Market Fragmentation and Consolidation

The game industry is undergoing a major transition in 2014.  The proliferation of platforms for games (once just PC and Console, but now including Facebook, smartphones, tablets, handhelds, interactive TV, and a number of other devices) is fragmenting the market at an unprecedented rate.  This is great for overall growth of the industry; as more and more opportunities become available for gaming to broader and more diverse audiences, more titles can find success, and the size of the industry, from indies to traditional developers to publishers to platform holders, continues to grow.  There is no doubt that more game development is happening now than at any time in the past, fueled by record numbers of game players and the concomitant growth in revenues.

However, this shifting landscape poses major problems for the game development community.  In the past, opening up new platforms meant blue ocean opportunities, great for start-ups and entrepreneurs, leading to fantastic opportunities for venture capital and publishing, eventually settling out into franchise maintenance and IP portfolios.  Now, though, each platform is already a highly competitive, red ocean scenario.  Trying to get noticed on the iTunes app store, Google Play, or even Steam these days is difficult for the best of companies, a problem so common that it has earned its own moniker: “the discovery problem”.  The continuing escalation in development costs for AAA PC and Console games (predicted years ago and well-documented since) is drying up opportunities for mid-sized and independent studios.  Publishers are relying on in-house talent wherever possible, buying successful products and teams rather than investing in up-and-comers.  At both the low end and the high end, margins are getting squeezed aggressively by the competitive dynamics of the marketplace, which makes game development an ever more cutthroat endeavor.

The clear winners in this scenario are not the indies; aside from a handful of success stories like Minecraft, indies are now assuming a lot of the risk that used to be leveraged by publishing houses.  VC money has dried up for start-ups in the mobile and social spaces.  If you’re trying to start a business with a small team, chances are good that you’re securing the capital needed yourself, through sweat equity or private financing.  Assuming you are successful in putting a product on the marketplace, you have serious challenges in user acquisition.  Traditional development houses have been falling like dominoes over the last several years.  If you’re not owned by the publisher, deal terms are getting tighter and tighter, and with fewer publishers, there aren’t a lot of options.  Midway and THQ both folded in the last five years, and anyone who doesn’t own a tentpole IP (the only things keeping Ubisoft and Take 2 alive at this point) is bound to follow.

The one clear winner in this scenario is the platform holder.  Apple, Facebook, Google, Amazon, these are the players who stand to benefit from the changing dynamics, at least from a Western perspective.  Tencent, Nexon, and others with a more global base of operations and experience running massive games-as-a-service are, in essence, running their own virtual platforms; the competition between these global information, entertainment, and media companies is what will shape the next decade.

You probably noticed that I didn’t mention Microsoft, Sony, or Nintendo yet.  Console gaming isn’t dead, and much like PC gaming, it will never die out entirely.  But the growth dynamics are simply not comparable.  Sony probably won’t do as well in hardware sales with the PS4 as they did with the PS3, which itself did not measure up to the PS2.  Microsoft is still making its play for the hardest of the hardcore, but institutionally, doesn’t seem to know how to adapt to current realities.  You can play in that niche market, but you’re not going to see the massive numbers necessary to move the needle.  Similarly, Nintendo will continue to be profitable, with its gamer focus and attention to console player dynamics (something that both Sony and Microsoft seeming to be losing focus on), but you’re not going to see the kind of growth in hardware adoption that you see with tablets and smartphones now or that you saw with the Gameboy back in the day.

What the top companies in this space understand now (and many saw coming years ago) is that it’s not about hardware; it’s not about software, even; it’s about the network.  Owning the consumer trumps owning the IP the consumer is spending money on.  It doesn’t matter what the current fad is, MOBA’s or FPS’s, MMO’s or casual games; it’s not a genre or a playstyle that is going to lead to success.  It’s a diverse ecology already, and growing more rapidly so every day.  Owning the framework for that ecology, the way that consumers discover product, experience entertainment, and spend their money, that’s the key.  Apple doesn’t have a discovery problem; people developing for iOS do.  At that level, we’re still in for waves of consolidation, as companies that generate products (Disney, Universal, Activision/Blizzard) become part of networks that distribute them.  It’s not a question of if but when and how.  Clearly, Tencent knows this and is making strategic investments for the future, witness their financing of Activision/Blizzard’s spin-off from Vivendi.

There’s more room to play than ever, but the sharks are everywhere.  In other words, if you’re not playing to an end-game that involves being acquired or owning the network, you’re destined for extinction.

Retail Is Not Dying

There was an interesting article on Gamasutra today.  While it is specifically concerned with an analysis of GameStop, I believe that it holds an important lesson for the broader retail market of the games industry.

At first glance, it would seem like the retail market has never been more challenged than it is today.  There are more alternatives to brick-and-mortar stores than ever before; in games alone, we now have a variety of platforms, each with their own digital delivery systems and currency (iOS, Kindle, Facebook, etc.), even PC gaming has digital delivery services that cover wide swathes of the market (Steam, GoG, etc.), and publishers are more and more capable of reaching out directly to their own consumers (Activision Blizzard, EA, etc.).  If that fails to meet your needs, you can currently buy any number of console or PC titles either directly from the platform holders or at a variety of online outlets (Amazon being the mothership).

Matt Matthews points out, astutely, in his article that even as online businesses are thriving, conventional retail outlets are taking advantage of these new economies by providing currency purchasing through cards.  His example is Steam Wallet sales for GameStop, but look around your local Target or Walmart, and you’ll easily find an entire section devoted to virtual currency sales representing most of the above mentioned businesses and quite a few others besides.  In other words, people are buying physical items at brick-and-mortar stores that represent virtual currency for online activities.  What is with that?

There are two aspects of this that are not going to shift radically anytime soon; there will be a gradual shift, to be sure, but it’s more likely to be generational.  The first is a resistance to e-commerce.  While many of us have moved wholeheartedly into the 21st century, embracing online shopping, banking, and bill-paying, there are still many people who remain skeptical or outright refuse to put their credit card information into more sites than they absolutely have to.  That’s aside from all the people who do business in cash out of necessity, like having no credit cards, limited access to banking, budgeting in cash, or being kids.  I have little doubt that the Millenials are going to convert faster and in higher numbers than Generation X did, but that’s a slow process, and it’s going to take time.

The second important consideration here is gift-giving.  Again, the social conventions here are going to be slow to change, because the polite e-mail that says you’ve received a gift just isn’t going to have the same impact as the pretty little box with a bow on it, or even the Hallmark card (and the fact that they haven’t gone out of business should tell you something about the longevity of outdated businesses) with a card tucked inside.  There are very good reasons why the traditional “holiday window” extended from the calendar fourth quarter into the following quarter and publishers are now willing to launch high-profile, big investment titles in January rather than squeezing everything out in December.

Keeping in mind impulse buying, the joys of browsing, cluster purchasing behaviors, personal interaction, and the merits of physical artifacts as nostalgia inducers, there are plenty of reasons why brick-and-mortar stores are not going anywhere.  Smart businesses understand this and are partnering, rather than resisting.  And that trend will extend the lifecycle much longer.