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By MARCELO PRINCE and PETER ROTH
THE WALL STREET JOURNAL ONLINE
December 21, 2004
It's shaping up to be a high-scoring year for the videogame industry. Microsoft Corp.'s "Halo 2" broke records when it raked in $125 million in its first day on the market, more than any movie has ever made in an opening weekend. After one month in stores, the alien-fighting game has topped $250 million in sales.
Several other sequels, including "Grand Theft Auto: San Andreas" and "Doom 3," have lived up to their blockbuster billings -- and Hollywood-level budgets. U.S. videogame sales are expected to rise 10% this year to $7.76 billion, according to Wedbush Morgan Securities. That's not far behind total U.S. box office receipts, which stood at $8.6 billion at the end of November.
But the fast-growing industry also faces a major challenge: Escalating development and marketing costs are sowing the seeds of an "arms race" that analysts say will intensify as publishers rely more heavily on big releases to generate the lion's share of their profits.
The string of big-budget games released for the holidays is expected to put pressure on some of the smaller publishers, who have significantly fewer titles on shelves and may not be able to survive if even one of them stalls. Among them, Britain's Eidos PLC -- which gained fame with its popular "Tomb Raider" series of games -- has already explored a sale.
"If you're not making a lot of money right now, you're not going to make it in the next generation," says Jeff Brown, vice president of communications for Electronic Arts Inc., the publisher of "Madden NFL 2005" and the industry leader with annual sales of nearly $3 billion.
Once the arena of children and hobbyists, videogames are now a big business dominated by a handful of large media firms that are spending heavily on popular franchises. Just this week, Electronic Arts signed an exclusive five-year deal with the National Football League and the league's players' association to protect its Madden franchise amid a price war in sports games.
Developers now spend upward of $10 million to create their leading games -- an unheard of amount just a few years ago -- and budgets for some high-profile titles can be much higher. Analysts estimate production costs for Microsoft's "Halo 2" were about $20 million (a Microsoft spokeswoman says the cost was "less than $20 million," but declines to be more specific). It's not uncommon for publishers to spend even more on marketing for a hot game.
"What used to be a huge budget with PlayStation One, in the range of $5 million, is now an average budget for PlayStation Two," says Bruno Bonnell, chairman of Atari Inc. "Twenty million dollars. Twenty-five million dollars. These are significant budgets for the industry. We will see, during the next cycle, this kind of investment."
Some games have already eclipsed those levels. Valve Corp., one of the few big independent developers, spent more than $40 million on "Half-Life 2," says Doug Lombardi, Valve's marketing director. The game, known as a first-person shooter for the style of gameplay, was released in November.
Meanwhile, Mr. Bonnell says Atari spent $17 million to develop this summer's "Driv3r" and about $17 million more to market the racing game, which sold more than three million copies but analysts say failed to live up to expectations.
A Microsoft spokeswoman says "Halo 2" has already sold more than five million copies. "The costs to create stellar games continue to increase, but we are looking at ways to help the industry streamline rising costs," she says. Those efforts include building standardized software tools developers can use to make games.
Despite rising costs, hit games are extremely profitable. Take Two Interactive Inc. spent less than $10 million to develop the latest "Grand Theft Auto," says President Paul Eibeler. The game, which retails for $50, could generate world-wide sales of $400 million by year end, says Michael Pachter, analyst at Wedbush Morgan. After taking into account advertising, bonuses for the designers, hardware royalties and manufacturing costs, Mr. Pachter figures the game's gross profit -- in the three months since its release -- has been about $285 million.
Higher Costs Make Firms Risk Averse
Development costs are rising as machines become more powerful and games are packed with better artwork, music and 3-D graphics. Costs are also rising because publishers often create versions for multiple game machines, including several new portable devices. Moving a game from one system to another can cost more than 10% of the original development cost, says Miguel Iribarren, Midway Games Inc.'s vice president of strategic planning.
"The bulk of development cost is the number of people on a team and amount of time they work. As systems become more complex it take more people and longer to develop," says Kevin Bacchus, president of Infinium Labs Inc., a Sarasota, Fla., firm creating a new game machine called the Phantom.
The jump in development and marketing costs has made the videogame industry "enormously risk averse," says Mr. Bacchus, who was an early member of Microsoft's Xbox development team. "It is producing virtually no new franchises."
In recent years, a handful of games has dominated the annual sales figures. But in 2004, publishers released an exceptional number of blockbuster titles, many of them sequels to games from previous years. Banc of America estimates that the top six PC and console titles will generate roughly $1.2 billion to $1.5 billion in sales in the U.S. and Europe this holiday season.
"Normally there are only three really big games every year," says Mr. Pachter. The success of the blockbusters, however, has come at the expense of lower-tier titles. "All the [industry's] growth is being absorbed by new, big games," he says.
Publishers have largely focused on making sequels to successful titles or games based on movie or comic book characters, which are seen as less risky. "We don't green light any more things that will be small or average size games. We push forward on things we imagine can be a top 10 title," says Kathy Vrabeck, president of Activision Inc.'s publishing unit, which made the "SpiderMan 2" game.
"One of the consequences of escalating budgets and escalating conservatism is an awful large number of brilliant game designers' ideas are laying fallow right now," says Seamus Blakley, an Xbox veteran who now works as an agent at Creative Artists Agency in Los Angeles representing a handful of star game designers, like Sims creator Will Wright.
Fewer potential blockbusters are slated for next year, analysts say, as publishers and game designers focus the budgets on new titles for next-generation game machines. Among those slated for 2005 are Sony Corp.'s "Gran Turismo 4" and Nintendo Co.'s next "Zelda" game. Again, there will be many games tied to movies, including "Batman," the "Fantastic Four" and even "The Warriors," a cult hit released in 1979.
Looking Offshore to Cut Costs
Meanwhile, publishers are trying different ways to mitigate costs. In recent years, several have acquired the studios behind hit games to bring development in house -- a trend industry watchers expect to continue. Others are looking to raise game prices or send some design work to Asia where labor costs are lower. Atari's Mr. Bonnell says China and Vietnam have made "incredible progress" in recent years fostering talent for 3-D graphics and computer animation.
"If all games cost $20 million going forward, this industry will be gone in 10 years," says Steve Allison, chief marketing officer at Midway. "I think we'll see a spike in costs and then a leveling off back down to between $10 million to $14 million."
Midway, publisher of fighting game "Mortal Kombat: Deception," plans to reduce production costs by doing two-thirds of its game design internally, which is 15-20% more profitable for the company. It now splits its development evenly between in-house teams and outside programmers.
Jennifer Jordan, an analyst at Wells Fargo Securities, notes that so far the soaring costs have been offset by rapid growth. But she sees the industry headed toward an "inflection point" where growth cools and companies get squeezed by rising development budgets. Some game publishers are already mulling a price increase next year -- no small matter in an industry where premium games can already cost more than $60.
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Ah what we do for news without such insight by Jeff Brown. I hope he attends E3 next year, something tells me it would be his last.
Was shocked that GTA San Andreas cost less then 10 million to develop considering the size of the game. Cost less to make then DriV3r from Atari.
