ONE UP
Creativity, Competition, and the Global Business of Video Game Games
$ JOOST VAN DREUNEN
Introduction
In late 2015, Bobby Kotick, the CEO of one the world’s largest game publishers Activision Blizzard, told a journalist, “We now have 500 million players in 196 countries around the world. In the past, our business was largely concentrated around middle-class consumers who could afford $300 or $400 for a dedicated game console or $1,000 for a PC. Now, with the introduction of high-quality mobile devices, we’re looking at everybody being a consumer.”1 Kotick said this when asked why the maker of popular franchises Call of Duty and World of Warcraft had acquired the mobile publisher behind Candy Crush. To many, the acquisition was odd. By entertainment industry standards, the publisher had just spent a ludicrous amount of money. Activision Blizzard paid $5.9 billion for King Digital, which is more than what Disney paid for Marvel ($4.24 billion) or Lucasfilm ($4.05 billion).2 Despite several high-profile acquisitions in recent years, transactions of this size centered purely on acquiring content occur infrequently. Yet this purchase indicated a change in the firm’s strategy. Having long catered to audiences that play shooter and role-playing games, buying a mobile game maker was a deliberate move to reach a broader demographic. The rationale was based on a different idea about gamers and deviated from the existing stereotypes surrounding this audience. Finally, with a single pen
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INTRODUCTION
stroke, one of the largest incumbent game makers in the world embraced and acknowledged the shift of the industry to digital. Activision Blizzard built its success largely on the traditional brick-and-mortar business. By moving into mobile, it instantly came to rely for a third of its revenues on a new model it knew little about: digitally distributed free-to-play titles. Why would a top industry firm make such a drastic move by spending so much to enter a territory that it barely knew? Contemporary interactive entertainment hardly resembles that from the time when the world was infatuated with Pac-Man and Mario Bros. Over the course of roughly three decades, video games had gradually transitioned from the fringes to become a mainstream form of entertainment. As Kotick pointed out, everyone is a gamer now. For most of its history, however, game makers had targeted a narrowly defined demographic. Aside from the stereotypical gamer who is between eighteen and thirty-four years old, plays shooters until late at night, lives in his parents’ basement, and is covered in bits of potato chip, publishers had successfully alienated everyone else. This approach had ensured that the category long remained a sideshow to other amusement markets. Among the broader, socially accepted activities of watching television, going to the movies, reading books, listening to music, and attending sports games and musical performances, video games were the odd one out. Today, however, this industry caters to a common crowd. In the summer of 2016, for example, thousands of Pokémon GO players took to the streets of every major metropolitan area around the world looking for Pokémon. News reports of the hordes of people in the streets playing together evidenced in broad daylight exactly how popular and widespread gaming had become. From Washington Square in New York to Shibuya Crossing in Tokyo, droves of players roamed the streets. This scenario presented many with a stark contrast of what they had thought the average gamer audience looked like. If Pokémon GO is the most obvious example of how widespread gaming has become, it is by no means the only one. Countless titles now draw audiences that run into the tens of millions of regular players, including Candy Crush Saga, Roblox, League of Legends, and Fortnite: Battle Royale (see table Int.1). The audience for interactive entertainment has grown to become an enormous global business. In growing, it also has changed. As games have grown in popularity, the category has transcended its traditional modes of reaching audiences and emerged as an entirely new cultural and economic phenomenon. In March 2018, a blue-haired
INTRODUCTION 3
Table Int.1
Top twenty game titles worldwide, 2018 Title
Parent Company
Monthly Active Users
Platforms
1
Honor of Kings
Tencent
207,862,859
Mobile
2
Candy Crush Saga
Activision Blizzard
150,216,638
Mobile, PC
3
Pokémon GO
Niantic
131,323,177
Mobile
4
Roblox
Roblox
120,598,657
Mobile, Console, PC
5
Fight the Landlord
Tencent
97,674,969
Mobile
6
League of Legends
Tencent/Riot Games 86,350,034
7
Fortnite: Battle Royale
Epic Games
70,386,232
Mobile, Console, PC
8
CrossFire
Smilegate
61,839,375
Mobile, PC
9
Rank
PC
Homescapes
Playrix Games
52,498,118
Mobile
10
Anipop
Happy Elements
46,891,281
Mobile
11
Candy Crush Soda Saga
Activision Blizzard
42,614,901
Mobile, PC
12
Subway Surfers
Kiloo
42,420,089
Mobile
13
Dragon Nest
Shanda Games
41,912,768
Mobile
14
Free Fire
Garena International 38,523,222
Mobile
15
Mobile Legends: Bang Bang
Moonton
36,451,241
Mobile
16
Lords Mobile
IGG Inc.
