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Video Games Industry Analysis 2009

Video Games Industry Analysis 2009

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Published by Pantadarell
This 45-page document (excluding exhibits and bibliography) focuses on the future of online distribution and online games. Based on the overall study of the industry's target market and the cost analysis of bringing a game to market, the opportunities and threats of shifting to online models are examined closely.
This 45-page document (excluding exhibits and bibliography) focuses on the future of online distribution and online games. Based on the overall study of the industry's target market and the cost analysis of bringing a game to market, the opportunities and threats of shifting to online models are examined closely.

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2009

Video Games Industry Analysis

Vincent Courson
[Pick the date] i

Vincent Courson

March 15, 2010

Is the extreme diversification of video games’ online distribution and gaming possibilities a threat or an opportunity for the industry?

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I would like to thank the following people who provided me help and support throughout the writing process of this document:

Professor Caroline Dusautoir of Reims Management School, my thesis supervisor, who was there when I needed advice and who helped me to refine my subject until I was plainly satisfied with it.

Professor Thomas Cullinane of Northeastern University, who gave me invaluable pieces of advice and used his networking abilities to give me names of people in the industry.

Eitan Gilnert and Albert Reed, respectively founders of Fire Hose Games and Demiurge Studios, who both accepted to meet with me in their Cambridge, MA offices and provided me with industry insiders’ point of view that helped me understanding the industry’s functioning.

All the contributors to informational blogs concerning the video games industry around the world. You know how some pieces of information can be tricky to find, and the relentless work of many passionate people helped me a lot in this process.

My family and friends who have supported me while I was writing this thesis.

Vincent Courson March 15, 2010

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Table of Contents
Introduction ........................................................................................................................................ - 2 I. The Video game Industry ........................................................................................................ - 3 1. History and Growth ....................................................................................................... - 3 A. B. 2. History .............................................................................................................. - 3 Industry size ..................................................................................................... - 5 -

Today’s target Market ................................................................................................... - 9 A. B. C. Global sales number......................................................................................... - 9 Demographics in the target ........................................................................... - 10 New promotion media ................................................................................... - 13 -

3.

Diversification in the type of games............................................................................ - 14 A. B. C. D. Blockbusters ................................................................................................... - 14 Nintendo and the Wii ..................................................................................... - 16 Mobile Applications ....................................................................................... - 18 Online Games ................................................................................................. - 20 -

II.

Online Video Games Industry ............................................................................................... - 20 1. Market size .................................................................................................................. - 21 A. B. 2. Background for the development of online gaming ...................................... - 21 Recent Growth ............................................................................................... - 22 -

Diversification of online environment ........................................................................ - 23 A. B. New Revenue Streams ................................................................................... - 24 Specific online game types trends ................................................................. - 27 -

3.

Online distribution trends ........................................................................................... - 33 A. B. C. Comparison with analogue industries ........................................................... - 33 Statistics for specific online distribution platforms ....................................... - 36 OnLive: the future of online video gaming?................................................... - 41 -

Conclusion ........................................................................................................................................ - 44 Exhibits ............................................................................................................................................. - 46 Bibliography...................................................................................................................................... - 51 -

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Introduction
In the past decade, the video games industry has become a huge part of the global entertainment industry. In fact, numbers tell us that the video games industry is now grossing more revenue than the movie industry: while combined U.S. box office and DVD sales revenues added up to $18.6 billion in 2009 in the U.S.1, video games amounted to a staggering $20.2 billion2 in the same period. It has become pretty clear that this industry is now a major component of the global entertainment environment. As their popularity soared among many new segments of the consumer market, video games started to diversify and to adapt to an ever stretching demand. From the hardcore-gamer software developed in a basement and designed for extremely tech-savvy early-adopters, the whole product has evolved into a myriad of different experiences proposed at different prices, on both ancient and new platforms, using new distribution channels and new promotion medium. Among all these changes, one trend is particularly interesting to study: the spread of the online attributes of video games, regarding both the product features and the distribution channels of the product. By diversifying the product features and including online characteristics when using the product, the goal is to broaden the revenue stream models of the industry, while enhancing online distribution should enable distributors to reach a broader market. But it is unclear under what conditions, if any, these goals can be met and what their long term implications are. In this document, we are going to examine the causes for the recent evolution of the video games’ environment, and analyze the consequences on the industry model, especially the opportunities of shifting the industry to the digital side, whether it corresponds to the demand in the U.S., and what the consequences, positive and negative, will be for the industry as a whole.
1

Sarah McBride, Cinema Surpassed DVD Sales in 2009, January 4, 2010, The Wall Street Journal, http://online.wsj.com/article/SB10001424052748704789404574636531903626624.html 2 James Brightman, NPD: Video Game and PC Game Industry Totals $20.2 billion in ’09, January 14, 2010, Industrygamers.com, http://www.industrygamers.com/news/npd-video-game-and-pc-game-industry-totals202-billion-in-09/

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I. The Video game Industry
1. History and Growth
The Birth date of video games is unclear. In its very first years, computer games were created in academic and military labs, as part of development projects for computing equipment. As soon as 1947, a patent was issued for a form of entertainment using a computer and cathode Ray Tubes3. Other systems were also created in the 1950s and 1960s, but they only worked on huge and extremely expensive mainframes. The first video game to be released widely on the consumer market and to meet popular success was Pong, developed by Atari in 1972.Being the first time a video game successfully entered American bars (and later, homes in 1975), it is often referred to as the starting point of the video games industry. A. History The successive generations of products The video game industry has always been based around performance of hardware. Game systems had to respect a few ground rules if they wanted to be saleable: they had to have reasonable proportions; they should not be too expensive, since they are an entertainment product, and they should offer a large offer of supported games. This was reflected in the fact that new hardware came out following a cyclical pattern: consoles that pertain to a same generation generally have noticeably the same features, offering the same level of graphics, and using similar technologies. Exhibit 1 exemplifies the succession of the last few generations of consoles and illustrates some of the common characteristics that different products share. For clarity’s sake, only the most successful gaming systems are represented. Alongside those consoles, handheld devices appeared in the 1980s and they were generally engineered by the same companies that developed regular consoles.

3

Dennis Hevesi, Thomas T. Goldsmith Jr, a TV Technology Pioneer, Dies at 99, March 14, 2009, The New York Times, http://www.nytimes.com/2009/03/15/arts/television/15goldsmith.html

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Main actors of the industry The industry is divided in three: hardware manufacturers, developer studios and video game publishers. The main manufacturers today are Nintendo, Sony and Microsoft. They manufacture hardware that supports products developed either internally in their developing studio or in independent studios. Nintendo: Created at the end of the 19th century in Japan, Nintendo issued its first console in 1974. It has since been a remarkably consistent player in the industry. Its latest pieces of hardware have had a lot of success, especially its handheld hardware (the Nintendo DS is the biggest selling game console in history, totaling over 127 million units sold worldwide4) and the Nintendo Wii (so far the biggest seller of the seventh generation of hardware 4). Sony Computer Entertainment: Sony, the giant Japanese consumer electronics firm, got involved in the video games industry in the mid 90s when it released its first console, the PlayStation (1995 in the U.S.). Its console was successful enough to lead them to issue a second version in the beginning of the 2000s, and a third one in 2006. It has also released a handheld console, the PlayStation Portable. Microsoft, Entertainment and Devices Division: Although primarily a computer hardware and software company, Microsoft entered the video games market in 2001, with the Xbox console. They are an influential player on the market, since their console is today the second best-selling of the seventh generation. Those manufacturers develop games for their platform through in-house developer studios. But they also allow independent developers’ studios to create content for their hardware, hence diversifying the offer and giving the potential customer more incentives to buy the gaming system. Of course, the third party developers pay a price to the manufacturer to be allowed to develop their games for a specific machine. These video games developers can choose to distribute their games themselves, or they can use a game publisher. The most successful game publishers are Nintendo, Electronic Arts, Activision

4

According to Pro-blog www.vgchartz.com, as of March 7, 2010

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Blizzard and Ubi Soft5. These companies have an incredible marketing power and hold brand names that are strongly recognized by the gamer community. When it comes to computer gaming, there are no specific manufacturers since all games are compatible for all brands of Personal Computers. As for Apple computers, they support very few video games, and the market is almost negligible (Mac OS, the Apple Operating System only has a 5% marketshare6). Overall, the Computer Gaming market is substantially less important in numbers than the Console Gaming market (revenues of $528 million in 20097). However, like we will see later in this document, it is a segment that has a huge potential for online revenue growth. The publishers and developers studios involved in the computer market are often the same ones that operate in the console market, but some companies focus only on the PC. B. Industry size Rate of growth In the past decade, the revenues figures of the video games industry rocketed immensely to become a $20 billion industry. Leading consumer and retail research group in the video game industry, NPD Group Inc, has been monitoring retail sales for over a decade, and has therefore been able to witness this incredible increase: in an early 2010 press release, NPD industry analyst Anita Frazier said “the industry *…+ has grown *since 2000+ by more than 250 percent at retail alone”8. And these figures are probably underestimated since they don’t include online sales and other forms of online revenue. As we can see in exhibit 2, the growth of the industry revenues in the U.S. has been following a staircase pattern over the last decade. The growth was pretty flat from 1997 to 2000 (respectively $5.1Bn to $6.1Bn). Then, the revenues shoot to $9.4Bn in 2001, which is
5

Gamasutra.com, Game Developer Reveals Top20 Publishers, October 6, 2009, http://www.gamasutra.com/php-bin/news_index.php?story=25506 6 Marketshare.hitslink.com, Opreating System Market Share, February 2010. http://marketshare.hitslink.com/operating-system-market-share.aspx?qprid=8 7 Jose Vilches, Retail PC Game Sales Decline 23 percent in 2009, January 19, 2010, techspot.com, http://www.techspot.com/news/37632-retail-pc-games-sales-decline-23-percent-in-2009.html 8 NPD Group Press Release, 2009 U.S. Video Game Industry and PC Game Software Retail Sales Reach $20.2 billion, January 14, 2010, http://www.npd.com/press/releases/press_100114.html

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the year that all consoles from the 6th generation have been released in (apart from the PlayStation 2 in 2000), and stay flat until 2005 ($10.5Bn). Then, revenues increase again substantially in 2006 ($12.5Bn) and even more so in 2007 ($18Bn). It is interesting to note that once again, the year marking the next incremental increase in revenues is the one when all new consoles from the next generation are released (7th generation of consoles was released in 2006). Therefore, we can conclude that the industry is largely dependent on the hardware sales to support its growth (also, hardware sales amounted to $7.8Bn in 2008 in the U.S., 36.6% of the total industry revenues9). What is also remarkable is the fact that the growth today does not seem to be following as straight-forward a pattern as before: in 2007 and 2008, the industry has continued growing by large numbers (+$5.5Bn and +$3.3Bn respectively) even though no new major hardware was introduced on the market, which might show a change in the format of the revenue model of the industry. This can also be strongly correlated with the strong sales for the Nintendo Wii and DS consoles, totaling almost 9.6 million and 11.2 million units respectively in 200910. However, the industry has grossed smaller revenue in 2009 than in 200811, following the global economic downturn following the financial crisis of the end of the decade. Industry analysts expected the industry not to suffer much from the crisis, with for example video games analyst at IDC, Billy Pidgeon, who said “gamers will consider purchases more carefully *…+, will demand quality games and not buy games that are considered second rate”12. However, video games expenses still represent 5% of total U.S. Households entertainment share of wallet13 (and 9% for Video Games Buying Homes) which is the 4th biggest expenditure in multimedia entertainment (after TV, movies and cell phones).

