Report By Dean Takahashi from the Login Conference
It's good to step back and get a good look at the various cross-currents in the games landscape. Over the last few weeks I've been surrounded by game developers at the Login online games conference in Seattle and the Quo Vadis game developers event in Berlin, both events where I was invited to speak, and have seen several trends emerging — some good, some bad. Here they are:
1. Game startup financings have slowed from last year. Everyone in the game industry is aware that sales for U.S. console games in March slowed by 17 percent and another 17 percent in April. That's not too alarming, since a year ago the launch of Grand Theft Auto IV was a huge event, and it's hard to beat the numbers from a year ago. But it's the first sign that the game industry can't work miracles in the midst of a recession.
Along with that, financings have slowed. So far this year, 25 companies have raised $126 million, according to our calculations. Game and virtual world fundings for 112 companies hit $936.8 million in 2008 by our count. That compared to $613 million raised by 62 companies in 2007, according to Jussi Laakkonen.
It looks like 2009's game venture fundings are not going to exceed last year's totals. The biggest funding so far this year was Offerpal Media, which monetizes social games with special offers for users. It raised $15 million. By comparison, the biggest funding last year was $100 million raised by China's 9You. While the funding environment's not as good as a year ago, it isn't so bad that game fundings have dried up.
While funding may drop for game startups this year it's interesting to see how far they've come. Five years ago, no respectable VC wanted to make a bet on hit-driven businesses. They stayed away from it the way they stayed away from Hollywood movies. But now the active VCs this year include some of the best-known in the venture capital industry: Charles River Ventures, Mohr Davidow Ventures, Kleiner Perkins, Norwest Venture Partners, Draper Fisher Jurvetson, D.E. Shaw, and Oak Investment Partners. Among those actively looking are Trinity Ventures, Lightspeed Venture Partners, Blue Run Ventures, and many others.
The ecosystem is healthy, and the reason is that games are constantly expanding their borders. The Wii has done a great job recruiting new gamers. But the monthly NPD sales numbers haven't captured the explosion of games on the iPhone, Facebook, casual games on the web, and PC online games. Even more immeasurable is Funware, which refers to the use of game mechanics in non-game applications. Other industries are recognizing that games are so engaging that they're trying to make their own products more game-like.
As Jordan Weisman, founder of 42 Entertainment, once said, "Games are like oxygen. They are part of every activity, from reading to toys to TV to any kind of experience. They can be played on any kind of platform," beyond the consoles. The broadening of the game market is why games can be somewhat resistant to the recession, even as other retail products suffer.
Even scarier is the rise of free games. There are a couple of thousand free games on the iPhone. There are thousands more on social networks and casual web portals. Perhaps 90 percent of players on the web are choosing to play games for free when they have a choice between a free version or a paid version. And the quality of the free games is getting better and better.
What happens when the user decides that free is best? This is the same problem that newspapers, movies, music, and other producers of content are facing as the Internet undercuts the traditional barriers that have kept prices high, as conveyed in Chris Anderson's recent book, Free.
In-game advertising may turn out to be a great market. But this is what happens when expectations race too far ahead. Back in the days of the building of the transcontinental railroad, everyone was optimistic about railroad companies. But many of them went bankrupt, just like a lot of the companies that poured money into the dotcom market. From the point of view of venture investors, the in-game ad market has "jumped the shark," a phrase I'm told means passed its peak. It just means that the people who are going to make big money here have already invested, and there's no way you can make money by chasing their exhaust. Or so the thinking goes.
While in-game ads may be suffering, other ad-based game businesses can still grow. Video-based wrapper ads are growing so much for Wild Tangent that the company posted 65 percent growth in its ad-based revenues in the first quarter. Analyts Edward Hunter of market researcher comScore disagrees with me that in-game ads are sinking. He notes that in-game advertising will show faster growth if it's measured properly by independent media trackers. And he notes that while total ad views on the Internet dropped 20 percent in December of 2008, in-game ads saw a rise of 8 percent. Once the advertisers catch on, they may pile into this sector, he says. But in the meantime, the layoffs suggest there is a big reset in expectations happening.
