The Hitmakers

For some useful lessons on how to be more nimble, look no further than the video-game industry.
Tim BurkeNovember 1, 2008

When The Dark Knight was released in July, the much-hyped Batman flick grossed more than $155 million in its opening weekend, a box-office record. Yet three months earlier, the release of the video game Grand Theft Auto IV hauled in twice that sum — in a single day.

Such is the state of the computer/console-games industry today, where corporate revenue is counted in billions and companies compete fiercely for the attention and dollars of a rapidly expanding customer base. The industry will be worth $48 billion this year and nearly $70 billion by 2012, predicts PricewaterhouseCoopers.

But don’t think the CFOs of these companies have it easy. Even as the spotlight shines favorably on the industry, the cost and complexity of developing games are rising. As their creative counterparts try to keep gamers glued to the screen, finance chiefs worry about many of the same issues as CFOs in other industries — achieving stronger balance sheets, greater scale, and improved operational efficiency, all of which help them develop more titles, push more products, and make more money.

The quest for scale prompted Activision to merge with the games subsidiary of French media group Vivendi in July, resulting in Activision Blizzard, a $3 billion giant nipping at the heels of industry leader Electronic Arts. For its part, EA has been aggressively pursuing Take-Two Interactive Software, but that deal seemed to fall apart last month when Take-Two announced that, after a strategic review of all of its options, it would refuse EA’s hostile advances and remain independent.

Success in this industry, CFOs say, hinges on a combination of solid risk management and savvy research and development. “There’s this concept that this is a hit-driven business where you throw a lot of things on the wall and hopefully something sticks,” says Thomas Tippl, the 41-year-old CFO of Activision Blizzard. A 14-year veteran of Procter & Gamble, Austrian-born Tippl says “Our job and our strategy have always been to make sure we have a plan in place that grows our existing franchises every year.”

Easier said than done. The industry has been driven largely by franchises, be it the Grand Theft series, Call of Duty, Tony Hawk skateboard-oriented games, or what have you. But these days it’s less about sequels and spin-offs and more about tapping into new markets with new products. That can require lightning-fast strategy shifts.

One new model involves subscription online offerings. The beauty of these games for CFOs is that they help to smooth the industry’s notorious sales peaks and troughs around the lifecycles of traditional consoles such as Sony’s Playstation 3, Microsoft’s Xbox, and Nintendo’s Wii. “This has been a super-cyclical industry, and the thing CFOs want the most is predictability,” says Jason Mauricio, an analyst at Arete Research in London. “Some of the newer developments coming up in the video-game industry are allowing that to be more of a reality.” Activision Blizzard already generates more than $1 billion in revenue and more than $500 million in profit from subscription businesses, thanks largely to its ownership of the Blizzard-developed World of Warcraft, an online game with some 9 million monthly subscribers. EA also sees this as a growth area and expects online revenue to rise by 50 percent, to more than $285 million, in its current fiscal year.

Another new focus is what gaming executives call the “casual” market, a loose term covering simple games that anyone can pick up and play, such as sports simulations played with the Wii console’s motion-sensitive controller. Casual gamers might be put off by the array of buttons on a normal console controller, but, as Tippl says, “everybody knows how to swing a tennis racket.” Or play air guitar: Activision’s Guitar Hero is perhaps the signature title in this market.

Casual gaming has also been a hit for Ubisoft Entertainment, a $660 million French publisher and developer. According to Ubisoft CFO Alain Martinez, one major appeal is the relatively low cost of development. Because casual games made for the handheld Nintendo DS device, for example, can be developed far more cheaply than those for consoles, Ubisoft can experiment in ways it couldn’t afford to do for the Playstation or Wii. “You can make 30 games for the price of one and try different things,” Martinez says.

In 2000, Ubisoft owned only one brand; today it has 14 multi-million-selling franchises, with more on the drawing board. “The cost of development and the ambition of these projects are getting higher all the time,” says Martinez. “Therefore, fewer companies are capable of taking risks on several projects like we do.”

Ubisoft has 3,500 developers working in 19 studios in 15 countries, often in regions where the company benefits from lower costs, such as Romania, Morocco, and China. In June it announced plans to open a 20th studio in Sao Paulo, Brazil. As for development and production costs, Martinez says the company can spend €300 million each year. But despite its ambitious plans, last year the company managed to cut R&D spending to 28 percent of sales from 34 percent, thanks to strong sales.

If efficient development is one key to success, Martinez says that another is to own most, if not all, of the intellectual property (IP) in a company’s portfolio. While Ubisoft has made games based on the TV show “Lost” and the film King Kong, it normally focuses on in-house brands from which it takes all revenues rather than pay royalties. Owning the license for a game based on a popular Pixar movie is good, Martinez admits, “but if you’re capable of creating your own IP that can [be equally as popular as a movie], that’s even better.”

