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The Game Industry and the Economics of Failure

By François-Dominic Laramée | Published Nov 23 1999 12:01 PM in Business

game games people product market 000 press money want
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For the past two years, the game industry has been mired in what the financial press calls a "consolidation phase". Despite growing sales for the industry as a whole, not a month goes by without some once-proud publisher announcing drastic cutbacks to its release schedule or being bought out by a more successful one. Countless start-up development studios set up shop, barely manage to survive until the release of their first title (when they manage to do it at all), and disappear without a whimper. Meanwhile, the cost of developing a top-tier title keeps growing, and the marketing budget required to support its release skyrockets even faster.

No matter which way we look at it, one glaring fact remains: not very many people make money in the game industry. Especially not the people who create the product.

It is my contention that the current economics of the industry, as supported (actively or tacitly) by publishers, retailers, the gaming press and most developers, is completely and utterly inadequate. This article presents some of my observations, and attempts to identify a few potential solutions which might help improve our lot as a community.


The Distribution Bug

In the early days of interactive gaming (say, until 1988 or so), the "lone wolf" basement-dweller who developed an entire game (code, art and music) by himself in a few months was, if not the rule, at least a common phenomenon. Virtually all software was sold to and by hobbyists, whether in the city's single mom-and-pop computer shop or by answering adds in specialized magazines. The computer-enthusiast shop owner enjoyed nothing more than to see the local game publisher (often the developer himself) drop by once a month with his Ziplock bags full of floppies, which he had copied himself all night long. They'd talk for thirty minutes or an hour, playing the new releases while the customers, all of whom knew each other by their first names and proudly showed their own clever bits of BASIC code to "the professional". In such conditions, a developer could write 2-3 titles a year, make a comfortable living off of 1,000 copies of each, and then, after a few years, go out and get his driver's license. A game could sell for years. Taking a risk with an innovative title didn't require nerves of steel, as not much money went into it anyway. This was the Golden Age.

However, as computers gained popularity, the hobbyist retailers were gradually replaced by large, nation-wide chains, which have themselves lost a tasty chunk of the software market to generalists like Price Costco and Wal-Mart. Now, it is estimated that the top 8-10 retail chains (i.e., Circuit City, CompUSA and Toys R Us) control approximately 85% of all game sales in North America.

This changes everything.

First Law of the Game Industry: Channel to Market is Everything.

On the one hand, the professional buyer who is in charge of acquiring PC games may very well never play them at all. He is a businessman, with responsibility for a huge budget, of which games may not even be the most important item. His job is to acquire product that will move off his shelves as soon as it hits them. Shelf space it precious, and there are so many products out there that if one doesn't sell through fast, he'll find another one that will. Besides, the buyer is a busy man, with lots of salesmen competing for his time. Unless you happen to be hawking NHL '99, chances are he doesn't even want to see you. It is not uncommon for a game publisher's salesman to have less than fifteen minutes to pitch his entire quarterly lineup to a man who can make or break 10% of his company's channel to market. You, Joe Salesman, had better make an impression right now if you want to see your big Christmas release in this guy's 2,000 outlets.

That being said, please tell me, what is easier to push in 90 seconds: a weird, wildly innovative game unlike anything anyone has ever played before, or the sequel to last spring's 500,000-unit seller with better graphics?

On the other hand, if you know that the only product you can get on the shelves is something that the buyer feels comfortable with, chances are your competitors do, too. So, if all of you are coming out with first-person shooters and real-time strategy war games, which are all essentially the same game, how do you make sure yours is the one that will sell the most? Why, you advertise more, of course. If you shout louder than everyone else, people will hear you. This is why game marketing costs have become so staggering. Ten years ago, a standard of one dollar of marketing for each dollar of production (back when games cost a few hundred thousand dollars to make) was about right. These days, with network broadcast spots becoming almost commonplace, a 2-to-1 or 3-to-1 ratio is not all that uncommon. Turok: Dinosaur Hunter reportedly came out with a $7 million marketing budget; I don't even want to know how much Sony spent to push Final Fantasy VII.

