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What it takes to “Deal the Game”?
Authored By:
Luv Parakh
IIM Indore – Batch of 2009
Mail : p07luvp@iimidr.ac.in
“And in my opinion, entertainment in its
broadest sense has become a necessity rather than a luxury in life ...”
Walt
Disney
When Steve Russell, Martin Graetz and Wayne
Wiitanen of the Massachusetts Institute of Technology conceived of a “space
toy” on their oscilloscopes, better known as SpaceWar! to the world, little did they know that they would be laying the foundation for
a whole industry. An industry, which provides the most boundless and immersive
form of entertainment thought of in the mind of Man.
 The
sheer realm of possibilities with interactivity and the novelty of the medium
led to the “Golden Age” of electronic gaming in the late ‘70s and early ‘80s.
But the initial success (as exemplified by well known names like Atari) was
short-lived, because of market saturation due to the entry of more and more
mediocre products and also, players in associated fields like toys and mass
media. Around ’83-’84, the nascent industry imploded upon itself with little
hope of resurgence. Interactive gaming seemed to have become another flash in
the pan.
But the arrival of Nintendo from the Land of the Rising Sun
reinvigorated the dying market in the States. Their success was a result of hardware
innovations and creative software development, coupled with stringent quality
control and almost a paranoid protection of IPR. Their almost monopolistic grip
can be gauged from the fact that their flagship product, the Nintendo
Entertainment System (NES) is considered to be synonymous with early video
games.
From that time onwards, the gaming industry hasn’t looked
back. The global video game market, currently at not a very modest figure of
$37.5 billion, is slated to continue its growth trend according to PwC: It is
projected to reach a whopping $49 billion by 2011. Hollywood is already well
overtaken and the US music industry is also projected to be overwhelmed this
year itself. The PwC report also says that from now till 2011, it is going to
be the Asia-Pacific market which is going to register the largest growth and
see the largest amount of spending, peaking at almost $19 billion in 2011 with
a CAGR of 10%, as compared to that of US
market’s 6.7%
Not Child’s Play Anymore
 According to the Entertainment Software
Association (ESA), the American body dedicated to handling the business and
public affairs needs of video & computer game publishing companies, the
average age of an American game player is 33 years, and has been playing for
the past 12 years. The average age of the most frequent game buyer
is 38 years. In 2007, 92 percent of computer game buyers and 80 percent of
console game buyers were over the age of 18.
“"Male, female what's the difference? Power is beautiful
and I have the power."
–Flea, Chrono Trigger
Other surprising statistics: Female players over 18 years of
age constitute a larger chunk of gamer population (30%) than boys below 18
(23%)! And contrary to the popular notion about games, the share of “violent”
shooting and action computer games among the last year’s bestsellers (19.1%)
pales in comparison to the share for strategy games (30.8%). This latter
statistic could explain the increased penetration among the female population.
Industrial Insight
The gaming industry primarily consists of two parties: the
publishers and the developers.
Game publishers are companies that fund development, guide
content creation, manufacture the physical product, get the games onto the
shelves of stores, and promote them to the consumer. In the case of console
games, some publishers also own the hardware platform on which their games are
distributed. For example, Sony owns the PlayStation2, Nintendo owns the
GameCube and Game Boy, and Microsoft owns the Xbox.
Typically, a publisher will contract with an external
development company to create a game, paying the developer in instalments as
various milestones are reached. These payments are usually an advance against
royalties, so if a game is successful, the developer will “earn out” and get
additional payments. Some publishers also have internal development groups,
usually referred to as studios.
Development companies are the organizations that actually
build the games. Developers write the code, create the art, record the sounds,
and perform all the other myriad tasks that go into making the “master disc”
from which thousands or millions of copies will be made. There are several
kinds of relationships a developer can have with a publisher, each with its own
name:
 First Party Developers are
studios owned by publishers. These studios generally create games exclusively
for the platforms that are manufactured by their parent organization. We have
not listed first party developers since they are owned by publishers.
