Analysis Of Technological Change Effects On The Games Industry

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NANYANG TECHNOLOGICAL UNIVERSITY

ANALYSIS OF TECHNOLOGICAL CHANGE EFFECTS ON THE GAMES INDUSTRY

NANYANG BUSINESS SCHOOL THE NANYANG MBA B6835 – Competitive Strategy Group Written Assignment September 7, 2009 Written By: Chong Sheng Jiat, Corey (Email: [email protected]) Jan Goh Sze Ching (Email: [email protected]) Michelle Lau (Email: [email protected]) Vic Hui Co (Email: [email protected]) Rabani Gupta (Email: [email protected])

Course Instructor: Prof. Patrick T. Gibbons Page 1 of 14

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INTRODUCTION The Games industry continuously innovates and makes use of new technologies to gain market share. Players include digital entertainment & graphics design companies that have revolutionized the way people play games. Most recently, there are news reports covering the beta launch of Cloud-based Online Gaming Platform called OnLive that brings games on-demand, anytime, anywhere to gamers all over the world. Our report is a non-exhaustive commentary on the games industry. To aid us in our discussion of the prognosis for the future, we have done a strategic analysis of the top three players by market capitalization and market segment, and two new entrants by geographical region (China) and disruptive technology (Cloud). Through our research, we found that the video games industry experienced profitable growth. Revenue increased for the last 5 years at a Compound Annual Growth Rate (CAGR) of 17.7%

and

total

market

capitalization

is

estimated to be around $49.6 billion (Figure 1). The global market growth by segment appended in the table below: The video game industry has been plagued by piracy since the 1980s. The console and PC gaming segments are the worst-hit due to rampant hacking. With the advent of the Internet, the video games industry captured the lost revenue (of traditional consoles & PC games to piracy) by capitalizing on consumers’ preferences of collaborative play and the multi-user environment in the online gaming market. This accounted for the large difference in CAGR of these segments. Although with technology advances to deter piracy (e.g. server-side security firewalls, game protection technologies and password protected logins for users), it did shift the distribution control back to the game provider, pirated PC games still continued to be sold. Moving forward, our report will analyze the key players in this industry and postulates how the future will look like for the video games industry.

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KEY PLAYERS IN THE GAMES INDUSTRY

1. Activision, Inc. & Blizzard Entertainment Activision, Inc.’s Positioning & Key Strategic Moves - The year 2006 marks the beginning of transition in consoles and shift in consumer demand away from the current generation software to new consoles. Activision had established an early presence in next-generation platforms since 2004 by forging several key alliances and expanded into new geographies. In one such move, Activision and Nielsen Entertainment entered into a strategic alliance to jointly create a reliable measurement of the effectiveness of in-game advertising (Activision, Inc. Annual Reports 2004-07). Activision’s key strategy was simply to create, license and acquire a group of highly recognizable brands, and market them to a variety of consumer demographics. Activision actively pursued game title development that is compatible to all new console platforms (e.g. Sony PlayStation 2 and 3, Nintendo GameCube, Microsoft Xbox, Nintendo Game Boy Advance, PlayStation Portable, Nintendo Dual Screen and Nintendo Wii). Given their large and growing installed base, they had a clear strategy in place to build significant presence at the launch of each new platform while being careful not to move away too quickly from the current generation platforms. Blizzard Entertainment’s Positioning & Key Strategic Moves - Blizzard Entertainment was founded in February 1991 by three UCLA graduates. After a series of product launches, the company created Warcraft in 1994 and the breakthrough MMOG version World of Warcraft (WoW) in 2004. WoW boasts monthly subscribers of 11 million around the globe today. Blizzard has a culture that champions both productive and experimental creativity which inspires devoted players. Jeff Green, editor-in-chief of the online gaming magazine 1Up.com says, “[Blizzard people] are essentially design geniuses, making games easy enough for casual players and deep enough to attract and hook hard-core players. Simple to learn, difficult to master

Sony, 2% Ankama, 3% Square-Enix, 3%

Others, 8%

is the holy grail of game design, and Jagex, 8%

Blizzard does this every single time.”

NCSoft, 14%

Blizzard, 62%

Blizzard Entertainment dominated the online gaming segment with 62% market Figure 2: MMOG Market Share

Source : Business Insights Ltd

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share (Figure 2)

and entered the console market through $18.9bn strategic

acquisition of Activision in 2008 to form Activision Blizzard, Inc, producing games that can be played across all consoles. The merger helped Blizzard enter the dedicated systems market produced by Microsoft, Nintendo and Sony, and has positioned Activision Blizzard as the largest, most profitable, pure-play interactive entertainment software publisher even till today. Activision Blizzard, Inc.’s Performance, Positioning & Key Strategic Moves – As per its 2008 Annual Report, Activision Blizzard, Inc. grew by 26% (year-on-year growth) through the merger. However, in 2008 net loss of $107 million was reported, because of increased product costs, software royalties, intellectual property licenses, and sales & marketing due to the acquisition. Activision Blizzard, through its subsidiaries, develops and publishes online video games via Battle.net, personal computer (PC), console, and hand-held games worldwide.

