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All to play for: The video games industry reaches a turning point

As Google and Apple expand into video games, we explore where the industry is heading – from 'free-to-play' to the rise of cloud streaming – and what the coming wave of disruption means for investors.

10 minute read

In Red Dead Redemption 2, a video game developed by Take-Two Interactive, players assume the character of a cowboy navigating the Old West. Designed to run on high-spec consoles, the game is startlingly realistic, with cutting-edge graphics and intelligent, AI-driven enemies. It shifted 15 million copies in its first week on release.1

Last year’s other blockbuster game could not have been more different from Take-Two’s contemplative Western. Epic Games’ Fortnite is a so-called battle royale, in which 100 online players compete in frenetic, cartoonish shoot-outs. The game is available across multiple platforms for free, although users are encouraged to buy optional add-ons such as extravagant costumes and dance moves to taunt their opponents. Conservative estimates put the game’s 2018 revenues at some $2.4 billion.

These titles – the first an immersive, story-driven epic with sophisticated graphics; the second a multiplayer extravaganza that can be streamed over the internet using a mobile phone – point to different paths forward for the video games industry.

With the current generation of consoles soon to be replaced, some developers are weighing up the possibilities of souped-up processors and VR headsets that promise even greater levels of graphical realism.

At the same time, big tech firms such as Google and Apple are working on cloud-based streaming and subscription platforms that could make dedicated gaming hardware look as old-fashioned as RDR 2’s tobacco-chewing cowboys. So what does the coming wave of disruption mean for investors in the industry?

Turning point

Investors’ perceptions of gaming began to change over the last decade as major publishers delivered impressive sales growth

The video games business was once considered more-or-less uninvestable: it tended to be hits-driven and swayed by unpredictable holiday-season sales. But investors’ perceptions of gaming began to change over the last decade, a period in which major publishers delivered impressive sales growth.

Popular franchises emerged and proved resilient: the likes of Call of Duty, Battlefield, Assassins’ Creed and FIFA continue to sell well version-to-version, even through changes in studios and development teams. The transition from hard copy to digital distribution increased publishers’ profit margins and the rise of multiplayer online games improved engagement.

“The whole ecosystem – publishers, developers and platforms like Sony’s PlayStation and Microsoft Xbox – worked together to change the industry model,” says Mikhail Zverev, head of global equities at Aviva Investors. “Companies became more profitable and those profits became more predictable; valuation multiple re-rating and share-price outperformance followed.

“Advances in technology enabled ever-more realistic gameplay and richer, open-world environments, making games more compelling. The only losers were video game retailers with physical stores – and parents’ wallets,” Zverev adds.

Global industry revenues increased from $43 billion in 2000 to around $138 billion in 2018, according to analyst Pelham Smithers, whose London-based consultancy tracks the industry. But momentum has begun to slow; Smithers expects revenues to fall slightly to around $136.5 billion this year and remain flat into 2020 as the console cycle turns and publishers experiment with new commercial strategies.

One issue is that companies are unsure whether to stick with the ‘pay-up-front’ approach that has served them well or attempt Fortnite-style monetisation. A new, free-to-play battle royale game, Electronic Arts’ Apex Legends, has attracted players this year but is struggling to match Fortnite’s outsized revenues.

You have to wonder whether consumers have now been trained to expect more for free, and the $60 price point will come under pressure

“Only a few free-to-play games have achieved any meaningful success and scale, and several publishers are planning to retain the traditional, $60 upfront model for most of their output. But you have to wonder whether consumers have now been trained to expect more for free, and that $60 price point will come under pressure. This will remain a source of uncertainty for the industry in the near term,” says Zverev.

A previous EA title, Star Wars Battlefront II, dramatically illustrated the importance of keeping the target audience onside. The game required an upfront payment but also offered competitive advantages in return for extra cash. This sparked a furious backlash among gamers – unlike in Fortnite, rich kids could buy better guns – and EA promptly removed these transactions. The company’s forthcoming Star Wars tie-in, Fallen Order, will dispense with in-game monetisation altogether.

Emerging market opportunities

Another headwind currently buffeting the industry originated in China. Chinese regulators abruptly stopped approving new games in 2018 – ostensibly over concerns about gaming addiction among the millions who frequent the nation’s smoky internet cafes. While the licensing process has now resumed, there are thousands of titles in the queue.