33,777,239
Mobile
17
Dungeon Fighter Online
Nexon
32,055,004
PC
18
Clash Royale
Tencent/Supercell
31,137,339
Mobile
19
Clash of Clans
Tencent/Supercell
30,063,797
Mobile
20
Minecraft
Microsoft
28,673,361
Mobile, Console, PC
Source: Author’s compilation based on data provided by SuperData Research. Note: Based on aggregated average monthly active user counts for each title across all platforms (non-deduped).
live-streamer on Twitch named Ninja spent several hours playing a multiplayer shooter title called Fortnite with musical artist Drake. It resulted in a record number of concurrent viewers on the platform’s history and instantly propelled Ninja to become a household name. What followed was a series of appearances on television and social media for Ninja. For publisher Epic Games, it meant that Fortnite skyrocketed to become the world’s most popular title, generating $4 billion in its first two years and helping the firm raise an additional $1.25 billion in funding. Suddenly, Fortnite was
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INTRODUCTION
everywhere. Not just as a game played by many but also in the form of its odd in-game dances as celebrities and athletes everywhere copied the dance moves in public. A far cry from the 1980s stereotypes, the games industry has come to occupy an entirely new cultural space. Video games are big business. But that is hardly the most interesting thing about them. What sets this industry apart is that its various value chain participants have managed to thrive in the face of sweeping changes in how amusement is delivered and consumed. Over the past fifteen years, video games have transitioned from the fringes of the entertainment business to become one of the biggest and fastest-growing segments during a period characterized by two developments in particular: the widespread adoption of consumer broadband and the popularization of smartphones. First, in both industrial and emerging economies, the number of people with access to fast internet has grown explosively in a relatively short period of time. Today, more than one billion people subscribe to a fixed broadband connection that provides download speeds greater than 256 kbit/seconds, and there are almost six billion mobile broadband subscriptions globally.3 This growth plays an important role in how creative content is produced and consumed. Removing the restrictions historically imposed by physical boundaries, such as geographic limitations, inventory management, and retail distribution, the penetration of high-speed internet connectivity has changed the circumstances in which creative firms now develop content and bring it to market. Second, the popularization of smartphones has both greatly expanded the total addressable audience and reduced the number of intermediaries between creatives and consumers. The distribution of content through telecommunications infrastructure has profoundly changed how it is produced and consumed. Billions of people walking around with what is effectively a computer in their pocket means content creators can reach a much broader audience. Where previously games were burned onto a disc and distributed by retail channels, internet technology enables end users to directly download and stream content to a myriad of devices. Through platforms like Apple, small creative outfits may access millions of potential customers. The rapid adoption of smartphones has shifted the existing power distribution on the supply side. Instead of having to go through a specialty retailer like GameStop, a publisher like Activision Blizzard can now deliver its content directly to players using digital downloads. Such an improvement in efficiency and associated margins has benefited both big companies in their pursuit of scale and small game makers who can now reach players directly.