It

also

publishes

interactive

software

products

and

peripherals

internationally, and covers various game genres, including action/adventure, action sports, racing, role-playing, simulation, first-person action, music, and strategy. In North America, Activision Blizzard was the number one console and hand-held software publisher in dollars for the quarter ended December 31, 2008, according to The NPD Group. With increased creation of game titles based on popular movie titles, the license royalties also increased the product costs payable to affiliates such as Lucas and to movie makers. 2. Electronic Arts, Inc. Electronic Arts, Inc.’s Positioning, Performance & Key Strategic Moves Electronic Arts, Inc. develops markets, publishes, and distributes video game software and content that can be played on various consumer platforms. The company provides its products through mass market retailers, electronics specialty stores, game software specialty stores, online stores, mail-order and distributors. EA has three major game labels – the Games Label, Sports Label, and Play Label. EA Games label is home to the largest number of EA studios and development teams, which together create an expansive and diverse portfolio of games, in such genres as action, action-adventure, role playing, racing and combat games. Page 4 of 14

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It also provides a collection of sports-based video games under EA SPORT label. This brings together a wide collection of sports-based video games marketed under the EA SPORTS brand, ranging from simulated graphics

sports based

titles on

with

real-world

Figure 3: Number of EA Game Titles Developed for Console Platforms in FY2009

Platform

realistic sports

leagues, players, events and venues to more casual games with arcade-style game play and graphics.

Number of titles developed and published by EA in fiscal year 2009

Xbox 360…………………………….. …………………………………………..

24

PLAYSTATION 3…………………….. …………………………………………..

22

PC……………………………………. …………………………………………..

22

Nintendo DS…………………………. …………………………………………..

22

Wii……………………………………. …………………………………………..

20

Play Station 2……………………….. …………………………………………….

14

PSP………………………………….. …………………………………………..

Distancing its portfolio from other competitors, EA’s Play Label creates and markets games and experiences that are easily accessible, inspire creativity and fun, and transcend core video game culture into a world of engaging and relevant entertainment for people of all ages. Due to EA’s extensive games portfolio and positioning, it is in direct competition with Sony, Microsoft and Nintendo for the packaged goods videogame segment, and other players like Activision Blizzard, Capcom, Infogrames Entertainment SA, Koei, Konami, Ubisoft, and so forth. EA’s key strategic focus is to drive hits for its game titles on console platforms (see Figure 3), improve marketing through partnerships with Wii, in particular by specially designed “pushing play” EA-Wii games, expand digital services and providing Internet-based advertising and digital content, through game titles such as The Sims, thus generating advertising revenue from wireless devices. 3. The Console Players: Sony, Microsoft, Nintendo Console Players’ Positioning & Key Strategic Moves - The console gaming segment has the largest market share within the electronic games industry and is dominated by 3 big players – Nintendo (Wii), Sony (Playstation) and Microsoft (Xbox). We can regard their business model as resembling a razor and blade strategy with the console hardware as the razor and the games software as the blade. Hardware is typically sold with minimal profit or even at a loss but recouped with a higher margin Page 5 of 14

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software business. It is the sales of blockbuster games that helped to generate profits for the company. Referring to Error! Not a valid bookmark self-reference., Nintendo was the best performer with consistent profit margin of 18% to 29%. In contrast, Microsoft has been suffering huge losses in this business segment although it turned positive in 2008. In terms of market share or revenue, Sony was the market leader but Nintendo caught up rapidly with Sony within the period 2007-2008. The war of the console was traditionally fought based on technology, features, graphics and games sophistication to attract the hardcore gamers. When Microsoft introduced its X-box in 2000, its specifications exceeded almost all aspects of the Sony Playstation 2. Its targeted customer’s base was young hardcore gamers in the 18-28 year age bracket. Sony responded with an improved PS3, but the launch was delayed due to its strategy to try to incorporate a Blu-ray drive within every PS3. Blu-ray was at that time competing against HD-DVD as a standard next generation high definition video player. Putting its Blu-ray player in every PS3 would immensely improve the chance of it being adopted by the industry instead of HD-DVD. As it turned out, Blu-ray emerged the winner in the high definition standards race but Sony lost out in its race against Microsoft and Nintendo to capture installed base in its game console market space. While Microsoft and Sony were competing to launch more powerful consoles, Nintendo had other things in mind. Nintendo’s strategy with the introduction of Wii was crucial to its success. Instead of crowding within the hardcore gamers’ market space, it aimed to target a new group of customer segment and carve out a new niche for itself. First, it lowered its cost structure by decreasing the processor speed and graphics quality and followed by designing games that do not need such high hardware requirement. Such games are then marketed towards family oriented customers who have different requirements such as simple to play, cartoon graphics instead of 3D-realism, family games, bodymotion based instead of game pad controller, etc. Nintendo designed a new set of wireless controls that allows gamers to mimic life-like actions (like fishing, bowling and tennis) for gaming control. Through this strategy, Nintendo managed to create a new market space for itself with larger customer base, gain first mover’s advantage in this new segment, and enjoy cost leadership in this price sensitive consumer goods industry.