9

Ryan Kim, Video Games Announces record revenue, January 16, 2009, SFGate.com, http://articles.sfgate.com/2009-01-16/business/17196633_1_anita-frazier-hardware-units-game-industry 10 NPD 2009 Sales Figures, Wikia gaming, http://vgsales.wikia.com/wiki/NPD_2009_sales_figures 11 See Note 2. 12 John Gaudiosi, Video gamers Take on a New Battle –the Recession, April 2, 2009, Reuters, http://www.reuters.com/article/idUSTRE53132720090402 13 Nielsen Wire, Video games Score 5% of U.S. Household Entertainment Budget, February 22, 2010,

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Life cycle of the industry Today, the video game industry is considered by many to still be in the development stage of its life cycle. The growth numbers tend to show that the industry is overall still growing. Moreover, as of August 7, 2009, 40% of American households possess a gaming system14, which illustrates the current shift from early adopters’ equipment to a generalized global market possession, but also shows that there is still a large place for new customers. However, some characteristics of the industry are more relevant to the mature stage of the life cycle of an industry. For example, there has been a wave of strong consolidation since the beginning of the 2000s. This has taken the form of game publishers’ backward integration of independent development studios in order to “gain development expertise, proprietary technology, intellectual property and a competitive advantage and prevent other publishers from access to the technology and content that the best developer offer15”. This is associated with the higher costs involved in producing software for the industry, and the higher risks taken. Overall, the industry is still pretty young, and room for innovation is still huge, which will help prevent clogging up the market and there should not be signs of any price wars among manufacturers and publishers. Moreover, the market is still rapidly evolving and product differentiation is always possible using technology to add new product features. Increasing development costs The recent increase in development costs is one of the major reasons for consolidation of the industry. Over the years, and with each new generation of consoles, the graphics are improved, the score is more ambitious, and many more features of games cost more and more to produce. For example, while it cost only “from $800,000 to $1.7

The Nielsen Company, http://blog.nielsen.com/nielsenwire/consumer/video-games-score-5-of-u-s-householdentertainment-budget/ 14 Kris Graft, 40 Percent of US Homes Have Gaming Console, August 7, 2009, based on study by the Cable & Telecommunications Association for Marketing http://www.gamasutra.com/news?story=24757 15 Nick Shah and Charles Haigh, The Video Game Industry, An Industry Analysis, From a VC Perspective, March 11, 2005, Tuck at Dartmouth MBA program archives.

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million to develop a game for the original PlayStation16”, the costs soared to between $5 and $10 million for the next generation17 (PlayStation 2). Additionally, leading game publisher Ubi Soft’s chairman and CEO, Yves Guillemot, tells us that developing top games for the PlayStation 3 is generally around $20-$30 million, and he expects that games for the next generation of consoles could reach $60 million to make18, on a regular basis. This major increase is paralleled by marketing costs that are also going through the roof, and other costs starting to follow in the same direction (license acquisition, R&D, legal…). In the end, this represents a much higher risk for game developers and publishers: they invest more money into fewer “new content” games, issuing sequels to popular series, cinematographic adaptations (using licenses like Star Wars, Indiana Jones, Disney movies, etc…) and generally less daring experience-oriented games. The latest (and probably one of the only) exception to this state is the Game “Heavy Rain”, released on the PlayStation 3, which is more an “interactive movie” than a video game, and so far, the sales are looking good (it has sold 500,000 copies worldwide two weeks after its release19), but it is unusual for the industry to have an unconventional game being this successful. All of these major cost increase are a strong reason for developers not wanting to have the next generation of consoles being released too soon, but manufacturers, who get a large part of their revenues from hardware sales, will probably try to push forward the introduction date of new consoles. Experts think the current generation of consoles could last until 2012-2014, maybe even more. Until then, there should not be any major revolution in the console market worldwide.

16

Journal of Business research, Volume 58, Issue 7, Pages 995-998, Cathy Leach Waters, The United States Launch of the Sony PlayStation 2, July 2005. 17 ibid 18 Chris Morris, The Next Generation of Gaming Consoles, June 12, 2009, CNBC.com, http://www.cnbc.com/id/31331241 19 VGChartz.com, data accessed on March 8, 2010, http://vgchartz.com/games/game.php?id=7703&region=All

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2. Today’s target Market
Today’s targeted population has greatly evolved from the techno geek early adopters who used to buy and play video games from the beginning of the 1970s through the end of the 1990s. This population has also evolved in size over the years. Those two factors have enabled game developers and publishers in the past few years to offer a wide range of products that correspond to several different sub-target markets. A. Global sales number The global target market for video game products is now reaching a huge proportion of adults and teens altogether in the USA. According to market survey conducted by the Entertainment Software Association of America (ESA, the biggest organization of publishers in America), 68% of American households played video games in 200920. Those video games playing households bought a total of almost 300 million units of software in 200821, divided as follows: - Console games: - Computer games: - Portable games: 189.0 million games sold ($8.9 billion revenues) 29.1 million games sold ($701.4 million revenues) 79.5 million games sold ($2.1 billion revenues)

These numbers emphasize how the market is pretty unbalanced, leaning toward providing console gamers with games, but tell us that the sales of software added up to $11.7 billion, which is much more than the $8.37 billion grossed by DVD sales in the U.S. in 200922. Other statistics are really interesting to look at: the ESA market survey shows that the average age of the most frequent game purchaser is 39, and that 92% of the time, parents are present when their children buy or rent games. Therefore, the buying power of

20

The Entertainment Software Association, 2009 Sales, Demographic and Usage Data; Essential facts About the Computer and Video Games Industry, http://www.theesa.com/facts/pdfs/ESA_EF_2009.pdf 21 Theesa.com, The entertainment Software Association website, Industry Facts, Sales & Genre Data, information retrieved on March 9, 2010, http://www.theesa.com/facts/salesandgenre.asp 22 See Note 1

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the regular purchaser of video game software is pretty high compared to what is generally accepted in the public’s opinion. B. Demographics in the target What is even more interesting than software sales trends is the slow shift in the general demographics of the video games user. From the teen agers and young adults that used to play the earliest video games, the target has evolved to include a much wider range of players and buyers. Aging target population In 2006, the average age of the video games player in the USA was 33 years old23. In a 3 year time period, this average age has increased by 2 years to reach 35 years24. Moreover, Exhibit 3 gives an interesting perspective on the evolution of age classes of video game users. While the proportion of 50+ year old gamers stays almost constant, the proportion of young players goes down (-6%) with an almost equivalent increase in players aged 18 to 49 (+5%). This, as we will see further on, is not a sign that less young people play video games. The reason is elsewhere: all the video games users who were 15 years old in 1980 or 1995 are nowadays anywhere between 29 and 44 years old. Coupling this fact with the average age of players tends to show that even though they grow up, video game players don’t really stop playing. They might spend less time on their devises, but they are still buying material and feeding the industry. At the same time, new generations of gamers arrive on the market, but the “under 18” category being comprised of fewer years (18) than the “18-49” category (31), it seems logical, given that the industry has really started picking up in market size only a decade ago (10), that the proportion of adult players has a large potential.

23

The Entertainment Software Association, 2006 Sales, Demographic and Usage Data; Essential facts About the Computer and Video Games Industry, http://www.theesa.com/facts/pdfs/ESA_EF_2006.pdf 24 See note 20

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There has been a clear understanding of the phenomenon in mainstream media, with CBS25 and USA today26, major media companies in the USA, writing articles on this topic. Adult vs. Teen usage There is a unanimous response from teens when they are asked if they play video games: YES. According to some research conducted by the PEW Internet & American Life Project, 97% of teens between 12 and 17 years old play video games, using consoles, a computer, the web or mobile devices27. This survey, of which a table is illustrated under exhibit 4, shows that one out of two children declared having played at least one hour on the day before they were interviewed and approximately one out of four played for two hours or more. Boys tend to play a little more regularly and a little more time than girls, but race, ethnicity and family income were not determining factors in the time spent on video games. Funnily enough, still according to the PEW Internet & American Life Project survey, the rate of college level or college graduate students playing video games is slightly higher than the rate of high school drop-outs. But the average time spent by younger players on video games is longer than it is for older players. On the whole, both young and old customers are interesting for video games marketers. They both represent two somehow different opportunities: young gamers play more on consoles than older gamers who in turn play more games using computers, says the survey. Women and video games There is a common stereotype regarding the composition of the target market in the video games industry: it is an overwhelmingly male world. This, however, might not be as
25

Daniel Sieberg, Nove Over Teens: Adults Are Gamers Too, November 8, 2008, CBS, http://www.cbsnews.com/stories/2008/12/08/eveningnews/main4656412.shtml 26 Reuters press release, Survey: Video Gamers Getting Older, Heading Online, May 12, 2004, http://www.usatoday.com/tech/news/2004-05-12-gamer-demographics_x.htm 27 PEW Internet & American Life Project, Teens, Video Games and Civics, based on a market survey conducted between 11.01.2007 and 02.05.2008, http://pewinternet.org/Reports/2008/Teens-Video-Games-andCivics/04-11-Who-Is-Playing-Games/2-Virtually-all-teens-play-games.aspx?r=1

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true as some people want to make it look like: according to the Entertainment Software Association, 38% of all gamers are female, and they spend on average 7.4 hours per week playing video games28. This stereotype is so strong nowadays but it’s “not a gender issue, *…+ it’s a marketing issue”29. Most mainstream games feature cars, guns, action or other characteristics that, on a first impression basis, may not interest women as much. A Matt West article for CNN in early 200830 gives us a very interesting insight on the problem: “Women are out there in significant numbers playing MMOs, action games, firstperson shooters. What is lacking in the equation are women behind these games. […] Studies and sales data have shown that women are more likely to play hand-held casual games, such as the Nintendo DS, along with social oriented games such as ‘The Sims’ where women make up more than 55 percent of players” This paragraph gives us two takeaways: the first one is that there is generally confusion between women playing and women making video games. If it is true that the workforce is highly male, it is far from true for the consumer target. The second takeaway is that women, even if they might not play some of the same games than men do, have participated in creating new significant segments on the market: the example in the article, The SimsTM, is a franchise that was born in 2000 and that has grossed over $2.5 billion of revenue as of early 201031. Traditional gaming is evolving, and women are a part of the new picture that is being drawn. On the whole, we have witnessed recently a target market that is expanding and diversifying immensely. This is a slow and profound trend that has started to have an influence on the industry as a whole around the beginning of the 2000s. Incidentally, new communication channels have risen between game publishers and gamers, and new previously untapped media are now in use for promotion of video games.
28

David Jenkins, ESA: 38% of Gamers Are Female, March 3, 2008, Gamasutra.com, http://www.gamasutra.com/php-bin/news_index.php?story=17699 29 Matt West, Wooing Women Gamers – And Game Creators, February 28, 2008, CNN, http://www.cnn.com/2008/TECH/ptech/02/27/women.gamers/index.html 30 ibid 31 Electronic Arts Inc., EA’s Groundbreaking Franchise The Sims Turns Ten, February 4, 2010, investor.ea.com, http://investor.ea.com/releasedetail.cfm?releaseid=442922

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C. New promotion media Before Internet had become a commonly accepted technology, video game manufacturers and publishers used to market more to retailers than to the general public. Also, ads in numerous magazines were issued but were targeted to a small and very knowledgeable (almost exclusively) fan-based audience. In the past decade the video game industry has greatly increased the number of channels used in communicating with fans. Blogging: some of the old magazines have become specialized online blogs animated by independent authors who comment new releases and industry trends. They are supposed to be uninfluenced by distributors, but if triggered correctly by those distributors, the network of blogs and online independent content can create a buzz that greatly helps sales of a particular product. Social Networking: Following the trends that appeared with the advent of the Web 2.0, video game publishers and manufacturers have joined the bandwagon of companies going online to create a special link with their customers. Facebook groups, viral marketing campaigns and e-newsletter are generally part of the campaign opening the way for the product’s final release. TV ads: it is not exactly new to have video games commercials on regular TV in the US. What is new, however, is that while the advertising used to be about hardware, nowadays more and more spots are for software products. Game publishers devote an ever growing part of their advertising budget to broadcasting commercials during high ratings programs, the pinnacle of this trend being Electronic Art broadcasting a 30 second commercial for its game Dante’s Inferno during the 2010 Super Bowl in the U.S.A. The Super Bowl is known as the most waited-for moment in TV advertising every year, and in 2010, a single 30 second spot is said to be worth between $2.5 and $2.8 million32. But Electronic Arts president Frank Gibeau was ready to pay that price as he “felt that advertising during the Super Bowl is an

32

CBS News, Super Bowl Ad Prices Dip, But Still Pricey, January 11, 2010, http://www.cbsnews.com/stories/2010/01/11/sportsline/main6082591.shtml

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excellent way to introduce this new IP to a massive cross-section of people33 […+”. TV ads for video games are now used to reach a very vast array of potential buyers. These different strategies focus on reaching a target audience as vast as possible in order to comply with the ever growing diversity of the members of the gamers’ community.

