Editor’s note: Seeking Alpha is proud to welcome SJN Insights as a new contributor. It’s easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »
Nikolay Evsyukov/iStock via Getty Images
If you’ve read the financial statements of the biggest third-party video game publishers, you might have noticed the seismic shift from traditional full game revenue to “live services” revenue, which comes from microtransactions. For some publishers, this revenue stream now accounts for more than two-thirds of the total. This shift did not happen overnight. It evolved in less than a decade, and that has respectively created its own set of opportunities and issues.
Playing a free-to-play game supported by microtransactions will create different expectations from the user than a game that requires an upfront investment. Today, the traditional model of “pay once for the full game experience” is predominately championed by Nintendo (OTCPK:NTDOY). Other major publishers of “AAA” games – i.e., blockbusters with huge development and marketing budgets, like “Call of Duty” – have incorporated some degree of live service monetization but that too has evolved in leaps and bounds. The days of paying for traditional DLC (downloadable content) – which started with horse armor for “The Elder Scrolls IV: Oblivion” back in 2006 – has been usurped by battle passes, loot boxes, and microtransactions, meaning spending can at times be recurring.
The picture is constantly changing, and it has become a lot more complicated in the last several years. Today, live services – which have propped up the revenues for some of the biggest publishers in the industry for some time now – are now facing an existential crisis of confidence.
The problem is that games which incorporate live service elements will need to be beyond good. They will need to be excellent. There are too many games offering similar game services, each vying for consumer loyalty and time – and for both there is only so much that can go round. Many are now beginning to fall by the wayside.
To make matters worse, the pandemic bolstered revenue for almost all video game publishers to record levels – but what goes up must come down. In the future, publishers will need to prepare stockholders for the bad news that revenue will decline and that stock prices will inevitably come down. Perpetual growth in this industry is an impossibility because there are only so many gamers who can spend so much.
Taken at face value, the evidence of this potential slowdown is not evident, but the seeds are there. The financial statements for publicly traded companies for calendar year 2021 have so far shown resilience. Revenue for many AAA publishers in the past year has either grown since 2020 or has plateaued.
Video Software Revenue, $B (SJN Insights)
In many regards, 2022 could be seen as a potentially better year than 2021. Many projects that were postponed last year have already released this year with strong sales, such as “Horizon Forbidden West,” “Elden Ring,” “Lego Star Wars: The Skywalker Saga,” and “Pokémon Legends: Arceus.” The problem is that this momentum can only last so long.
The boost in sales that came from many gamers’ buying catalogue will have waned, and the industry is very reliant on new products driving revenue forward (unless it’s publishers like Take-Two Interactive (TTWO), Microsoft (MSFT), and Epic Games, which own the evergreen games “Grand Theft Auto V,” “Minecraft,” and “Fortnite,” respectively). New games that drive revenue take time to make – in some cases, like “Call Of Duty,” up to three years. As consumers demand more there is only so much new stuff coming out. Many publishers are eyeing alternative revenue streams that rely less on the hit they get from full game releases and more on the certainty of recurring spending. Just like media companies are all vying for the consumer dollar for their subscription services, so too are video game companies with microtransactions.
Back in 2009, the PC gaming market was in a slump partly due to a high level of piracy. The emergence of microtransactions was seen as an opportunity to combat piracy by giving games away for free. During this time, a group of gamers were asked about their experiences with microtransactions. The gamers provided both a critique of their experiences and some recommendations to improve the value proposition for paying gamers, while at the same time not frustrating non-paying gamers. Even then, criticisms revolved around an inability to move virtual assets across games, an inability to have use-based rather than time-based rental periods, purchasing of ineffective items because of their perceived cheapness, overconsumption, the threat of new gamers buying their way to success, and peer pressure to “keep up with the Joneses.”
Fast forward to 2020 – rather than solving all these issues, microtransactions was the least appealing aspect of the video game industry. In a survey conducted by ISFE’s GameTrack, microtransactions came in last in terms of why people buy video games. Game price and discounts dominated decision making.
This comes against the backdrop of heavy criticism of some of the monetization methods adopted by the industry. A 2019 academic peer review of in-game purchasing revealed that behavioral economics contributed to the revelation that “some in-game purchasing systems could be characterized as unfair or exploitative.” This included incentivizing continuous spending, limited protections like refund entitlements, and the potential to exploit vulnerable players such as adolescents and problematic gamers. Childnet International, a UK charity that aims to make the internet a safe place for children and young people, has warned parents of the danger of loot boxes, citing research and government investigations into how loot boxes can cause problem gambling. The UK government is also putting pressure on the industry to ban the sale of loot boxes to children.
The industry is trying to address some of these concerns. For instance, Electronic Arts (EA) has FIFA Playtime, a feature in FIFA 21 that allows gamers to manage their game habits in terms of money spent and time played. Better transparency on loot box odds and deployment of possibly less harmful battle passes are other steps forward. Electronic Arts followed up with its much-maligned decision to load microtransactions onto “Star Wars Battlefront II” with microtransaction-free games “Star Wars Jedi: Fallen Order” and “Star Wars: Squadrons.”
