The video games market can generally be divided into three major forms of consumption.
First you have the traditional sector of console and PC games, the old world of packaged media, which is still by far the biggest market.
Next, there’s the downloads and digital distribution market, which is fast-growing, of course, but has the smallest share of the overall opportunities available.
And lastly, we have the online services market. This sector is also fast-growing and with the most long-term potential.
If we examine boxed product across all forms of entertainment media, video games continue to be a key growth driver. Games’ share of the total physical media spending globally has grown larger and larger in the last five years. Spending on games has been robust compared to other media types such as home video and music.
BEHIND THE DECLINE
However, we believe the packaged games industry hit a peak back in 2008. Unfortunately the market has declined over the last two years and this is expected to continue.
Even with the release of new platforms, we do not believe that packaged spend will return to the heights of 2008 (see ‘The future of packaged games’).
So what’s underlying the current declines in the packaged market? Well, there are multiple factors happening simultaneously.
As you all know, the hardware part of the console business is a cyclical business and we’re into the latter stage of the cycle on a number of platforms, resulting in a decline in spending.
There is also a natural drop in the average sales price of games as the volume of cheaper software increases through the lifecycle. This sees spending amounts decline more heavily than sales volumes.
We’ve reached a tipping point for the digital distribution of retail equivalent PC games. While retailers have withdrawn shelf space for packaged PC games, download retailers such as Steam have been widely adopted.
There is now much more spend going through digital channels – though, not more than retail channels – but it’s getting to a point where it’s very significant (see ‘The rise of digital’).
We’ve also got aggressive growth of the pre-owned games market, so that’s growth that isn’t going through the publisher revenue stream. In addition, piracy has been significant, especially in the handheld sector, undermining new sales.
Last but not least, is the growth of new distribution channels, new platforms and new business models driving new consumption habits (see ‘A fragmented audience’, overleaf).
STRIKING A BALANCE
Over the next few years the traditional sector faces structural challenges and solid growth opportunities with the introduction of new technologies such as the Nintendo’s 3DS, Sony’s Move and Microsoft’s Kinect.
The major challenges revolve around increasing investment costs resulting in a risk/reward criteria more heavily weighted towards risk than ever before.
Console games have always been a relatively high-risk business but it’s becoming even more so. If you don’t have a blockbuster hit now, the return on investment calculation becomes very tough.
THE FUTURE OF PACKAGED GAMES
Over the next five years, we’re looking at declines in the overall market across all platforms. We now feel that the peak year for packaged sales was 2008. We expect a heavier decline over the next couple of years, which will be moderated by the introduction of new platforms in 2013/2014 and then growth from 2015 onwards.
THE RISE OF DIGITAL
The importance of online distribution channels is clear and online and mobile sales are fundamental to the market going forwards. The share of spending that is going through those channels is expected to increase by another 10 per cent in 2012, and reach 34 per cent by 2015. Note that this is the UK market only, which has a strong packaged games market. Other territories are even more advanced in online and mobile share.
PLUGGING THE SPENDING GAP
Even with strong growth in digital and mobile revenues we do not expect these sales to completely fill the gap in spending left by the decline in packaged sales over the next few years. It is unlikely we will see a combined market opportunity as big as 2008 until 2015 at the earliest.
Unlike the movie business, which games are often compared to, there is no aftermarket. Film studios have a lot of release windows that come after theatrical, which are ways they can make the money back. The games business has always been more constrained in terms of where you can make your money back.
This is not helped by difficulties in the catalogue market, which has been under pressure for some time now. Competitive pricing from retailers, the pre-owned sector and the volume of content in the market have all hit catalogue sales.
While the packaged market is declining, the unfortunate news is that there remains a spending gap across a combined packaged, mobile and online games opportunity until at least 2015 compared to the high point of 2008 (see ‘Plugging the spending gap’).
Of course, the great strength of the current generation consoles is that many are connected to the internet and therefore offer a hybrid distribution strategy straddling both physical media and digital distribution (see ‘Consoles as digital platforms’).
But with the high penetration of broadband services, we’re seeing the emergence of new devices, channels, and consumption habits in the home and that is making the competitive landscape for consoles increasingly intense and crowded.
Consumers only have two things: time and money. Those are the things we’re interested in and they’re both finite quantities. When you have more and more connected devices and new distribution channels you have more competition for those commodities.
We’re also seeing more competition in the mobile gaming space – handheld devices perhaps facing even more competitive pressures than their console cousins.
The rapid transformation of smartphones, tablets and portable media devices like the iPod Touch into sophisticated gaming devices is a trend that’s apparent to all of us.
There will be a fight back with the introduction of 3D from Nintendo’s next ieration of the DS, of course, but the mainstream consumer is increasingly being intercepted earlier in the consumption chain by non-dedicated devices.
ALL ABOUT CONTENT
If we look at the grand digital transition that’s underway in games, it’s interesting to remind ourselves that we’re already 15 years into that transition – and there are a few years to go yet.
We’ve passed a number of the key stages already: Early MMOGs, sophisticated browser-based games, online consoles and we’re now moving into the stage of social media, social devices, sophisticated streamed on demand services and social network games.
We’re slowly moving towards the endgame point of providing content when and wherever customers demand it.
A SLICE OF THE MARKET
The online and mobile games market is a complex whole, divided into different slices. This fragmentation means achieving scale is a major challenge. But UK online spending is expected to top 600m within a few years.
CONSOLES AS DIGITAL PLATFORMS
We’re moving towards a forecast 70 million active connected consoles worldwide by the end of 2010 across the current generation. The proportion of total console games spending digitally distributed is forecast to growth strongly over the next few years. By 2014 about 23 per cent of all games spending on console games will be through online platforms.
Each of these transition stages brings with it new competitors – most recently social media start ups that are flexible, fluid, service-based and analytics-driven.
These companies, that have brought with them disruptive and advanced business practices, are able to adapt and pivot more nimbly than their competitors that have dominated the market for some time.
PUTTING THE PIECES TOGETHER
As a result of all of this, the industry and associated market offerings are becoming increasingly fragmented across content, devices and channels – and that also translates into fragmentation of the overall market opportunity (see ‘A slice of the market’).
While these fragmented opportunities support a few big companies, achieving scale for many companies operating in the online space remains a real challenge.
Those companies that are early movers or that have large cash reserves are best positioned to scale effectively. We expect there to be lots more consolidation in these markets as a result.
To sum up, we’re entering an exciting but turbulent time for the games industry, with challenges on one side across both traditional markets and new online and mobile markets and great opportunities on the other.
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