Square Enix director Yosuke Matsuda has outlined the structural deficiencies within the packaged goods industry that weakened apparently successful titles like Tomb Raider and Hitman: Absolution.
In a briefing held on May 13, 2013, Matsuda pin-pointed Sleeping Dogs, Tomb Raider and Hitman: Absolution as examples of products being failed by the prevailing packaged goods model. Despite hitting the right level of quality on all titles, Matsuda said, Square Enix suffered in the "critical metric" of net sales to customers - a much more relevant figure than the oft-cited number of units sold into retailers and the distribution network.
"We have seen significant degradation in results," Matsuda said. "In the packaged sales business, very strong competition in the marketplace has resulted in pricing methods such as price protection (costs incurred to maintain pricing) and back-end rebates (sales incentives) growing in increased importance, and creating a critical increase in pricing method costs."
"I believe that this situation is not a one-time event for the fiscal year ended March 2013, but it is a structural issue within the packaged sales product model"
Last year, the company's "Provision for Allowance for Sales Returns" more than doubled to almost ¥4 billion ($39m/£26m), while advertising costs shot up by ¥5 billion to hit ¥12.3 billion ($120m/£80m) as it struggled to maintain consumer interest.
"Even though development expenses were covered, these titles did not sufficiently contribute to profits," Matsuda added.
"I believe that this situation is not a one-time event for the fiscal year ended March 2013, but it is a structural issue within the packaged sales product model. As a result, I believe it is difficult to guarantee an appropriate return on our investments within the revenue model of purely packaged software"
So, in the long-term, Square Enix will be moving away from the "rigidity" of the packaged goods business model, and the slow asset turnover of the "long-term, large-scale development" required by games like Tomb Raider and Hitman. The company will continue to invest in games of this kind, but its approach will need to change with consumers' spending habits.
"There is a huge difference from the perspective of business risk between a model where no revenue opportunities take place for several years until the product is completed (upon which investments are recovered at one time), and a model where revenue opportunities exist in some form prior to product completion, even if the amount of money invested is the same.
"I believe this is a crucial point. The problem is not simply a financial issue."
Matsuda pointed to Kickstarter and Steam Greenlight as examples of unifying development and marketing, while opening up possibilities for consumer feedback and pre-release revenue.
"What should we present to our customers before a game is finished, how can our customers enjoy this, and how do we connect this to profitability, is something we are thinking about implementing, and which can improve our asset turnover in the process."
"I think it is necessary to review the definition of 'AAA Title', and we need to pursue a new type of blockbuster title"
Square Enix will also increase its focus on smartphones and tablets, with the intention of releasing the sort of products that it would once only have sold on consoles - story-driven, single-player games. It will also place more emphasis on regional markets, moving away from the assumption that a single product can have a global reach by targeting specific groups of consumers through both its products and their marketing campaigns.
"We will continue to invest in flagship titles that showcase our technological prowess, pursuing high-end game quality, and which can earn profits on a global basis," Matsuda said, indicating that the company will reveal more on its strategy at E3.
"That said, we cannot reasonably finance this direction for every single title, and we have to think about our entire product portfolio.
"Our strategy of selling AAA titles of 10 IPs around the globe has implicitly assumed Hollywood-style cinematic major games centred on single-player experiences. Going forward, I think it is necessary to review the definition of 'AAA Title', and we need to pursue a new type of blockbuster title, in addition to the conventional type of blockbusters."
Matsuda has set Square Enix a target of reaching ¥25 billion operating profit as soon as possible. Last year, the company made an operating loss of more than ¥6 billion.