COOL Ain’t So Cool: Suffering From a Shift in the Gaming Value Stack
Overview
I’ve written a lot about gaming: console manufacturers, game developers and the companies that house them. Most of the talk has been about one console versus another (i.e., Wii vs. PS3 vs. Xbox 360) and the ramifications for the game developers that write for them (i.e., ERTS). I’d like to take a step back and look at a shift in the gaming landscape, where the value stack is rapidly changing and where winners and losers should sort themselves out fairly quickly. I’d also like to offer up a straw man for how the industry might shape up over the next few years, using Majesco (NASDAQ: COOL) as a vehicle for illustrating how these changes are impacting companies with broken business models, and to draw some parallels with what is happening with Microsoft and Vista in the Consumer Era of Computing.
My thesis after distilling the online data:
- Offline game distribution and marketing will become less and less important as the online distribution model takes hold;
- Console design and manufacturing will become increasingly important as it serves as the window into the user’s online gaming experience;
- Developers that can rapidly and efficiently develop multiple titles for
multiple platforms will win the day, as price per unit will fall in an
online distribution world but where winners will more than compensate
by higher sales volumes; and - The “long tail” of gaming will emerge, as legacy titles are made available on the Internet in a low-cost and efficient manner, much as how Amazon has brought a long-tail book archive into our home and how the value of film libraries has skyrocketed.
So the value is in the platform and the content, not the means for delivering the content, as the Internet will render the offline distribution model increasingly obsolete. Which is squarely where COOL finds itself. Much to the chagrin of its shareholders.
Game Development - Complicated, Costly, and a Failed Experiment
Majesco recently bounced back from a near-death experiment with big-budget game development, as discussed in its recent earnings release. From GameSpot 01/30/2007:
Aided by solid sales of Jaws Unleashed, distribution deals with both
Valve and Trymedia, and the critical success of the DS title Cooking
Mama, Majesco reported a balance sheet that company officials say holds
signs of a turnaround.
Majesco president and interim CEO Jesse Sutton said that the company
was in the midst of a new approach toward the marketplace that has
already served the company well over the past year.
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Majesco CFO John Gross also addressed the company’s new apprach,
saying, “We have transitioned away from the big-budget games and
dramatically decreased our development costs and operating expenses,
thereby significantly reducing our use and loss of cash.”
For a taste of the dynamics of the game development and publishing business, take a look at this insightful and detailed post from Japanmanship 02/22/2007. As it relates to COOL’s earnings announcement, ok, but what does yet another strategy shift mean for the future? In 2005 it was the push to develop first-party titles, spending big cash to license expensive properties and signaling a shift from value-oriented games towards the high-end. That didn’t last long and almost pushed COOL to the financial brink. So now it is heading back to its roots - licensing properties, acquiring the rights to third-party developers IP and leveraging its experience in product packaging, marketing and distribution at the value-oriented price point. Focusing on “affordable, mass market” games for the DS and the Wii. But what about enduring value for shareholders, as embodied by either leading-edge IP or a robust distribution pipeline that will fuel earnings for years to come?
Game Licensing - Long-term Value through Control of IP
The issue of enduring value raises the inconvenient fact that COOL’s popular Cooking Mama property is not its own, but was licensed from the Japanese company Taito, which, in turn, sourced the original game development from a Japanese firm called Office Create. And these licensing deals, per Majesco’s most recent 10-K (dated 01/29/2007), are generally 2-3 years in duration. Now Cooking Mama has been doing pretty well - 242,000 units sold as reported by VGCharts.com. But if Cooking Mama really takes off, demonstrates longevity and the potential for leveraging the sequel cycle, doesn’t it stand to reason that Taito may want to assert greater control over its property? It is not as if Majesco doesn’t understand these risks. The following is an extract from the Risk Factors section of the aforementioned 10-K filing. Please note the text I have underlined for amplification:
If we are unable to maintain or
acquire licenses to intellectual property, we may publish fewer titles and our
revenue may decline.
Many of
our video game titles, are based on, or incorporate, intellectual property and
other character or story rights acquired or licensed from third parties. We
expect that many of our future products will also be based on intellectual
property owned by others. The cost of acquiring these licenses is often high,
and competition for these licenses is intense. Many of our competitors have
greater resources to capitalize on licensing opportunities. Our licenses are generally
limited in scope to specific platform and/or geographic territories and
generally last for two to three years. We may not be able to obtain new
licenses, renew licenses when they expire or include new offerings under
existing licenses. If we are unable to obtain new licenses or maintain existing
licenses that have significant commercial value, at reasonable costs, we may be
unable to sustain our revenue growth in the future other than through sales or
licensing of our independently created material.