Independent Third Party
Developers are independent companies who are not bound to a particular
publisher or platform.
Second Party Developers are
independently-owned studios that create games for a publisher that owns a
particular hardware platform.
Note that a single developer may maintain
different kinds of relationships with different publishers.
Besides them, there also are contractors specializing in
specific areas of content creation like music, sound effects, high-end
graphics, physics engines etc.), and the distributors who act as middlemen
between publishers and small independent retail stores which can’t be reached
by the publisher’s sales force.
Games the Sellers Play
It used to be that a new game had four to six months after
its release to find an audience. Advertisements were timed to appear a few
weeks after the initial shelf date because marketers didn’t see any sense in
promoting something the public couldn’t yet buy. Magazines focused on re-views
instead of pre-views because they wanted to see the final product before
passing judgement. TV ads were unheard of.
Not anymore.
Today, a game has as little as two weeks to prove that it
belongs on retailers’ shelves. Chain stores have specific targets for “turning”
their shelves and are strict about enforcing them. If a game is not meeting
those goals soon after it comes out, your sales group will come under immediate
pressure for markdowns (sometimes called price protection) or returns.
When a game goes onto a store shelf, it hasn’t yet been
truly sold. The retailer has the right to return it to the publisher for a 100%
credit against future product. This creates an interesting struggle between the
retailer, who wants to carry only games that sell well, and the publisher, who
wants all their games to stay on store shelves as long as possible. This
balance of power is usually even: The retailer wants a supply of games to sell,
and the publisher wants a place to sell his games.
Sometimes, however, the equation becomes unbalanced. If the
retailer has a large backlog of the publisher’s games languishing on their
shelves, they can refuse to bring in more until the deadwood is cleared out. On
the other hand, if a publisher has a hot new game coming out, they can try to
muscle other games in the door on the coattails of the hit.
It is this dynamic that prohibits small, independent
publishers from flourishing. When you have only one or two games per year, you
are too risky a proposition for the retail channel to deal with. They are
afraid (and rightfully so) that if one of your games is not successful, they
will have no realistic chance of getting back their money and will be stuck
holding the bag. With larger publishers, new products are always coming along,
and it’s in the best interest of both parties to clear up inventory problems as
the year goes along.
Before retail buyers will bring in a game, they have to be
convinced that it will sell. They use various guidelines to help with this
decision: the pitch from the sales force, the sell sheet, the box art, the
industry buzz, and above all, pre-orders. This means that the marketing, PR,
and sales campaigns all must be geared to create maximum consumer demand for
your game before it even ships! Games almost never start slowly and then ramp
up. Generally, the largest sales come within four weeks of release, and the
ultimate lifespan is determined by how slowly the weekly sell-through numbers
degrade thereafter. Exceptions occur, but they are rare and usually caused by
chance factors, such as a popular movie suddenly sparking interest in a
particular subject.
This pressure to create advance demand is why there are
advertisements for games that won’t be out for another six months. It’s why
publishers push magazines to run previews of their games. It’s why web sites
devoted to games in development have sprung up. More than anything else, it’s
why there is such pressure on the development team to deliver the game on time.
Wheeling and Dealing
 Whether
it’s a publisher’s producer working with an outside developer or an independent
developer selling his wares to a publisher, at some point there would have to
be negotiations for a development deal.
An advance is a royalty that is paid before it is earned.
Generally, for every unit a publisher sells, he pays the developer a percentage
of the money received. An advance is money paid by the publisher to the
developer before the product has sold those units.
Advances
Advances are generally not recoupable i.e. after a publisher
makes a payment to the developer, he usually can’t get it back.
When a game has sold enough units to cover these advances,
it is said to have earned out. Money
paid to the developer after this point is commonly called the back end.
Publishers want the developer on the lowest advances
possible, not just for their own cash flow but also to give incentive to the
developer to make a great game so that he’ll get to the back end. If a
developer has huge advances, he knows that the odds of earning out are slim,
and there is correspondingly less incentive to extend himself for the game.
