Business Models of Video Games: Past, Present, and Future
The global video game market reached $152.1 billion in 2019, growing at a rate of 9.6% year-over-year. This article examines the evolution of business models that have impacted this growth in the video gaming landscape over the past few decades and glimpses into the potential of what’s to come. This is not meant to capture every business model ever used or to say that business models of the past are not still in use today, but rather to show how the industry has evolved over time.
The first consumer-facing video games trace back to the ’70s and ’80s in the form of arcades. During this time, each game was housed in its own separate physical device due to the hardware requirements of running video games. As such, these businesses relied on physical locations and high fixed costs to provide consumers with a limited number of game options by today’s standards ranging from Pacman to Galaga.
Following a “pay to play” business model, these coin-operated machines created the first-ever microtransactions in gaming that required players to insert coins in exchange for time or lives in the game. This business model led to wild success, including Namco’s Pacman, which generated over $3.5B in revenue by 1990, and Taito’s Space Invaders, which generated $2.7B by 1982. While microtransactions remain popular in today’s video game landscape and will most likely continue into the future, the underlying monetization strategy has been used for decades.
Retail / Boxed Revenue
As computer technology improved in the ’80s, we saw the introduction of home computers. This technology provided gamers with the ability to play games from home and to play multiple games using the same platform. During this period, we saw the introduction of the first and second generation of video game consoles, most notably the Atari 2600, which sold over 30 million units. While this technology continued to evolve as new entrants such as Nintendo, Sega, Sony, and Microsoft entered the market, the underlying business model of boxed revenue remained the same.
The boxed revenue model is where game publishers would sell physical copies of their games (e.g. cartridges, discs) at retail outlets. This generates a one-time revenue opportunity for the publisher as gamers would purchase the game, play through the content, and then repeat the purchasing cycle as they moved on to a different game. Consumers expected to receive all of the content in the game upfront upon purchase, which varies significantly from current expectations, as we will later discuss. In this model, the developer/publisher would sacrifice an estimated 25% of revenue to the retailer while incurring greater costs related to physical packaging and distribution. This retail model would remain popular for many years through generations of popular consoles, like the Nintendo 64 and Xbox.
8th generation consoles (Xbox One, PS4), modern PCs, and mobile games make up the primary game platforms popular in the present day.
Digital Revenue and Distribution
Like many other industries, the gaming industry was largely impacted by the shift to the digital age. Digital transformation enabled publishers to sell their games directly to the consumer through a digital storefront. Players no longer required physical copies of the game; they gained access to the newest titles immediately upon release rather than standing in line at their local GameStop, waiting for the midnight release of the new Madden. Beyond these benefits to the consumer, this also enables publishers and developers to capture more of the revenue from game sales by cutting out the retail component and eliminating packaging costs by delivering the game to the user via download. To highlight the disruption of this digital shift, in 2009, digital sales made up only 20% of overall video game sales in the US; in 2019, it made up over 80% of all US game sales.
All major console makers have invested in their digital storefront from the Nintendo eShop to the PlayStation Store, enabling them to capture a portion of the value chain from game sales made directly on their platform. We have also seen game publishers create digital storefronts, including Activision Blizzard’s Battle.net, Electronic Art’s Origin, and Valve’s Steam, which increased their revenue from game sales while removing the third party (e.g. Microsoft, Sony) costs from the sales process. Beyond controlling the distribution of their own games, platforms like Valve’s Steam open up new monetization opportunities by becoming a digital marketplace for other developers’ games, similar to the Apple App Store or Google Play Store. Steam offers other game developers access to their large player base to help drive user adoption in exchange for a 30% revenue share. This model enables Valve to not only create a new revenue stream but to also attract more players into their ecosystem, which in turn bolsters their own game sales.
Microtransactions (In-game purchases, DLCs, season passes, loot boxes)
Digital distribution of games not only enabled publishers to capture more revenue upon sale, but also allowed them to further monetize players beyond the initial game sale through different forms of microtransactions including downloadable content (DLC), loot boxes, and season passes. DLCs allow game publishers to monetize their audience after the initial release of a game by offering additional content distributed over the internet. This content can range from cosmetic updates like new “skins” to more expansion-like content, such as introducing new levels, items, and characters. In 2017, revenue generated from DLCs surpassed revenue from box sales of games, and this gap is continued to widen in 2018 as DLCs generated ~$6 billion more than box sales.
Season passes are another way traditional DLC content has evolved. Instead of paying for a new map pack or expansion content when it is released, gamers can purchase a season pass at a discount, which offers all current DLC content and access to future content as it is released. In addition, these passes provide access to exclusive content that can only be attained through purchasing a season pass. For example, Fortnite’s Battle Pass allows players the ability to unlock content in the game through completing objectives for a one-time purchase of the pass each season. In February 2018, it is estimated that Fortnite sold over 5 million Battle Passes on the first day of their 3rd season, earning approximately $50M in revenue.
