Are revenues coming at the expense of profits?

Looking at the sales numbers it is clear that the industry showed significant growth and most public game companies have been reporting strong revenue increases. Of course, with market conditions as they are, this growth has not translated into increased investor value.

In the latest issue of the DFC Dossier, we presented a report comparing the 2008 performance of 14 leading public game companies. We divided those companies into three categories:

1) Western Game Publishers
2) Japanese Game Publishers
and 3) Asian Game Publishers.

The results proved interesting because they highlighted how the market is shifting from a pure physical product business to a hybrid product/service business. While Western publishers showed the strongest revenue growth, it came with a decline in profits. Meanwhile, the Asian companies that focus on online PC games are showing very strong profits as their service-oriented products generate revenue for years, long after development costs have been amortized.

Overall in 2008 the seven major Western game publishers we selected have shown a 50% increase in revenue from the equivalent period in 2007 (in most cases the six months from 3/31 to 9/30). Only THQ showed a revenue decline. However, at the same time, these seven publishers reported an aggregate net loss in both 2007 and 2008. Furthermore, this net loss increased 42% in 2008. Only Activision Blizzard, Take-Two Interactive and Ubisoft showed positive net income in the first reporting periods of 2008/fiscal 2009. Take-Two Interactive was the only company that showed an increase in income (or decrease in loss).

The traditional Japanese retail game market has struggled for several years. Meanwhile, an online game market is just starting to emerge in Japan. As a result, Japanese publishers have for sometime been forced to expand beyond their domestic market and look at emerging online business models. In 2008, it started to appear that some of the Japanese publishers may be better positioned to weather market conditions than their Western counterparts.

The large Japanese game publishers did not experience the revenue growth of the Western publishers. Overall in 2008 the four major western game publishers included had a 17% annual increase in total revenue for the comparable six month period from 3/31 to 9/30 (for the Western publishers it was 50%). However, unlike the Western publishers the Japanese publishers showed a 272% increase in income. As a result, the stocks of Japanese game publishers were not as hard hit.

Of course, the big success story in 2008 was the Asian PC online game companies. The three Asian online game companies used for this report had a stellar performance in 2008. The market value of these company’s stocks not only held steady but for NCsoft (Korea) and Netease (China) showed an increase. Aggregate revenue for these three companies was up a total of 26%, while net income showed a more modest 6% increase. However, these companies are not only showing growth they continue to be very profitable. The Asian online game companies have already mastered making money from games as more of an ongoing service as opposed to a ship and forget product.

It is becoming clear that the profit margins for successful online games far exceed that of traditional retail products. Companies like Shanda and NCsoft are still earning money from games released years ago. Furthermore, consumers are showing a willingness to pay money for a service. Unlike a pure digital product, it is hard for a pirate to steal a good game service. This is very good news for the overall industry, but bad news for the large boxed publishers that have not been able to figure out the service-oriented online business.

Online game play and digital distribution are just starting to change the business models and power structure of the industry. More than that, they are also changing the game playing and buying habits of consumers.