Ideally, what the publishers want is a partnership in which the developer is
participating in the risk. The more the developer shoulders the up-front costs,
the higher his royalty will be. The developer, on the other hand, wants the
advances to be high enough to cover the costs of running his business while the
game is in development. It is in neither party’s best interests for the
developer to go belly up halfway through the project. On top of that, the
developer  wants
to build in a little profit up front because the publisher always retains the
option to kill the game at any time. This can leave a developer, who has been
counting on reaching the back end, high and dry. Sometimes this particular
contingency is addressed by establishing a kill
fee - a fee paid to the developer if the publisher decides to drop the
game.
The negotiation over
advances is always about finding each others’ “point of pain” and determining
whether an accommodation can be reached whereby both sides are only a little
uncomfortable.
Royalties
Royalties vary greatly, and the percentage changes with how
much risk the developer is willing to take on. Development houses that fund all
their own development and don’t take advances from the publisher are entitled
to a higher royalty because they are taking on the risk of development.
The basis of the royalty is also important. Usually, it is
the wholesale (not the retail) price paid for the game, less the COGS (Cost of
Goods Sold), marketing, and shipping. Other items that the publisher will
request and the developer will resist are market development funds (MDF),
license fees, and the publisher’s distributed overhead costs.
The royalty percentage is likely to decrease as the game is
managed through its lifecycle. When the wholesale price drops below a certain
percentage of its original price, the royalty can disappear altogether. Then a
publisher can get rid of old product without being hampered by royalty
accounting.
If a publisher and developer are working on more than one
game at a time, the publisher can seek to cross-collateralize the games. This
links the finances of the two. The practical result is that the publisher can
withhold royalty payments on one product if the other product has not earned out
its advances. This is favourable to the publisher and will be resisted by the
developer.
Reserve Against Returns
Because retail stores can return 100% of their stock to the
publisher at any point, a game isn’t truly sold until it has sold through.
(Even then, things can get dodgy because some stores allow limited return
rights to their customers. Even a unit that has sold through can sometimes find
its way back to the publisher.)
Because publishers hate to go back to a developer and try to
extract money they’ve already paid, they build in a reserve against returns.
This means that whenever a royalty is due, the publisher holds back a certain
percentage of it, just in case the game eventually comes back from the
retailer.
This reserve ranges from 15% to 30%. The reserve is
generally liquidated over a 12 to 18-month period.
Milestones and Deliverables
Advances are generally hooked to milestones, which are
significant points in development marked by the completion of a certain amount
of work (a deliverable). An initial advance is usually paid on the signing of
the contract, but the rest of the payments hinge on completion of the
deliverables. The milestones are appended to the contract, and their
deliverables precisely defined. This protects both sides.
It is entirely reasonable for the milestone dates and
deliverables to change in the course of development.
Rights
Generally, each side of the table wants to retain as many
rights as possible. A developer with an original intellectual property (IP),
thinks long and hard before assigning it to a publisher. A publisher, however,
thinks equally long and hard about ploughing millions into developing and
promoting an IP that the developer can walk away with after two years.
Proprietary Technology
The publisher needs to have access to all the code necessary
to publish and maintain the game. The developer should have the right to hold
on to his own engine and tools. Some negotiation must take place here, but the
issue should be explicitly addressed within the contract so no disputes arise
over who owns what after the companies go their separate ways.
Other issues to be factored into the contract or deal can
include a fixed term, so that no side has obligations for long periods, deal
termination and its consequences, confidentiality, and ancillary revenues.
End game
Electronic games are interactive media par excellence
because their entertainment value arises from the loop between the player and
the game, with or without networked co players. This interactive feedback cycle
is often represented as a dramatic releasing improvement over traditional
one-way media and passive audiences: a step up in cultural creativity,
technological empowerment, and consumer authority. Video and computer games
herald a brave new world that has broken completely with the constraints and
compulsions of the mass media, and whose future is as bright as mankind’s.
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