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The Big V: The Great Games Market Split

Wed 06 Jul 2011 6:55am GMT / 2:55am EDT / 11:55pm PDT
Business

Tim Merel of Digi-Capital looks at the market divide between value and volume

We are entering a world where the games market is fundamentally splitting in two, like the media market of a decade ago. Back then what we now call "old media" scoffed at "new media" upstarts for giving away content, bizarre business practices, and products and services which made no sense to the wise old birds. "They’ll destroy more value than they’ll create," was the mantra.

Well, welcome back to the future.

Today’s games market is fundamentally splitting into "Value" and "Volume" markets, both by sector and geography. The two-speed market this is creating may have more rapid and profound effects on the games market than it did on the media market, with meteoric rises for some and slow going for others.

Let’s start by defining what we mean by "Value" and "Volume".

Value

  • Users: thousands to tens of millions
  • ARPU (Average Revenue per User): $-$$$
  • Costs: $ millions to tens of millions
  • Operating profit: negative to 20%+
  • Growth rates: negative to 10%
  • Business model: unit sales, subscriptions, virtual goods

Volume

  • Users: thousands to hundreds of millions
  • ARPU: ˘ - $$
  • Costs: $ tens of thousands to millions
  • Operating profit: negative to 60%
  • Growth rates: negative to 20%-100%+
  • Business model: unit sales, free, virtual goods, ads

Please note that these are not hard and fast rules, so there will be exceptions (such as World of Warcraft in Retail MMO when we get to sectors). But as a way of thinking about how the games market is dividing and what it means, they are useful rules of thumb.

In terms of thinking about where each games market sectors fits, here's a starter:

Value sectors: Pure console, retail MMO.

Volume sectors: Social online, casual online, mobile, social-mobile, browser based MMO.

This categorisation may be relatively uncontroversial, but the geographic divide possibly less so. Please note that for geography we are discussing user markets, not necessarily developer markets. Companies from any geographic location can succeed in other geographic markets, such as Zynga (US) and Rovio (Finland) globally.

Value geography: North America.

Volume geographies: China, India, Brazil.

Mixed Value/Volume geographies: Europe, Japan, South Korea.

Put all that together, and you get the "Big V".

Image 1

The eagle eyed will have spotted the small categorisations in brackets under Value (large long-term niche) and Volume (mass market growth) in the Big V chart above. If there is genuine controversy in this world view, it is probably here. So let’s explore.

Our forecasts are that online and mobile games should grow total video games market size to $87 billion and take 50 per cent revenue share at $44 billion (18% CAGR 09-14F). The historically strong pure console sector is flat to down.

Image 2

Our forecasts are that Asia Pacific and Europe should take 90 per cent revenue share for online and mobile games (China 49%, Europe 17%, Japan 14%, South Korea 11% in 2014F). North America remains important.

Image 3

The drivers of this growing and changing world are socio-demographic and cultural, as well as technological. The most concrete statistics are socio-demographic, for which we’ll look at China as an example.

In 2010 China had 29 per cent internet penetration, with around 382 million users. So more Chinese internet users than the entire US population. China is forecast to reach 56 per cent internet penetration (754 million users) by 2015, or more than twice the US population, with the bulk of Chinese games played in internet cafes and on mobile phones. So while ARPU for gamers in China is much lower than America, the huge volumes enable Chinese online/mobile games companies to use incredibly efficient business models to deliver 50%-60% operating margins. To give a sense of scale, Tencent generates up to 20 million peak concurrent users, or roughly the population of Australia playing a Tencent game as you read these words.

China and the various online/mobile games sectors are the poster children for the Volume market, and fit the "mass market growth" description well.

For the Value side of the divide, the US and Console markets are good examples.

The US population is stable, so remains a large market. The Console market is flat to down, and despite recent and anticipated hardware launches we are unsure that this trend will change. Yet gamer ARPU in the US is much higher than China, and good Console titles still sell for high prices at retail (even if increasingly bought online or with digital downloads). So the US and the Console markets remain great games markets.

Yet compared to countries like China, the US is no longer the leading games Volume market in terms of gamer population. Even compared to Europe, the US is a smaller by volume. When it comes to the Console market, volumes, revenues and profits across the industry are generally trending down despite blockbusters like Call of Duty.

So in global terms these markets look like they may become large long-term niches. Still great places to operate, valuable, capable of producing great games companies and great games, but generally not on the same scale or with the same growth rates and profitability as the Volume markets. Some of these Value markets are trying to transform themselves into Volume markets, and they may succeed in doing so despite the challenges. As before, this is not absolute and there should be many exceptions.

Recent games investment, M&A and public company valuations (see the June transaction update of our Global Video Games Investment Review 2011 for the data) indicate that investors may be taking a similar view.

So what does this mean for your games company investment?

Whether you agree with this world view or not (and it’s certainly open to interpretation and discussion), the underlying trends are what they are. They can’t be ignored, so you may as well embrace them.

As a starting point, ask yourself some simple questions. Depending on your answers, you may start thinking differently about how to invest, plan and operate to take advantage of the brave new world.

