|
Developments in Development
June 2002
Following a period of proliferation during the latter half of the 90s, the independent games development market in Europe has
begun a consolidation phase, the inevitable result of oversupply and narrowing demand. A number of trends are now beginning to emerge that will have important ramifications within the traditional games value chain.
1995: An amateur industry
Games developers would typically pitch a game idea to a publisher who, if
they saw potential in the concept, would fund the development of that title through to completion using advances on royalties (at a pre-agreed royalty rate). Few developers would build an operating margin into their
advances and most developers would see little or no post-advance royalties on their product. What profit was generated from development would frequently be distributed as personal bonuses. As a result, such
developers remained entirely dependent on, and therefore at the mercy of, the publishers who used this status quo to retain punitive deal terms and keep the flow of wealth heading exclusively in their direction,
thus perpetuating a form of development "poverty trap".
Where a developer did achieve a major success, the publisher would more often than not simply buy the developer out - and would often secure their target
for a song due to the developer's business naivety combined with their limited demonstrable historic financial success.
Since games development is an inherently creative process that relies as much on artistic
inspiration as technical capabilities, games development companies rarely scaled well. The larger a developer became, the more management infrastructure would be needed. The more management strictures were applied,
the more constrained the artistic process would become and the less likely the developer would be to create a hit product. Compounding this was the fact that management-level staff within developers would often come
from within the games industry and would gain these positions more because of their relative industry seniority rather than any management skills or experience.
Until the late 90s/early 00s there were no listed
pure-play games developers in the US or UK and few games development companies with more than 5 development teams and/or sales in excess of £10m per annum (i.e. not even at small local publisher levels).
2002: Evolution
7 years on and although wholesale and retail prices are on average lower, the addressable
market of games players and the value of the games market is around 3 times larger. However, developments teams and development costs are on average around 4 times bigger, now necessitating a diverse range of
technical, artistic and other creative talent. Games development has become a considerably more complex, risky but ultimately lucrative business.
At the same time, Publishers are now emerging from the industry's
cyclical transition period (during which most dipped into the red) and have become highly cost-conscious as a result. A corollary of this is that publishers have begun to focus an increasing proportion of their
development investment towards a smaller number of projects and towards larger, more financially stable developers. They are also deliberating for longer over deals and are only rarely willing to invest in a product
at concept stage, preferring instead to sign product at prototype stage or beyond.
This situation has undoubtedly precipitated consolidation but has, at the same time, also opened up considerable opportunities
for intermediaries and given rise to a new type of development company.
The rise of the "super-developer"
Smaller, single team development companies and older development companies that
have failed to keep up with current technology standards have been most at risk although the inability to manage cash-flows and secure regular publishing deals can sink (and has sunk) larger, multi-team development
companies too. Some 7 development companies have gone under in the last 7 months in the UK and this is likely to accelerate into the remainder of 2002 and 2003.
In contrast, the last 7 years, and last 4 years in
particular, has seen the rise of a new type of development company, with greater financial independence, professional corporate structure, experienced management and the ability to scale without jeopardising the
quality of product being developed. Many in this category have made use of buoyant capital markets to raise money privately or on public markets and it is this financial self-sufficiency that is beginning to change
the value chain. These companies, often dubbed "super developers" within the industry, have used their cash in a number of ways:
Subsidise development
– Since most publishers prefer to sign product only after they have seen a prototype of the product in development, developers need to invest to get their product to a sellable stage. Many developers do not have the financial resources even to do this.
Self-fund development – Some have elected to use third party finance to fund the development of a product,
either to completion or to a stage where the quality of the finished product is demonstrable. Examples of this amongst UK developers have been Warthog with its Rally Championship console SKUs, Vis with State of Emergency and Argonaut with Malice.
In both instances the developer managed to secure a higher royalty from the publisher in return for undertaking some or all of the risk.
IPR retention – Often a feature of subsidised or self-funded development, the retention of intellectual
property rights by the developer gives them a considerable asset should the title prove successful. Most publishers try to secure the rights outright but often concede to the developer rights of first refusal on
sequels and derivatives. For a developer to retain the full rights within a standard publisher-funded agreement, they usually have to cede ground on their royalty rate.