3. Diversification in the type of games
“Video games used to be the type of entertainment that sucked dollars from TV, music and the box office,” said Evan Wilson, an analyst with Pacific Crest Securities. “Now, inside the video game industry, it’s having its own internal distraction issues. There are lots of options.34” This situation has been caused by too many similar games being released on consoles, and for too high a price. Therefore, instead of entering a head-on battle on the console market with the same old “regular” types of games, developers and publishers have found many other ways to make profits. What they have done is mainly trying to appeal to new trends in the target market, and created products that answer the new needs of these customers. A. Blockbusters Releasing games for consoles is a pretty hazardous thing to do nowadays. This is especially true for Sony’s PlayStation 3 and Microsoft’s Xbox 360. Those consoles feature extremely realistic graphics and require to be used with a high definition TV to unleash their fullest potential. Those requirements involve increased development costs. Therefore, when releasing a game for these consoles, publishers need to know that they will get enough sales in order to generate profits. As a result, blockbuster-type games have started sprouting in the video games offer in the last years. These games offer technical characteristics that used to pertain to the biggest Hollywood productions up until now. For some games, like “Heavy Rain”, released in 2010, the focus on the plot is the major interest of the software, which was even qualified as a
33

Jake Gaskill, EA’s First-Ever Super Bowl Commercial: Dante’s Inferno, February 1, 2010, G4TV, http://g4tv.com/thefeed/blog/post/702242/eas-first-ever-super-bowl-commercial-dantes-inferno.html 34 Matt Richtel, Video Game Makers Challenged By the Next Wave of Media, March 29, 2009, The New York Times, http://www.nytimes.com/2009/03/30/technology/30game.html?_r=2

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“game noir35”, in reference to the “film noir” genre used in the film industry. For some other games, the realistic atmosphere that comes from the breath-taking graphics is used to blow the gamer off his feet, like for example “Call of Duty: Modern Warfare 2” which features incredible war scenes that hold as much intensity as Spielberg’s “Saving Private Ryan”. That same game’s main musical theme was written by Oscar-winner Hans Zimmer, best known for his remarkable work on huge Hollywood movies like “The Lion King”, “Gladiator” and the “Pirates of the Caribbean” series. As a result of including all these features in video games, development costs have gone through the roof in recent years. Out of the 10 games that are reported as having the highest development budgets (see Exhibit 5), eight were released after 2007, using the 7th (and current) generation of consoles, either on Sony’s PS3 or on Microsoft’s Xbox 360. Developing a game is becoming a very risky thing to do. These figures are even more impressive when you factor in the advertising and distribution costs: the recently released “Call of Duty: Modern Warfare 2” is said to total an all-inclusive budget of approximately $200 million36, which is unheard of in the video games industry. However, this investment was completely profitable to game publisher Activision who reported having grossed over $1 billion37 only 2 months after the game was released. The game was so anticipated that it became “the biggest launch in history across all forms of entertainment38” from a sales point of view. These blockbusters are expected to become a regular part of the market in the oncoming years, with the major publishers fighting against each other on that specific market with, just like in the film industry, prequels, sequels, spin-offs and other derived

35

Stephen Armstrong, Revolutionary Gaming With Infinite Possibilities, February 28, 2010, Times Online, http://technology.timesonline.co.uk/tol/news/tech_and_web/gadgets_and_gaming/article7039682.ece 36 Ben Fritz, Video Game Borrows Page From Hollywood Playbook, November 18 2009, Los Angeles Times, http://articles.latimes.com/2009/nov/18/business/fi-ct-duty18 37 Ben Fritz, Call of Duty: Modern Warfare 2 tops $1 billion in sales, January 14, 2010, Los Angeles Times, http://articles.latimes.com/2010/jan/14/business/la-fi-warfare-game14-2010jan14 38 Ben Silverman, ‘Modern Warfare 2’ Breaks Day-one Entertainment Sales record, November 12, 2009, videogames.yahoo.com, http://videogames.yahoo.com/events/plugged-in/-modern-warfare-2-breaks-dayone-entertainment-sales-record/1372471

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products. But since they capture such a large part of the total spending dollars of the consumer target, there is only a limited market for those blockbusters every year. Finally, it is interesting to note that there is often no link between a movie blockbuster and a concurring license-based game. Hollywood studios often release games as part of the merchandising campaign for the movie, and the quality of those games, due to short deadlines, is often lesser than that of a regular game. Failure to meet projected sales is the reason why some publishers decide to reduce their involvement in that segment, which is for example the case of Ubi Soft39, following the disappointing sales of ‘James Cameron’s Avatar: The Game’, in spite of the huge revenues of the movie. B. Nintendo and the Wii For those developers and publishers not ready to take the risk of not selling enough games to cover the costs of immensely high-budget games, other solutions were created. Nintendo for example foresaw the threat of increasing costs, and therefore, the company “deliberately did not add high-definition capability to the Wii [console] so games would be cheaper to make40”, said Mr. Fils-Aime, president of Nintendo of America. This meant that less games had to be sold to earn the publisher a return on investment, which was much less risky than when developing a game for another console: games on the Wii do not have to be blockbusters in order to reach break-even point. However, this move meant that the Wii console, which was released in 2006, after its two major competitors, had to have a specific selling point, given that the mind blowing graphics/realism segment was already tapped by Sony and Microsoft. Therefore, Nintendo focused on a new feature that would render the console unique: a 3 dimension motion sensing remote controller that also serves as a pointing device on the screen. Based on infrared and accelerometer technologies, this controller brings a totally new gaming experience, more interactivity than ever before in console gaming.

39

Chris Remo, Ubisoft CEO Guillemot Explains What Went Wrong With Avatar, January 15, 2010, Gamasutra, http://www.gamasutra.com/view/news/26842/Ubisoft_CEO_Guillemot_Explans_What_Went_Wrong_With_ Avatar.php 40 See note 34

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This innovation was from the start designed to bring in as many new customers as possible. It led production costs of the hardware down, hence resulting in a console that sold for only $249 at its launch in the U.S., compared to (on average; different bundles existed) $349 and $549 for Microsoft’s and Sony’s consoles respectively. This ended up in the Wii console selling around 68 million units worldwide (see exhibit 6 for more details), much more than its competition, making the Wii the undisputed leader on all markets worldwide. Moreover, Wii games often have a smaller price tag than their competition (respectively $50 versus $60), which enables them to sell more games: since its launch, which was after its competitors, the Wii has sold over 455 million games worldwide, while the Xbox360 has sold around 330 million units and the PlayStation 3 has sold 217 million 41. Where Nintendo really showed genius was by creating a space in the video game industry for people that had never before played a video game, or who only seldom did so. Seeing the rise of number of casual gamers, Nintendo used its revolutionary motion sensor controller to attract people who were not hardcore gamers, and who looked for something new in gaming rather than the classic challenge or difficulty that arose. Nintendo, witnessing women becoming a more and more important part of the gamers’ community, created games that appeal specifically to them, like for example the ‘Wii Fit’ series. This game is based on “an add-on to the gaming system designed to appeal to women looking to lose weight42”. This new kind of targeting has been an overwhelming success for the Wii, since the original ‘Wii Fit’ game has sold over 22 million copies worldwide (making it the 9th most sold game in history) and the second installment in the series has already sold over 10 million copies. Finally, Nintendo has, following its long history, established a very specific style. They have a few series of games that have gained an utterly amazing fan base, and each of this series bears only one game per generation of consoles. The result is that those games show year after year a very strong attachment rate (a game has an attachment rate of 50%
41

VGChartz.com, Worldwide Weekly Chart For Week Ending 27 February, 2010, Software Totals, source accessed March 11, 2010, http://vgchartz.com/weekly.php 42 Suzanne Vranica, Nintendo hopes its ‘Wii Fit’ Works Out, April 23, 2008, The Wall Street Journal, http://online.wsj.com/article/SB120889895144235997.html

th

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if it is bought by one out of 2 Wii owners). For example, the ‘Mario Kart Wii’ game has shown the same attachment rate of around 25% both in 2008 and 200943, up to 3 years after the console was released. In conclusion, Nintendo’s strategy consists of selling high volumes of less expensive games (less expensive to produce as well as to buy), which creates a widened brand recognition among a diversified target, and a market penetration rate that is a very unique achievement in today’s industry. C. Mobile Applications The introduction of more and more powerful phones combined with many people in developed countries adopting a more urban/technology lifestyle has led to a fast increase in the number of games downloaded to mobile devices in recent years. Some mainstream publishers have created ‘mobile divisions’ that are responsible of coming up with games for devices like the iPhone or the Google Android phones. The market for downloadable games has reached new heights in 2009 (almost $540 million in the U.S., up from $382 million in 200644) in spite of an overall video game industry revenue going down from 2008 to 2009. The main platform that influences sales in the mobile gaming sub-market is the iTunes Store, developed by Apple Inc. The iTunes Store serves as a downloading platform for the iPhone device, whose sales are estimated to have reached around $33 million units as of the end of Apple’s Q4 200945 (September 26, 2009). During 2009, the number of applications (apps) downloaded via the iTunes Store reached 1 billion, although not all of them were games, and even among games, some of them were free apps, not grossing any revenues for the mobile gaming sub-industry. Even if it is possible to develop an app for as low as a few thousands of dollars, it is very difficult to make it visible on a market where hundreds of competing apps appear
43

Chris Kohler, NPD Analysis: How to Sell a Wii Game, January 15, 2010, Wired.com, http://www.wired.com/gamelife/2010/01/npd-analysis-how-to-sell-a-wii-game/ 44 Jason Ankeny, Mobile Gaming Revenues Approach $540 Million in 2009, January 28, 2010, Fierce Mobile Content, http://www.fiercemobilecontent.com/story/mobile-gaming-revenues-approach-540-million2009/2010-01-28 45 Data retrieved from successive Apple’s Quarterly Earnings Reports. Example for Q4 2009 at http://www.apple.com/pr/library/2009/10/19results.html

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every week. Hence, it is easier to make a mobile game visible, and therefore profitable, if it is associated with a strong brand name. This is why companies like Electronic Arts Mobile and Gameloft studios are the leaders of this sector. EA Mobile alone accounted for a full 20% of the $540 million revenues46. They have released games like ‘The Sims’, ‘Need for Speed’ and ‘Tiger Woods PGA Tour’, which are already successful games on the console market. Therefore, a large part of successful mobile games are ports from console games designed to enable fans to play their favorite game while on the move. Gameloft, one of the most known names on the market, has also based some of their games on renowned licenses, like the “Assassin’s Creed’ series for example, but have also created some new IP, which lets them somewhat diversify their offer. This model is however limited. The pricing of games is often very low (between $0.99 and $9.99, even though the average is probably around $2.00), requiring huge sales numbers in order to bring profits back to the developers. However, it is a very young industry and it is growing in a globally depressed economy. It is also predicted to do so in the near future: sales of iPhones are expected to go through the roof, attaining 80 million in 201247, according to an RBC Capital Markets Estimates research. As a result, a number of publishers are currently making moves to enter this potentially huge market. Sony for example is thinking about including a downloadable game option on future cell phones48. Another problem is that innovation is hard to find these days within the mobile gaming offer. Many games are ports of pre-existing games, and while these are successful now, developers will run out pretty fast of games that have a sufficient brand image on consoles to bring revenues on mobile gaming. But at the same time, “it’s hard to provide unique games without excessive risk of getting no revenue from a game that’s so unique

46 47

See note 44 Sam Oliver, iPhone Sales Predicted to Top 80 Million by 2012, August 19, 2009, The Apple Insider, http://www.appleinsider.com/articles/09/08/19/iphone_sales_predicted_to_top_80_million_by_2012.html 48 The Sixth Axis, PSN to Move to Mobile Phones, February 16, 2010, http://www.thesixthaxis.com/2010/02/16/psn-to-move-to-mobile-phones/

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that no one understands it49”. On the whole, the mobile developers and publishers have yet to find the right balance to make the best out of mobile gaming. D. Online Games Among all the solutions that video game developers and publishers trigger to diversify their revenue streams, online gaming is the widest and most complex there is. It takes many forms, follows many different patterns, and grosses revenues in many different ways. We will focus on this trend of online gaming in the second part of this document, in order to be able to really study in-depth its trends, its profitability and its future.

