developers and publishers in the traditional gaming world

In 2003, video game software sales across all gaming platforms exceeded eleven billion dollars. For the last three years game sales have generated more revenue than Hollywood, as box office revenues in 2003 were approximately nine billion. The game software segment of the video game industry is ruled by two major segments, the developers and the publishers. While both play a key role, major international publishers like Electronic Arts rule the industry in PC and console gaming, so we will examine that markonline PC games)

The publishers generally commission and pay for the development of a game, in much the same way that a television channel works with a production company to create a program. Because publishers have the finances to fund the majority of projects, they control which products reach the market, on what formats, and at what time of the year the games are released. Beyond commissioning the games, publishers often handle the marketing and distribution of games. Production includes the creation and manufacturing of the components, while distribution requires negotiating deals with retailers to get the title to consumers.

Figure Two below illustrates the video game software value chain.



As a simple example of how the relationship between publisher and developer works consider the following. The developer gets a five million advance to create the game and ten percent royalty based on the publisher’s revenue following deductions. The developer will see royalties after the game has generated fifty million in revenue for the publisher. If a game sells for $30, it must sell one million units before the developer sees royalties. The video game software industry is dominated by large, international publishers, none more so than Electronic Arts (EA). Over the past three years the average company in the industry has seen an 8% increase in their stock price, while at the same time EA has increased by 123%. The following example shows the strength of position that EA holds. At the end of 2004, EA felt that it had lost market share to Take-Two Interactive and Sega Corporation’s ESPN NFL 2K5, a game in direct competition with EA’s Madden Football (the Madden franchise has generated over $1 billion in revenue over the last fifteen years). NFL 2K5 was aggressively priced at $19.95, less than half of EA’s title, basically resurrecting the ESPN football title. To counter this move by Take-Two, EA acquired the licensing rights of the NFL for all developing, publishing and distribution of interactive football games. This type of maneuvering is why we think this is a difficult segment for start ups. EA essentially locked out other publishers from producing NFL games for the next five
years, in similar fashion to deals EA has with professional soccer and golf (Tiger Woods). Because this industry is very mature and dominated by large international players, we feel that there is little opportunity for venture backed companies. It takes an enormous amount of capital to lock up the increasingly exclusive content and without such deals it will be hard for publishers to compete. Additionally, publishing is a segment characterized by strong relationships (with developers and retail outlets)and starting from scratch without these relationships would be extremely difficult. Further, there has been a large amount of consolidation in the market and starting a new console or PC game publisher is unlikely to be a lucrative business.

Developers

Software developers create the games that consumers will eventually play. The majority of software developers are independent companies, but some of the larger publishers have internal development teams or own a stake in external developers. In general the development process involves design, research, implementation, testing, and mastering. Games fall into three main categories, licenses, conversions, and originals, with developers tending to specialize in one segment. A licensed game is based on intellectual property that the publisher generally owns or has bought the rights to. A conversion is a game that has been developed for one game platform and converted to another. Finally, original games are based on a
developer’s concept. The majority of original ideas are created by independent publishers, who then try to get the game signed by a publisher. Original games are generally cheaper to produce because there is no licensing fee, but are riskier because of the uncertain consumer response to a new product. There are roughly 200 independent video game developers in the US today, with most working under the typical structure of an advance from a publisher as discussed above. This space is also dominated by the large publishers like EA who either control the game flow or develop games internally. Software development in the video game industry is an area likely to continue to grow at a strong pace, particularly in late 2005 and
early 2006 as new consoles are released (expected U.S. and European CAGR of 12%).