Mobile Gaming is a Giant Treadmill

I find that I have been having the same conversation about mobile gaming repeatedly, with a number of different people. Usually, that’s a signal that I should publish something. Ben Thompson’s post the other day about BuzzFeed was close enough to my subject that I wanted to respond, and just as I went to publish this piece I noticed there is something related on Techcrunch (I have not read the TC post yet, but you should go ahead and click, they need the pageviews more than I do).

Mobile Gaming seems to be the great success story of the Appconomy. There have been something like a dozen game-related IPOs in the past few years, probably double that if you count the China companies. There have also been a large number of nine-digit exits.

Yet for some reason, the mobile gaming industry does not feel like a growth industry. As I posted a couple weeks back, Independent developers are re-considering their career choices. And if you look at the major, public game companies it is hard to find clear signs of mobile wealth. Having spent a few days last week in the Valley, I get the sense that VCs are making few new mobile gaming investments. They are supporting their existing portfolio companies, but there does not seem to be a lot of appetite for new gaming investments.

We could delve back into the subject of the problems with App Stores and new app discovery, but I think there is a broader issue. Mobile gaming has become intensely competitive, and is now very much a hit-driven industry. The most immediate example of this is the decline of King Digital’s fortunes. Their stock is off sharply since the IPO. Their hit title Candy Crush seemingly came from nowhere to become a huge hit. It still throws off incredible amounts of cash, but its growth is slowing and the company has no easy way to replace those declines.

This is the central issue with gaming. Every few months some new game comes along and goes viral, generating huge downloads and revenue ramps. But eventually they fade. Candy Crush seems to have been displaced by a Kardashian game. Remember Farmville? That great Zynga hit, which eventually fell victim to Clash of Clans and Candy Crush itself.

Mobile Gaming is a treadmill. Individual games can grow quickly and last for a long time, but eventually the decline sets in. I think it may prove impossible to build a game with a long shelf life in mobile. Or at least, there will be very few games that can last a long time. This is not so terrible in itself, but it makes it very hard to build an ‘investible’ business, meaning one that can become a sustainable public company.

I think gaming companies are going to start looking a lot more like movie studios. Investment dollars will flow to management teams that can prove they can build a pipeline of games. These gaming ‘studios’ will need to adopt a portfolio approach to game development, knowing that 7 out of 10 games will fail, two will carve out niches for a period, and one will be a multi-year hit or franchise.

The problem with this is that this is not the kind of business that VCs want to invest in. See Thompson’s Stratechery post for more on why that is. For movie studios today, the truth is that movies are just a small part of the business. Any individual film is financed through a hodgepodge of sources. The studios actually outsource a lot of financing of films, and most movies probably lose money. But the studios continue to make a lot of money by selling rights to the movie to every available channel – including DVDs, cable channels, online streaming and merchandising rights. (If you want to understand more of this, I highly recommend you read “The Hollywood Economist”. That work shapes a lot of my thinking about this subject and is very revealing for those of us in Northern California seeking to understand Southern California.)

When I originally started looking at this subject, I thought that today’s mobile gaming companies would end up looking a lot like mobile gaming companies from a decade ago. Remember Jamdat? Probably not, but they were the first mobile gaming company to go public and eventually sell themselves for a healthy sum. Ten years ago, there was an initial rush to build mobile games for phones that were just starting to have color screens. This business was hijacked by the carriers who insisted on something like 50% of the economics, or more. Apple broke that model completely, and if nothing else, we should all be grateful to them for doing so.

However, the more I worked on this, the more I realized that today’s mobile gaming market, for all its problems, is much healthier. In the last go-round, mobile gaming companies ended up being largely dependent on existing media brands. There was no way to build a successful game through word of mouth or feature-phone based ‘app stores’. For a while, there were several dozen mobile gaming companies all trying to buy licenses for whatever movie was due to come out that month. If the movie was a flop, then the mobile gaming company went out of business, having bet their entire cash balance on upfront payments.

Today, mobile gaming companies are no longer stuck between the movie companies and the carriers. They still have the potential to build a hit game. And there is still a lot of room for independents to get lucky. Clash of Clans, Candy Crush and many others are immensely profitable. It is so much cheaper to launch a game today than ever before. As a result there are a lot of profitable games out there.

So while conditions are much improved from ten years ago, mobile gaming is still a cottage enterprise. To become a real industry will require some corporate structure that allows for greater scale. My guess is that companies like Pocket Gems, Kabaam and probably even Zynga, are steadily moving in this direction. These all seem to be doing fairly well now (we’ll see about Zynga), but I think that with time their business model will gradually shift. Instead of designing all their games themselves, they will become platforms for smaller developers to emerge. This is less about technology and more about licensing and clever talent-spotting.

Will the media conglomerates dominate this field too? It would seem natural that the seven studio majors could eventually dominate mobile gaming, given the overlap in content and business model. On the other hand, I think the mobile market is different enough that a few mobile studios will emerge. They will find a way to better cross-promote across their brands. This has so far been hampered by some of the iOS policies, but that is a subject for a different day, and probably not a hard and fast rule in itself. Mobile studios will find ways to make the most of what mobile has to offer and use that to their advantage.

Another way to gauge the value of this market is through the tool makers. A few weeks ago, I admitted that building developer tools did not look like a promising area, but there are still some stand-out successes in gaming. Notably Unity, they build what is probably the leading mobile gaming graphics engine out there. Given the huge number of Unity-based games out there, this company could end up becoming one of the great success stories of mobile gaming. (That being said, I have no idea what their financials look like.)

In the end, I think we still have a lot of transition and exploration ahead of us.