II. Online Video Games Industry
Many studies foresee a glorious future for new technologies in the entertainment industry. As an example, PricewaterhouseCoopers states: “The five years to 2013 will see digital technologies become increasingly pervasive across all segments of entertainment and media […].As a result, by 2013 there will be “no hiding place” from the impact of new digitally-enabled models and revenue streams across the industry50. And the video game industry is no exception to that statement. But before anything else, we should stop a moment and try to define “online gaming”. It can be described in two ways. The first one, which is more academic, would be to say that “online gaming is a technology rather than a genre, a mechanism for connecting players together rather than a particular pattern of gameplay”51. Basically, it is connecting players across internet to let them play together games which have specific gameplay styles (may it be racing games, shooting games, etc…). The second possibility to describe what online gaming is can be

49

Hasan Kamal, Mobile Gaming Trends for 2010, January 14, 2010, TkXel blog, http://www.tkxel.com/blog/2010/01/14/mobile-gaming-trends-for-2010/ 50 Global Entertainment and Media Outlook 2009-2013, Digital Migration Leaves No Hiding Place in 2013, PricewaterhouseCoopers, http://www.pwc.com/en_GX/gx/global-entertainment-media-outlook/pdf/hidingplace.pdf 51 Ernest Adams, Andrew Rowlings, 2006, Fundamentals of Game Design, p.591, Berkeley CA, New Riders Press.

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voiced as follows: any type of gaming that uses Internet-enabled technology to be accessed by the game player. Once again, the game itself can take as many forms as it wants. It is important when analyzing online video games to focus on the two aspects: online gameplay- based games on the one hand, and online distribution of games on the other. Both are driving growth in this sector.

1. Market size
In recent years, the online part of video gaming has grown much faster than the rest of the video game industry. According to research led by Strategy Analytics, online game revenues should grow at an average of 18.7% a year to reach $24.8 billion worldwide by the end of 201352. To put things into perspective, this is more than the actual total revenue of the U.S. entire video game industry in 2008. A. Background for the development of online gaming When examining the reasons for such a positive anticipated growth for this sector, one has to look over the social and technological background, and the changes that occurred in the market. The first explanatory insight that we can consider is the relative media consumption trends: Internet consumption has never stopped increasing ever since Internet became accessible to the public in the mid-1990s. Moreover, people nowadays more and more go online while consuming some other media at the same time. For example, 56.9% of the population surveyed by the Nielsen group declared regularly or occasionally watching TV while going online53 (at least once per month). American media users are more and more connected, increasing the time they spend online, which also enables them to diversify their activities and to come to play games online. Another major trend that partly enables online gaming to have such hopeful prospects is the broadband technology penetration rate in American households: according
52

Rainier, Online Game Revenue Fuels Global Video Game Software Market, February 18, 2010, Worthplaying,com, http://worthplaying.com/article/2010/2/18/news/72455/ 53 nd The Nielsen Company, A2/M2 Three Screen Report, Volume 5, 2 quarter 2009, http://blog.nielsen.com/nielsenwire/wp-content/uploads/2009/09/ThreeScreenReport_US_2Q09REV.pdf

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to some OECD statistics, 26.7% of Americans have access to a broadband connection at the end of Q2 – 2009, up from less than 5% at the end of Q4 – 200154. Moreover, this growth has been very steady over time (see exhibit 7). This is essential for online gaming, since broadband brings more download and upload capacity in terms of sheer volume of information exchanged between distant hardware terminals. Therefore, software used to play online can use more and more demanding capacities from the physical internet network, and it speeds the process of playing online at the same time as it enhances the gameplay and the experience associated with playing online. Finally, the equipment rate in mobile devices that enable downloading games has soared these past years. The open war between cell phone companies to install their devices on the market is raging. While RIM, the Blackberry manufacturer, has a clear lead on the market (52% market share after Q2 – 2009), Apple and the iPhone are catching up (23.3% market share, up from 7% a year before)55. This competition leads to a 40% increase in the market, meaning that the number of potential customers for mobile gaming companies is also increasing at that rate. B. Recent Growth The really interesting fact about online gaming is that it has been the only growing sector of the US video game industry in 2009, in a generally depressed market. Even with the highest grossing month of the industry’s history (December 2009), the hardware and traditional games sectors have not made as much as in 2008. But online gaming gains more publishers and players each year. This increase is visible on many levels. For example, the global audience, even if it is very complicated to come up with aggregated results, is surging everywhere. For example, a Comscore study defined that the online gaming audience (as defined in this study, online gaming concerns websites that provide online flash games requiring no purchase, those
54

OECD Broadband Portal, Directorate for Science, Technology and Industry, data accessed on March 10, 2010, http://www.oecd.org/document/54/0,3343,en_2649_34225_38690102_1_1_1_1,00.html 55 Henry Blodget, Smart Phone Market Update: Apple’s Eating Everyone Else’s Lunch, October 8, 2009, Business Insider, http://www.businessinsider.com/henry-blodget-smart-phone-market-update-apples-eatingeveryone-elses-lunch-2009-10

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website make money on advertising) grew by 22% in the U.S. between May 2008 and May 200956 whereas the total online audience only grew by 2%. Meanwhile, an NPD Group online gaming study published in 2010 revealed that among gamers who report playing online, the time spent playing online has gone up by 10%57 (from7.3 to 8 hours per week). Overall, these figures tend to show that people are spending more of their gaming time online, therefore illustrating the slow shift from traditional gaming to online gaming. This growth in online gaming is deemed strong and sustainable in the medium term, which is positive for already established publishers in the field, and it also attracts a lot of newcomers on this specific market. This influx of talents is a major progress for the industry. It keeps bringing new ideas, creativity at its fullest. In the last years, many formulas have been enhanced or created in order to take advantage of this growing segment. Overlooking at all these diverse types of online gaming is necessary in order to understand the potential of each, and to try to comprehend where the industry is headed in the future.

2. Diversification of online environment
When innovating in a field, there is almost all the time the problem of how to make money. Monetization is always a big deal when trying to tap into new demographic segments, using new technologies or when there are many other free options for the customer: online gaming has to deal with these three issues! Revenue models focused around online video games, focused on the community of gamers, are changing, new solutions have risen, and we should not doubt that many more will appear in the coming decade, to begin with. There are also new ways of making money based on the game itself, on how the game sells, what platform it uses, etc...

56

Comscore Press Release, Online Gaming Continues Strong Growth in U.S. as Consumers Increasingly Opt for Free Entertainment Alternatives, July 10, 2009, http://www.comscore.com/Press_Events/Press_Releases/2009/7/Online_Gaming_Continues_Strong_Growth _in_U.S._as_Consumers_Increasingly_Opt_for_Free_Entertainment_Alternatives/(language)/eng-US 57 Annette Gonzalez, Study Shows Increase In Time Spent Gaming Online, March 2, 2010, GameInformer, http://gameinformer.com/b/news/archive/2010/03/02/study-shows-increase-in-time-spent-gamingonline.aspx

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A. New Revenue Streams The spreading of online gaming habits among the gamers community has opened the way for publishers to create alternative revenue streams to the traditional sales-based revenues they had experienced since the creation of the industry. In-game advertising In-game advertising has almost always been present in the video game industry. The way it used to work was that the development team would for example hardcode data in the virtual world created for the game in order to make the name of a company visible by the player while using the product. For example, a player driving a car in a racing game could sometimes see the name of the development studio on the side of the track. This was mainly self-promotion, since video games companies were not experts in media space selling. But today’s consoles and computers alike are permanently connected to the Web, with the widespread of Broadband usage. This has led to games being enabled for edition of dynamic ads directly from an advertising agency. This process gives more flexibility to media buyers: just like traditional TV or billboard advertising, they can choose the in-game location as well as the duration of display of the ad, as well as the geographical location of the target market. “These publishers have integrated advertising space capabilities”, says Tracy Jennings, Canadian Entertainment Media Leader at PricewaterhouseCoopers58. “Advertising in video games has shifted from a developing process (implemented during the physical development of the game) to an ad-space sales process”, which is much more businessoriented, and therefore much more understood by media planners. Moreover, Tracy Jennings also specifies that given the shift of 18 to 34 year old men from TV to video games in recent years, in-game advertising is a unique possibility for advertisers to recover this lost audience segment59.

58

Tracy Jennings, Global Entertainment and Media Outlook, Video on the Global Video Game Market’s growth, PricewaterhouseCoopers, http://www.pwc.com/gx/en/global-entertainment-media-outlook/videotracey-jennings.jhtml 59 Ibid

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A perfect example is this kind of in-game advertising is that of the American Democratic Party that featured in-game ads in several games a few weeks before the 2008 presidential vote60 (see exhibit 8). They used the in-game specialized ad-agency Massive Incorporated, owned by Microsoft, that was able to reach as many as 18 games for over 3 weeks in 10 states. There has been some amount of negative reaction from gamers, because of a perceived intrusion in a media that was until then previously mainly ad-free. But ads can be slipped into some video games pretty seamlessly, without disrupting the experience, actually making it even more realistic: in sports games, ads on the side of the playing field that are similar to those that can be seen on TV will not be invasive. Similarly, a game set in an urban world can bear billboards on the side of some buildings. The main point advertisers have to be cautious about though is not to include more advertising spaces than can actually be seen in any given urban environment. Plus, they should of course not try to include a billboard featuring a soda in the middle of game happening during the 1st crusade! The in-game advertising spending is estimated to attain $1 billion by 201461, up from $56 million in 2005. However, this has been the case for some years now. In 2006, some industry insiders announced that the figure of $1 billion was going to be reached in 2011, but it was never the case. It is possible that the economic downturn of 2008/2009 has had an influence on this spending, but it can’t be the only explanation. A more sensible explanation would be to say that industry specialists were overly confident back in 2006, with a new generation of consoles just out the manufacturer’s plants, and with an immense potential for growth. There is also the problem of the resistance to in-game advertising caused among online gamers by some very badly publicized examples of disruptive advertising (for example, Sony implementing a disruptive ad at the beginning of each race of the game WipeOut through its in-game ad-agency Double Fusion and having to retract just a

60

Brendan Sinclair, Obama Campaign in Burnout, 17 Other Games, October 14, 2008, Gamespot.com, http://www.gamespot.com/news/6199379.html 61 Screen Digest Global media Intelligence, In-game Ads Poised for Primetime, May 26, 2009, http://www.screendigest.com/press/releases/pr_26_05_2009/view.html

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few days later due to customer complaints). Therefore, in-game ads still have to find their place. Sales of virtual goods Another new revenue model in the video game industry is the virtual goods sales. Virtual goods are objects that are bought with real money, but that are designed to be used in an online, virtual world. Many occidental industry professionals were skeptical of this model since they could not see why people would take some of their spending dollars away from their “real life” and invest it into a virtual world, an online community that does not have tie-ins with their lives. However, with the rise of casual gaming, people are spending more and more time in virtual communities, interacting with other participants. These timeconsuming activities have broken down the barrier that existed between online worlds and real life, enticing players to invest money in their online experience in order to enhance it. As a result, the 2009 ‘Inside Virtual Goods’ report announces that virtual goods sales reached $1 billion in 2009, up from around half a billion in 2008, and the forecast for 2010 is around $1.6 billion62. These virtual goods include both objects bought on social networking websites, such as Facebook and Myspace, and objects bought in stand-alone gaming applications that revolve around a strong community of players. Given the rise in users of both of these medium, as seen later in the document, sales of virtual goods should be booming for at least a few more years. This model can be very lucrative for a company editing worlds involving buying virtual goods, but also for the players who created an avatar (a player’s representation in a virtual world) in those virtual worlds. The well-known example of the Second Life world is perfect to illustrate this statement: Linden Lab, the creator and editor of the game, created a virtual world and also created a virtual currency, the Linden dollar (L$). A whole new economy was therefore created in the virtual world, with the ability to change your real $ into L$ at any time, and in both directions. Market economics being the reference in the
62

