The gaming industry used to have a traditional business model. But the internet changed everything. It has affected how products are sold, the size of the market, business models and user experience.
While there are good growth opportunities in the gaming sector, investors need to understand how the creative disruption of the world-wide web influences different market participants. They should also be aware of how it will continue to shape and change the industry.
Uprooting the conventional
A decade ago games were mostly sold through retailers in the form of CDs to be loaded onto personal computers. But they can now be downloaded, which allows the games publishers to communicate directly with their users and become less reliant on retailers.
Not only could traditional players interact with players but so too could builders of games. In the past, a developer would need funding from a publisher to build a game as this was a capital intensive exercise.
But the arrival of the internet and the smart phone changed that economic model. Now the developer has two billion potential customers it can reach. And it became much cheaper and easier to develop a product with the increase in the range of new software tools.
What used to be a high-entry business became a low-entry one. That resulted in a flood of new mobile phone applications. But while market entry had become much easier, making a profit became harder.
To make money out of a mobile game requires building a brand and retaining customers. But that’s difficult to do when there are thousands of free options. It’s only a few, such as Candy Crush and Angry Birds, which have achieved this goal.
New feedback loops
While the internet has created both opportunities and threats for the builders of smart phone apps, it also changed the relationship between traditional publishers and their audience.
Immersive computer games create an emotional connection between the game and the player because of the time invested. The world-wide web could be used to enhance this experience by building communities of gamers in a similar manner to social networking.
As selling directly allowed publishers to improve their gross margins, they could reinvest this cash in building vibrant online communities. This creates the perfect feedback loop which enables those organisations to discover what new tweaks consumers loved or loathed.
Doing things differently
More fundamentally, it has made publishers rethink their business model. They realised they no longer need to charge $100 for a game. Instead they can charge a smaller fee and develop a longer relationship with the user through the community and drip-feeding new charged-for content.
Over time it’s likely the producers of more complex games will adapt a similar business model to the makers of mobile phone apps: they will give the game away for free and look to monetise the longer term relationship with the user.
This free-to-use business model is likely to increase the size of the audience for the immersive experience, which will help producers to grow revenues − providing they can build customer loyalty.
The rise of e-sport
The creation of online communities has created a new phenomenon – gaming as a spectator sport. Around three million people will log onto different social media platforms every day to follow their favourite gamers.
Publishers are capitalising on this trend by hiring out sports stadiums and running public competitions for people to watch. And they are also filming these events and making them available on terrestrial TV, just like more traditional sports.
The most optimistic forecasts compare the earning potential of such events to the English Premier League or the National Football League, which both generate tens of billions of dollars.
Playing in the cloud
The gaming industry is also looking to mimic television disruptors like Netflix. Over the next five years games will be streamed from the internet without ever having to download them to a computer.
This is significant because it has the ability to expand the more immersive gaming market to billions of potential consumers as it will reduce the upfront costs.
Winners and losers
Three large companies dominate this sector – Electronic Arts, Take-Two Interactive and Activision. There is a long tail of smaller companies such as Frontier Development and Cheetah Mobile.
Those firms with large communities and well-recognised games are most likely to benefit from cloud gaming. Electronic Arts and Activision look well-positioned to take advantage of this trend.
Disney is another firm which could also benefit as it owns a significant amount of intellectual property which could be turned into gaming content. They have already converted their Star Wars into a game via a licence with EA.