To this end, Ubisoft, having developed action games over the past 10 years based on author Tom Clancy’s creative output, struck a deal earlier this year to buy the rights to all IP using his name. The deal gives the group a chance to develop the franchise in new ways. While early games were based on books, for example, Martinez sees no reason why future products can’t begin as games and then become books and movies. Call it “thinking outside the Xbox.”

Out to Launch

Publishers need to sell about one million copies of a game on the PS3 or Xbox 360 just to break even. But as in the film industry, plowing money and time into a new title is no guarantee that it will receive good reviews or attract consumers. If Ubisoft’s slate of five new franchises looks ambitious, what does that say for the 15 new (or newly acquired) brands that EA has in development?

“We were essentially flat in our performance [in fiscal 2007] in an industry that was growing nicely with the console cycle,” says EA finance chief Eric Brown. “The net result was that we lost some share. That’s not something EA is accustomed to.” Last year the company restructured around four divisions: EA Games, EA Sports, EA Casual, and a separate division for its popular Sims franchise. That gives the group a fresh framework, says Brown, and introduces new priorities for him as CFO. “To the extent that we can enable and enforce autonomy and agility while maintaining all the advantages of scale, common systems, [and] common reporting, we’ll get the maximum operating leverage,” he says. It could be a long journey. In the fiscal year to April 2008, revenue rose but the company reported a $454 million loss. The board expects to report a profit for next year, although its losses continued into the first quarter.

Mauricio at Arete Research says launching that many brands in one year is risky given the sizable marketing costs. Brown counters that EA’s lineup is “the best we’ve ever had” and that the company balances its portfolio to ensure it has an offering for almost every type of player and demographic.

Along with products, it also has something else: advertising. The company has spent two years developing in-game advertising, so that a player of the racing game Burnout, for example, now speeds past billboards advertising clothing brand Diesel and vehicles emblazoned with the Gillette logo.

Another new revenue model has been developed with an online soccer game that EA launched in collaboration with international soccer organization FIFA in South Korea. It’s free for gamers to play, but they must pay for extras such as new gear for their virtual footballers. Brown won’t confirm whether the company makes more from these microtransactions than it would from selling the game as a packaged product, but claims that FIFA Online generates about $1 million a month of revenue, split between several parties, including the football association.

Monetizing the User Base

At Activision Blizzard, Tippl reckons that with games such as World of Warcraft, the company has lessons to offer the digital industry about how to develop dependable revenue streams from an online community. “These are things that Facebook and MySpace and others still have to figure out how to do — it’s a big step from offering a product for free to charging for it,” he says. “We are already there. We are already monetizing that user base, and as a result I think we have a big advantage over many of the media companies.”

Media companies are keen to catch up. Disney has been investing more in its in-house games-development studio, while Warner Brothers has invested in UK publisher SCi Entertainment. “Gaming companies are attractive targets for media players,” says Edward Williams, an equity analyst in the New York office of BMO Capital Markets. “As the consumer looks for more dynamic and interactive forms of entertainment — and these games really represent that — I think other companies not currently in the games category will move in more aggressively.”

Tippl is not concerned. “It’s one thing to identify a fast-growing segment that is very profitable. It’s another thing to actually figure out how to get your piece of the pie,” he says. Nor do he and others seem overly concerned about the current economic downturn. The games sector has proven reasonably recession-proof in the past — consumers who enjoy video games consider them good value for the hours of entertainment they get, and Tippl sees no reason for that to change, credit crunch or not. “They can’t afford to drive anywhere, and they can’t afford to dine out,” he says. “What else are they going to do? They’ve got to be entertained somehow.”

Tim Burke is senior staff writer at CFO Europe.

Brand Awareness Cuts Both Ways

As video-game developers and publishers merge, what will that mean for smaller companies? “Small guys can win [in this industry],” says Phil Stokes, an entertainment specialist at PricewaterhouseCoopers. “The question is, can they win consistently?”

It’s a question that SCi Entertainment, the UK-based publisher that owns the Tomb Raider franchise, has struggled to answer. Its shares fell this year when a takeover rumor proved to be no more than that, and CFO Phil Rogers was tapped to become CEO as the company tries to turn itself around. Analysts claim the company has been too reliant on too few brands; delayed product launches have also posed a problem. But shipping out quality titles at the right time is far from easy. Stores need the games on time, but companies risk alienating consumers if they ship faulty products. California-based Flagship Studios, developer of Hellgate: London, a PC game set in a post-apocalyptic London, learned that the hard way. When the game was released last year it was riddled with bugs. Blogs and Websites teemed with disgruntled players, and their ire grew when a patch intended to fix the problems wiped out players’ previous scores. Now some gamers refer to products launched prematurely as “Flagshipped.” That’s the kind of brand recognition companies could do without. In fact, Flagship is now bankrupt. But one Flagship founder is already back in business, as head of the new Runic Games, providing a neat parallel between computer games and reality: sometimes you can die a horrible death and get right back up again. — T.B.

Projected growth of the video-game industry