PlaySpan has stepped into the market to provide everything from a payment system to handle virtual goods to in-game virtual goods sales processing to retail game cards that let kids who aren't old enough to have credit cards purchase virtual goods. Some of the games are getting pretty clever at integrating virtual goods. You can buy a virtual race car in Upshift Strike Racer, a racing game on Gala-Net. Then, after you put some miles on the car, you can sell it as a used car to another player. PlaySpan's chief executive, Karl Mehta, predicts the company will handle a billion transactions, worth a total of $100 million, this year.
Other companies in the larger space of monetization include Twofish, LiveGamer, Fatfoogoo, Offerpal, Super Rewards, Viximo, and Jambool. Outspark, which is importing free-to-play games to the U.S., has said 10 to 13 percent of its users are buying virtual goods. And of those, the average revenue per user is $45. That's so high that those players would be better off paying a subscription. This virtual goods wave has swept through the whole world. It's wonderful that the game industry is returning to that micro-transaction currency that's served it so well in the past: the quarter.
Virtual goods started thriving as a business model for companies such as Shanda in China a few years ago. Online games thrived in China because they enabled operators to authenticate users and thereby beat rampant piracy. World of Warcraft did great in China's Internet cafes, but the free-to-play model is taking over, according to market researcher Niko Partners.
Will this become a global advantage for the Asian companies that have embraced this business model first? It was a couple of years ago that Shanda said it would switch all of its games to virtual goods models. And now Shanda is the biggest online game company in China with $500 million in revenues. In my speech in Berlin last month, I brought up the topic of geographic arbitrage. I noted that a couple of books by Annalee Saxenian, Regional Advantage, published in 1996, and The New Argonauts, published in 2007, showed how differences between regions could make a big difference in terms of who thrives and who doesn't.
Geographic arbitrage means that you exploit your region's advantage. For a time, the French stock market overvalued game companies. That gave rise to Infogrames, which used its valuation to buy other game companies. One of the most symbolic occasions of the French invasion of the video game industry happened when Infogrames bought Atari. DFC Intelligence has noted that much of the profits of the game industry have migrated from the money-losing Western companies to the Far East.
In Berlin, I all but predicted that the Koreans and Chinese would take over here. But we've seen some abortive attempts at crossing borders. NCSoft made a fortune with Lineage in Korea and tried with Destination Games in the U.S. But NCSoft's Tabula Rasa failed and was shut down. And Perfect World has launched a couple of games in the U.S. but hasn't yet acquired anyone. The whole Chinese online games market is expected to be $3.8 billion in 2009, according to Niko Partners. It is growing at a rate of 38 percent.
But here's the reality check. The revenues for Shanda are still only about an eighth of the revenue at Electronic Arts. ChangYou had one of the only IPOs in the past few months. The Chinese company raised $200 million in its debut on the NASDAQ. The Chinese companies are not yet in a position to come into the U.S. market and take over. The wave could happen someday, but not just yet.
The market capitalization of the top eight Chinese game companies is about twice that of EA's That will get bigger. The Chinese companies are scouting now in anticipation of buying more later. Maybe they'll do better than the Koreans. But troubled U.S. companies can't look to the Chinese as saviors.
Companies such as Zynga, SGN, and Playfish are thriving on Facebook. They're taking advantage of the ability to spread games in a viral fashion to stand out. If you can get your users to spread your game for you, then you don't have to worry as much about marketing costs. Thanks to viral marketing, it's possible for small titles to get noticed in the long tail of thousands of games all competing on the Facebook platform, which has 200 million users.
Zynga, SGN and other Facebook companies are moving to the iPhone. Playdom is moving from MySpace into Facebook games. One of these days, somebody is going to build a cross-platform social games empire.
Wanda Meloni of M2 Research came up with some interesting data about this last week. She said that since July, 2008, 60 game companies/studios have publicly announced layoffs that have eliminated 8,450 jobs. Most of those are in North America, where there are an estimated 53,900 people working at game companies, according the Game Developer Census. She calculates that roughly 12 percent of the whole game industry has been hit by the layoffs. That sounds awfully depressing.