Dean Takahashi, Virtual Goods to Hit $1 Billion in 2009 as Social Games Pay Off Big, October 14, 2009, Games Beat, http://games.venturebeat.com/2009/10/14/virtual-goods-sales-to-hit-1-billion-in-2009-as-socialgames-pay-off-big/

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virtual world, some avatars made money very quickly, by manufacturing objects or providing services to other avatars (all of this being virtual), and finally changing the earned virtual L$ into regular dollars. Some gamers even became millionaires by using this scheme63. This anecdote is interesting because users therefore develop a strong fidelity to a game, and the probability of them leaving for a competitor’s virtual world is smaller because of the incentives given to players. Therefore, companies editing these virtual worlds can count on strong and regular revenue from many users. B. Specific online game types trends In-game advertising and virtual goods sales are new revenue streams that did not exist in their present forms a decade ago. However, there are also some segments of the online industry that are booming, and that attract more gamers each year. These types of games, made possible by the increase in broadband and wireless technologies’ usage, propose a specific gaming experience to the players, using specific features that we are going to review. Traditional Multiplayer online Gaming Video games have always involved multiplayer modes, ever since the Pong game was released in the early 1970’s. But what started out as two gamers playing on the same TV set or on two locally connected computers transformed into gamers being able to play with people from all over the world by plugging their gaming device to Internet. That shift happened for Personal Computers around 1995 and the introduction of Internet for home computer’s usage in the U.S. For video game consoles, the introduction of modem-based technology came with the sixth generation of consoles in 1999, with Sega’s Dreamcast, and later with Microsoft’s Xbox, followed by Sony’s PlayStation 2 and finally Nintendo’s GameCube (see exhibit 1). Using this kind of online gaming possibilities, the principal characteristics of the gameplay (the way to play the game and how to win successive levels) are often not
63

Rob Hof, Second’s Life First Millionaire, November 26, 2006, Business Week, http://www.businessweek.com/the_thread/techbeat/archives/2006/11/second_lifes_fi.html

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changed from the single player mode to the multiplayer mode. Albert Reed, co-founder of Demiurge Studios, says “the multiplayer mode on many games is just a feature; multiplayer development is less interesting for many studios64”. Therefore, the multiplayer mode is often secondary to the interest of the single player mode, and very rarely motivates by itself the purchase of regular console and PC games. The games that feature such multiplayer modes playable online for no additional fee than the original buying price are counted as traditional software sales in a regular brickand-mortar store. Therefore, it is not possible to estimate for how much revenue they amount. These games are typically priced at $50 or $60, which is the average price for computer and console games. Massive Multiplayer Online Games A Massive Multiplayer Online Game (MMOG) offers gamers a unique experience: a persistent world that evolves even when the player is not connected, a very strong community focused around attaining objectives that can’t be attained by a player on his own, hierarchical structures and meritocracy based on experience gaining function of the skills shown by each individual in playing the game, and much more. The customer’s appeal for this kind of game is the creation of an avatar that will live in a strong community, gamers organizing themselves into guilds/factions/clans, and where content is always updated or added by the game developers. The loyalty of gamers is secured by the experience system: once someone has spent so much time making his avatar evolve, why go into another game to start all over again? Therefore, publishers of MMOG hold a great CRM asset in the nature of the game itself. This category of games has exploded since the release of the game World of Warcraft by publisher Blizzard Entertainment in 2004. This particular game has acquired a

64

Interview with Albert Reed, co-founder and studio director of Demiurge Studios, at the studio’s headquarters in Cambridge, MA, USA, on February 26, 2010, by Vincent Courson

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huge fan base, reaching 10 million users in early 200865. Overall, there are around 46,000,000 MMOG players in the United States alone66, and this number is still growing. Generally, the revenue model associated with this kind of online gaming is subscription-based. The only compulsory fee for the gamers, apart from the software acquisition costs (boxed product sold or client download), is the monthly subscription that is charged by the game publisher, either by credit card payment or by prepaid card. Some discounts can be applied for purchasing of several months at a time, in order to create incentives to play for a longer period of time. The fees can vary according to several quality criteria, but they generally are between $5 and $15-20 a month. The publishing companies also provide paid services related to the MMOG to the gamers, creating another source of revenue. Finally, publishers also take a cut whenever there are direct micro-transactions within the virtual world, or when virtual currency and real currency are changed. This segment of online gaming presents therefore pretty high revenue: Blizzard Activision, the company behind World of Warcraft, grosses revenue of around $150,000,000/mo just with this game (if all players worldwide pay the equivalent of $15/mo). From a general point of view, the U.S. market is approaching $4 billion revenues (See exhibit 9). It should be profitable for some time, since the communities created are very strong, and if new games come out in the series, they are not stand-alone games, they are extensions of the previous version, so that the editor of the game does not risk losing customers in the process of migrating its fan base from one game to the other, which is a huge average over any kind of competition. Gaming using social networking websites
In early 2009, games using social networking websites like Facebook.com or myspace.com as their gaming platform have started appearing all over the internet and they were very quickly successful. Such games propose a somehow simple gameplay, often asking the user to repeat

65

Blizzard Entertainment, World of Warcraft Reaches New Milestone: 10 Million Subscribers, January 22, 2008, Press release, http://www.diablo4.fr/press/080122.shtml 66 TNS/Gamesindustry.com, Today’s Gamers Graphs MMO Revenues, March 2010, Gamesindustry.com, http://www.gamesindustry.com/about-newzoo/todaysgamers_graphs_MMO

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predetermined actions in order to attain goals defined in the long term. These games have observed the habits of social networks’ users: checking their account at least once every day, sometimes more than once, spending a certain time online on these sites, importance of multitasking… and they have integrated those patterns in their games. For example, many social network games require the user to come once a day to reap the benefits of the actions he took the previous day. This system enables those games to build a strong and committed user-base. The major company issuing social games is Zynga, a 3 year old Californian company. They have managed to release some of the most popular games on Facebook (acclaimed FarmVille, Mafia Wars and Zynga Poker games) and the company shows a spectacular growth potential, with ‘Inside Social Games’ providing the following statistics: the company’s user base has grown from 100 million in September 2009 to 200 million in … November 2009, potential revenues of $200 million in 2009 and of $355 million in 2010 (provisional) and the company’s valuation of between $625 million and $1 billion67. The number of full-time employees has also jumped from 156 to 561 in just a year68, giving indications on the prospects of the company. The revenue model of such companies is mainly based around virtual goods sales, the company offering the possibility to buy objects that help greatly players to complete missions faster. Even though a small part of the millions of players actually pay for such services, it still grosses large revenue for Zynga and similar companies, who can therefore work on other projects: some iPhone and Android applications have been developed and sold by Zynga, in an effort to reach even more customers and to increase their spending on the games, as well as obtaining the revenues from the sales of the apps. It is interesting to see that the focus in this segment of online gaming is put on Facebook, and specifically a certain kind of popular games that seem to copy each other’s worlds constantly: game developer Playfish accused Zynga of copying ideas, gameplay and graphic universe from their

67

Eric Eldon, The latest Stats on Zynga: New Traffic, Revenue and a $1 Billion Valuation?, November 23, 2009, Inside Social Games, http://www.insidesocialgames.com/2009/11/23/the-latest-stats-on-zynga-new-trafficrevenue-and-a-1-billion-valuation/ 68 Reuters, Facebook Nearing $1 Billion Revenue Run Rate, Zynga revenue Triples, December 17, 2009, http://blogs.reuters.com/mediafile/2009/12/17/facebook-nearing-1-billion-revenue-run-rate-zynga-revenuetriples/

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game Restaurant City in order to create Café World69. As a retaliation, Playfish has developed ‘Gangster City’, which is very similar to Zynga’s ‘Mafia Wars’, which is one of the most successful social game. In the midst of all those games, it is difficult for game developers and publishers to make their games known to the target market. Therefore, they try to cross-promote their own creations in already successful games, using in-game banners and side advertising on social networks. Zynga has an important promotion budget on Facebook, which is the platform they use most for their games. It enables them to keep their customer base and to advertise to it without even having to concentrate on other media promotion. This situation leads to only a few developers attracting most of the gamers in this segment: according to the independent Facebook application metricstracking organism AppData, only 4 developers have a customer base of over 50 million players (including Zinga, Facebook itself and Electronic Arts) and only 8 have numbers of over 30 million70. The prospects are good, since social network users’ figures are growing at an incredibly high pace, especially for Facebook, with today over 400 million users who spend an average of 55 minutes on the website71. Another good sign that there is still a lot of place for growth is the rate at which social gaming companies raised funds in 2009: the two biggest fundraising campaigns made by games companies were done by social gaming ones72 (Zynga raised $180 million and Playdom raised $43 million).

Advergames / Casual Gaming
Ever since its beginning, Internet has held websites that propose many games using the Adobe Flash technology in order to play casual games. These games require minimum involvement and difficulty from the player’s part, the player should be able to enjoy the game right away. These characteristics, associated with the low costs of development, make the number of such games almost impossible to count.
69

Andrew Webster, Cloning or Theft? Ars Explores Game Design With Jenova Chen, December 9, 2009, ars technica, http://arstechnica.com/gaming/news/2009/12/cloning-or-theft-ars-explores-game-design-withjenova-chen.ars 70 AppData, Leaderboards for the week ending March 7, 2010, http://www.appdata.com/leaderboard/developers/ 71 Facebook official statistics, data accessed on March 12, 2009, http://www.facebook.com/press/info.php?statistics 72 Dean Takahashi, Revised Video Game Financing List: 115 Game Companies Raised $663.1M in 2009, March 9, 2010, Games Beat, http://games.venturebeat.com/2010/03/09/revised-video-game-financing-list-115game-companies-raised-663-1m-in-2009/

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We will focus on advergames used by companies to promote either a specific product or their brand name in general. Some studios specialize in advergames creation and have created an impressive client-reference list. For example, Three Melons, a 5-year old Argentina-based company, has worked with multinational brands such as Coca-Cola, Pepsi and Sprite in the beverage industry, ABC family, MTV and VH1 in the media industry and other famous brands like Audi, Axe and Lego73. This company has raised capital in 200974 in order to work on more projects, exemplifying the interest of major consumer-market companies to use advergames as a way to reach their target. Advergaming enables to catch the attention of a specific target when they are young, and to increase the brand recognition throughout their lives. What is interesting is that advergames can be used by marketers at many different times of the life cycle of a product: when the product is launched, advergameing solutions are used to bring traffic to the website of the product or of the company; when competing against many competitors, advergames create a special attachment for the potential customers to a specific brand rather than another, when sales are starting to plummet, an advergame can retain a certain audience for a few extra days/weeks/months, etc… Overall, the future of the industry is deemed profitable, even if it is nowadays outshined by other segments that look more promising. Some research by the Yankee Group shows that the advergames segment could grow to generate $312 million in 2009, up from $84 in 200475, but these numbers are not widely accepted. What is sure though is the fact that users find the experience of playing online advergames enjoyable, and they tend to retain better the brand name than with many other forms of advertising, since they associate the entertainment value of the game with the brand that is being promoted. Therefore, the real gain that companies take away from using this medium is intangible, as it might take the form of an increase in sales, a higher website traffic, or other metrics that can not be measured across all segments of the global industry.

73

Three Melons corporate website, Information retrieved on March14, 2010, http://www.threemelons.com/en/clients 74 Robin Wauters, Advergaming StudioThree Melons Raises $600,000, March 24, 2009, TechCrunch, http://techcrunch.com/2009/03/24/advergaming-studio-three-melons-raises-600000/ 75 Wannaplay Corporate Website, What We Do page, data accessed on March 14, 2010, http://www.wannaplay.se/index.php?option=com_content&view=article&id=57&Itemid=55

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In conclusion, game developers and publishers have found other ways to gross profit out of their products while using the online features of their games. Some of these subsegments are still very small compared to the $20+ billion U.S. industry, but they are a major development for the future of the industry, since they are the sectors that are growing the fastest, and they tend to bring in more and more players that would not have played before.

