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Online vs. Retail Game Title Economics

As online distribution becomes more valuable, game developers need to balance an increase in the online R&D budget with meaningful ROI. Here's a breakdown of the return on investment for two hypothetical games, one using the traditional retail sales channel and the other using an online subscription model.

The development costs of an online-only game such as GemStone III and Ultima Online and a retail product (even with online capabilities) do not differ as greatly as one might think. In fact, budgets are quite comparable.

The primary difference (other than one product is really a service with years of revenue generating potential, and the other has maybe six weeks at retail to "hit" it big) is in the number of "buyers" necessary to drive the ROI.

However, as online distribution becomes more viable, the question that traditional (retail-only) game developers are really faced with is how to migrate a portion of ongoing R & D to online production, and justify that expense with a meaningful ROI.

Many traditional game developers and publishers dabble in online (i.e. websites, match-making services, licensing product to one or more of the game networks etc.), but they won't make an investment decision in a big way while retail is still the big money maker.

Right now, the existence of the Internet is actually lengthening development cycles for some retail products because developers are trying to figure out how to make those titles "multiplayer," and then get them online. It takes time to do that, and most developers don't allocate the time until the end of the development cycle. Multiplayer capabilities are often an afterthought.

The migration path for retail developers could follow several scenarios, and include:

Updating

Getting a new/updated client to a customer in real time (versus putting those assets in a box) has an implied efficiency. Consider that publishers have traditionally had to deal with "bug" fixes incrementally (i.e. version 1.01, 1.02, 1.03 etc.), then figuring out how many previous units are in the channel and matching those up with a silent update going out.

After those issues are sorted out, there is still be a 6-8 week lag from warehouse "sign-out" to gold master. After that, there is packaging, shipping to warehouse and then out to retail. It's not efficient.

Previously, publishers tried to get from 20-30 issues addressed before shipping new goods. The Internet allows FTP uploads, fixes or enhancements on a daily basis when a customer touches a publisher's site.

Update efficiency is bound to have a direct impact on title profitability. How many times has a title been plagued with a bug or compatibility problem with a specific system that actually stopped people from buying the product? Ongoing updates should increase product life cycles by addressing those shortfalls, which implies two things: 1) a need for less material to be shipped on a ROM; and 2) a longer window of exploitation once the product is in the market.

Customization and Ease of Game Entry

Games and game content cannot be all things to all people. Games have failed to attract mass audiences in large measure because developers have chosen to cater to the hardcore game enthusiast. It's one of the narrowest demographic segments in the marketplace for entertainment product.

There has been very little R & D effort to move games beyond the hardcore player demographic. And, even though that's NOT where the mass market is, a fascination with hardcore gamers has caused developers to accept the reality of ever-lengthening development schedules and rising production values (i.e. costs).

Incremental release of product adds a customization aspect to the game. An arcade hobbyist would typically want all game elements to really make the game a challenge. The hobbyist would want the most accurate simulation or technology experience, for example. Developers spend a significant amount of money in each product to appeal to those customer preferences, small though they may be.

The question is then, how to get started? Step "one" could be to start putting two separate teams into product development, or at least updates. Team "A" ships a version, while Team "B" is in development of the next version.

Instead of 24-month development cycles for games, it may come down to a six-month development cycle per team. Under that scenario, it will be much easier to beat the competition to market with new types of gaming enhancements and technologies.

Products will always be "up and coming," and developers will find themselves in the "service" business (i.e. making both product and updates available on a 24-hour per day, 7-day per week cycle).

With an online only game (see analysis below) budgeted at about $1-$1.2 million, about 20,000 monthly subscribers would be necessary to return a gross margin of 60%. Factoring in churn (subs dropping off the service) running at a monthly rate of 20%, a total of 68,000 new users over the course of one year would be needed to generate that level of profitability.

A comparable retail product selling through that number of units would be a financial disaster. Unit sales of at least 100,000 pieces would be necessary to generate a respectable ROI (see second table below).

Nevertheless, it's still a question of volume for online games as well. 3DO's experience with Meridian 59 revealed that while there is a dedicated group of online gamers, their numbers are small. Meridian 59 averaged about 10,000 players per month. That was enough to cover ongoing production and maintenance, but not enough to reach full development payback.

Both retail and online markets have their problems: Retail has too many products chasing too little retail shelf space. Online titles are chasing too few initiated users and investors have yet to warm up to the concept.

COMPARATIVE INTERACTIVE PRODUCT DEVELOPMENT ANALYSIS
Online vs. Packaged Media Game Development Costs
       
Pro-Forma Online-Only Game Title      
Robust PRG Game Category      
 
----------Year--------------
Production Line Items/Yearly Scenarios
1
2
3
 
 
 
 
Upfront Development Costs
$500,000
$0
$0
Annual Ongoing Development Costs
$112,500
$112,500
$150,000
Annual Billing/Customer Service
$75,000
$75,000
$100,000
Annual Bandwidth Expenses
$150,000
$150,000
$200,000
Annual Computer/hardware costs
$75,000
$75,000
$100,000
Annual Marketing costs
$187,500
$187,500
$250,000
Annual Tech support**
$ -
$ -
$ -
Annual G/A
$150,000
$150,000
$200,000
 
 
 
 
Total Annual Ongoing Costs
$750,000
$750,000
$1,000,000
Total Upfront/Annual Costs
$1,250,000
$750,000
$1,000,000
 
 
 
 
Average Number of Players/Month
15,000
20,000
35,000
Average Number of Hours/Month/Player
10
10
10
Flat rate Fee Per Month
$7.95
$7.95
$7.95
Average Revenue Per Month
$119,250
$159,000
$278,250
Average Revenue Per Year
$1,431,000
$1,908,000
$3,339,000
 
 
 
 
Interactive Product Contribution (Deficit)
$181,000
$1,158,000
$2,339,000
Service Gross Margin #
12.65%
60.69%
70.05%
       
** = Included in Billing/Customer Support costs.
# = Pre taxes, depreciation, amortization, royalties, licenses and technology R & D.
Source: Paul A. Palumbo      
       
Retail Game Title Development And Payback Pro-Format
Robust PRG Game Category      
Self Publisher Model 
------------Year 1 Only------------
Units Shipped  175,000 150,000 200,000
       
Suggested Retail Price $49.95 $49.95 $49.95
Street Price $39.95 $39.95 $39.95
Retail Revenue $2,996,250 $5,992,500 $7,990,000
Wholesale Sell-in Price $24.95 $24.95 $24.95
Wholesale Revenue $1,871,250 $3,742,500 $4,990,000
Marketing/sales $280,688 $486,525 $598,800
Development/R & D Costs $1,500,000 $1,500,000 $1,500,000
Returns Reserve $130,988 $261,975 $349,300
Packaging/Pressing $225,000 $375,000 $500,000
G & A $350,000 $350,000 $350,000
Total COGS $2,486,675 $2,973,500 $3,298,100
Title Contribution -$615,425 $769,000 $1,691,900
Publisher Margin -32.9% 20.5% 33.9%
Source: Paul A. Palumbo      


Paul A. Palumbo is an interactive entertainment analyst, business consultant and reporter based in Seaside, California. He spent three years at the media research firm Paul Kagan Associates, Carmel, CA. as an M & A (mergers & acquisitions) writer and analyst specializing in entertainment media. Mr. Palumbo is a regular contributor to such widely read industry publications as Multimedia Wire, Multimedia Week, New Media Strategist and Lightwave Magazine. He also works with interactive and online publishers/developers to secure finance and expand business opportunities.  He can be reached at [email protected].

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