INTRODUCTION 5
The demand side also has changed. Many people have found that they, too, are gamers. Look on the subway in any major city and you’ll see a slew of people playing on their phones. In particular, titles that offer more casual experiences like Angry Birds, Bejeweled, and Candy Crush have managed to reach broad audiences. And with a worldwide consumer market of more than two billion people, it is fair to say that video games currently enjoy a market that is several orders of magnitude larger than it was just a few years ago. Combined, these two technological shifts have resulted in the lowering of entry barriers and provided access to a much larger addressable audience. Size alone isn’t everything, of course. Because of their popularity, video games have emerged as a critical component to the businesses of many of today’s largest companies. Indeed, several of the world’s largest firms— Apple, Microsoft, Sony, Tencent—rely heavily on interactive entertainment for their success. Take Apple, for instance. According to its earnings reports it generated approximately $11 billion in 2018 revenues from mobile games. By comparison, its music services and iTunes combined made just over $7 billion (see table Int.2). After a somewhat-lukewarm relationship to the gaming business earlier in his career, founder Steve Jobs gleefully reported during the 2010 Apple event that his company had not “set out to compete with Nintendo or Sony on their PSP, but we are now a significant part of that market.”4 Since then, mobile titles have been a prominent feature in Apple’s annual showcase to promote the capabilities and graphics of every new generation of iPhones. In contrast, Sony, which has long been the dominant market leader, generated $21 billion from device sales, network fees, and platform fees in that same year. With a global install base of ninety-two million PlayStations in 2019, the Japanese console maker holds more than double Microsoft’s footprint and almost five times that of Nintendo. According to its financials, Sony relies on its PlayStation division for about 23 percent of its $75 billion in annual income. Its rival Microsoft earned $10 billion in 2018 in interactive entertainment across its PC and console operations that same year, persuading its CEO to acquire more content and invest in new platform and cloud technology to secure the firm’s future. Tencent, a relative newcomer, earned $19 billion in 2018, both from its substantial content inventory that includes well-known subsidiaries Riot Games and Supercell and from licensing fees paid by publishers looking to enter China. Roughly two-thirds of its game-related income
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INTRODUCTION
Table Int.2
Gaming revenue generated by leading firms, 2018 Company
Total Revenue (US$, billions)
Gaming Revenue
Share of Total (%)
Mobile
Console
PC
Amazon
141.4
1.6
1.1
–
–
+
55.8
0.7
1.3
+
–
+
136.2
1.9
1.4
+
–
+
Apple
260.2
11.0
4.2
+
–
+
Microsoft
110.4
10.0
9.1
–
+
+
Sony
78.0
21.0
26.9
–
+
–
Tencent
45.4
18.6
41.0
+
+
+
827.4
64.8
7.8
Total
Source: Author’s compilation based on company reports. Note: Gaming revenue defined as all revenue generated from interactive entertainment, including publishing entertainment software, selling consoles, microtransaction revenue, platform fees, and ad revenue. Because each of the firms have a different business model, it should be obvious that their revenue models differ, too. As a consequence, these figures are not to be compared against each other, but rather illustrate the exposure each of these companies has to the business of video games. The right side of the table shows the major platform categories in which each of these firms is active.