On the gripping hand, with so few people controlling so much of your livelihood, you absolutely can not afford to pass on their business. So, you do whatever they tell you to. You spend $25,000 a week for a two square-inch add on page 14 of their flyer, which will net you about as many sales as if you spent the money on Great Aunt Edna's Senior Girl Scout cookies. You invest fortunes in snazzy in-store displays. You promise to take back (and refund, in full) every item that fails to sell through, whenever the retailer decides to return it, even if it comes back in the original packaging, meaning that it never left the customer's warehouse. You promise that your release will be backed by a million-dollar print media campaign, and maybe 8 weeks of rotation on MTV. Next quarter, when your big competitor spends seven to ten million on his big game, you'll have to do the same.

And what does that buy you? Four weeks, maybe six. If your product hasn't sold by then, it is out of there, and don't expect a second chance, either. Even if the product sells reasonably well, it probably won't stay on the shelves for more than 2-3 months, because there will be other, newer games available by then that could sell even better. Only big hits (i.e., Tomb Raider or Starcraft) get more generous treatment.

So, where does that leave you? With a product that costs you millions of dollars to market and with 60 days to recuperate that investment, assuming you manage to get a decent channel to market. In all likelihood, it won't work. As a publisher, your strategy is to put a good selection of products out there, hoping that a few will catch fire and more than make up for the money you will lose on the others. Risky business. Given the fact that the safest way to conduct risky business is to minimize costs, and knowing that ever-increasing sales and marketing budgets are a fact of like, where do you cut?

Why, in developer advances, of course.


The Development Cost Bug

Which brings us to the second part of this equation for catastrophe.

Second Law of the Game Industry: Whoever stands between you and the customer holds you by the balls.

You are Joe Developer, and you just barely managed to write a cool little demo and a design document, while working a day job coding credit card databases and surviving on a diet of macaroni and cheese because all of your money went into computer hardware. You finally have a meeting with a publisher. He probably won't want to sign you up, but if he does, he'll pay you enough money to finish your product, right?

Probably not.

The last figures I saw placed the average cost of developing a PC game at approximately $2 million. (That figure, by the way, was double what it had been two years earlier, and more than forty times what it had been a decade before.) Unless your name is Sid Meier or Lara Croft, you won't see that much money before you ship your finished product. In fact, chances are you won't even see it after, either.

The game industry works pretty much like the book publishing industry: the publisher buys the developer's product for a cut of gross sales (typically $6 to $10 per unit for PC games, a bit more for console titles). Most publishing contracts also stipulate an advance against royalties which the publisher agrees to pay before the game ships. Most, but not all: desperate developers have been known to sign with dubious publishers for no advance, maybe getting a bigger royalty per copy in exchange. Still, advances are the norm. Advance money is usually non-refundable, no matter how poorly the game performs on the market (although if the developer fails to deliver the product at all, the case may end up in court.) Some of that money may be paid upon signature, or upon meeting certain development milestones.

However, advances are supposed to represent an early payment of royalties, so of course they depend on expected sales. Since most PC games sell between 15,000 and 50,000 units, few publishers will pay advances based on bigger numbers than these, unless you happen to have a fantastic track record or a great license to build your product upon. Therefore, assuming that you negotiate a contract for $8 per copy, with a guaranteed advance covering the first 50,000 copies, your advance check in going to amount to $400,000. That is, twenty percent of the average cost of developing a game.

So, how will you finance the rest? Venture capital, maybe. Bank loans, if your banker is a very optimistic man or if you can get him drunk. Sweat-equity, probably; that $2 million figure can be misleading, because it estimates the value of the work performed, and the principals in a start-up game studio often work for little or no pay. Or maybe your publisher or another bigger company will buy you out and fund the rest of the production. Or maybe you won't finish the project at all, and go bankrupt. It happens. Often.

Now, assume that you manage to finish your game and to get it published. Further assume that it sells three times the expected amount, or 150,000 units, which would make it a minor hit. You are still $800,000 short of the average budget, but that's OK, because most of your staff have been working for a cut of the profits, so your out-of-pocket expenses were much less than $2 million. Now what? Unless you want to keep writing games after business hours, you'll want to start paying your people regular salaries. And now, you're in trouble, because you have to start the process all over again, and this time, you'll really have to spend that $2,000,000.

It is estimated that between 1,200 and 1,800 PC games are released every year. Less than 10% of them break even; fewer still earn significant profits. Not surprisingly, very few independent start-ups remain independent for very long. They either collapse, or get bought out by bigger companies with more cash flow. (Companies founded by industry legends who have publishers at their feet begging for the rights to their products are the obvious exception, but how many Peter Molyneux's and Sid Meier's are there?)

