Evolution and Future of Online Gaming

Yesterday I visited the Electronic Arts headquarters in Silicon Valley and had the chance to talk to senior management about the company’s business model, its current situation as well as its future plans. In this post, I want to shortly share the main ideas we discussed and based on that and some further research explain the value chain of the gaming industry and how it is affected by recent trends.

Electronic Arts’ business model has been the development of all kinds of PC and console games. During the last years, the company invested a lot of money to gain market share in the field of online games because those offer a much higher return on investment.

I want to start this post with the description of the video gaming industry and based on the different stages of the value creation process explain how online gaming differs from the traditional business models. After this analysis, I will describe recent trends in the online game business and discuss how companies in this industry should modify their business model to stay competitive.

Video gaming value chain

Software Developers

Software developers are primarily responsible for the ideation and development of console games. Similar to the movie industry, there are a lot of small studios that develop a concept and then seek funding from major game producers or also called software publishers.

Software Publishers

The large publishing houses like Electronic Arts are responsible for the funding and distribution of the game titles. Besides, they act in the fields of product testing, packaging and user manual development, customer service, marketing and PR. Around 300,000 units must be sold to break even. Recent studies show that this is the case with one out of four games. The business is quite risky and an intelligent allocation of the resources essential.

Console Manufactures

This part of the value creation process is controlled by the three big console manufacturers, Nintendo, Sony and Microsoft. No game can be developed and distributed without their consent. In addition, developers are required to pay a licensing fee for each unit sold of about 15% of the revenue. With only three players, the value captured per company in this stage is the highest in the whole value chain. It is no exception that consoles are sold below manufacturing costs to increase the user base. Besides licensing, the manufacturers also develop games on their own (first-party development).

Retailers

After producing the disks and design the cover, they are distributed through a network of retailers. The main distribution channels usually are large software stores, electronic retailers like BestBuy and mass merchandizers as WalMart. In average, those retailers capture 40% of the final price per unit.

Online gaming value chain

Content creators

The value chain in the online gaming market is shorter. Since in most cases, online games are less complex to develop, especially in terms of graphics, software publishers are no longer required. The content creation process is done by both, small software developers as well as major video game companies, like EA.

Aggregators

The games are made available to mobile operators and web platforms through an aggregator which is in charge of combining content from different sources. The aggregator is also in charge of the communication to content creators, rights owner and in some cases a collecting agency. If the games are distributed by a telecom operator, latter in most cases is also in charge of the billing. Independent portal usually have an external billing partner.

For a few social gaming companies, like Zynga, there is one more step into the value chain: the interaction with social network sites. In order to be able to host the game on a social network platform, there are some requirements that have to be fulfilled and the game has to be licensed. Furthermore, the network takes a part of the revenues generated.

Distributors

This content is distributed through two main channels. The first one is the Internet. The other, rapidly increasing distribution channel is mobile. This can be done either via portals from the telecom operator (on-deck) or through accessing website (off-deck). The emergence of web and mobile broadband access further drove the evolution of new online game markets.

Key trends in online gaming industry

After the brief explanation of the online game value chain, I want to go on with the discussion of recent trends in this sector.

The number of platforms for hosting a game has been multiplying within the last years. For example, there are social networks, Steam, iPhone/iPad, Android, Raptr/Xfire, Onlive, and many more. Even though there will be some consolidation, I think that this high fragmentation is likely to persist during the next years. For online game developers this means two things. It makes the distribution more complex because the games have to be offered through many different channels. On the other hand, it means less dependency on the distributor. In general this is true but there are also some exceptions. For example, many social game developers are still very dependent on Facebook due to its dominating market power.

While this high number of platforms may seem like an obstacle for some companies it at the same time offers many opportunities. There will be a growing demand for cross-platform games referring to the development of different gameplays, on different platforms targeting different audience but linked. A promising interaction seems the integration of massively multiplayer online (MMO) games with social networks. Another interesting model is the combination of MMO games with the mobile web, offering opportunities to integrate features using geolocation or augmented reality.

Another interesting business model is the development of niche products. While many companies still are trying to launch games based on already proofed concepts, the introduction and sound implementation of new ideas will become an increasing trend in the near future. Developers should think outside the box and come up with something new. This probably includes a higher risk but at the same time, if the game is a success the rewards are much higher.

An important trend that many companies have missed until now is becoming more international in terms of offering modified versions of their games to regional target groups. This is still a great opportunity for many developers, especially on social games platforms. Failing to localize and customize their games to other markets is practically an invitation for local companies to develop a similar product and grab market share. An important recommendation for developers nowadays is to offer their products in more languages, taking in mind possible country-specific adaptions according to regulations, religion, traditions, etc.

Another trend is the concentration of the gaming industry. Many traditional publishers are trying to increase their share in the online gaming business through acquisition. For example, Mythic was bought by EA, Atari acquired Cryptic and Activision merged with Blizzard. As the online gaming market is growing, the number of B2B service providers (such as payment solution companies, ad networks, customer support software, analytics solution, etc.) also increased significantly. However, this business especially in the areas of payment and advertising has caught the attendance of many mid-size companies as well as global players. Furthermore, the products offered are standardized services with very low differentiation. For this reasons, I think that this sector is getting increasingly competitive and concentrated.

Conclusion
In summary, I think that will be essential changes in the gaming industry.  While in the last years, most development was done in the graphical area, players now want to be more connected and until a certain point also include their offline life in this experience. Online games offer a great new revenue driver with a very high ROI and low cots compared to traditional video games. Due to the increased popularity and profit potential, more and more companies are entering this industry, resulting in an increasingly competitive environment. 

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