comes from operating as a local partner to foreign publishers who are prohibited from going directly to Chinese consumers. This has allowed Tencent to achieve a market value that rivals Facebook and makes it the largest game publisher in the world today. It suffered a massive drop in share price value, however, when its government froze the mandatory approval process (to protect consumers, the Chinese government has to approve every title before release and generally is skeptical of the cultural merits of the sector). This freeze meant that Tencent missed out on revenues generated by a popular title like Fortnite right as it reached the pinnacle of its success. Finally, several other tech giants are looking to penetrate interactive entertainment. In late 2019, Google launched its cloud gaming service, Stadia, to capture market share and take on a more significant role as the industry transitions to a new distribution model. Facebook similarly invested in cloud gaming with the acquisition of PlayGiga, after already having invested billions in both virtual reality technology (with the acquisition of Oculus) and content creators like Beat Games. And Amazon has been developing its own gaming division: after establishing its Amazon
INTRODUCTION 7
Game Studio and acquiring Twitch, it has started to quietly develop its own cloud gaming service under the code name Project Tempo. Combined, these organizations generate $827 billion in revenue, and video games represent about 8 percent of this total. Interactive entertainment is a vital component to each of their business models and serves as a proxy for their overall performance. Their share prices rise or fall depending on how well they manage to convince investors and consumers alike that their games division is healthy (see table Int.2). This book reveals how video game companies have adapted to the changing economic foundation of the overall industry. After decades during which games were largely a physical, retail-based business, key economic activities like development, publishing, marketing, distribution, and monetization started to change following digitalization and the popularization of new technologies. This equally challenged and prompted creative firms to formulate innovative strategies and resulted in a drastic change in the industry’s overall competitive landscape. On the basis of an extensive data set combined with detailed case studies, I show that rather than relying solely on creative merit, critical and commercial success in video games is more often than not the result of formulating an innovative business strategy. Set against a background of the broader structural shift from a product-based business to a gamesas-a-service model, I discuss how various company types—developers, publishers, retailers, platform holders, and distributors—have solved strategic challenges by formulating novel business models and innovations. I argue that successful companies in interactive entertainment apply the same degree of creativity to strategy as to making video games. The intercourse between the growth of the industry in value, its broadening consumer base, and its digitalization present the key drivers of change that are reshaping its overall market landscape. In this context, I assess how the structure of the industry has shifted, how individual firms have adjusted to these new economic conditions and developed competitive advantages, and how this has affected their creative agenda.
Book Structure
This book is organized in three parts. Each describes a different stage in the evolution of the business of video games. The analysis presented focuses on the practices observed from notable firms and how they capitalized on changes in the industry’s underlying economic principles.
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INTRODUCTION
Part 1 offers an overview of the traditional business and looks at the challenges of the games-as-a-product model. It starts with a historical perspective to establish how different companies operate, followed by a discussion of how amusement in a broad sense has changed. Chapter 1, “Digitalization of Interactive Entertainment,” looks at the remnants of traditional, product-based entertainment publishing and the challenges music, film, and video game companies sought to overcome with varying degrees of success. Chapter 2, “Games Industry Basics,” describes in broad strokes how the traditional business has operated for almost three decades and serves as a starting point to better understand the changes that follow. It offers an account of how firms like Nintendo, Naughty Dog, and Electronic Arts successfully tackled business challenges and managed risk. Next, a key discussion that has emerged as a result of the popularization of downloadable content and digital distribution is the changing role of the brick-and-mortar retailers. To that end, chapter 3, “Empire on the Edge of the Volcano,” offers an in-depth account of how GameStop became the world’s largest specialty games retailer and how it manages, or at least tries, to reinvent itself. It provides an overview of the retail business in key industrial economies and discusses how core strengths like customer education, promotion, and used game sales are being repurposed to suit the needs of a changing market. Part 2 categorizes the digital games business into core segments and explains their recent evolution. The underlying business model is gamesas-a-service. This part emphasizes how mobile, console, and PC game companies have dealt with strategic challenges as economics shifted. Chapter 4, “Everyone Is a Gamer Now,” begins with a discussion of the ascension of video games to a mainstream form of entertainment. The rise of casual titles across mobile platforms and social networks has allowed the gamer demographic to expand both in size and diversity. The chapter explains how the industry has struggled to shift its focus from a traditionally narrow definition of gaming consumers catering to a global, mainstream player base and the implications for both marketing and design. Chapter 5, “Myth of the Mobile Millionaire,” examines the rapid rise of mobile gaming and explains how a company like Supercell managed to produce not one but four titles that generated more than a billion dollars in revenue. It looks specifically at how developers and publishers alike face the increasing costs of development and marketing even as worldwide demand for mobile games continues to grow in size.
