Analyze This: Online Game Services for the Next-Generation Consoles

You've read their comments countless times in the gaming and, especially, mainstream press. They are the ones who are approached by a reporter on deadline when a story about the videogame biz needs to quote an "expert," and they are even more relied upon when someone is required to distill the intricacies of this industry to people who are not totally familiar with it beyond knowing who Mario or Lara Croft is. They are the professional analysts, whose day job it is to research, follow, advise their clients, and opine to the media about, specifically, the gaming business.

In what we hope will be a regular monthly column, "Analyze This" will simply cut to the chase: Rather than reporting on a subject, and throwing in quotes by analysts to support or refute a point, we'll present a topical question and let the analysts themselves offer their thoughts.

Question: How much of a factor will online gaming services be for the next-generation game consoles? Xbox Live has gotten a lot of hype and critical acclaim. Nintendo and Sony are making moves into online services for their next-generation consoles. But is any of this really that important to ensure the success of a new gaming platform? And which service will matter most -- online multiplayer or downloadable content?

David Cole, DFC Intelligence: "Clearly, online play is starting to become a key feature for all games, especially for a certain core consumer group. Microsoft is making a bet that a robust online game service will be a distinguishing factor for the next generation gamer. I think the key for Nintendo and Sony is to make sure that they do not give the impression that they have fallen too far behind the competition in the area of online games.

"In the short term, a service like Xbox Live can be viewed as a loss leader that is designed to build an installed base. Microsoft is charging such a low subscription price that, on its own, Xbox Live isn't likely to turn a profit in the short term. However, it is proven in the game industry that building a large hardware-installed base becomes very profitable for the manufacturer on many fronts. Thus, the financial importance of Xbox Live is directly tied to how many hardware units it can help sell.

"Online multiplayer, in terms of direct profitability, is an unproven area. Multiplayer is a free value add and, thus, can be seen as an added feature which increases development costs. It may be required to get consumers to buy a certain product, but, like better graphics or sound, it is hard to measure in sheer dollar value.

"Downloadable content is a much clearer profit model and in the long term is likely to have a much bigger effect on shaking up the whole economic structure of the game industry."

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Anita Frazier, The NPD Group: "As technology and capabilities advance, not having some of these [online] capabilities would simply make the system appear to be behind the times. Core gamers are technology lovers and, whether they actually use online play features all that much, having that capability helps games appear more cutting edge. And we do know that, with teens and young adults 'hanging out' online so much these days (a la MySpace), there is an appeal of an online community.

"That said, our research shows that for most games, the amount of time spent playing online is usually less than the time a player spends offline. Online capability seems to have appeal, but it's unclear how broad that appeal extends.

"A big MMO game can be hugely profitable, and generates a great repeat revenue stream via subscriptions, but there is probably a finite segment of the gaming population that will devote that sort of time to these games. The size of the 'less core' audience is much larger and provides more potential opportunity for these micro-transactions."

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David Mercer, Strategy Analytics: "[Xbox] Live is a critical part of the Xbox platform and will improve its overall financial viability. We expect steadily improving take-up of Live as the userbase grows, and online revenues will become an increasingly important component in the overall Xbox business model.

"For Sony, online is just as critical as for Microsoft, but Sony has more to prove because it has a poor track record in Internet and online services, in general. Nintendo is a late-comer to the online world, but its growing support for WiFi games on the DS suggests that it will also promote online capabilities on the [Wii].

"In the near term, online multiplayer is going to be the key driver, but over time we expect console platforms to increasingly add downloadable content as a supplement to physical media distribution."

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Michael Pachter, Wedbush Morgan Securities: "Microsoft has made Xbox Live the centerpiece of its value proposition, and they expect it to drive console sales in the next generation. The biggest differentiator so far is Xbox Live Arcade, which is a great aggregator of casual game content. However, I don't see Microsoft coming close to 50 percent participation, and anticipate that the average will end up around 25 percent. A large niche, but a niche nonetheless. It's hard to assess whether PS3 Online will be sufficiently similar to compete favorably. Nintendo and Sony are entering online solely to neutralize Microsoft and one another.

"I think that ultimately competition will lead to console manufacturers providing [a free] incentive for developers and publishers to create online games. The area I see console manufacturers focusing on is sharing the micro-transaction and in-game advertising pie.

"At the end of the day, console purchase decisions will be made based upon [off-line] content, with Nintendo having the greatest number of exclusive (but the fewest number of third-party) titles, and Microsoft having the fewest."

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Got a business-related question about the gaming industry that you would like to suggest for discussion in a future installment of "Analyze This"? Or, are you a professional analyst who covers the industry and would like to take part in this column? Feel free to send an email to [email protected].

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