3. Online distribution trends
The video game industry has recently started to trigger the growing data transmission speeds associated with new technologies (fiber optics for example) in order to distribute their products to their target over the Internet, hence diving into the digital distribution frenzy that has overwhelmed many segments of the global entertainment world. The reasons for this shift are multiple, but the mains one is because of the increase in development costs with the arrival of the 7th generation of consoles in 2005 – 2006. Developers and publishers seeing that it cost more to actually produce the game itself saw their overall budgets explode, and the number of sold games necessary to reach break-even on any given project was becoming dangerously high. Other major factors for this new distribution channel are the increased facility in reaching diverse customers, the cutting of costs associated with manufacturing the games’ support (today, mainly DVDs) and shipping it to retail stores, and finally the decrease in overhead costs, such as number of employees. A. Comparison with analogue industries Online distribution model of movies Online distribution already exists on large scales in other industries. The example of the film industry is particularly compelling, with Netflix being the most obvious example that springs to mind. Netflix started out as a DVD rental website: they gave the possibility to create an account and a film queue: the customer added the movies he wanted to see to his

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queue, and the corresponding DVDs would be shipped to him, in the limit of a certain number of DVDs at once. Then, with the appearance of faster connection speeds and larger bandwidth, Netflix started offering a service of online streaming of movies in 2007. The service enables most Netflix customers to stream an unlimited amount of movies for only $9 per month. The movies are streamed directly to their computer’s desktop using a regular high-speed internet connection or to stream them to their television, using devices that are connected to Internet. These include a very wide range of internet-connected Blu-Ray players, HD televisions, specific streaming players, and, funnily enough, through game consoles Wii, Xbox360 and PS3, which all feature internet connection possibilities76. Today, the explosion of wireless technologies makes Netflix look in the direction of mobile handheld devices as a new vector for the distribution of movies, especially for the iPhone77, which represents such a big part of the market of smart phones. The way Netflix is able to propose thousands over thousands of movies and TV shows in its catalogue is by securing licensing deals with major Hollywood studios 78, one after the other, in order to have the highest customer satisfaction. Furthermore, Dan Rayburn states on his Online Video Business Blog “it’s the cost associated with licensing the content that really makes or breaks their streaming service, not the cost of bandwidth 79”, which he estimates at around 5 cents per movie. However, Edward Jay Epstein tells us:

76

Netflix corporate Website, List of Netflix Ready Devices, information accessed on March 14, 2010, http://www.netflix.com/NetflixReadyDevices?lnkctr=mhWNRD 77 Eliot Van Buskirk, Netflix Eyes iPhone for Movies, TV Streaming, March 2, 2010, Wired Online magazine, http://www.wired.com/epicenter/2010/03/netflix-eyes-iphone-for-movie-tv-streaming/ 78 Jeff Meisner, Netflix Wades Deeper Into On-Demand Stream With CBS, Disney Deals, September 23, 2008, ECommerce Times, http://www.ecommercetimes.com/rsstory/64591.html?wlc=1268605861 79 Dan Rayburn, Detailing Netflix’s Streaming Costs: Average Movie Costs Five Cents to Deliver, March 17, 2009, BusinessofVideo.com, http://blog.streamingmedia.com/the_business_of_online_vi/2009/03/estimateson-what-it-costs-netflixs-to-stream-movies.html

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“The first sales doctrine [which enables Netflix to rent physical DVDs without paying any rights] does not apply to streaming or downloading DVDs, so Netflix must buy Digital Rights, which is exceedingly expensive for new titles80”. This comes from the fact that companies distributing movies using streaming technologies only rent them, and therefore the royalty / digital rights system comes into place, creating large cost increases for the distributor. Online distribution model for video games The way online distribution works for video games is mainly hardware based. Each console manufacturer has included online access capacities in their product, which enables the buyers to do 3 main activities: play certain games online with people from all over the world, update the software running the console and finally download games via the dedicated platform built by the manufacturer. Each console connects to a network specifically designed for it and ran by the manufacturer: Sony’s PlayStation 3 connects to the PlayStation Network; Microsoft’s Xbox360 connects to the XBLA (Xbox Live Arcade); Nintendo’s Wii connects to the WiiWare. The iPhone also holds an online platform for downloading games: the Appstore, which sells games as well as other types of applications. It works slightly differently for PCs. There are a variety of different options for users since they have more liberty over what software they install on their hardware. A multitude of services are available, such as Direct2Drive, Download.com or Real Networks, but the most visible and acclaimed one is the ‘Steam’ platform, created by Valve Corporation. All of these video games online distribution platform adopt similar models: developers or publishers ask to be broadcast in the network, the content is then validated by the manufacturer (who runs the platform) and when a game is sold, the scheme for

80

Edward Jay Epstein, Why Netflix Won’t Be the HBO of the 21 Century, February 16, 2010, Business Insider, http://www.businessinsider.com/why-netflix-wont-be-the-hbo-of-the-21st-century-2010-2

st

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profit sharing is around 1/3 for the manufacturer and 2/3 for the developer 81. The games are featured in a list and have a rating, generally based on sales numbers and customer review. The main difference between video games and movies online distribution is that the video games are distributed, indirectly, by their creators, which means there are no royalties of any kind to be paid by the manufacturer. Moreover, a significant advantage for the developers is the profitability: the games are limited in size and therefore require less content creation, bringing down the developing costs. Eitan Gilnert, founder of online distribution oriented studio ‘Fire Hose Games’, states that “online distributed games are plainly easier to develop82”. He estimates that they can often bring back $11 to $12 to the studio out of a $15 sales price, while a game distributed via traditional channels would only bring back $15 to $18 out of a $60 sales price. These calculations should prove the interest that developers have into entering the online distributed games’ model. B. Statistics for specific online distribution platforms Even if, on paper, the online distribution model seems to be the perfect way to go for developers and publishers, let’s examine the main platforms and see if they are profitable and if the market is growing. XBLA – Xbox360 Microsoft’s online distribution platform, the Xbox Live Arcade, functions using a currency, the Microsoft Points (msp), which is used by players to buy games on the platform. In the U.S., $10 are equivalent to 800 points. Those msp can be bought either online or in retail spaces, as ‘Microsoft points cards’. The XBLA was launched in November 2004, originally supported by the first Xbox console (6th generation). Therefore, when the Xbox360 was released in 2005, the platform just had to be transferred from one console to the other, which made it available very early
81

XBL ARCADE, XBLA Business Models Gets Nod From WiiWare, November 13, 2007, http://www.xblarcade.com/node/1409 82 Interview with Eitan Gilnert, founder and creative director of Fire Hose Games, at the GAMBIT’s location in Cambridge, MA, USA, on February 27, 2010, by Vincent Courson

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in the console’s life. Although sales were small in the first years, the XBLS has finally taken off in 2009. A report by the Forecasting and Analysing Digital Entertainment group (FADE) states that the XBLA has grossed around $103 million in 2009, a 34% increase from 200883. All indicators are positive for the platform in the coming years: the FADE reports the average price of a purchase is growing (from $8.33 to $9.12 between ’08 and ’09), “65% of connected Xbox360 customers [download and play] Arcade titles84”, and given “that the number of connected consoles in the U.S. is expected to rise in oncoming years, from 16% in 2008 to 27% in 201185”, the potential target for the segment is going to grow immensely. An interesting trend that can be observed is the fact that, even with a low pricing, some games can really gross revenues that, even though they can’t compare with traditionally distributed blockbusters, represent significative revenues for the publisher: for example, the highest selling XBLA game ‘Battlefield 1943’ has grossed $12.5 million worldwide86, which amounts to over 800,000 units. PlayStation Network Sony’s PlayStation Network (PSN) is a much more complex platform than the XBLA. First of all, while the XBLA only proposes games and movies via Netflix, the PSN has a longer list of services: games and movies of course, but also music, themes, free online gaming... The reason for this is that Sony is much more diversified in the consumer electronics market, with brands like PlayStation (video gaming), Vaio (computing), Sony Ericson (phone) or Bravia (television). Sony’s aim is probably to create a unified experience for its customers all around its devices, and they plan on using the PlayStation Network as the backbone of this unified network87.

83

Ben parfitt, XBLA Revenues Hit $100m in ’09, February 5, 2010, MCV, http://www.mcvuk.com/news/37460/XBLA-revenues-hit-100m-in-09 84 Microsoft Casual Games, Why Develop for Xbox Live Arcade, information accessed March 12, 2010, http://zone.msn.com/en/microsoftcasualgames/xbla.htm 85 See note 81 86 See note 82 87 Tuffcub, Sony “iTunes” Early Next Year?, November 21, 2009, The Sixth Axis, http://www.thesixthaxis.com/2009/11/21/sony-itunes-early-next-year/

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However, it is difficult to isolate data for games sales within the PlayStation Store, the platform for games sales in the PSN, because the Store holds games both for the PS 3 and for the PlayStation Portable (PSP, Sony’s handheld console), and because Sony only communicates global figures for the whole PSN (including movies, etc…). However, Sony expects to hit $500 million in the fiscal year ending March 2010, which is a triple of year-toyear figures88. An educated guess would be to say that video games have participated in this threefold growth. Given the fact that the number of PSN members has reached around 33 million in only 3 years, and is still growing, the future also looks bright for Sony. WiiWare – Wii The WiiWare online distribution platform was introduced by Nintendo for its Wii console in May 2008, over a year after the PSN, and over two years after the XBLA for Xbox360. The platform, much like the PSN and XBLA, uses a virtual currency, the Nintendo points, in order to price its games. The platform is divided between regular WiiWare (which sells new Wii games) and the Virtual Console (which sells ports of games developed for older Nintendo consoles). Figures have not been released yet by Nintendo about its digital sales in order to develop the less than two-year old service away from the public eye, but research firm Forecasting and Analyzing Digital Entertainment (FADE) estimates that the 2009 sales for WiiWare was $59 million, while Virtual Console earned $66 million89, amounting for a total $125 million. This number, supposedly reached in less than 2 years, is based on the number of consoles sold worldwide (68.66 million units worldwide as of March 14, 2010). Interestingly, the Virtual Console part of the market is going down, and the WiiWare part is increasing. This is logical, since the catalogue for new Wii games is becoming bigger and bigger, offering more new experiences to customers. The online offer on this console however is lower than on XBLA and PSN, and this is a consequence of the Wii being partly targeted both at

88

Kenji Hall, Sony’s Hirai Talks About an i-Tunes-Like Store, November 20, 2009, Business Week, http://www.businessweek.com/globalbiz/blog/eyeonasia/archives/2009/11/sonys_hirai_tal.html 89 Daemon Hatfield, WiiWare, Virtual Console Sales Exposed, February 23, 2010, Imagine Games Network, http://wii.ign.com/articles/107/1071420p1.html

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younger gamers and at more casual gamers, both categories not spending as much on downloadable content than the more “hardcore” gamers, who are in general less repulsed by the idea of online purchase and are more tech-savvy. Therefore, the WiiWare is not a pertinent opportunity for all publishers, but more of an opportunity for simpler games that take advantage of the Wii motion sensing controller with studios getting less involved in graphical development. Steam – PC On Personal Computers, Valve Corporation’s ‘Steam’ platform is the current leader in terms of revenues and market share in games online distribution, with an estimated 70% of the market’s revenues90, according to Brad Wardell, from Impulse, the second company in PC online distribution. The long-term growth of the service is undeniably incredibly fast paced, with statistics such as a fifth straight year of unit sales growth of over 100% (205% for 2009)91, an increase in player’s accounts numbers (25+ million active users) and over 1,000 games available, compared to 640+ at the beginning of the year92. However, beside the growth in usually looked-at stats (customers, revenues…), it is necessary to analyze two trends in the Steam model. The first point of interest is the fact that Steam made available the Steamworks suite: development and publishing tools are freely available to selected studios to let them understand the models behind the steam platform and use the system to its full extent. This initiative by Valve, which leans toward the free software scene, is greatly appreciated by developers and they therefore thank Valve for its transparency by bringing their business onto the Steam platform, hence increasing drastically the offer range, the number of games itself, and ultimately the final sales. Transparency and mutual help in the developing, publishing and distributing