INTRODUCTION 9
Chapter 6, “Greatly Exaggerated Death of the Console,” dispels the myth that dedicated gaming hardware is on its way out by outlining the strengths of organizations like Microsoft, Nintendo, and Sony. These companies challenge each other for dominance over the center of the living room and, in the process, incorporate downloadable and streaming content to create a competitive edge. Chapter 7, “Glorious Return of PC Gaming,” examines how PC-based game development has persevered thanks to audience loyalty and the emergence of digital distribution. In addition to discussing the innovative genius that drives the success of an organization like Valve, the chapter explains how Blizzard came to dominate the online role-playing category and how a South Korean firm named Nexon managed to penetrate the U.S. market. In addition to its various merits, digitalization also presents a series of challenges to game companies. The abundance of available content as a result of digitalization presents a growing challenge for creative firms in connecting with consumers. Part 3 examines more recent innovative developments. It resolves around the emerging business model of gamesas-media as the industry looks to both old and new strategies to navigate and monetize the digital marketplace. Chapter 8, “Epic Quest for Intellectual Property,” explores the central role of licensing to the success of conventional titles. It presents an assessment of different companies looking to reduce the financial risk involved in development and publishing by relying on established franchises and brands, as many of these principles are employed by participants in digital games. Examples like Angry Birds, Madden NFL, and Pokémon GO provide key case studies in understanding the role licensing plays as publishers seek to innovate without alienating their existing customer base. Chapter 9, “Watching Other People Play Video Games, and Why,” takes on the topic of live streaming and the popularity of Twitch streamers and YouTubers. The practice of people watching other people play games, providing commentary and input along the way, is a relatively recent phenomenon, but it already has significant implications for the industry at large with regard to marketing and discovery. It further explores the emergence of competitive gaming as it slowly materialized into a global phenomenon over a two-decade period, only to find itself suddenly thrust into the center of mainstream media attention. This brings us to chapter 10, “Next-Gen Revenue Models,” which discusses the viability of new earnings models, including advertising and subscriptions. After several failed attempts to introduce ads into video games,
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INTRODUCTION
the current size and diversity of its audience suggests there may yet be an opportunity for advertisers to play a significant role in the contemporary games industry. And as new technologies like cloud gaming emerge to disrupt the industry’s landscape once more, it explores the question how different financial pressures and operational affordances will govern the overall creative process.
Empirical Procedure
Throughout this work, I have tried to be transparent by relying on accessible data sources and common methodologies. To provide an analysis of the global industry and how it has changed over the years, I relied on a variety of data sources to illustrate the various relevant changes. The appendix provides a detailed explanation of my empirical procedure.
Praise for
ONE UP
“One Up is by far the best book I’ve read about the business of video games. It’s at once analytical, instructional, and highly readable. It should be required reading for anyone interested in the interplay of creativity, innovation, and business strategy in interactive entertainment.”
— BEN FEDER, PRESIDENT, INTERNATIONAL PARTNERSHIPS (NORTH AMERICA), TENCENT GAMES “Joost van Dreunen’s One Up reflects his many years of experience in the games business, offering his unique perspective as a consultant and an academic. His positioning at the intersection among creators, manufacturers, business executives, investors, and financial analysts makes this book a must-read for anyone interested in learning more about the games business.”
— MICHAEL PACHTER, MANAGING DIRECTOR AND EQUITY RESEARCH ANALYST, WEDBUSH SECURITIE S “The essential book for understanding the changing landscape of the game industry as it has moved from physical goods to downloads to continually evolving games-as-a-service.”
—JESPER JUUL , AUTHOR OF HANDMADE PIXELS: INDEPENDENT VIDEO GAMES AND THE QUEST FOR AUTHENTICITY “In One Up, van Dreunen illustrates how business and strategy decisions can make or break the success of a game or platform. He breaks down the complex, rapidly changing business of video games in a way that will enlighten and entertain industry veterans, investors, and noobs alike.”
—ASHLEY MCENERY, BUSINESS OPERATIONS, DISCORD “There were no good books about the video games business— until now. One Up is required reading for anyone who wants to understand how video games went from a toy in the basement to the most dynamic sector of the global entertainment industry.”
— BEN DECKER, HEAD OF GAMING SERVICES MARKETING, MICROSOFT $29.95
Printed in the U.S.A.