Licence acquisition – Although the acquisition of licenses (such as the games rights to films) need not be
capital intensive – developers can secure the rights and a publishing deal back to back with no net cash outflow- many licence deals involve a cash advance to the licence holder, as well as a back-end royalty. Given
the growing dominance of licence-based games, licence-holding developers can use the licence as a bargaining chip to secure better deals with publishers. Examples of UK developers acquiring such a licence are Bits
Corp with the Die Hard console rights and Blitz Games with Chicken Run.
At the same time, the changing development market has seen the intermediation of a number of new types of company:
Middleware providers: Middleware is a catch-all term that refers to technology that is used in the
development process to increase functionality, improve efficiency or assist the management of a project. Games development is a highly competitive and technology-intensive process. Where 4 years ago most developers
would prefer to develop their own game engines, middleware use is now common, even amongst the highest rated developers. With its potential to reduce cost (and thus mitigate development risk) whilst enhancing
functionality, the importance of middleware will only increase and is gradually transforming the business of creating games software from one that is highly technology based to one that is more creative and
artistic.
Outsourced development resources: Related to this but at a nascent stage only, is the concept of outsourcing
elements of the development process to maximise efficiency, minimise costs and improve quality. Due to the scarcity of high-grade, niche talent (such as AI and localisation experts) and the commoditisation of
low-grade development work (such as QA testing and some aspects of art), many developers realise that maintaining such resources in-house is both uneconomic and can constrain the quality of the final product. For
example, developers are increasingly outsourcing elements of their art requirement to specialist art resource companies operating out of India, the Far East and Eastern Europe who can undertake the work quickly and
at considerably lower cost than via UK-based artists.
Development funds: A number of different funds have been announced (if not launched) during the last 6
months. The two principal types are prototype funds and full development funds:
Prototype funds
address the growing gap, discussed earlier, between publishers' reluctance to fund a title's development from concept stage and developers' inability or unwillingness to fund the product to prototype stage. Such funds rely on their ability to firstly identify sellable propositions and secondly potential hits. Although the two may seem synonymous, the prototype fund's principal aim is to secure their investment back as quickly as possible, either on placing the product with a publisher or via milestone payments to the developer. Back-end royalties are an ancillary revenue stream and although they represent the bulk of the upside for the fund, they tend to be restricted by the small proportion of the development budget that their investment covers. An example of a prototype development fund is the Start! games fund.
Full development funds
take the prototype fund concept further by undertaking the majority of or complete funding for a title as well as its project management. The success of such a fund is very much dependent on its ability not only to discover potential hit titles but to manage their development and their eventual placement. As with self-funded development described above, by taking a title to a later stage of development, the fund increases the chance of securing more favourable terms from distributors and publishers. Indeed, if the title has obvious AAA potential, the fund can maximise their returns through auctioning the title amongst publishers. An example of a full development fund company is Capital Entertainment Group.
Interestingly, to meet the growing number of independently funded titles, many publishers have established or expanded their affiliate label and co-publishing divisions. These specialise in undertaking the
sale and marketing of finished goods and are more often than not run with a degree of autonomy to the main publishing division. Whilst they do not carry any development investment risk, these divisions often commit
to marketing and promotional budgets so do not always act as plain distributors. They are significant because they represent a change in the status of the publisher, from developer's employer to developer's
customer. Development companies or development funds with independently-funded and valuable IP have publishers pitching to them rather than having to pitch to publishers. They tend to be able to dictate terms to the
publisher rather than vice-versa and thus allow the developer to take a considerable step up the games value chain.
The next stage
The volume of development projects that are significantly subsidised or self-funded is still small but
as more companies seek and gain independent funding, this market will continue to grow in size and significance. Since these products are more likely to come from the larger, better quality developers, they will
increasingly include AAA potential titles, whether original products, sequels or licenses. Since publishing such products is essentially a low risk or risk-free solution, there will always be a market for them.
Despite the fact that this model diminishes the size of the pie that publishers can claim, it is also a trend that, while the capital market continue to see opportunity in this sector, will prove very difficult to
reverse.
|