There are advantages of season pass models over separate DLC expansions for both publishers and consumers. Publishers receive revenue upfront, and consumers need only make a single purchase to receive all content over the defined period of time versus purchasing each DLC as it is released. In addition, this prevents players from being segmented based on content. For example, in the past, if your friends purchased the new DLC for a game and you didn’t, you may no longer be able to play with them until you purchase additional content.
Loot boxes serve as consumable mystery bags that players can purchase or earn in-game and then open to earn rewards. These boxes are the virtual version of unwrapping a pack of Pokemon cards, never knowing which pack could hold the coveted holographic Charizard. The loot box was first introduced in the western market through Valve’s Team Fortress 2 and has expanded to many other games, such as Blizzard’s Hearthstone, where players open virtual packs of cards to develop their in-game deck that is used for battling others.
Apart from their expanded use in console and PC games, microtransactions gained immense popularity with the rise of mobile games. The majority of mobile games follow a free-to-play model where the game is free to download, but players pay small amounts for virtual goods during play. Some games offer only cosmetic purchases, such as a new outfit or “skin” for your character, while others follow a “pay-to-win” structure, where the items for purchase give the player an advantage in the game. An example of this is Clash of Clans, which allows players to purchase in-game resources that speed up the construction of a new building or troop.
It should be no surprise that with the rise of subscription streaming services such as Netflix, Hulu, and Disney Plus, it was only a matter of time before gaming companies would adopt the subscription model. Console manufacturers have been providing subscription services like PlayStation Now and Xbox Game Pass for quite a few years. These services offer players a wide library of rotating games to play. In recent years, video game publishers have also started offering subscription services such as Ubisoft’s Uplay Plus and Electronic Art’s EA Access and Origin Access services.
Typically these subscription services offer access to mostly older games in their library. Consumers must still pony up an additional ~$60 for the new Battlefield game if they want to play it upon release. Unique subscription models also exist in today’s marketplace such as World of Warcraft where players pay a monthly fee to play the game in addition to purchasing the new expansion every few years for ~$40 to play the latest content.
The cost of developing games has increased drastically over time with most AAA blockbuster games costing hundreds of millions of dollars over multiple years of development. Given this high cost, more and more publishers and developers will create games that follow live services, or a games-as-a-service (GaaS) model. Live services-focused games are developed to live on long past their initial release by providing players with fresh content on a frequent basis. Currently, these games are being monetized through microtransactions (e.g. season passes), creating an easy transition towards a true subscription model.
Subscription revenue models will become increasingly popular as cloud gaming becomes more feasible and widely adopted. Cloud gaming allows users to stream video games in the same way TV shows are streamed from Netflix. This means that users will be able to pay a small monthly fee to stream a library of games rather than paying the upfront cost of owning the hardware (e.g. Xbox, Playstation) and purchasing each individual game title. While latency and other technical challenges exist with massive multiplayer games, products like Google’s Stadia and Microsoft’s Project xCloud will attract new gamers by breaking down financial barriers. The ability to create compelling content (making great games is DIFFICULT) and enabling seamless online play will be instrumental in widespread cloud gaming adoption.
For years, publishers have battled third party gold farmers who sell in-game currency in exchange for real money. Blizzard’s World of Warcraft is notorious for the impact of gold farming in the in-game economy. Some “players” spend hours “farming” gold through killed enemies that they can then sell to other players who would rather pay for these resources than spend time collecting them on their own. Currently, these marketplaces are operated by third-party providers, and engaging in these exchanges can result in bans from playing the game. The current black market that exists offers publishers no opportunity to capture revenue from players purchasing in-game currency and items from one another.
When Diablo III was released in 2012, it launched with a real-money auction house in an attempt to legitimize third party trading in-game rather than using third-party websites. The marketplace was short-lived as players spent more time gaming the auction house to get the best gear rather than slaying the monsters as the action-packed RPG intended. Identifying ways for publishers to create marketplaces for players to exchange currency across game titles while not deteriorating the integrity of the game through making it “pay-to-win” will open up new revenue opportunities and remove third-party providers.
Younger generations are watching less and less traditional media than prior generations. Because of this, advertisers are looking for new ways to target this younger population and to engage them within video games. Unlike streaming a show or movie where you could be on your phone multitasking through a “second screen,” video games require full attention, presenting unique advertising challenges and opportunities. Of course, due to concern for player sentiment, game publishers are not likely to slap an insurance company logo on the side of a new weapon; however, savvy advertisers will find ways to authentically insert brands into the game in a way that adds value to both the players and the brands.
Thank you for reading. I would love to hear your thoughts in the comments and please feel free to share other topics that you would like to learn more about.
*Thoughts and opinions are my own and do not reflect the views of my employer