Like happening upon a gnome in the online fantasy game World of Warcraft or breaking the speed limit in Grand Theft Auto, PricewaterhouseCoopers' June analysis of the growth of the global video game industry is hardly surprising. In its annual report "Global Entertainment and Media Outlook: 2007-2011," the financial firm predicts the video game market will continue to expand at a compound annual rate of 9.1% over the next five years. Other reports, such as the NPD Group's annual report on the U.S. gaming industry, show similar growth.
"It's not something that has snuck up on us," says Stefanie Kane, a partner with PwC's Entertainment & Media Practice. "Video games continue to be one of the fastest-driving segments of the market, no matter what region you look at." The surprise, more likely, will be that the video game industry grows even faster than these analysts predict, flexing its muscle across the entertainment industry and beyond.
Casual Gamers Will Drive Growth
PwC estimates that the global video game market will increase from $31.6 billion in 2006 to $48.9 billion in 2011, growing in every region. (The report includes video game sales and, in the U.S., advertising within games, but not hardware sales.) This makes video games the third fastest-growing segment of the entertainment and media market after TV distribution (9.3%) and Internet advertising and access spending (13.4%). (For highlights of the report, click here.)
But while the PwC analysis is thorough and offers a solid assessment of how the mainstream gaming industry will grow, it doesn't look at the innovations happening on the fringes of the industry—innovations likely to mature into whole new markets or to cross over into nongaming industries and create entirely new revenue streams. "The real growth in video games will come from the casual and nontraditional game market," says Evan Wilson, an analyst with Pacific Crest Securities.
"Traditional games have become too complex for all but the most hard-core players in the industry, and it's the stimulation of the non-hard-core audience that will drive meaningful industry growth." It's this growth that suggests the video game market of 2011 will be even bigger than the PwC report predicts. Or, as Ben Sawyer, president of the Portland (Me.)-based consulting firm Digitalmill and co-director of the Serious Games Initiative, puts it: "the report itself is sort of conventional for those of us working on the outermost edges of the industry."
Games with a Serious Purpose
Look to the fringe, and you'll see two promising areas for growth that aren't acknowledged by the report: the broad category of so-called serious games and the newer attempts to meld gaming with the social-networking features of Web 2.0. (To be fair, PwC does note the popularity of World of Warcraft, the MMOG (massive multiplayer online game) with 8 million players worldwide, and it acknowledges the growth in online games, the fastest-growing consumer-spending segment in the U.S. and Europe/Middle East/Africa regions.) Notably, both nascent markets reflect a shift from thinking about games as products to understanding them as services.
Serious games are used for nonentertainment purposes including education, corporate and military training, and health care. The category includes games developed for professional use, such as Full Spectrum Warrior (a military training game later released commercially), Re-Mission, and Peacemaker, as well as recreational games adapted for serious purposes, as when teachers use Take 2 Interactive Software's Civilization in the classroom, or consumers use Konami's Dance Dance Revolution as a form of exercise (see BusinessWeek.com, 8/17/06, Harnessing the Power of Video Games).
There are no hard numbers on the size of the serious games market, but Digitalmill's Sawyer offers what he says is a conservative estimate of $150 million, excluding traditional "edugames" developed for primary or secondary school education such as Carmen Sandiego and Math Blaster. "My Fortune 500 clients are collectively spending almost $4 million on serious games. Then there are sales of games like Brain Age—eight million SKUs at $20 each—and Dance Dance Revolution, which we estimate 1 in 20 consumers is buying for exercise," he explains. "I think there's no reason it can't be a billion-dollar market within a decade or sooner."
Gaming's New B-to-B Model
To reach the billion-dollar mark, the market will have to overcome the common wisdom that games are inherently not serious. A serious games market will also require game developers to shift from the traditional business-to-consumer model to a business-to-business one. Today when major studios and publishers are approached by companies interested in commissioning, say, an employee-training game based on a successful commercial title, more often than not those studios and publishers decline. Even if the interested company is offering $5 million, it's not worth the gamemakers' time to divert engineers from a commercial title likely to generate hundreds of millions of dollars in sales.