90

Kris Graft, Stardock Reveals Impulse, Steam Market Share Estimates, November 19, 2009, Gamasutra, http://www.gamasutra.com/php-bin/news_index.php?story=26158 91 Steam News, Steam Realizes Extraordinary growth in 2009, January 29, 2010, Valve Press Release, http://store.steampowered.com/news/3390/ 92 Eitan Gilnert, Digital Distribution Comparison, May 12, 2009, Fire Hose Games Blog, http://www.firehosegames.com/2009/05/digital_distribution_comparison/#more-393

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processes are good for all the actors on the value chain, and in the end, the customer is enabled to make a more educated choice when buying a game. The second important trend is the fact that the steam platform provides a full range of integrated services, including digital distribution, online multiplayer gaming, digital rights management and communication medium, all provided by Valve. Users who have a Steam account can therefore perform a wide range of activities using the same platform, which strengthens the Steam brand, associated with all kinds of positive customer experiences. Gabe Newell, president of valve, sees the potential of this cross-activities platform and “plans to continue to expand and grow the platform to better serve the developers supporting the open platform and millions of gamers logging in each day93”. Appstore – iPhone We have already seen numbers for the mobile gaming industry were promising, and especially for the iPhone device using the Appstore as an online distribution platform, earlier in this document. However, looking more precisely at the Appstore model, some interesting takeaways appear. First, the Appstore is part of a much bigger platform, the iTunes Store. Using the same account, a user can buy online movies, music, books, video games, applications of all sorts, TV shows. This iTunes Store platform also proposes for free an extensive list of radio streaming and podcasts. This huge offer of entertainment product has helped iTunes become the first online seller of music, and the biggest host of third party mobile applications since the launch of its Appstore in 2008. The second factor to take into account is the fact that with the huge number of applications available in the Appstore, it is very difficult for a developer to make his application known without spending thousands upon thousands of dollars on advertising, with his chance for profitability only increasing slightly. It is easier for already wellestablished names in the industry to launch a game on the Appstore, since they will take advantage of both the name of popular games series to launch a sequel or a prequel and they will trigger their strong advertising and marketing branches.
93

See note 90

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On the whole, online distribution systems for consoles, PCs and mobile devices have all experienced a constant rise in past years. They are an amazing opportunity for developers and publishers alike, as it enables them to cut development costs and distribution costs by selling simpler games. However, this segment of the whole video games industry is not destined to replace the regular distribution on a short-middle term basis. Too many gamers rely on in-game counseling by salesmen and the brick-and-mortar distribution system still attracts many players that are not yet adopters of online technology. What we will probably observe in the 5-10 coming years is at first a continued steep rise of digitally distributed games until they reach a plateau in their percentage part of the market, most probably under 50%.
C. OnLive: the future of online video gaming?

On June 17, 2010, a revolutionary service will be released in the U.S. only: the OnLive Game Service. 8 years in the making this service’s promise is to deliver games to the user through the internet, without the user having to buy any console. The game will be run on the cloud service, at the company’s servers: it will receive commands from the user’s controller or keyboard, execute the actions in the game, compress the video resulting from these actions, and send it on the user’s PC, Mac, TV and even iPhone screen. And all of this in a split second! Scale economies are applied for the company since projected revenues for one server being leased by the company will be bigger than the actual price of leasing the server and transferring the data94. So with any rise in demand, the company leases an additional server, and makes profit out of it. The pricing strategy is pretty simple: replacing the cost of hardware (mainly consoles like the Wii, PS3 and Xbox360) by a monthly subscription of $14.95, and then selling or renting video games to the customer, according to his needs. The Business model seems flawless from a first perspective.
94

Steve Perlman, The Process of Invention: OnLive Video Game Service, December 29, 2009, Video part 3 of 5, http://www.youtube.com/watch?v=tW5-xD7gzLY&feature=player_embedded

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One of the major interests of the OnLive service for gamers is that they do not have to wait for the long download to be complete before they play a game. They can also play from any device they choose, as long as they have a broadband connection; their game saves will be accessible from anywhere, since they are saved in the cloud computing network. And since the spread of fiber optic cables is continuing in the U.S.95, the global average speed of data transmission should enable games to be played seamlessly, without any technical problems. However, there are some uncertainties about this product. First of all, it is a “console killer”. Today, consoles amount to 36.6% of the total retail sales of the video games market96, they represent a huge part of the revenues of Sony, Microsoft and Nintendo. These three companies however also publish games, for their own console and other platforms alike. These games are often successful, especially for Nintendo with licenses like Mario, Pokemon and others. These games represent a non negligible part of software sales, and if the publishing departments of the three main manufacturers decide to boycott the OnLive system in the hope of keeping hardware sales up, it could be a big blow to the new service. Not being able to buy or rent many major games will drive customers away from the service. Another issue is the long-term financial interest that gamers can or can’t get from using the OnLive service. First of all, a few years after new consoles are released, they often engage into a price war, their purchasing costs dropping drastically. This results in consoles being sold for very attractive prices. For example, the Wii console has now dropped to a $199 retail and online price (at Amazon.com) as of March 14, 2010. This means that after 14 months of paying the OnLive monthly subscription, the customer will be paying more than if he had bought the console on March 14, 2010. If we include the price of the two controllers, that figure might reach 18 to 20 months, which is still a small time compared to the life cycle of today’s consoles. Moreover, Eric Brown, CFO of Electronic Arts, stated about
95

Brian Womack and Ari Levy, Google Plans High-Speed Fiber Optic Network Test to Boost Internet Speed, February 10, 2010, Bloomberg, http://www.bloomberg.com/apps/news?pid=20601087&sid=a8fmUF5nd_sc&pos=7 96 See note 9

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this generation of consoles that things will be different this time around concerning the expected life cycle of the current console97: today’s consoles will last longer than the usual 5 to 7 years of a generation. Therefore, paying a $15 monthly subscription will in the end be more expensive than buying the expensive hardware in the first place. Finally, there are doubts about the games being able to be streamed without any lag experienced by gamers. Lag is a slight freezing of the screen due to technical difficulties in rendering the graphics as fast as the action happens in the game, and if there is lag, the game can quickly become impossible to play. And this is a huge problem in the U.S., since the country features low average internet connection speeds: in 2008, the average connection speed was of 1.9 Mbps in the U.S.98 and the OnLive service requires a working minimum of 1.5 Mbps. This should be enough, but we have to remember that the largest video game using hours in the week are nights and weekends, and some of these time periods are in conflict with high internet usage periods. Therefore, lag could be a huge issue for OnLive. All these potential problems for OnLive risk making it unsuccessful, but then again, this new technology could very well win many supporters in the coming months and years. We’ll start to know on June 17, 2010 and after if the system will be the future of gaming or if it has too many drawbacks to be successful yet.

97

Jim Reilly, EA: Console Price Cuts Have A Long Way to Go, February 23, 2010, Imagine Games Network, http://xbox360.ign.com/articles/107/1071385p1.html 98 Circle ID, U.S.Internet Speed growth Too Slow, August 13, 2008, Circle ID Internet Infrastructure, http://www.circleid.com/posts/us_internet_speed_growth_too_slow/

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Conclusion
Over the years, the demand for video games has incredibly increased, with kids of the first waves of video games in the 1870s and 1980s having turned into video game playing adults, and new generations coming in for the newest games. This demand has enticed manufacturers to come up with more developed technologies in order to feature more realistic graphics, new types of gameplay, a more immersive experience and such other characteristics. This has led to a surge in development costs of video games, alongside a consolidation in the video games industry. Some major publishers today control the market, and the space left for smaller developers and publishers is much scarcer, particularly because of increased costs in development of course, but also in marketing, distribution and overhead, as more talents join the industry. Many solutions have been found by actors of the industry, but many of them have major flaws: blockbuster type video games still represent a huge risk, since only a handful of those can come out each year, since they drain such an important part of the consumers’ spending budget; Wii games are selling very well, but they are mainly a reserved domain for Nintendo’s publishing department, with third party publishers struggling to make theur way to the top; mobile gaming is also a profitable segment, but in the midst of thousands of developers, once again, only a few publishers have the possibility to be in full view of most gamers, and therefore to gross profits. However, the final major solution the industry has found, online gaming, is really interesting in two ways. First, the revenue streams have been immensely diversified, enabling companies to make profits using other models than the regular sales schemes that appear to have hit a wall recently, with the global U.S. industry decreasing in numbers from 2008 to 2009. Some new revenue streams, in-game advertising and sales of virtual goods, seem incredibly promising for oncoming years, and should definitely be used by the industry to develop in the right way. Secondly, distributing games online has created a whole new system and, more importantly, a community based on new rules and business practices.

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It has been observed that many digital distribution platforms propose features that create a real competitive advantage over regular retail distribution. Integrating different products and/or services, like is done on the PlayStation Network, the Steam network and the Appstore, enable the customer to merge his previously different, diverse and complicated experiences into seamless navigation, facilitating the browsing, and ultimately, the buying process, which is positive for the segment’s growth in this starting decade. The current generation of consoles is deemed to last much longer than the previous ones, since the added value that better yet graphics would bring to the customer would be too small to justify immense research & development costs from hardware manufacturers. This gives the industry some time to continue fully experimenting alternatives before the technologies change again. Online gaming is probably the way to go for developers to continue expressing their creativity, their talents, and to continue making great games. In the video game industry, customers attach a huge sentimental value to specific products that are often of outstanding quality. The online features of today’s games enable gamers to enter a new millennium where joy and entertainment are shared all over the world, be it inside the game, or in the communities created around a person’s favorite software, but always using this incredible medium that is Internet.

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Exhibits
EXHIBIT 1

Generation

Manufacturer – game system Sega – Saturn Sony – Play Station Nintendo – N64

Release Year (North America) 1994 1995 1996

Common Characteritics Full 3D Technology Support: Switch from Cartridges to CDs (except for the N64)

5

th

6th

Sony – Play Station 2 Microsoft - Xbox Nintendo – Game Cube

2000 2001 2001

Apparition of online gaming possibilities Use of multiple kinds of controllers

7

th

Microsoft – Xbox 360 Sony – Play Station 3 Nintendo – Wii

2005 2006 2006

HD TV enabled consoles Creation of online selling platforms

EXHIBIT 2

Source retrieved on March 8th, 2010, at http://vgsales.wikia.com/wiki/Video_game_industry

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EXHIBIT 3

The average game player's age
50% 40% 30% 20% 10% 0% under 18 18-49 50+ years 2006 2009

Source: The Entertainment Software Association, Sales, Demographic and Usage Data; Essential
facts About the Computer and Video Games Industry. Data for years 2006 and 2007

EXHIBIT 4

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EXHIBIT 5 Video Games with the highest development budget Game name Console Budget Release Killzone 2 PS3 $45 M 2009 Final fantasy XII PS2 $48 M 2006 LA Noire PS3/Xbox360 $50 M 2010 All Points Bulletin PC/Xbox360 $50 M 2010 Halo 3 Xbox360 $55 M 2007 Metal Gear Solid 4 PS3 $60 M 2008 Too human Xbox360 $60+ M 2008 Shenmue Xbox/Dreamcast $70 M 2000 Gran Turismo 5 PS3 $80 M 2010 Grand Theft Auto 4 PC/PS3/Xbox360 $100 M 2008 Source: Digital battle, Top 10 Most Expensive Video Games Budgets Ever, February 12, 2010
http://www.digitalbattle.com/2010/02/20/top-10-most-expensive-video-games-budgets-ever/

EXHIBIT 6 Global sales of hardware (not including handheld devices) Nintendo Wii Microsoft Xbox360 Sony PlayStation 3 68.63 38.48 32.78 32.26 22.27 13.12 10.02 1.26 4.86 26.35 14.95 14.81

Worldwide Sales - American sales - Japan sales - Others

Source: http://www.vgchartz.com Data accessed on March 11, 2010.

