The Online Games Market – Part 1

Introduction

With a global market size estimated at over $15bn (exceeding that of the Hollywood film industry) and with individual releases that can, on their first day’s sales, gross over $150m in a single territory, the computer and video games industry is clearly no longer child’s play. Not only does the games industry out-gross the film industry, but the business model behind games creation is considerably more attractive, with vastly enhanced returns on investment. Games typically cost between $1m and $3m to develop (few have gone beyond $10m and none beyond $26m) but can take as much as $400m or more at retail.

Despite such advantages and despite the popularity of games as a content area on the internet, the industry has struggled to come up with a solution for profitably transferring their business to an online medium. Indeed, it has only really been in the last year that we have seen the first of what we expect will be a series of profitable online business models. The purpose of this article is to outline the current state of what many have dubbed “the zero billion dollar industry” because of its as yet untapped potential and to outline why we believe that this emerging online industry will radically alter the games market over the next 5 years.
Industry Background

The games market is comprised of a computer games market and a video games market. The Computer games market refers to games played using PCs and Macs. This market has experienced stable growth since the beginning of the decade and we believe that this will continue for the foreseeable future. The video games market refers to games played using consoles (such as Playstation and N64) and hand-helds (such as the Game Boy). Because of the finite sales lives of these games devices, this market has proven highly cyclical to date, and currently stands at a cyclical peak period. A typical console platform sales cycle lasts around 3-6 years, depending on the success of the console. This success is determined by a number of factors although the regular release of a large quantity of quality titles is critical as software sales drive hardware sales.

However, even the most successful console platforms require time to build up their installed base and this can take years. As the market is about to undergo a transitory period (with the Playstation and N64 likely to be pushed down the value chain over the next 2 years while Sony, Sega Nintendo and possibly Microsoft’s next generation machines are introduced), we foresee limited growth and even a minor downturn until 2001/2. Sega’s Dreamcast has now launched in Japan and the USA and is due in Europe during October 99. Playstation2 is due in Dec 2000 and Nintendo’s Project Dolphin is due in the west during 2001. Microsoft is known to be working on a ¥200-¥300 PC-console hybrid which is earmarked for next year. Finally, Nintendo aims to upgrade its Game Boy hand-held next year with the Game Boy Advance. Interestingly all of these future consoles will have connectivity potential built into the device, if not via a modem shipped in the box, then through the use of high speed USB and Firewire ports capable of accepting xDSL, cable modem and other access technologies.

Setting The Scene: The Aggregators

To date, it has been PC users that have dominated the online games market because until the release in Japan in November 99 of the Dreamcast, no console offered any form of internet connectivity. Sega has explored satellite and cable distribution of games for its popular Megadrive console (at its peak between 91-93), but failed to update the service for its next console, the Saturn, which was released in 95.

Online, multiplayer gaming can trace its roots back to a number of developments, although the creation of multi-user dungeons (MUDs – text-based Dungeons and Dragon’s style adventures), was a significant influence. These adventures are indeed still played today. However, in general, games publishers have adopted an attitude of caution towards the internet. The first wave of mainstream titles that supported internet gaming emerged around 1994/5 but gained considerable ground with the release of id Software’s Quake, a first-person perspective shooting game set in a dark, hellish 3D environment. With separate multiplayer environments and support for up to 8 players, it became a considerable multiplayer as well as single player hit, selling over 2m copies (and grossing over $80m). Internet support was provided so that players could log onto the internet via their normal ISP and connect to a “Quake” server and either play in a free for all or as part of a team against others on that server. Quake quickly built up a cult following as hundreds if not thousands of dedicated Quake sites emerged, Quake servers became ubiquitous and Quake teams (known as clans) started to make a name for themselves. However, id Software and its publisher, GT Interactive,made little effort to capitalise commercially on the success of Quake as an internet game, despite the potential of online usage as a value-add that bolsters sales of the boxed product.

As the number of Quake clones and other multiplayer games supporting internet play grew, so the first of the online gaming business models emerged. Aggregation services that supported a number of online games were lead by Dwango, Total Entertainment Network (TEN), MPath and Engage in the US and by BT’s Wireplay in the UK. These services offered a matchmaking service allowing single users or teams to meet and play against or with each other. Revenue models varied widely and rapidly with pay-per play, hourly charges, daily charges and monthly subscriptions coming in and out of favour on a regular basis. The providers quickly found out, however, that there were potential problems with levying charges for such services. In most cases, the games that were hosted were not exclusive to any particular service, and so there was little reason (apart from network performance) to remain loyal to a given service. Some providers did attempt to secure online multiplayer rights to games on an exclusive basis, but this proved to be a costly failure as it proved impossible to secure the exclusivity to some key titles at a technical level (one could play multiplayer games through other means) and thus the appeal was limited.

The aggregation services then began to focus on an advertising-based model and with this came a concerted move towards traffic generation through alliances with heavily trafficked sites and services. The fragile state of this new business model began to claim its first few casualties with Dwango unable to keep up with the competition and with Engage forced to shed a considerable number of employees to bring costs in line with lower revenues. Others turned to equity financing although the reliance on traffic partnerships remained and was displayed poignantly when Kesmai, an online games service, was kicked off the AOL games channel and was forced to dramatically cut its staffing levels back as revenues plummeted by 90%.

Read Part 2