Gaming industry heavyweights facing uncertain futures

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The videogame industry, upended by a surge in the popularity of 'casual' mobile and social gaming apps, faces some dramatic years of rethinking and evolution. At the beginning of the current gaming 'generation,' the model comprised two broad categories: consoles, like Microsoft's ( MSFT ) Xbox 360 and Sony's ( SNE ) Playstation 3, and PC games running on home computers.

The widespread adoption of smartphones - used by over half of U.S. consumers and over two-thirds of the key demographic aged 25-34, according to Nielsen - disrupted this dynamic, opening up the portable and versatile world of mobile gaming. At the same time, the rise of Facebook ( FB ) as the world's dominant social network, with over 800 million active users to date, spread fallow ground for the growth of social games, such as Zynga's ( ZNGA ) FarmVille and CityVille.

The new model more closely resembles the traditional structure of PC gaming. The consumer buys or downloads applications onto a multi-purpose piece of hardware that they already own, rather than purchasing or renting software for a dedicated game console hooked up to a TV. In many cases, social and mobile games use a "freemium" model in which the product is offered for free up front but the structure of the game pushes the player towards a series of addictive micro-transactions, garnering cash on the back end from a minority of dedicated, high-spending players. That, in turn, challenges the traditional development tracks of major companies like Electronic Arts ( ERTS ) and Activision Blizzard ( ATVI ), encouraging a transition to more subscription-based models rather than a reliance on major annual releases for their revenue.

Videogames created in the old way changed the face of the entertainment industry, proving, for instance, that games could set first-week sales records which blew traditional movie revenues out of the water. Witness, for example, GTA IV's $500 million opening week for Take-Two Entertainment ( TTWO ) and Halo 3's $170 million first-day sales.

However, the last five years of change in hardware, software and business model mean that the next generation of hardware and software will evolved in radically different ways than they have over the last decade and a half.

Recently, leaked documents purportedly from the Microsoft firm laid out a potential roadmap for development of the Xbox 360 sequel, dubbed the Xbox 720. Key details include a $299 pricepoint, holiday 2013 release date, Blu-ray drive, upgraded Kinect motion capabilities and integration with the company's recently-announced Surface tablet and an as-yet augmented-reality glasses tech called "Fortaleza," the Guardian reports.

"The document goes into great depth about Microsoft's plans to dominate the living room entertainment space, offering video on demand, transmedia entertainment and other applications as well as gaming. It lists the company's key rivals as Apple, Google and OnLive - all producing TV and streaming content solutions. There is also plenty of material related to Microsoft's recently announced SmartGlass app, designed to allow cross-platform interaction between the Xbox console, smartphones and tablets," the British paper writes. "There is 'information', too, on the Xbox 720 tech specs. A slide refers to processing power 6x in excess of the current Xbox 360 - although there seems to be ambiguity over whether the CPU will be based on ARM or Intel processors."

The market for 'traditional,' couch-based gaming remains massive. Witness the success of Activision's Modern Warfare 3, which set an all-time record for an entertainment release reaching $1 billion in revenue last year, hitting that mark in just 16 days (1 day sooner than Avatar). Microsoft appears to want to have its gaming cake and eat it too, pushing for a bigger share of the mobile and tablet industries with its Windows 8 platform and Surface hardware. 

Microsoft has neither confirmed nor denied the authenticity of the leak, but the details seem plausible. As laid out, the plans for the Xbox 720 appear relatively attractive to consumers, but much will depend on rise or decline of demand for big- budget , console-based games and the penetration rate of the new mobile-focused Windows ecosystem. The Redmond, Washington company also needs to shed some of its image as a dowdy office application provider to appeal more effectively to the Apple ( AAPL ) iPhone and Motorola ( MOT ) Droid buyers of the world.

In this, it may take some cues from the history of its competition. The best-selling console of the seventh generation, as it's usually called in the industry, was Nintendo's (PINK: NTDOY ) Wii. This device helped gaming reach out to a broader and more diverse audience, expanding beyond the company's traditional popularity with young men to draw in more women, older gamers and those who previously had no interest in the medium, largely by employing motion controls, cartoonish graphics and a market-beating low price point.

While some purists decried the company's efforts to appeal to these previously ignored demographics, Nintendo rode a wave of critical acclaim and financial success for years. However, discounts on Microsoft's and Sony's offerings eroded the cost advantage of the Wii console, while the new markets it sought out appear relatively saturated and distracted with the novelty of cheap and accessible social and mobile games.

Nintendo also failed to focus on online gaming with the same fervor as its competitors , ceding critical advantage in the market for unified entertainment. Microsoft and Sony happily grabbed that baton and ran with it, mutating their offerings from simple web-enabled game platforms to multimedia centers drawing together services from Hulu, Netflix ( NFLX ), ESPN and other sources.

An editorial by Penny Arcade Report editor Ben Kuchera suggests that Nintendo may have lost its way, fumbling the launch of its new console - the Wii U - and missing the boat on hardware upgrades. The Wii U's controller - a fusion of traditional gaming peripheral and tablet - seems poorly understood by the gaming community . While Nintendo has definitely boosted its processing power, the Wii U won't be able to compete with whatever offerings Microsoft and Sony debut in the next few years.

"Many writers have spilled gallons of ink underestimating Nintendo, but as the company struggles to give the Wii U a strong identity it becomes clear that the system is already troubled. New systems work when they launch with a strong vision and a clear idea of their identity, and right now the Wii U has neither. If Nintendo can't fix that problem, and create an attractive elevator pitch for the market, the holidays are going to be a bloodbath," writes Kuchera.

Of course, everything won't necessarily come up roses for its competitors. Little is known about Sony's replacement for the Playstation 3, which entered the market in 2006 at an eye-watering $500 pricepoint for the most basic model. Though its Cell hardware was innovative, it proved difficult for developers to efficiently code for it, meaning that only a handful of games looked and ran better than competing offerings from Microsoft. The combination of higher prices, late introduction and similar catalogues relegated it firmly to third place behind Microsoft and Nintendo in terms of sales, while high manufacturing costs prevented Sony from making any profit on it.

Microsoft ran on a similarly loss-leading model with the Xbox 360, and massive hardware failures (the Red Ring of Death) hurt the console's reputation early on. However, Microsoft's deep pockets allowed it to bring the hardware to market faster and discount it more aggressively, allowing it to beat the Playstation 3 handily for second place.

The next generation of console wars won't look like the last set, and the surge of social and mobile gaming appear poised to upend traditional juggernauts while creating new champions. It's not clear whether hardware, software or hybrid companies will perform better. Finally, investors should remember that's what good for gamers isn't necessarily what's good for shareholders - and vice-versa.

?Disclosure - the author holds long positions in Zynga ( ZNGA ).



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , Technology , US Markets

Referenced Stocks: NFLX , ZNGA

Daniel Pereira


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