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EXHIBIT 7

Broadband penetration, G7 countries through June 35 30 25 20 15 10 5 0 2001- 2002- 2002- 2003- 2003- 2004- 2004- 2005- 2005- 2006- 2006- 2007- 2007- 2008- 2008- 2009Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2
Canada Germany France United Kingdom United States Japan OECD Italy

S

OECD Broadband Portal – Data accessed on March 10, 2010

EXHIBIT 8 Examples of in-game advertising

Screenshot from a game of the NBA Live Series

Screenshot from a game of the Burnout Series

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EXHIBIT 9

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Bibliography
(Repeated sources have been listed only once for clarity purposes) Primary Sources
Interview with Albert Reed, co-founder and studio director of Demiurge Studios, at the studio’s headquarters in Cambridge, MA, USA, on February 26, 2010, by Vincent Courson Interview with Eitan Gilnert, founder and creative director of Fire Hose Games, at the GAMBIT’s location in Cambridge, MA, USA, on February 27, 2010, by Vincent Courson

Research Groups and Academic Sources
Marketshare.hitslink.com, Opreating System Market Share, February 2010. http://marketshare.hitslink.com/operating-system-market-share.aspx?qprid=8 4 According to Pro-blog www.vgchartz.com, as of March 7, 2010 NPD Group Press Release, 2009 U.S. Video Game Industry and PC Game Software Retail Sales Reach $20.2 billion, January 14, 2010, http://www.npd.com/press/releases/press_100114.html NPD 2009 Sales Figures, Wikia gaming, http://vgsales.wikia.com/wiki/NPD_2009_sales_figures Nielsen Wire, Video games Score 5% of U.S. Household Entertainment Budget, February 22, 2010, The Nielsen Company, http://blog.nielsen.com/nielsenwire/consumer/video-games-score-5-of-u-shousehold-entertainment-budget/ Nick Shah and Charles Haigh, The Video Game Industry, An Industry Analysis, From a VC Perspective, March 11, 2005, Tuck at Dartmouth MBA program archives. Journal of Business research, Volume 58, Issue 7, Pages 995-998, Cathy Leach Waters, The United States Launch of the Sony PlayStation 2, July 2005. VGChartz.com, data accessed on March 8, 2010, http://vgchartz.com/games/game.php?id=7703&region=All Theesa.com, The entertainment Software Association website, Industry Facts, Sales & Genre Data, information retrieved on March 9, 2010, http://www.theesa.com/facts/salesandgenre.asp The Entertainment Software Association, 2006 Sales, Demographic and Usage Data; Essential facts About the Computer and Video Games Industry, http://www.theesa.com/facts/pdfs/ESA_EF_2006.pdf The Entertainment Software Association, 2009 Sales, Demographic and Usage Data; Essential facts About the Computer and Video Games Industry, http://www.theesa.com/facts/pdfs/ESA_EF_2009.pdf PEW Internet & American Life Project, Teens, Video Games and Civics, based on a market survey conducted between 11.01.2007 and 02.05.2008, http://pewinternet.org/Reports/2008/Teens-VideoGames-and-Civics/04-11-Who-Is-Playing-Games/2-Virtually-all-teens-play-games.aspx?r=1 th VGChartz.com, Worldwide Weekly Chart For Week Ending 27 February, 2010, Software Totals, source accessed March 11, 2010, http://vgchartz.com/weekly.php Global Entertainment and Media Outlook 2009-2013, Digital Migration Leaves No Hiding Place in 2013, PricewaterhouseCoopers, http://www.pwc.com/en_GX/gx/global-entertainment-mediaoutlook/pdf/hiding-place.pdf Ernest Adams, Andrew Rowlings, 2006, Fundamentals of Game Design, p.591, Berkeley CA, New Riders Press. nd The Nielsen Company, A2/M2 Three Screen Report, Volume 5, 2 quarter 2009, http://blog.nielsen.com/nielsenwire/wpcontent/uploads/2009/09/ThreeScreenReport_US_2Q09REV.pdf TNS/Gamesindustry.com, Today’s Gamers Graphs MMO Revenues, March 2010, Gamesindustry.com, http://www.gamesindustry.com/about-newzoo/todaysgamers_graphs_MMO

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OECD Broadband Portal, Directorate for Science, Technology and Industry, data accessed on March 10, 2010, http://www.oecd.org/document/54/0,3343,en_2649_34225_38690102_1_1_1_1,00.html Tracy Jennings, Global Entertainment and Media Outlook, Video on the Global Video Game Market’s growth, PricewaterhouseCoopers, http://www.pwc.com/gx/en/global-entertainment-mediaoutlook/video-tracey-jennings.jhtml

Press Releases and Official Companies’ Communications
John Gaudiosi, Video gamers Take on a New Battle –the Recession, April 2, 2009, Reuters, http://www.reuters.com/article/idUSTRE53132720090402 Reuters press release, Survey: Video Gamers Getting Older, Heading Online, May 12, 2004, Reuters, http://www.usatoday.com/tech/news/2004-05-12-gamer-demographics_x.htm Electronic Arts Inc., EA’s Groundbreaking Franchise The Sims Turns Ten, February 4, 2010, investor.ea.com, http://investor.ea.com/releasedetail.cfm?releaseid=442922 Data retrieved from successive Apple’s Quarterly Earnings Reports. Example for Q4 2009 at http://www.apple.com/pr/library/2009/10/19results.html Comscore Press Release, Online Gaming Continues Strong Growth in U.S. as Consumers Increasingly Opt for Free Entertainment Alternatives, July 10, 2009, http://www.comscore.com/Press_Events/Press_Releases/2009/7/Online_Gaming_Continues_Strong_Gr owth_in_U.S._as_Consumers_Increasingly_Opt_for_Free_Entertainment_Alternatives/(language)/eng-US Blizzard Entertainment, World of Warcraft Reaches New Milestone: 10 Million Subscribers, January 22, 2008, Press release, http://www.diablo4.fr/press/080122.shtml Reuters, Facebook Nearing $1 Billion Revenue Run Rate, Zynga revenue Triples, December 17, 2009, http://blogs.reuters.com/mediafile/2009/12/17/facebook-nearing-1-billion-revenue-run-rate-zyngarevenue-triples/ Facebook official statistics, data accessed on March 12, 2009, http://www.facebook.com/press/info.php?statistics Three Melons corporate website, Information retrieved on March14, 2010, http://www.threemelons.com/en/clients Wannaplay Corporate Website, What We Do page, data accessed on March 14, 2010, http://www.wannaplay.se/index.php?option=com_content&view=article&id=57&Itemid=55 Netflix corporate Website, List of Netflix Ready Devices, information accessed on March 14, 2010, http://www.netflix.com/NetflixReadyDevices?lnkctr=mhWNRD Microsoft Casual Games, Why Develop for Xbox Live Arcade, information accessed March 12, 2010, http://zone.msn.com/en/microsoftcasualgames/xbla.htm Steam News, Steam Realizes Extraordinary growth in 2009, January 29, 2010, Valve Press Release, http://store.steampowered.com/news/3390/ Eitan Gilnert, Digital Distribution Comparison, May 12, 2009, Fire Hose Games Blog, http://www.firehosegames.com/2009/05/digital_distribution_comparison/#more-393 Steve Perlman, The Process of Invention: OnLive Video Game Service, December 29, 2009, Video part 3 of 5, http://www.youtube.com/watch?v=tW5-xD7gzLY&feature=player_embedded

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Specialized press and blogs
James Brightman, NPD: Video Game and PC Game Industry Totals $20.2 billion in ’09, January 14, 2010, Industrygamers.com, http://www.industrygamers.com/news/npd-video-game-and-pc-game-industrytotals-202-billion-in-09/ Gamasutra.com, Game Developer Reveals Top20 Publishers, October 6, 2009, http://www.gamasutra.com/php-bin/news_index.php?story=25506

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Jose Vilches, Retail PC Game Sales Decline 23 percent in 2009, January 19, 2010, techspot.com, http://www.techspot.com/news/37632-retail-pc-games-sales-decline-23-percent-in-2009.html Kris Graft, 40 Percent of US Homes Have Gaming Console, August 7, 2009, based on study by the Cable & Telecommunications Association for Marketing http://www.gamasutra.com/news?story=24757 David Jenkins, ESA: 38% of Gamers Are Female, March 3, 2008, Gamasutra.com, http://www.gamasutra.com/php-bin/news_index.php?story=17699 Jake Gaskill, EA’s First-Ever Super Bowl Commercial: Dante’s Inferno, February 1, 2010, G4TV, http://g4tv.com/thefeed/blog/post/702242/eas-first-ever-super-bowl-commercial-dantes-inferno.html Ben Silverman, ‘Modern Warfare 2’ Breaks Day-one Entertainment Sales record, November 12, 2009, videogames.yahoo.com, http://videogames.yahoo.com/events/plugged-in/-modern-warfare-2-breaksday-one-entertainment-sales-record/1372471 Chris Remo, Ubisoft CEO Guillemot Explains What Went Wrong With Avatar, January 15, 2010, Gamasutra, http://www.gamasutra.com/view/news/26842/Ubisoft_CEO_Guillemot_Explans_What_Went_Wrong_W ith_Avatar.php Chris Kohler, NPD Analysis: How to Sell a Wii Game, January 15, 2010, Wired.com, http://www.wired.com/gamelife/2010/01/npd-analysis-how-to-sell-a-wii-game/ Jason Ankeny, Mobile Gaming Revenues Approach $540 Million in 2009, January 28, 2010, Fierce Mobile Content, http://www.fiercemobilecontent.com/story/mobile-gaming-revenues-approach-540-million2009/2010-01-28 Sam Oliver, iPhone Sales Predicted to Top 80 Million by 2012, August 19, 2009, The Apple Insider, http://www.appleinsider.com/articles/09/08/19/iphone_sales_predicted_to_top_80_million_by_2012.ht ml The Sixth Axis, PSN to Move to Mobile Phones, February 16, 2010, http://www.thesixthaxis.com/2010/02/16/psn-to-move-to-mobile-phones/ Hasan Kamal, Mobile Gaming Trends for 2010, January 14, 2010, TkXel blog, http://www.tkxel.com/blog/2010/01/14/mobile-gaming-trends-for-2010/ Rainier, Online Game Revenue Fuels Global Video Game Software Market, February 18, 2010, Worthplaying,com, http://worthplaying.com/article/2010/2/18/news/72455/ Annette Gonzalez, Study Shows Increase In Time Spent Gaming Online, March 2, 2010, GameInformer, http://gameinformer.com/b/news/archive/2010/03/02/study-shows-increase-in-time-spent-gamingonline.aspx Brendan Sinclair, Obama Campaign in Burnout, 17 Other Games, October 14, 2008, Gamespot.com, http://www.gamespot.com/news/6199379.html Screen Digest Global media Intelligence, In-game Ads Poised for Primetime, May 26, 2009, http://www.screendigest.com/press/releases/pr_26_05_2009/view.html Dean Takahashi, Virtual Goods to Hit $1 Billion in 2009 as Social Games Pay Off Big, October 14, 2009, Games Beat, http://games.venturebeat.com/2009/10/14/virtual-goods-sales-to-hit-1-billion-in-2009-associal-games-pay-off-big/ Eric Eldon, The latest Stats on Zynga: New Traffic, Revenue and a $1 Billion Valuation?, November 23, 2009, Inside Social Games, http://www.insidesocialgames.com/2009/11/23/the-latest-stats-on-zynganew-traffic-revenue-and-a-1-billion-valuation/ Andrew Webster, Cloning or Theft? Ars Explores Game Design With Jenova Chen, December 9, 2009, ars technica, http://arstechnica.com/gaming/news/2009/12/cloning-or-theft-ars-explores-game-designwith-jenova-chen.ars AppData, Leaderboards for the week ending March 7, 2010, http://www.appdata.com/leaderboard/developers/ Dean Takahashi, Revised Video Game Financing List: 115 Game Companies Raised $663.1M in 2009, March 9, 2010, Games Beat, http://games.venturebeat.com/2010/03/09/revised-video-game-financinglist-115-game-companies-raised-663-1m-in-2009/ Robin Wauters, Advergaming StudioThree Melons Raises $600,000, March 24, 2009, TechCrunch, http://techcrunch.com/2009/03/24/advergaming-studio-three-melons-raises-600000/

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