But new business models are developing. Some new companies are focused entirely on serious games, and others are developing hybrid models. In June, 2005, the successful British developer Blitz Games established TruSim, a division focused on creating serious games for the military, health-care, corporate, and education markets. Also last year, Japanese company Square Enix partnered with the publisher Gakken to create a serious games unit called SG Labs. In addition to its two dozen consumer titles, the Seattle-based Zombie Studios has developed training simulators for defense contractors and the Defense Dept. BreakAway Games, in Hunt Valley, Md., has also established a successful hybrid model, as has the Raleigh, (N.C.)-based Epic Games, whose Unreal Engine technology has been used both for professional training projects and for consumer titles.
And as more businesses such as IBM (IBM), Cisco (CSCO), Johnson & Johnson (JNJ), and Alcoa (AA) look to gaming technologies to train their staffs and connect far-flung employees, more traditional studios and publishers seem to be waking up to the opportunity (see BusinessWeek.com, 8/13/07, "The Name of the Game Is Work"). In April, 2007, XOS Technologies announced that it had licensed the core technology behind Electronic Arts' (ERTS) popular Madden game franchise for use in a series of training tools for collegiate and professional football teams. "Soon every major studio will have a serious games person," predicts Sawyer. "So that when, say, [agricultural giant] Archer Daniels Midland's (ADM) training director calls to ask about developing a sales game there won't be a long pause at the other end of the phone."
In addition to serious games, a second niche has been attracting attention: projects at the intersection of gaming and social-networking technologies. "At conferences, Web 2.0 and games have been the meme all year," says Sawyer.
One of the most high-profile efforts in this area is the L.A.-based Areae, founded by industry veteran Raph Koster (former chief creative officer at Sony Online Entertainment (SNE)) in December, 2006. Still in stealth mode, the company is talking very broadly about its plan to reinvent virtual worlds. But the basic idea is to bring down the astronomical development costs of the popular MMOGs by borrowing from the equally popular and vastly more economical Web 2.0 technologies supporting sites such as MySpace and YouTube. (Game design stalwart David Perry is also working to bring down game-development costs by using Web 2.0-style crowd-sourcing to develop an online multiplayer game, Top Secret (see BusinessWeek.com, 8/13/07, "Video Games Entertain and Educate") .)
Areae's proposition to combine the best elements of two of today's hottest media genres has attracted funding from both Crescendo Venture Management and Charles River Ventures, and it isn't the only player in this sector. The Boston-based Conduit also has raised venture backing for its plan to blend social networking with gaming. Kaneva and Cyworld, which originated in Korea and now boasts an American version, already offer 3D virtual worlds focused on social networking (see BusinessWeek.com, 4/13/07, "Digital Suburbia"). And while it's too early to estimate the size of this market, Disney's (DIS) recent purchase of the casual MMOG Club Penguin for $350 million—with another $350 million on the table if the site's operator, New Horizons Interactive, hits earnings targets—provides a useful data point.
From Product to Service
Even studios that aren't focused on the Web 2.0 model need to think about how their games can function as services rather than as three hours of packaged entertainment. Through a partnership with ESPN, Electronic Arts now offers a real-time sports news ticker in games such as NCAA Football 07. Similarly, EA's NCAA Photo Album function allows players to capture game highlights, add captions, and share the images with friends.
"Every game should have a feature that allows a kid to print out a frame of their game or upload it to Flickr. And why doesn't every game have a Machinima output?" asks Sawyer, referring to the fan-developed technique of making short films using game technologies. "Gamers are doing things with games that the companies never intended," he concludes, pointing to the users posting clips of the Sony karaoke game SingStar on YouTube.
Such changes are happening slowly, because most companies are just focused on shipping in time for Christmas, when a game can bring in $50 million to $100 million (see BusinessWeek.com, 8/13/07, "Console Makers: Move It or Lose It"). But as the mainstream video game market continues to expand—and it will, as the PwC report shows—and companies increasingly look for new market opportunities, the once-niche markets on the fringes of the industry will be tomorrow's growth drivers.