But there are thousands of people now jumping into iPhone game development, or development of games for smart phones. Moblyng just announced last week that it developed games that could be quickly and easily ported across all smart phones. Just as some big companies die, new ones are being born.
People call it creative destruction when one thing collapses and another takes its place. The big companies cut back, and the game startups form to fill the void. 3D Realms, the maker of Duke Nukem, closed its doors the same day WonderHill announced it raised $7 million. The lesson of 3D Realms is, don't take more than 13 years to develop your game.
The difference in approaches is going to be a fascinating experiment in capitalism. Nintendo deliberately limits its own games on its platforms and closely regulates what games can be published for the Wii and the DS. There are only dozens of WiiWare downloadable games on the Wii, whereas Apple has opened the floodgates. Apple clearly offers its consumers more choice in games, but iPhone developers may have a terrible time getting noticed on the iPhone and keeping hits alive for more than a couple of weeks. Nintendo says it prefers to have healthy developers on its platform. The suggestion is that Apple's platform won't truly take off until it provides ways for developers to make money. If you know who's going to win, tell me.
Apple has a popular and fast-growing platform. With the iPhone 3.0 software, it's going to have new game-friendly features such as virtual goods. But it is leaving the game development to its developers. At some point, it would be great to see dueling keynotes between Nintendo CEO Satoru Iwata and Apple's Steve Jobs at E3.
With the Wii, and soon the Wii MotionPlus, it has redefined the game controller and inspired a wave of gesture-based technology companies that include PrimeSense, 3DV Systems (acquired by Microsoft), Canesta, Softkinetic, Omek Interactive, and others. Microsoft is rumored to be working on its own gesture-control system, and Sony will likely go farther with this technology as well.
It's like in real estate. A whole neighborhood gets built out, but there are a few empty lots. Some companies just move on to new neighborhoods because they figure the game is over in the old ones. But then the backfillers go back to the empty lots and build houses on them.
I thought of this strategy when I heard about Virtual Families. This game from Last Day of Work is focused on taking on The Sims, which has sold more than 100 million copies. This category of people simulation has been dominated by Electronic Arts. Most people would, and have, stayed away from this neighborhood. But Virtual Families is shooting to produce a much more casual experience than The Sims.
Conclusion: Games deserve the same kind of financial maturity that others have enjoyed. Why should you only be able to get rich -– or lose your shirt — at a Web 2.0 company? Or at an investment bank? Or a cleantech company? Games are a haven from the storm. More venture money is bound to flow into games as VCs retreat from shell-shocked markets into ones that are better off. Big game companies such as Gazillion (which has a license to make Lego and Marvel massively multiplayer online games) and OnLive, which is creating a server-based games on demand service, are tapping the financial community in a big way to get what they need. These are the kinds of companies that have the potential to be home runs.
As VCs pour money into the different markets, some segments will become saturated. Virtual worlds accounted for more than half of the fundings last year. There are now 200 kids virtual worlds in development. But there are promising new areas in brain training, funware, games for health, educational games, music games, exercise games, and sports 2.0. I can only imagine that some more exciting than the iPhone, perhaps a new version of it, will come and blow us all away with its gaming capabilities. And, of course, it's not too early to start thinking about next-generation game consoles. There are great riches on the horizon, as long as you don't step into that ditch right in front of you.
Movie games come and go, as does Hollywood's interest in games. Certainly, they generate a ton of revenue. The latest Lord of the Rings game from Electronic Arts got bad reviews, but it still sold a million copies. Most of us would like movie games to fail, just because they are so cynically piggybacking on something better.
But even inside a lousy trend, it's possible to build an interesting company. Exponential Entertainment won both the judge's pick and people's choice at GamesBeat. They're making a casual game site with movie-related material. These folks were the makers of SceneIt?, the DVD trivia game that has generated $500 million in sales. Here they are in a new company that takes the same kind of movie trivia game to the web. They're looking to raise just a small amount of money.
Even though you can be aware of what's a good trend or a bad trend, you can ignore them when you're thinking about your own game. What a game really needs is a combination of passion, innovative thinking, and execution. If you have all of that, then you can pull off something great no matter what the trends are.