Furthermore, the decision by EA to cancel “Anthem 2” and to indefinitely postpone updates for “Anthem” is testament that the market for live service games is far from guaranteed. That could be because there are now so many live service games such as “Fortnite,” “Destiny 2,” “Apex Legends,” “Warframe,” “League of Legends” and “Tom Clancy’s Rainbow Six Siege.” These are examples of the successful ones that have stuck around. They can’t all grow in revenue year after year. In Sony’s (SONY) 2021 fiscal report no less than 11 live service games were being developed.
A crowded market is one issue, but if the tide turns against live services more swiftly, either from disgruntled consumers or from the law, the options to sustain high revenue growth must come from other sources.
In March 2021, Take-Two’s CEO Strauss Zelnick doubled down on his remarks he made in September 2020 to justify $70 games:
We announced a $70 price point for NBA 2K21, our view was that we’re offering an array of extraordinary experiences, lots of replayability, and the last time there was a frontline price increase in the US was 2005, 2006, so we think consumers were ready for it.
Apart from his dubious assertion that “consumers are ready for it,” which is wishful thinking at best, he is not wrong in that games have not seen a price increase in over a decade.
The counter argument against higher game prices largely follows three points: publishers are already swimming in money and so a price increase is greedy; full priced games already come with extra spending thanks to microtransactions, so a price increase is unnecessary; and gaming is already expensive, so a price increase will create haves and have-nots within the gaming community.
The COVID-19 boom that filled the treasuries of video game publishers was, of course, neither planned for nor expected. It was driven solely by customers and was serendipitous to the publishers. In many cases, full game spending has either plateaued or declined, supplemented by live service revenues. For example, according to their financials, full game spending at Electronic Arts declined -7% during their fiscal 2020. The pandemic has created a K-shaped recovery. Video game revenues increased due to the lockdowns, but so did home entertainment streaming services like Netflix (NFLX) and computer manufacturers like Nvidia (NVDA).
With the potential squeeze on future live service revenues, publishers that decide to increase full game prices to supplement revenue losses are making a calculated assumption that demand will not fall too greatly to warrant the price increase. “NBA 2K21” was the litmus test to some extent. It was among the first games to charge $70. In its first four months on the market, it sold over 8 million units and experienced a 14% increase in engagement compared to the previous year’s “NBA 2K20.” The bet is that any lost customers will come back for future releases.
Given the technical prowess of the new consoles and gaming PCs, they create an inherent problem for AAA video game makers. Ambitious games will get more expensive and take longer to make. That will mean bigger teams, more sophisticated game engines, and more testing. And then add in the pressure that a game, which could cost hundreds of millions of dollars to make, might flop as the return on investment is always unknowable when it comes to entertainment properties. The publisher is taking all the risk upfront.
At the end of the day, the consumer is king. If gamers hate the higher price of games they will keep their wallets closed and a new equilibrium will be established. Publishers respond to consumer demand and will make decisions accordingly. This was very much in evidence when Electronic Arts embraced full-experience single player narrative games again, such as “Star Wars Jedi: Fallen Order.” It could be argued that expensive games could even rejuvenate the used market, as gamers might seek to get back some of their high investment if they finish the game quickly.
There is always the old adage that if gamers really want to play a new game but cannot afford to pay on day one, they’ll just wait for a price drop. Potential buyers of new games do not even need to wait that long until the price drops to “affordable.” This is even more so for digitally available games that often see price promotions. It’s understandable that people want to buy on day one and be part of the conversation, but like most things now, hard spending decisions need to be made. Therefore, with price increases of limited use, the options to sustain high revenue growth for the industry must come from other sources.
The recent spate of mergers and acquisitions in the video game industry is not just likely to continue, it might even speed up. In many cases a lot of these takeovers are done to secure consumer interests in ecosystems, such as Microsoft’s acquisition of Zenimax Media and Activision Blizzard (ATVI), Sony’s acquisition of Bungie, and Electronic Arts’ acquisition of Codemasters. Acquisitions are of course done to shore up competition, which in turn could undermine revenue potential. If future revenues could be undermined by falling demand as COVID-19 lockdowns are lifted (i.e., customers start spending money on other things not video game related), and if the future of microtransactions are uncertain and price increases unworkable, publishers will be forced to grow market share by other means. There is a threat that acquisitions could result in fewer games, but it should also result in economies of scale and cost savings. One such economy of scale is the blockchain.
A conventional table-structured database like an Oracle one is stored on a computer system, typically owned by a company, government agency, or an appointed individual. A blockchain turns this approach on its head. A blockchain structures its data into groups or blocks that are chained together. A decentralized blockchain, as opposed to a private and centralized one, has no single person or group control. Furthermore, it allows digital information to be recorded and distributed, but not edited. Consequently, it facilitates exchanges that prioritize increased transparency, speed and decentralization.
