Analysis: Do Big Investments In Innovation Hurt Publishers?

Is the path to profitability truly "more of the same?" Alongside the economic downturn, it's become more and more common for publishers to report big losses -- even when revenues are up. Electronic Arts is one such company, and after its holiday portfolio fell short of expectations, CEO John Riccitiello is now admitting that the company needs to get its operating costs way, way down. THQ's story is strikingly similar to EA's -- the company invested heavily in diversifying its product line and in making meaningful improvements to its quality scores, and like EA, it achieved both goals. CEO Brian Farrell sounded similar to Riccitiello when, on the company's results call to investors, he cited the improvements in THQ's Metacritic scores. And few of either publisher's new marquee titles sold outright poorly, either. EA's Need For Speed: Undercover, which for a time many pegged as the last gasp in an embattled franchise, sold 5.2 million units, for example; THQ's quality-boosted Saints Row 2 and WWE Smackdown vs. RAW 2009, have shipped 2.6 and 4 million units, respectively. Clearly, both publishers outspent their earning power and overestimated the return on investment that new change efforts would yield. THQ in particular was between a rock and a hard place; many analysts say its stable of franchises is "declining," and yet it's lost cash trying to diversify, too. So is innovation really the straight path to financial losses, at least in a recession? Stick To What You Know "The companies doing the best are the ones who have stuck to what they know how to do," says Wedbush Morgan analyst Michael Pachter. Activision is one publisher that analysts expect to resist the recession well and to report strong profitability with its results next week. "Activision does two things: packaged goods and MMO, and it merged with the MMO," says Pachter. Most publishers agree it's crucial to explore new business models; EA's Riccitiello recently said he'd invest over $100 million in the long-term potential of online businesses, and Take-Two Board chairman Strauss Zelnick has also stressed that connected, multiplayer gaming must become an increasing part of the publisher's business. But the success stories seem to happen when publishers find a way to move in that direction without themselves making the investment. Don't Spend On Online? Activision gained its entire online business in one fell swoop when it added Blizzard to its lineup in the Vivendi merger. "They didn't spend a penny on MMOs, casual online, cell phone games, microtransactions delivery, etc. over the last few years, and focused all of their efforts on making blockbusters," Pachter says. Although Nintendo's often criticized for its relative slowness to create and support multiplayer gaming opportunities on its platform and in its first party titles, it stands as one of the current climate's few strongly profitable companies right now, even with "zero investment in online," as Pachter says. "On the other hand, EA and THQ both were trying to build cell phone games businesses, and both have invested a ton in online," the analyst observes. "Neither of those businesses have generated sufficient revenues for the two companies to justify the level of spending." Overspending On Owned IP And yes, both THQ and EA were too ambitious with their owned IP, Pachter says. "EA probably spent more on Spore than it was worth, and put a lot of resources into Mirror's Edge and Dead Space with only modest results." THQ tried against mounting odds to haul new franchises Stuntman and Juiced to life, wasted effort it ultimately abandoned. The publisher also put its back into Saints Row, Darksiders and Red Faction Guerilla. "Saints Row is probably good enough to justify the expenditure, but the jury's out on the other two," says Pachter. The weak economy means that hits from risk-taking become more pronounced. Electronic Arts tried launching three new brands over just a few months, while THQ tried to follow two 2007 failures with two modestly successful new properties in 2008. "EA is doing it again with Saboteur, Dragon Age, Dante's Inferno, Tennis, Mass Effect 2 and EA Sports Active, while THQ is doing it again with Red Faction: Guerilla and Darksiders," Pachter says. "Few companies perform well when they are focused on so many new games," he adds. "We haven't seen Activision introduce that many new brands over the last few years." This will change in the coming year, however, as Activision will try its hand debuting Singularity, Prototype and Bizarre Creations' new racing title. "We'll see if they have the same problem," Pachter says. "Companies that invest in growth ahead of the revenues from that growth are more exposed to small shortfalls in revenue, because their costs are so high," Pachter concludes.