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Going forward, the ability to integrate console gaming with the internet may be the next battle ground. For example, Microsoft’s new Xbox 360 online service, Xbox Live, will allow its customers to experience a whole new community-driven experience. Gamers would be able to download games and play against global gamers. Besides using their console for gaming purposes, Sony also hopes the PS3 with an incorporated Blu-ray player to be the default entertainment player in every household. This also sets the hardware specification needed to deliver high definition 3D graphics for future Sony games. With Nintendo Wii targeting the casual gamers using a low cost strategy, Microsoft XBox targeting the hardcore gamers using its technological features, and Sony PS3 focusing on providing an integrated entertainment device, it remains to be seen which one would turn out the winner. 4. The Rise of New Chinese Entrants: Nineyou.com (久游 久游) 久游 There has been a recent increase in terms of gaming appetites across the regions globally. North America is the largest gaming market with very strong emphasis on realism (action and sports titles); Japan is focused more abstract, cute designs and titles. In Asia, PC online game sales are exploding and companies such as Nineyou and Changyou exploit such opportunities in China (In 2007, online games revenue reached RMB 128 billion and expected to grow to RMB 400 billion by 2011 (iResearch, 2009). Nineyou (www.9you.com) is China's leading game developer & operator of Interactive Entertainment Community V2.0 and captures 55.6% of the Chinese Online Games market (iResearch, 2008, pp 15). It offers online game genres such as music and dance, sports (racing) & fighting simulation games in addition to multiplayer online role-playing games (MMORPG). Their target market is the Chinese around the world who enjoy a premium high quality one-stop interactive entertainment service. Since its establishment, Nineyou has adapted a unified account business model for users and adopted a licensing strategy for its in-house developed MMOG "Super Dancer Online", which has been licensed out for operations in over 42 territories abroad. Nineyou had over 380 million subscribers, as of 2009, and its website is one of the highest traffic online game portals in mainland China. 5. New Entrant using Disruptive Technology: OnLive, Inc. During the Game Developers Conference 2009, OnLive, Inc. shocked the videogame industry by unveiling a revolutionary change to the way games are played, via next generation cloud technology (Roper, 2009). Cloud technology is essentially Page 7 of 14

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an online web service for gaming that does away with the need to own expensive consoles, high end PC’s, or even to download games. The end user needs a PC connected to internet using the keyboard/mouse or an optional OnLive controller. The rest of the processing takes place on OnLive’s cloud servers. The gamer is also able to connect the output onto the normal PC screen, OnLive MicroConsole or an analog/High Definition TV. Everything is run on the Internet and the game can be played in the comfort of one’s own home. Well-known game publishers such as EA, Take-Two, Ubisoft, Epic, Atari, Codemasters, Warner Bros., THQ and Eidos are known to have signed up to launch games on this service. OnLive’s business strategy is making games available to anyone that has internet access and “pay as you play” pricing model. Though the OnLive Micro Console & Controller are optional, OnLive intentionally kept the price low and very affordable (cheaper than the cheapest of consoles). OnLive games could possibly be the answer to tackle PC game piracy as one can gain access to games only via a secured connection to OnLive servers (same as MMOG). The OnLive business model provides gamers an option to either purchase fully (own a game title) or to rent a title for a specified amount of time. The pricing model is likely to appeal to avid PC gamers.