This doesn’t seem like good news. It is almost setting them up to be victims of their own success, where they create a market (like bringing the very Japanese Cooking Mama to the U.S. market). And what happens if Taito changes their tune and re-assesses Majesco’s worth in the value stack? And, unfortunately for COOL, it appears that changes are afoot that could hasten this reassessment - acquisition. During 2006, a controlling interest in Taito was acquired by SQUARE ENIX, another Japanese game publisher. The implications for Taito - and, therefore, Majesco - is that SQUARE ENIX has a U.S.-based publishing operation. And they have experience developing and distributing successful games worldwide, such as the Final Fantasy series. From the SQUARE ENIX Annual General Meeting 06/24/2006:
“Our Games (online) segment recorded increase and profit, and we have no plan of changing our strategy. We have been making for further enhancement of such strategy. I mean by the term of “transitional period” that we have been trying to challenge various business models mainly in Games (offline) segment.”
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The purpose of the Taito acquisition is to have more touch points with customers. Looking at our competitors, game arcade business is a profit-making source. We seek to expand our customer base not only in game arcade business but also in all other business segments given increasingly lower birthrates.”
So now SQUARE ENIX is running the show. And if this wasn’t enough to make COOL shareholders concerned, check out these words as extracted from a SQUARE ENIX Management briefing reviewing the prior nine-month fiscal period dated 01/30/2007:
“In the console game software business, there are only 40 to 50 development staff. The reason why this business has been consistently making a loss of 500 million to 1,000 million yen annually with this number of staff is attributable to its practice of purchasing third party game software products for resale to the market.
“SQUARE ENIX releases 10 to 20 titles a year in Japan, while Taito Corporation releases 80 to 100. The difference is that Taito Corporation relies more heavily on the resale of third-party products. This practice has produced accumulated losses, and we have been scaling back the purchase of third-party products from the fal of last year. Because there are some unique products among its in-house titles, it has been specializing in development and then joining forces with SQUARE ENIX in sales and marketing.”
So if SQUARE ENIX is now doing the sales and marketing for Taito, where does this leave Majesco after its Cooking Mama licensing arrangement with Taito expires? Nowhere, it seems. SQUARE ENIX will take control of the entire development and distribution value stack, marginalizing the value of a distribution-oriented partner like Majesco.
Just a little more on Cooking Mama, which has definitely garnered a lot of attention considering its light, low-tech air. Further, Cooking Mama is not the only game Majesco has licensed from Taito; they also have the rights to Bust-A-Move:
From Wiifanboy: Peeking at Cooking Mama’s Potential 12/28/2006
From fourhman.com: Review: Cooking Mama 11/09/2006
Even though COOL has some interesting titles in development, i.e., NY Times Crossword (DS), Cake Mania (DS), Bust-A-Move (Wii) in addition to Age of Empires and Age of Kings on the DS, their major problem is a lack of original properties - true IP. This is what gives me pause when looking at their strategy and product portfolio.
Game Distribution - The Rise of Online Delivery
As with Amazon, who brought the world of books into our home, online style, a major shift is happening in the gaming world. Given the online capabilities of the new gaming consoles, even small publishers can distribute games cheaply and efficiently without the costs associated with a bricks-and-mortar, offline strategy. Again, what can this mean for the long-term strategy and prospects of Majesco? In short, not good. For a glimpse of the power, consider the List of Virtual Console games in North America per Wikipedia. This is a pretty nice start. It is also interesting to note that Taito has a few older “value” titles available for download. This is clearly the start of a trend, where more and more legacy titles will be made available for low cost via download. The “long tail” of the Internet beginning to take hold in gaming, where it has been for quite some time in books and music. The shift was inevitable, and now it is here.
More on this from SNK, where the USA President Ben Herman discussed the Wii Virtual Console. From Spong 03/02/2007:
“I know that Nintendo has all the code for NES and SNES titles, all of
the manuals and so on. They have a pretty good filing cabinet and all
they have to do is seek permission from the IP holder to put the game
out over Virtual Console, then share the income. When this was
announced, I said to you, wouldn’t it be great if they could put the
Neo Geo system on there. I didn’t mean the arcade system, rather the
AES home system. Right now I don’t know if the focus will be on AES or
MVS, even though they are largely the same, but the fact that the Neo
Geo is being added is a very exciting thing.”********************
So no conflict between the boxed SNK releases? “No. I think that if we
were to release games that have not been available on modern systems…
There are a lot of games that people want from us that we have been
unable to release for whatever reason, and it would be a nice
opportunity to deliver these games. There’d be a lot of money involved
in releasing a version of a game that has limited or niche appeal. This
way, if people want to buy something, they can just buy it.”