  • Users: are your games aiming at thousands, millions or hundreds of millions of users?
  • ARPU: do you measure ARPU in cents or dollars?
  • Costs: do you think of game development and user acquisition costs in thousands or millions, and do you have the right cost/revenue model for your markets?
  • Operating profit: can your business be flexed to deliver super-profits?
  • Growth rates: could your business deliver 20%-100%+ annual revenue growth?
  • Business model: what revenue sources are most important for your games - unit sales, subscriptions, virtual goods (currency/items), ads?
  • Geography: can your games operate across geographies and cultures, or are they domestically specific?
  • Platforms: are your games platform specific, or can they operate across sectors?
  • Value to Volume transition: what can you achieve in Value markets as they transform towards
  • Volume, and how does that compare to what you can deliver in existing Volume markets?
  • Scalability: are you building a genuine business platform with scale advantages, or a series of hits?
  • Exit: can you become a "must-buy" for one of the major players in either Value or Volume markets, and what does that look like?

There are many more questions you could ask yourself, but deciding whether you are a Value or a Volume player (and keep in mind it is becoming increasingly difficult to be both) may have a profound impact on the future of your games business investment from valuation, investment, strategic and operational perspectives.

Welcome back to the future – it's going to be a lot of fun.

Tim Merel is Managing Director of Digi-Capital, the games investment bank focused on Europe, North America and Asia (China, Japan and South Korea). As well as its investment banking and venture partner work, Digi-Capital publishes its 2011 Global Video Games Investment Review, which focuses on the rise of online/mobile games, China and investment across sectors.

5 Comments

Wonderful article, it's really comprehensive of every aspect of the actual market.

Posted:3 years ago

#1

Rick Cody PBnGames-Board Member

144 14 0.1
Hmm, I think these are some good insights. They got me thinking in ways I hadn't before.
Can't the volume developer's product be scaled up to offer the depth of the value market's products? I mean to say, can't a freemium game be given gameplay depth over time to suit the "core" markets of North America? Or am I focusing to much on the development and not the business?

Posted:3 years ago

#2

Tony Johns

520 12 0.0
I thought that Japan should be on the core North America side, considering how they have allot of niche markets that hardly ever get a footing in the western markets.

But it is better than what used to happen years ago when we often never saw many Japanese RPGs or even Japanese Visual Novels at all being released over in Western countries.

It is still like that for most Visual Novels that unless if you read Japanese you will have to play though the Japanese text and guess what is going on most of the time in the PSP Visual Novels that I have.

Posted:3 years ago

#3
Great article! I wonder how this V looked back during the transition the homes consoles from arcade cabinets (and even from home to portable for that matter). It's interesting to recognize the divide but more intriguing to see it all come back together. There's no doubt going to be a wave of value-driven volume games in the near future as long as developers continue to ask the right questions of their niche markets in terms of looking at revenue dollars and equating that to cost os development in a very rational sense (meaning platform and delivery). Chair and Epic Games comes to mind immediately as a Dev house looking to solve this problem and bring the V tighter.

Posted:3 years ago

#4

James Ingrams Writer

215 85 0.4
I think it's quite easy to see simple trends. Smaller European developers/publishers who tend to produce on PC for the European market and then console for the U.S. market are growing in number, unit sales and confidence. Example: GSC Gameworld with The Witcher and The Witcher 2. These companies can bring titles to market for half the major U.S. publishers, that due to development costs always need the game on all consoles as a minimum, and only tacitly supporting PC because of the size of that market. European developers make a profit at 1 million units, and quite often sell 2-3 times that in Europe alone.

I believe on PC initially and console too over the next 2-3 years, European developers will slowly but surely steal more and more niche genres, like the RPG genre, that generate 3-4 million sales. Because of their lower development costs they can produce more hardcore titles alongside more generic titles. The major publishers can only do the latter.

At the other end of the equation we have the indie market, that while initially was on PC only (and still is predominantly), is now moving to console too. These indie titles are more likely to cost $1 million than the $100,000 it did 2-3 years ago. We now get quite sophisticated games, like Galactic Civilizations, the Sam and Max episodes and The Path.

With the indie market squeezing major publishers at one end with their $1 million games and European developers coming at them with there $8-13 million titles, I see the major players pricing themselves out of the market. I think EA recognise this and so buy Bioware AND Popcap!

The genie has been let out of the bottle. We have gone 7 years+ with our current consoles, despite still calling them "Next-Gen". Gamers are not seeing the huge graphic jumps that used to happen with new consoles every 3-4 years, this has taught them that gameplay and value for money is where it counts. Look at the diatribe against Dragon Age 2, Look how unsuccessful $60 ten hour games like Dead Space, Mirror's Edge and Dreamfall: The Longest Journey have been, and how each Elders Scrolls 100 hour RPG's go from strength to strength.

If you are now buying the odd indie game for $10-20, and the odd European game like STALKER or The Witcher 1 or 2 for $50 and by virtue of that buying fewer $65 AAA titles, you have become a very different gamer over the last 5 years. Even if new consoles do eventually come out, I think gamers will approach them with a very different view than they did the 360 and PS3 when they first come out.

It's this new education of gamers that allow 360 Live Sony Arcade and GOG.com go from strength to strength with retro game re-releases. Between this and the ever growing indie market, it's almost as if gamers are suspicious of games now, if the graphics are too good!

Change is a foot, and it will never go back to what is what at the start of the Next-Gen market in 2004-5!

Edited 1 times. Last edit by James Ingrams on 15th July 2011 1:47pm

Posted:3 years ago

#5

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