The knock-on sales impact is hurting Chinese publishers such as Tencent. The company is planning to buy back ten per cent of its shares on the Hong Kong Stock Exchange to boost its stock value, which plunged in 2018 (this would be the second such buy-back within 12 months).2 The regulatory snarl-up has also hurt Western firms active in China. Chipmaker Nvidia, which specialises in graphics processing units, issued a profit warning after disappointing revenues for the fourth quarter last year, citing a slowdown in the Chinese gaming industry as a factor.3

As the market recovers, however, Chinese companies look well-placed to take advantage of the shift in the industry from upfront payments to piecemeal monetisation through in-game nudges, as this fits neatly with their existing development and publishing models.

Some of the big Western games publishers like Activision and EA are struggling to change from the cash-up-front to free-to-play model. But this is already a fundamental part of games design in emerging markets such as China, which has been largely free-to-play for years.

Way says the major Chinese gaming companies, Tencent and NetEase, should both benefit from the global rise of free-to-play. The success of these giants may also spur the development of smaller companies that target specific market niches, such as Singapore-based Sea Ltd, which licenses Tencent’s games in southeast Asia and Latin America.

To catch up with their emerging market peers, larger American publishers are seeking to acquire the necessary design and algorithmic expertise through M&A. In 2016, for example, Santa Monica-based Activision paid $5.9 billion to acquire King, a small Maltese-based developer that made Candy Crush Saga, one of the most successful free-to-play mobile games.4

The huge sum points to the fact that apparently simple games like Candy Crush are deceptively difficult to make – they need to be engaging enough to sustain the interest and paced in such a way that players won’t baulk when prompted to pay real money for in-game rewards. Less subtle forms of monetisation in free games face other pitfalls: ‘loot boxes’ that dispense random items, for example, could be deemed a form of gambling, and have already been banned in Japan.

Big Tech enters the fray

Recent technological advances have opened the door to another big shift in gaming, away from dedicated PC or console hardware towards streaming over the internet using the cloud. Sony and Microsoft already offer limited streaming propositions on PlayStation 4 and Xbox One respectively, but bigger cloud service providers are now looking to enter the market, drawing on their superiority in cloud infrastructure.

In March 2019, Google announced it was preparing to launch a cloud gaming service called Stadia, which aims to leverage the popularity of gaming videos on YouTube. Stadia promises to allow gamers to watch YouTube clips before seamlessly loading up the game on Google’s web browser, Chrome, to play it themselves. This could be the first shot across the bows in a battle with Amazon, which owns a dedicated game video platform, Twitch, and is reportedly mulling a cloud gaming service of its own.5

Stadia works by allowing players to piggyback on the brute computing power of Google’s servers, circumventing the need for expensive graphics cards or large amounts of computer memory.

At least, that’s the idea: as of April 2019, only three games are confirmed for the platform and the gaming press is sceptical: broadband speeds vary and multiplayer games require instant reaction times.6 But such hurdles are unlikely to be insurmountable.

“A couple of video games companies we have spoken with believe technical issues around game streaming will be overcome within a couple of years,” says Zverev. “History shows concerns about bandwidth should not stop us backing long-term structural technological changes. Streaming films and TV shows over the internet was once considered unfeasible, and now Netflix is the dominant global TV and film platform.”

Subscription services

A related development is the emergence of subscription-based platforms, in which a library of games is made available for a monthly fee. If companies can get this model right, it could provide a more reliable source of recurring revenues than both up-front payments for single titles and the unpredictable in-game monetisation system.

In April this year, Apple announced it would be launching Apple Arcade, which will have 100 new games ready for users to download when it goes live in the autumn. Apple aims to offer content from different developers, which may give it an advantage over existing subscription services such as EA Access and Microsoft’s Xbox Game Pass, which do not cross-license their own titles.

In the same way the rise of Spotify and other subscription platforms increased the value of music labels’ back catalogues, games publishers with a rich and well-recognised library of games – think Nintendo, the creator of Mario, Zelda and Donkey Kong – are likely to be key players as this trend develops, either through offering subscription services or as acquisition targets for others lured by their IP.

“We would expect Nintendo to go down the Disney route, and offer their portfolio of games on subscription, without taking games from other developers,” says Smithers. “Others, like Activision, might make their games available to different subscription services offered by Sony or Microsoft.”