DRIVERS

OF

OVERALL

PROFITABILITY

IN

THE

GAMES

INDUSTRY Just a few decades ago, electronic games were mostly played on PC’s where game titles were limited to poor graphics and simple storylines. With the explosive increase in processing power of CPU and graphic chips, game designers were able to design complicated games with high quality graphics to entice gamers. We have now seen from the Wii example (Wii targeted females and the older age-group attracted to casual and social gaming) that games need not be sophisticated to win market share. Going ahead, firms that can introduce innovative technologies to simplify game playing without removing the fun factor will have a first mover’s advantage. Online gaming has also been gaining popularity at the expense of the PC gaming segment. Even gaming consoles started to incorporate online capability as a default feature. Hence, increasing broadband penetration globally would have a positive impact on the games industry. According to Business Insights (2009), the number of global broadband users will increase to 667Mn in 2013 and reach a penetration rate of 9.5%. Besides the availability of broadband internet, the increased interaction Page 8 of 14

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between online gamers would also improve the experience of gamers and help to increase the popularity of MMOGs. Recent years have witnessed the growth of 3G phones and Smart phones (global mobile penetration increased from 27.6% in 2004 to 61.1% in 2008 and 3G share of mobile subscription is projected to hit 50% in 2013 compared to 4% in 2005) in particular the iPhone from Apple. Mobile phones of the future will not just be telecommunication devices but will also act as mobile entertainment devices and PDAs. Their ability to access internet cheaply and at fast speed through 3G technology would complement the online gaming market. On the downside, mobile games are many times offered free or with advertisements and it may not be a profitable business model (ex. Apple’s iTunes offers many games free). Instead, firms could introduce their online games to a mass audience through the mobile phone medium, and further entice them to upgrade to the full-blown version of their online games (through broadband connection), in turn reap real profits.

5 FORCES ANALYSIS FOR VIDEO GAME INDUSTRY Definition of Industry - The game industry under analysis includes: a) Electronic games software for PC/Mac, b) Hardware and software for stand-alone and mobile game consoles, c) All forms of online gaming (excluding gambling), and d) Mobile gaming applications for mobile device platforms.

Video games available as

amusement arcade machines are excluded. 1. Internal Rivalry - The sources of internal rivalry among the firms stem from the following: First-mover advantage: The ability to bring in new products and create excitement in the market is a key success factor in this industry. Blizzard Entertainment, with its World of Warcraft (WoW), was able to drive the market towards massive multiplayer online game (MMOG), and today, the company boasts of 11 million monthly subscribers across the globe. Contrastingly Sony, with its 6-month delay in launching PS3 in 2006, allowed Nintendo’s Wii to overtake and gave a year’s head start to Microsoft and its Xbox 360.

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Capacity to sustain product life-cycle: Creating excitement through new products that use new technology, new interface or new playing techniques is one success factor, but the ability to sustain this excitement through creating challenges and fostering communities brings another dimension to competitiveness. This is especially true with online games, where the switching cost is relatively very low. Mobility of players across format segments: With vectors of differentiation within formats being exhausted, players have begun to move across formats as a method of expansion.

In the case of console segment, the use of high-speed internet

connectivity has become an integral part of this group’s strategy in the recent years, and each player is addressing this through online game-play, digital distribution, community building and alternative content (music and movie). From the above analysis, it can be derived that the rivalry among firms within and across game formats (strategic groups) is high. 2. Barriers to Entry - The key barrier to entry comes from the cost of game development, both in the areas of hardware and software as well as the royalties paid. When Sony developed PS3, the brain of the machine, a fingernail-sized microprocessor was developed at a cost of US$400M, and Sony tied-up with Toshiba and IBM. Blizzard spent around US$500M in the development of WoW in 2004 (on-line games).

This, together with the manpower resources and the

corporate culture to come up with new innovative games and the identification of new technology for the gaming industry make the entry barrier high for the overall game industry. 3. Power of Suppliers - The key suppliers in this industry are the microprocessor developers for hardware, generally original equipment manufacturers (OEMs). Many OEMS would tie up with the game manufacturers in R&D but the intellectual property rights (IPRs) belong to the game developers. Thus we believe that the power here is relatively leveled and the barrier because the OEMs are also producing for the PC Industry (which is still much larger than the games industry). The entry barrier low to moderate for the overall game industry. 4. Power of Customers - In the case of console players, customers are basically locked up to the format after purchase, while in the case of online and mobile games there is no switching costs but communities can be formed.

Thus, a

customer’s bargaining power in this industry is dynamic, and is affected by other factors such as the stage in purchase cycle and degree of attachment/ addiction. Page 10 of 14

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The players need to identify and ensure that they capture the customer’s taste and preference in order to exploit these factors to their advantage. 5. Substitutes – There would be substitutes for the game industry if there is a new disruptive technology being invented and introduced that creates a new form of delivery. For example, the OnLive cloud service for gaming positioned the firm in direct competition with all existing segments. The entry barrier here is relatively low because game popularity or sales do not rely solely on big brand factor, it also relies heavily on fun, story plot, interface and addictive factors. With new entrants, the rivalry in the industry intensifies further.