This pretty much says it all. The IP owner has power via content and the console manufacturer has power via closeness to the customer. Further, the value of older games can be released today - via download - without cannabilizing more modern offerings. This is basically just free money by extracting value from game archives, which can be shared between the IP owner (game developer) and the platform delivery system (console manufacturer). Finally, even SQUARE ENIX gets the joke, as noted in its 2006 Annual Report:
“At the heart of the current revolution is a power shift from companies to consumers. There are many very hasty arguments about the meaning of this phenomenon; however, I would propose a reasonable definition along the following lines. The power of consumers was not recognized int he past, but now consumers are getting involved in one end of the supply chain.
A fundamental policy must be to make this power shift toward consumers an anchor within our menu of strategic options.”
And one more data point coming out of the recent Game Developers Conference, some really interesting comments from Greg Costikyan, CEO of Manifesto Games (as covered by Joystiq 03/08/2007), reinforcing the power shift among console manufacturers, publishers and retailers:
Greg Costikyan (CEO Manifesto
games): Two years ago he was at the game developers rant speaking about
the “sheep like behavior of the gamers.” Now that he’s a publisher, who
should is enemy be? Which leads us to the console manufacturers. The
only open platform is the PC, from 2 billion to 1 billion in the last
year. Once again, Nintendo became the target due to their quality
crackdown in 1985. Everything was subject to Nintendo’s marketing.
Nintendo Power was the only powerful magazine at that time, so they
promoted those who played by the rules got good promotion. He says you
can see the end with Xbox Live Arena. Digital distribution is viable.
Retailers can be cut out of the equation. If that happens, the console
makers own the only distribution of that game. He believes in the next
decade we will see the console manufacturers take control of the
publishers.
Conclusion - The Value Stack Has Changed and the Retail Model is Broken
My pal Rob pointed me to an interesting article from the 03/07/2007 issue of Game Developer Magazine titled State of The Industry: Digital Distribution. From Valve’s Doug Lombardi:
“There’s a reason you don’t see (retail) games for much under $20 bucks,” he explains, “and that’s because after everybody who touches the game gets their cut, 20 bucks doesn’t go very far; In order to have production values that are competitive these days you need to sell your game for at least $29 - or $40 really, after platform fees which means you need to build this really big game and invest $4 - $6 million, minimum, that’s awfully risky.”
So where does this leave Majesco, given its offline distribution model and value-oriented approach? In no man’s land, it seems to me. In the same article, John Smedley of Sony Online Entertainment raised an interesting point:
“Look at the sales of disc-based games and how many of them have sold 200,000 units or more,” he says “But Xbox Live Arcade has sold 200,000 units of UNO, of all things. Admittedly that’s at $5, and that’s not an insignificant factor. But eventually, volume is going to win out. Just like Pay-Per-View it’s the convenience of being able to sit in your home, click a button, and get a game when you want it that’s going to win out.”
This sounds just like the key-takeaways from my recent post on the threats and opportunities of IPTV. Here is an excerpt from the conclusion:
IPTV is right at the intersection of two technology and user mega-trends -
light, flexible, powerful and easy-to-use web-based applications (Consumer Era
of Computing) and on-demand content that is exactly what I want, when I want it
that can be consumed where I want it (Asynchronous World). The online
conversation clearly sees IPTV as massively disruptive to legacy content
creation and distribution platforms, forcing recognition of and adaption to
these new mega-trends.
I go on to discuss the broad acceptance of iTunes, and using this as a benchmark for how IPTV will need to be viewed in order for it to be successful. I think the online gaming business can be viewed in much the same way, as online platforms for purchasing games via the console makers will become increasingly ubiquitous over time. Bottom line - John Smedley has it right. The online model is the winning model, and it is only a matter of time before the old-line publishers reliant on purchased IP and offline distribution will see their revenues fall off, never to be replaced again. Those with content archives will have highly efficient and scalable ways of extracting value from these largely inert assets, while the console makers will serve as the lens through which online gaming content is viewed. It is this inevitable shift in power that gives rise to the increasing risks facing COOL - rendering its long-term prospects chilly indeed.
The author does not hold a position in the securities of these companies.