There is a risk some traditional video game publishers will become irrelevant if subscriptions come to dominate the industry

There is a risk that some traditional video game publishers will become irrelevant if subscriptions come to dominate the industry. As Zverev points out, television content distributors such as Amazon and Netflix deal directly with writers and directors, bypassing production companies such as HBO. The same could happen in games.

A decade ago, a large publisher was essential: it would stump up the money to make a game, advertise it and deliver it to retailers with which it had cultivated a relationship. But now sophisticated game engines are available ‘off-the-shelf’ for a relatively small royalty fee, online marketing is cheap and new subscription platforms promise to make distribution fast and efficient. Smaller, independent developers can deal directly with distributors and offer bright young talent more creative freedom.

Investment implications

So how can investors in the video games industry adapt their strategies amid these fast-moving trends?

In Zverev’s view, the scale of the coming disruption in the market means investors new to the industry would do well to adopt a ‘wait-and-see’ approach when it comes to the established international publishers, to assess how they handle these seismic shifts.

An alternative strategy is to focus on companies that provide video and mobile gaming publishers with technical services in the production of a game, such as engineering, art creation, testing and player support. Publishers’ willingness to outsource these services continues to increase as they focus on their core competencies in content development and marketing. Some publishers also lack the scale to productionise cost-effectively across global markets.

Keywords Studios is the largest outsourced provider of technical services to the gaming industry. Charlotte Meyrick, UK equities fund manager at Aviva Investors, expects “outsourced service providers such as Keywords to weather changes to publishers’ monetisation strategies, given this shift doesn’t change the service requirements necessary to bring a game to life.”

In Meyrick’s view, Keywords should be well-placed to capitalise on the rise of cloud-based streaming and subscription-based platforms, as it is device-agnostic. The expected growth in demand for gaming content in a streaming-led industry may also lead to an incremental rise in the company’s workload.

Hardware manufacturers strike back

The rise of cloud platforms and subscription models could be bad news for companies that make dedicated gaming hardware

By contrast, the rise of cloud platforms and subscription models could be bad news for companies that make dedicated gaming hardware such as consoles. Shares in Sony and Nintendo fell more than three per cent on the day of the Google Stadia announcement.7

Sony was particularly hard hit: while it has sought to diversify into software and services, it has less expertise in cloud computing than the likes of Google, Apple and Microsoft, and lacks Nintendo’s prized content library.

But games consoles may not be finished just yet. Sony is prepared to cede ground on the streaming of multiplayer games; instead, it is focusing on hardware advancements that could open new opportunities in the field of so-called ‘couch co-operative’ gaming.

Sony has released few details of its forthcoming PlayStation 5 – expected some time next year – but early reports suggest it intends to harness local processing power to make games that offer a level of detail and depth online streaming cannot currently match. One confirmed element of the new tech is the presence of ‘ray tracing’, a lighting technique that promises to make game visuals as impressive as Hollywood CGI.8

“A game in which the processing will all be done by a single powerful processor in a console on one TV will be very different to those spread across several different consoles and servers, because it enables much more interaction with the game’s environment,” says Smithers. “Little is known about the PS5 – the development kits come with stronger non-disclosure agreements than the latest Game of Thrones script – but the whispers are that what Sony is working on is very impressive.”

If Sony’s plans pay off, its hardware may be able to carve a niche in the fast-changing games industry, even as its rivals change tack and focus on the frictionless world of cloud streaming. Like one of RDR 2’s grizzled cowboys, reappearing at the hushed saloon bar having been left on the prairie for dead, console gaming may have some life in it yet.


  1. ‘Red Dead Redemption 2 tops 17 million copies shipped,’ Polygon, November 2018
  2. ‘Tencent to grant directors powers to buy back up to 10 per cent of company’s shares'
  3. ‘Nvidia warns of weakness in China, stock drops 13%,’ CNBC, January 2019
  4. ‘Activision completes $5.9 billion purchase of King,’ Wired, February 2016
  5. ‘Amazon plans “game streaming service” to take on consoles,’ The Independent, January 2019
  6. ‘Google’s Stadia looks like an early beta version of the future of gaming,’ The Verge, March 2019
  7. Bloomberg
  8. ‘Sony reveals PlayStation 5 details: 8K graphics, ray tracing, SSDs, and PS4 backwards compatibility,’ The Verge, April 2019

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