The first aspect of video games ripe for blockchain disruption is the ownership of in-game assets. Moving from being a licensee of game items, smart contracts allow for the transfer of digital assets from developer to gamer. Data in a blockchain is unchangeable, so it cannot be overturned by the developer. A legendary esports player could, for example, monetize their achievements, such as selling their most effective weapon. This transaction can then be viewed by anyone with simple access to the Internet.
Second, a decentralized game on the blockchain like “Age of Rust” by SpacePirate Games awards Enjin Coin (ENJ-USD), a non-fungible token (NFT) issued on the Ethereum blockchain, when completing game achievements. These coins were made available to be used to buy gifts cards for brands like Uber or Google Play. In fact, each non-fungible token is unique and cannot be exchanged equally for another token directly. But tokens can represent items like collectibles, badges, in-game characters, arts and awards. Monetizing in-game actions allows any gamer to build their own digital economies – not just handsomely rewarding esports superstars paid in fiat currency like U.S. dollars. More broadly, the tokenization of both digital assets and real-life goods is inching forward for gamers and non-gamers alike, despite its challenges and setbacks like conceptual understanding and pushback from the gaming industry and gamers.
Third, there are strong incentives for developers as well. Blockchain gives developers the ability to create the ecosystem for gamers to build their digital economies, such as preventing an oversaturated in-game market and ensuring trades are handled properly.
What’s in it for the publisher? On the revenue side, publishers and developers can generate revenue by billing trading fees, taxing peer-to-peer transactions, processing payments more cost-effectively and stamping down on fraud. A publisher could attain a small commission every time a gamer wanted to sell or rent out digital content such as a single piece of DLC or even a full game. An entire market could spring up whereby “tradable” digital content could be exchanged with the blessing of the holder of the digital rights. Ownership of digital content is being reviewed by law courts in France, and the pressure to own digital content by consumers will only grow especially if physical content keeps declining. Digital stores like Steam have already set up refund schemes for digital content due to this growing pressure. In time, consumer rights on digital ownership will be addressed one way or another and the blockchain lends itself to be a workable solution.
Publishers could also move away from having to maintain several digital economies for multiple games to a simple unified economy for all their IPs. Gamers could feel a greater attachment to these unified marketplaces. For example, credit earned for playing FIFA games can be spent in “Battlefield” games. Such marketplaces could be upscaled to generate greater brand loyalty and to secure higher conversion rates and time spent in the publisher ecosystems.
The first major game publisher to try and execute this blockchain vision is Ubisoft (OTCPK:UBSFY). For the last few years, Ubisoft has been positioning itself as a pioneer of blockchain technology and rolled out NFTs on “Tom Clancy’s Ghost Recon Breakpoint.” Stored on the relatively energy efficient Tezos blockchain in-game, serial-coded cosmetic items can be retained or sold, with its previous ownership recorded. Interestingly, this development comes soon after Facebook’s wholesale rebranding to Meta (FB), perhaps giving Ubisoft the confidence to claim “its NFT system is a first step toward ‘developing a true metaverse.'” It seems the momentum for a deeper online social and economic experience is gathering speed.
However, to date Ubisoft Quartz has not been well received by some of Ubisoft’s employees or gamers/NFT traders. There could be many factors at play. For example, “Ghost Recon Breakpoint” (released in 2019) is one of the lesser-known “Ghost Recon” games and is considered a weak sequel to “Ghost Recon Wildlands.” This does imply that a degree of FOMO (fear of missing out) is needed to drive demand for NFT products, and that releasing an NFT per se is not a guarantee of success.
In October 2020, Julie Shumaker of Unity Technologies said the following to GamesIndustry.biz readers:
When building your economy, you should do so with the player in mind: who they are, what they need, and what they want. At the end of the day, they all want essentially the same thing. Players want to derive value and enjoyment from a system that works as hard for them as they do for the economy. Give it to them.
By putting blockchain technology at the heart of the video game industry, that mission might become more attainable this decade. If there is money to be made from utilizing blockchain technology, game publishers will be closely monitoring the market for any signs of traction from gamers. The CEOs of Ubisoft, Take-Two, and Electronic Arts have all expressed interest.
All of this is food for thought. Publishers moved into digital full games, DLC, mobile gaming, live services, and esports. These are concepts that did not exist 20 years ago, yet these revenues now make up over three-quarters of the total. Today we think of them as nothing special, but rather a natural progression of the digital movement. Some of these monetization ideas might never bear fruit and other monetization ideas will surely crop up. If the last two decades in games has taught us anything, this industry does not stand still. When it comes to technology and video games always keep an open mind.
Investors should see this potential technological change in gaming monetization as another example of the creative destruction process. Investors with a keen eye on the future should embrace these changes, however uncomfortable they might feel in the short term. The changing nature of the video game industry still sits within a secular growth story, with a prospective virtual world known as the “metaverse” a new addressable market for game publishers to go after. That means long-term, patient investors in the industry are most likely to be rewarded handsomely.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.