GDC China: Online Opportunities In The Face Of Stagnating Consoles

Tim Merel, managing director of investment advisory firm Digi-Capital, delved into the present and future of the global game market at a Gamasutra-attended lecture during GDC China in Shanghai earlier this week. The reason for his talk? "Because investing and growing internationally is very exciting, but isn't necessarily as simple as you might hope."
 Trends in The Video Game Market According to Digi-Capital's research, "online and mobile video games should grow the total video game market size to $87 billion in five years." These games will, at that point, constitute half of the total market revenue; on the other hand, the "console sector is flat to down."
 "Asia Pacific and Europe should end up taking 90 percent revenue share of online and mobile," said Merel. Of that slice, half will be China. His conclusion? "If you aren't in China, you aren't anywhere." The North American market "will remain important, but the dominant market for online and mobile games is and will be China." "Consumer markets are fragmenting and growing, which is both an opportunity and a challenge," he said. When it comes to online and mobile games, "There are many ways of playing in this space... all of them require you to execute well. And they all require specific skills and approaches. It's different to the console model almost completely, and the business model is also different." In his view, the CEOs of the major publishers are not equipped to deviate from the strategy of making multimillion dollar console titles. When budgets are "less than half a million, they can't, and don't know how [to adapt]," said Merel. Working in the Online and Mobile Space Mobile and online developers have to be "not one game, hit-driven companies... they have two sorts of portfolios of games... They may have tried 10 games but maybe only three worked. The risk isn't all on one game." Companies should also spread out across platforms to create a "portfolio of distribution" to avert risk. While Merel calls social games companies like Zynga and Playfish "great businesses," they do have a weakness, in his view: "What keeps them awake at night is their friend Facebook... they are at the mercy of Facebook. They don't have a portfolio of distribution... they have a risk to their business." "That combination of portfolios is extremely important," said Merel, as is a strategy of "rapid low cost game development... It's about being able to respond on a daily basis." He described a European farming game which developed a virtual item in the form of a volcano immediately after the Icelandic eruption this spring hit the news, and sold it the next day -- the ash fertilized the farmland, a benefit to players. This bit of game design was "tied to not a pretty game element, but absolutely to how they make money." As a social game developer, said Merel, you also have "a very, very pragmatic, hard-nosed, objective view of when you cut projects." What Consoles Can Teach
 Though he doesn't see growth in the console industry, he says it's "very valuable in terms of history." In his view, "knowing the mind of the console players is very important." "If you do the numbers, broadly speaking, you need to sell half a million to 1 million units just to break even, and that's excluding all of your corporate overheads," said Merel. And though "video games rivaled Hollywood in 2009" and were "roughly similar in terms of revenue," he points out that the $60 price point for game titles makes it an unfair comparison. Worse yet, as all developers and publishers these days know, "failed games can be deadly." Moreover, investing heavily in a title doesn't necessarily imply anything about its potential for success, according to Digi Capital's research. In the face of these problems, the major console publishers are struggling to invest in the online and mobile markets; unfortunately, said Merel, their weakness is understanding big launches -- but how to do small is very difficult for them. "They don't know how to operate, distribute, and most importantly market" a mobile game. "Because of the need to do things quickly, fast, small-scale, the major publishers are not driving mobile and online game investment." Investment In the Video Game Space Venture capital into video games investment has declined 60 percent since its high point in 2007, Merel said. There's weakness in the VC market thanks to the global financial crisis, but worse yet VCs just don't understand the highly fragmented games market. "It's a very high-risk market and very tough to play," said Merel. "I've seen very smart, successful VCs make terrible investments." The result? Video game companies of all sorts are struggling to find investors. And while some new companies have sold for great deals of money, said Merel, "I think the valuations we see today won't last beyond another year. Some of them will pay off as people had hoped, and some of them won't. When some of them don't pay off, the stock market will punish the companies that have done them." "Investing in a startup is a very high risk game," said Merel, so investing in companies "where they're already generating revenue" -- even if profits are not huge -- is "very exciting... While focusing on the high growth sectors of social and online." The companies which will attract investment are the ones in which "it's very obvious what the exit path is... Falling in love with a company is dangerous. Investing in a company where you have a good view of who's going to buy them and why, that's the kind of deal you want to do."
 One last word of caution to investors: "It's incredibly easy for people to get excited by big deals... buying big because it's big is not a particularly clever thing to do."
 Advice on Chinese Partnerships
 "Broadly speaking, if you're a strong independent Chinese company growing quickly..." you have a good shot to "exit to major international games, media, private equity company," said Merel. 
 Chinese companies will also get a chance to "license successful international IP into China... it is not necessarily a straightforward thing to do. For the right games it's a good business to be in." He cautioned the audience that "when you go into international markets... unless you have someone who knows the culture and is a native speaker... partnering with someone who you can trust is a very good way to enter."
 For foreign companies, he advised them to "work in partnership with leading Chinese companies in the Chinese market, but recognize that your Chinese partners are the strong ones in that relationship. Investing into a great company is never a bad thing to do if you know what you're doing, and can tie it back to your business."
 In Merel's view, "Chinese companies bring a lot more to deals than just cash... First is, and most exciting for international companies, is access to Chinese markets. There is so much you can bring to them which they would greatly desire. The quality of people here is extremely impressive... but the costs in terms of staff is not as expensive as in international markets." International Business Relationships Doing business globally can present its own challenges, Merel said -- mostly cultural differences. However, "knowledge of potential international partners' motivations is key... if you know what they want and you can give them what they want, you can get whatever you want." "The most successful acquisitions I have seen [are those] where the appreciation for the culture in both directions exists, and flexibility in both directions exists." On the other hand, if management doesn't understand the culture of the company they've acquired, "the team gets frustrated with the management style, and in two years the earnout ends, and the team leaves and your business is done."