PROGNOSIS: NEXT GENERATION GAMING INDUSTRY’S ‘WARFARE’ To study the next generation of warfare in gaming, we chose to categorize the gaming battlefields across two parameters: 1. Profitability – shows the high degree of

variation

battlefields

prevalent i.e.

across

Consoles,

the

Mobile

Devices, PC’s and Online games. 2. R&D Intensity - The gaming industry is all about continuous innovation that will lead to greater technological advancement. Increased focus on R&D (budgeting for this) can enable companies to gain first mover’s advantage, create greater barriers to entry, in turn boost their profitability. We plotted the four segments in “Strategic Groups” and in our opinion Group 4 is the most viable “Strategic Group”. Clearly, since there are performance differences between these groups, there are strong incentives for players within each group to move between groups and ultimately to the most viable group i.e. Group 4. Strategic Group 1: This is not a viable group as it is not sustainable in the long run. A competitor who comes out with a superior, technologically advanced solution (due to his investment in R&D) can outpace a company that abstains from investing in R&D, and eventually capture its market share. Strategic Group 2 – PC’s: Being outpaced by new easy to use devices (mobiles, portable devices), and themselves requiring extensive hardware, PC gaming does not prove to be very profitable in the future. Also the games being played on PC’s are easy Page 11 of 14

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to pirate and that further drives down the profitability of this segment. R&D intensity of this segment is also relatively low in comparison to new entrants in the gaming battleground. Strategic Group 3 – Mobiles: The “Play on the Go” feature provided by these devices and the ease of availabilty of these devices has required significant investment in R&D (Although development cost of each game is not very high). Also to constantly sophisticate the graphics on mobiles requires further investments in research. On the profitalibility front however, freebies such as free games drive down profitability. Similarly, we think that this group has potential to move into a sphere of higher profitability and R&D intensity. Strategic Group 4 – Consoles: Many gamers look for sophisticated applications when playing a game. This naturally requires significant R&D investment and also results in highest profitaility. This is by far the best Strategic Group to be in. Strategic Group 5 – Online Gaming: The Online gaming segment though not as profitable as consoles, will pick up pace in our opinion. It is therefore clubbed in a group that has required medium R&D investment (which is on an increase).

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CONCLUSION As observed in the Strategic Mapping, existing key players will likely, in their quest for profit, strive to overcome their mobility barriers and eventually become more structurally viable by moving towards strategic group 4. From the gamer perspective, their willingness to pay depends on dimensions such as graphics, game plot, challenge level, availability and price, and they are faced with a plethora of media choices as well as a plethora of media devices. Due to a low capital requirement for typical software development projects, there is hence a low barrier of entry for small software firms or startups to innovate and publish game titles that are appealing to gamers, which is easily marketed and sold via Internet platforms like Facebook. Thus, such small players may disrupt the market should the game they develop become popular and tilt the market to their advantage. Key players in the console & online segments are likely to license such game titles or acquire startups, and at the same time involve in game creation and infrastructural building, shifting game play service onto a Cloud Infrastructure, seeking to generate revenue from every gamer globally by leveraging on Internet proliferation, distribution cost pains of game publishers, and Internet connectivity provided by mobile phones.

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APPENDIX – BIBLIOGRAPHY i.

Activision Blizzard, Inc. (2004-2008). Fiscal Annual Reports. Retrieved from the World Wide Web on September 23, 2009: http://investor.activision.com/annuals.cfm

ii.

Business Insights. (2009). The Video Gaming Market Outlook: Evolving business models, key players, new challenges and the future outlook.

iii.

iResearch Consulting Group. (2009). China Online Game Research Report for 2007-2008 (中国网络游戏运营商竞争力报告). Retrieved from the World Wide Web on September 23, 2009: http://www.iresearch.com.cn

iv.

Roper, Chris. (March 23, 2009). OnLive Introduces the Future of Gaming: Nextgeneration "cloud" technology could change videogames forever. Game Developers Conference 09. Retrieved from the World Wide Web on September 23, 2009: http://pc.ign.com/articles/965/965535p1.html

v.

AFP. (September, 2009). As phones get smarter, game makers ring the changes. Retrieved from the World Wide Web on September 23, 2009: http://sg.news.yahoo.com/afp/20090929/ttc-entertainment-japan-game-technology0de2eff.html

vi.

Global Entertainment and Media Outlook 2008 – 2012: Ireland – 16th October, 2008.

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