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The Evolving Games Industry: 1. A supply chain in transition
October 2000
Introduction
I have no doubt that the UK games industry is about to undergo its most significant transition to date. However, this change is not just predicated on the cyclical transition between console platforms, but is
also based on the introduction of new business models and, over time, the evolution of a new industry infrastructure. The aim of this short article is to analyse the current structure of the games industry supply
chain and to predict how the introduction of (digital) networks into this supply chain will alter its composition.
Please note that I have deliberately excluded the future of handheld/mobile gaming as this
will be covered in a separate article (now published here).
The market today
The market woes experienced during the last console platform transition in 94/95 were the result of a synchronised cyclical downturn for the two dominant consoles, SNES and MegaDrive.
The current transition is proving less severe for three principal reasons:
* Dreamcast has arrived early compared to other 128bit platforms.
* The dominant console and handheld platforms, PlayStation and Game Boy, have had a longer than anticipated lifespan.
* Compared to 94/95, the industry has a more stable backbone to it, in the form of the computer games market.
Growth will, as a result, be flat or negative until the end of 2001 when strong growth will resume.
This growth will be driven principally by the introduction of new console technologies from Nintendo and
Microsoft complementing those introduced already by Sega and Sony. Attempting to pick winners is considerably more difficult this time around. The traditional determinants of success (the hardware's technical
prowess, the efficacy of its marketing and the ability of the manufacturers to secure a consistent flow of high quality exclusive software) will be supplemented by a new factor, strategic communications alliances.
To put it simply, should any of the manufacturers adapt their console for use as a multi-function set-top box, it would only take a single order from one of the larger cable, telecoms or wireless companies
to shift the balance of power in the console market. Given that the current crop of new consoles already incorporate all the functionality that TV set-top boxes do (and can offer considerably more) and that most of
the manufacturers have considerable experience of making living-room friendly, low-cost, high-value devices, it is no surprise that communications options are being explored. Sega has formed close alliances with
cable companies in Japan, BT in Europe and AT&T in the US whilst both Sony and Sega have announced that their new platforms will be available for third parties (e.g. cable companies, other set-top box companies)
to license. We expect considerably more strategic partnerships to be revealed by the manufacturers.
These moves are born from the recognition that the advent of the online medium adds an entirely new, and
potentially very valuable dimension to the games market. It is one that will fundamentally change the composition of the games supply chain and will create both winners and losers out of the current constituent
companies.
The current games supply chain
At present the games supply chain flows around publishers who fund the development of (and as a result retain the intellectual property rights to)
games, and employs distributors/wholesalers to efficiently transfer their products to the myriad small and large retailers. The retailers, in turn, are responsible for selling to (and effectively owning) the games
buyer, but are assisted in the process by the publishers who market and promote their products.
Whilst power within the chain effectively rests with the publisher, the main beneficiaries in the video games
market tend to be the console manufacturers who in exploiting a contractually enforced format "monopoly", can command revenue on every title made for their machines irrespective of provenance.
Before moving
onto those areas of the supply chain that will change the most, it is necessary to highlight those that will remain unchanged. As long as the publisher remains the principal owners of the rights to games, it will
keep its key position in the chain. I have no doubt that new publishers might emerge and that developers will increasingly find the funds to self-publish their own titles but they in effect end up competing at the
publisher level and facing the same issue: how to get to the consumer.
The evolving supply chain
It is tempting to believe that the introduction of online distribution will disintermediate the
"middle-men" (i.e. both the retailers and the distributors/wholesalers) and allow the publishers to sell direct to the end-user. However, whilst the traditional roles of the retailer and distributor/wholesaler will
certainly be disintermediated, there will always remain the need for a third party distribution service for the following reasons:
* Gaining customers: Publishers/developers can spend a fortune on marketing their web site and promoting their games in an attempt to alert hardcore gamers and casual gamers to their product offerings. Whilst such promotion is necessary to an extent, relying entirely on this strategy to reach the broadest audience is highly cost inefficient and will be subject to considerable competition (especially considering how low the barriers to entry for games destinations sites are). Securing co-distribution deals with high-traffic partners (such as the AOL/EA US deal) appears to be the logical solution but will not survive for two reasons:
1. As the volume of developer and publisher titles being offered to them increases, traffic partners will, for logistical reasons alone, increasingly be forced to push
responsibility for aggregating them to third party publisher-independent online distributors.
2. No one publisher is big enough to service all of a partner's games needs and even
if a deal is done there will be a considerable and mounting opportunity cost for the traffic partner in not carrying the broadest selection of games. Electronics Boutique would not be able to survive with just Eidos
or Ubisoft games and neither will high-traffic online partners.
* As games move from being products to services, so quality of service will start to play an increasingly vital role in both winning, and most crucially in retaining paying users. Streamed and pre-distributed (e.g. via CD/DVD or single download) single player and multiplayer games require a substantial games network and distribution infrastructure. Such a network is highly cost-ineffective for individual games publishers/developers to build out and maintain themselves. In addition, since publishers/developers' will be increasingly unable to sign traffic individual partnership deals (see above), it is going to be impossible for publishers to build out a network that is large enough to guarantee a sufficiently high quality of service globally.
Many publishers are considering deploying a network of games servers at "central" network access points throughout the world as an alternative and as a means of going direct to the end-user. There are two
key problems with this:
1. The publisher is then faced with the uphill struggle of gaining and retaining customers through direct marketing and sales.
