funds, no point of sale marketing, customers who are always online, the long tail… the lure has glistened attractively for years. Industry commentators, often with patent vested interests, have for years proclaimed that retail’s time has come, that so-called ‘digital’ distribution (as if retailers purvey games made of glue and string) will triumph imminently. For just as many years that claim has been pure hyperbole, but 2008 has proved to be a watershed year for mainstream games content being distributed over the network to console and PC. Western publishers have begun to wake up to the potential – EA expects to generate over $500m from this category in its 2010 Financial Year. Far from being dead on its feet, retail still has a long life span, but last year network gaming suddenly came of age.

The 2008 global network games market was valued at $13bn, growing faster than retail – that’s saying something given that retail games boomed pretty much everywhere outside of Japan. Many types of games are in this basket: MMOGs and virtual worlds, mobile games, casual online games, downloadable console content, and full download PC games. 2008 was a predictably good year for most in the better known categories of network gaming. You’ll be sick of hearing about casual online games providers riding an upward trend, with growth healthy at 25% year on year. No surprise that MMOGs and virtual worlds grew strongly at over 30%, although smaller companies innovating at the edges, not the market’s resident behemoth, WoW, really drove the market’s expansion. Even the red-headed step-child of the games family, mobile gaming, broke out of its doldrums, with iPhone / smartphone gaming probably counterbalancing the contraction in regular mobile gaming to result in net growth.

The real success story wasn’t at the periphery of the industry, but at its heart, driven by the core gamer. The fastest growing area of network gaming was downloadable core content on console and PC. Surviving largely on hot air before 2005, it experienced a sudden growth spurt, reaching $800m in 2008. What caused this sudden adolescent exuberance? The availability of quality download services on console and PC was the trigger, resulting in core gamers buying and accessing games content solely online in rapidly increasing numbers. On PC, Steam is the leading platform, and PC gamers used Steam and others to download increasingly up-to-date full-scale games from EA, Take Two, Activision Blizzard, Sega, Sony and other leading publishers at or very near retail release. This has resulted in healthy growth – and margins – for publishers who are no longer wary of online distribution.

But the real powerhouse of growth has been downloadable games content on consoles, which grossed around $500m in 2008. Since late 2006, a wave of smaller games, expansion packs to major releases and other premium downloadable content (“PDLC”) has demonstrated that publishers came alive to the opportunities of selling content direct via console. That charge has clearly been lead by Microsoft, whose platform is easily the most mature both in terms of technology but also in terms of users, who are increasingly comfortable with buying all kinds of content via their 360s. Its importance to Microsoft is underscored by exclusive PDLC distribution deals for GTA IV (for which Microsoft paid a $50m advance) and Fallout 3 which will undoubtedly fuel a further growth spurt in 2009. Most publishers are following early movers Activision and Bethesda into PDLC with significant releases. Sony has been no slouch with PlayStation Store, Home, and the first full-scale online-only console release, Tekken 6. Even Nintendo’s lack of a hard drive hasn’t stopped its customers from purchasing games on the network. Now, as some PC games (such as EA’s Battlefield 1943) will bypass retail entirely, publishers are becoming increasingly emboldened to push the boundaries further.

EA’s term ‘direct to consumer’ category is another misnomer, because it suggests that there are no middlemen in the networked world. The networked world can have a cost equation for distribution, digital rights management, marketing and billing not dissimilar to that on the high street. Most of EA’s ‘direct to consumer’ products actually utilise a range of intermediaries, like mobile operators, online distribution partners such as Steam, online marketing partners like Yahoo and AOL, billing partners like Paypal, or its (troubled) DRM partners. However, mobile aside, most network distribution can be considerably more efficient and cheaper for publishers than retail as well as bringing advantages like usage and buyer tracking, or even, for publishers opening their own online store fronts, direct ownership of the customer. Marketing is of course still a key variable but it is far more accountable online.

So when will network gaming overtake retail? The way is littered with red faces and broken crystal balls, and the impact of the coming industry down-cycle merging with a global recession and rampant globalisation of the industry will have highly unpredictable effects on the market. What is sure is that retail costs for publishers are rising, recession is driving down the RRPs of boxed product, and some retailers are even beginning to question the logic of dedicating shelf space to gaming. In contrast, network gaming is growing fast on PC and console in the west, and on PC in Asia (outside of Japan) and particularly in China, with its negligible retail market and multi-billion dollar online market growing at relatively high double figures per annum. These factors will accelerate the global market’s shift towards network distribution, thus eating into retail’s market share. Today, networked games represent 30% of the global games software market, and we believe that, based on current trends, retail will take a minority share of the global market by 2013, although it will take several more years for the west to catch up.

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