Video game makers aim to captivate consumers across multiple platforms for longer periods of time, moving from packaged goods as a one-time delivery to digital games as an ongoing service. The industry expects a few benefits from this approach. Consumers will spend more money over the life of a game, especially through in-game micro-transactions and premium subscriptions, and digital services have lower costs and higher margins than traditional packaged goods.
Electronic Arts Inc. (NASDAQ:EA) notes two major drivers of this shift to digital: PCs and wireless platforms. Electronic Arts Inc. (NASDAQ:EA)’s wireless, Internet-derived, and digital advertising net revenue before deferral has doubled in just two years, going from $833 million in fiscal 2011 to $1.227 billion in fiscal 2012 and to $1.663 billion in fiscal 2013. Unfortunately, digital revenue growth for fiscal 2014 does not continue at such an impressive rate; Electronic Arts Inc. (NASDAQ:EA) expects $1.7 billion in revenue from digital in the 2014 fiscal year, which is an impressive 42.5% of total revenue but only represents a 2.2% increase over fiscal 2013’s digital revenue. Digital revenue in fiscal 2013 was higher than usual because the company recognized $121 million of Battlefield 3 Premium subscription revenue in the fourth quarter, whereas a Battlefield 4 Premium subscription service, if announced, wouldn’t be recognized until the 2015 fiscal year. Even if we remove the $121 million from fiscal 2013’s digital revenue, we still see only a 10% year-over-year increase in digital revenue.
Similarly, Activision Blizzard, Inc. (NASDAQ:ATVI) is focusing on releasing frequent updates to its major franchises that encourage either an ongoing subscription or additional purchases from an in-game store. Improvements on this front led to 28% of the company’s revenues in the first quarter of 2013 coming from digital. The company will need to act quickly, as its iconic World of Warcraft franchise lost 1.3 million subscribers (or 14% of its user base) in the last quarter, with further declines expected. At an estimated $10 per subscriber per month, this could represent a loss of over $150 million in annual revenue.
A new console generation
Digital is becoming more important as packaged goods sales tend to fall this late in a console generation. Packaged goods sales throughout most of 2013 should be lower as customers postpone purchases of current-generation games and consoles in expectation of the release of the next generation consoles in fall 2013. Sales in the last couple months of 2013 should be stronger than previous periods since a greater percentage of PS4 and Xbox One owners will likely purchase games early in the new console cycle.
One example of what not to do is Take-Two Interactive Software, Inc. (NASDAQ:TTWO)‘s planned release of GTA V in September 2013 for the PS3 and Xbox 360, but not for the next generation of consoles. I expect that GTA V’s sales will be significantly lower than they would have been if the game had been released a year ago — in the face of the new consoles, consumers are simply tired of the PS3 and Xbox 360.
The mobile market
What will drive video game makers’ online, direct download and wireless business over the next few years? One challenge with developing mobile apps is that the barriers to entry are significantly reduced compared to console games, in part because the games are not as complex and the graphics requirements are not as high. An example of the potential success of Electronic Arts Inc. (NASDAQ:EA)’s strategy is The Simpsons: Tapped Out, which earned $50 million in sales from its launch in August 2012 to March 2013, with March accounting for $10 million of that total. One concern is that $50 million in sales over 6 months is not large enough to make a meaningful impact on the performance of a multi-billion dollar company. It’s unlikely that this game has the staying power to ramp to hundreds of millions of dollars of revenue.