2. Most importantly, such a
central-server based network topology will only improve the quality of service to a limited extent and will by no means guarantee a high quality of service, especially with the advent of broadband (see later). The
internet is only as fast as the slowest router hop on the journey between the end user, the destination server and back again to the end user (this is made even more complex with multiplayer traffic). Latency and
bandwidth both become issues that can only be solved by keeping the network "distance" between the user and the destination server to a minimum of under 2-3 router jumps (and preferably just 1 hop). Since central
server-based games traffic has to cross the public internet, the publisher will still be susceptible to variations in the quality of its service which are totally outside of its control.
This is important
because consumers would not pay for a CD-based game if they knew that it was so bug-ridden as to be unplayable and neither would they continue to pay monthly subscription fees / session fees for games that do not
function properly because of latency or bandwidth issues. This issue is made even more critical if publishers/developers are looking to make inroads into the broader mass-market where only easy-to use, high quality
services will be accepted.
Far from making matters better, the advent of broadband connections will only serve to highlight the bandwidth and latency inadequacies of both the ISPs (none of whom will have
sufficient national and international capacity to cope with the widespread deployment of low contention-ratio consumer broadband services for many years) and the central server-based games network topologies. The
cost of national and international bandwidth for ISPs is coming down (at around 40%/year) but, for example, it still costs an ISP around $2500/month for a 2Mbps connection between London and New York or Brussels.
Indeed, most European ISPs do not have more than around 45Mbps of combined international capacity (i.e 23 concurrent ADSL users at full bandwidth!). One just has to look at the quality of service trouble experienced
currently by ISPs offering unmetered internet access (using mere 56k dial-up connections) to realise the considerable limitations of the current ISP infrastructure.
Supply chain solutions and timescale
The obvious solution to these problems is for a new set of publisher-neutral intermediaries to enter the supply chain. This will take place at two levels, roughly analogous to the existing offline
wholesale/distribution and retail functions.
Online distributors
In the PC market, the online distribution function will be fulfilled by publisher-independent "network" companies the first of
whom (TVML/Hi2) have already built out wide scale "private" distributed games networks through bandwidth rental and high-traffic partnerships. These narrowband/broadband networks have got round the problems
associated with central server based games services and allow multi and single player PC games to be run using CD-based or pre-downloaded titles and even via games streaming technology (which negates the need for a
CD/DVD-ROM) all at guaranteed low latency and optimum bandwidth.
The much talked-about broadband console networks are still a minimum of 12-24 months away (depending on which telecoms/cable/wireless deals are
tied up by whom) and face some mammoth problems. The console manufacturers need to provide a global broadband distributed network (that may not be able to use the existing PC-based ISP infrastructure). However, no
single telecoms/cable/wireless company can provide that on a pan-European (let alone global) basis without additional partnership and so the supply chain for the video games networks could become not only highly
complex but also filled with expensive intermediaries. Finally, the console manufacturer's problems will be exacerbated by the fact that their chosen networks may well be the target of numerous other data service
providers such as the network owner's own ISP/OSP services. High contention-ratios and the resulting poor performance could, therefore, become a major issue. The console companies have, in fact, only just started to
explore relationships with broadband network companies and, as a result of the above issues, the advent of wide-deployment broadband console networks could be as much as 3-5 years off and may well be a PlayStation 3
not PlayStation 2 phenomenon.
Online "retailers"
The traditional retail function in the PC market will be fulfilled online through a combination of direct and partnered sales
strategies. This is because no amount of marketing can ensure that the publisher can get to and win as paying customers all potential games players. But by incentivising other games destination sites/services to win
paying customers for them, they can broaden their user base with limited opportunity cost. I would guess that, for subscription-based games and pay-per play games, the partner will likely only receive a bounty for
initially providing a customer to the publisher, not a share of the ongoing revenue stream. Although a considerable change from the current e-retail margin-based model, this is typical of the current e-commerce
business model for destination content sites and since responsibility for product distribution would bypass the existing games e-retail sites, it would apply to them as well.
Since the proportion of total
games revenue that will come from ongoing sales (e.g. monthly subscriptions/pay per play) should increase dramatically from here on, the traditional "retail" business model could be seriously undermined, especially
if the initial "product" (CD-ROM, download) for subscription-based games is given away for free (a model already being employed) and as streamed games become commonplace. The knock-on effect of this is that price
will stop being the principal differentiator and there will, as a result, be an even greater pressure for the online retailer to generate traffic via other means (e.g. appealing content, community features) or to
change their business model (e.g. to become a content creator/owner).
The console networks could signify an even more gloomy future for offline/online games retailers as it is the intention of the
manufacturers to extend their control of title approval and CD/DVD-ROM manufacturing stages to encompass distribution and it would be a logical extension, once this has been achieved, to take closer control over the
retail stage too. The manufacturers will likely act more as an OSP (like AOL, CompuServe etc…) operating a "walled garden" online service than an ISP offering a vanilla access service. As such they will be in a
position to determine the extent to which the user can access the public internet and will also have complete control over which online services (including online "retail") are featured. Indeed, Sony could
theoretically control the entire retail process too, which would seriously shift the balance of power within the video games supply chain even further towards the manufacturers.
Conclusion
The
games supply chain is likely to become considerably more complex than it currently is and whilst there will be increasing disintermediation at various levels (e.g. physical distribution/retail), these will be
replaced to a great extent by analogous digital intermediaries. The advent of ubiquitous narrowband access has opened up considerable possibilities that few publishers (EA, Microsoft, Sony) have recognised and
benefited from. Broadband takes this further by introducing new pricing models (pay per play/hour/level/month etc…) the technologies for which not only already exist but are also already on commercial trial. By the
time broadband access has become ubiquitous, the games supply chain transition will be complete.
Nick Gibson
Senior Internet and Games Analyst
Durlacher Research Ltd.
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