It should be noted that the situation is different for console developers. Sony, Nintendo and Sega regulate who develops for their platforms, and who published what, so the number of titles on the market at any given time is much smaller. Furthermore, console owners buy more games than PC owners, and rental outlets buy large numbers of console games. Therefore, it is easier to break even with a console game than with a PC title. However, writing games for the PlayStation ™ is not a license to print money, as some people believe. If anything, console games cost more to develop.


The Press Bug

The so-called "Game Press" is a misnomer.

Third Law of the Game Industry: Style is at least as important as substance.

Over the years, I have met quite a few people who write in game magazines, and they are not "journalists". They are gamers, mostly in their early twenties (or late teens), who grew up on a steady diet of Doom and Super Mario. Most of them have very definite ideas about what makes a good game, and they stick to them. They are not objective, they are not investigators, and they are not supposed to be. Game magazines are basically written by fans of a specific type of game, for fans of the same.

Now, there is nothing inherently wrong with that, until you realize what it entails for the industry's economics. For the gaming press, Risk on CD-ROM is not a game. Neither is Barbie's Fashion Designer, no matter how many trillions of copies it may sell. You Don't Know Jack barely qualifies, because it is funny, but a dead-serious trivia game might not. In fact, a good game, in the eyes of the press, has to have the following:
  • More and better graphics than was thought possible six months ago;
  • Lots of fast action;
  • Stuff like secret levels, bonus characters and moves that are hidden so well that only Real Gamers ™ will ever find them.
So, basically, anything simple to play is not a game, unless it achieves 60 frames per second with 10,000 Phong-shaded and/or texture-mapped polygons per frame. And most of all, anything that could have been made with the technology available two years ago sucks. Which means that if you ever try to develop a game that would cost you significantly less than the above-mentioned millions, the gaming press will kill you.

Therefore, either you saddle up and work on the next framefest, or you find a completely different way to get people talking about your game. Not many people have achieved this. If you know a sure-fire way to do it, please tell me.


The Vaccine?

So, it seems that given the current channel to market situation, publishers can not survive while paying developers enough to allow them to survive as well. We are stuck in an economy where someone, somewhere has to fail on a regular basis to let the industry as a whole survive. This doesn't sound right. Besides pushing salaries down (and we all know that salaries in games are typically quite a bit lower than in the rest of the software industry), it wastes a tremendous amount of talent and effort.

What to do?

First, since success in the retail market, which depends on the press and on a few major retailers, is so difficult to achieve, we might want to look at the alternatives. Online distribution, via high-speed networks, might be an interesting avenue. Virtual shelf space is basically unlimited, so a game's life cycle could be multiplied by a factor of 10 easily. Unit prices might also go down (or, alternatively, more of the unit price could go to publishers and developers, reducing the sales volume required to break even.) Bundling can be extremely lucrative as well, and you don't have to spend on advertising.

Second, it is high time to stop sneering at low-cost game development, and the mostly untapped markets they represent. Face it: your grandma will never play Quake or Total Annihilation, but many, many older people would love to play simple, social, relaxing family games with their friends, children and grandchildren. And guess what: you can write them for a pittance, and make money with them. Low-cost games can also be distributed as part of multi-genre packages, along with magazines, web sites, books, etc., and publishers may be able to carry more of them for longer, giving developers a chance to produce titles somewhat out of the ordinary.

Third, realize that games do not have to be hard. Deer Hunter is not complicated, it is not difficult to play, and it is not overly flashy, but despite (or thanks to?) this, it appealed to far many more people than most big-budget titles.

Fourth, we need more games that appeal to a general audience, so that the regular computer press (and even the mainstream media) start paying us more attention. The gaming press is good at promoting a certain type of product destined to a certain audience, but if we want to reach mass-market penetration, we must generate awareness in the mass market! If games with a broad appeal become common instead of being oddities, access to the pages of high-circulation press will be ours. This is why I welcome traditional board-game publishers and media companies, like Hasbro or MGM, into our fold; if they can associate their market savvy to our talents, everyone will be better off.

Maybe, by implementing some of these ideas, we can increase the market profile of interactive entertainment as a whole, and allow more people to make a better living in this great business. Who knows, maybe by increasing the appeal of games in general, we might generate more demand, and even gain access to more of that elusive retail shelf space!





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