Dangerous Days for Video Games

For months, video game fans from Topeka to Tokyo had been salivating for Call of Duty: Modern Warfare 2, the sixth installment of Activision Blizzard's (ATVI) blockbuster shootfest. On Nov. 10, D-Day finally arrived. Thousands lined up outside Best Buy (BBY) and other retailers to grab the game when it went on sale at midnight. In Puerto Rico, the GameStop (GME) chain rented a stadium to handle the overflow.

Given the pent-up demand, Call of Duty likely will be one of the year's biggest hits. So why are Wal-Mart (WMT) and Amazon (AMZN) dangling $20 discount coupons to lure buyers? Because the game business isn't what it was. As of October, according to the research firm NPD Group, sales were off 12% in the U.S. At the same time, production and marketing costs are climbing as Activision and other game makers try to compete with a growing array of other entertainment options. "I do think the economy is [hurting game sales]," says NPD analyst Anita Frazier. "But what's having an even greater impact is the availability of so many free games" on the iPhone and ad-supported Web sites.

THE DVD COMPARISONVideo game makers say their $11 billion industry will bounce back once recent price cuts spur sales of game consoles. But analysts have lowered 2009 sales projections, and there are troubling comparisons to Hollywood's DVD slowdown. Video game companies are being forced to invest more to chase consumers. Viacom spent at least $10 million to license music for the Beatles version of its Rock Band game, whose recent launch underwhelmed. It needs a big Christmas for Viacom to break even or turn a profit on the franchise, says Chief Financial Officer Thomas E. Dooley.

Call of Duty, in which American soldiers chase terrorists through the mountains of Afghanistan, is an especially pricey bet. CEO Robert A. Kotick says Activision ultimately will spend some $200 million to launch the game (including what it pays hardware makers to put it on their consoles). Call of Duty cost as much as $40 million to develop, figures Wedbush Morgan Securities analyst Michael Pachter, about double what other games cost. That included the services of Oscar-winning composer Hans Zimmer. The team that made the game, which at one point numbered 400 people, used state-of-the-art computer graphics and relied heavily on focus groups.

Then there's the marketing campaign, which is costing $25 million or so. Activision spent $750,000 for two spots on the NFL's opening weekend and ran ads last spring during the NBA's Eastern Championship. As Call of Duty rolls out, Activision is plastering ESPN.com and YouTube (GOOG) with ads. On Nov. 10, Activision staged a premiere in New York's Union Square, where members of the New York Yankees played regular gamers. "They've really blown out the marketing on this," says Tony D. Bartel, GameStop's marketing chief, who says Activision let 5,000 of the retailer's managers play the game at the chain's annual conference in Las Vegas.

Activision will almost certainly get its money back, and more. Wedbush Morgan's Pachter figures it will sell more than 12 million copies of the $59.99 game by Christmas, generating over $580 million. Activision also expects to sell premium boxed versions of the game (which come with real night goggles) and online "map packs" that offer new battlefields for the warriors.

Still, the tough environment is forcing even the strongest players to retrench. After reporting a sizable loss on Nov. 9, Electronic Arts, maker of Madden NFL, announced that it was scaling back the number of games on its roster and will focus more on online titles. And while Activision generates some of the best profit margins in the business, it, too, has started playing safe. The company has three releases scheduled before Christmas, including Call of Duty and a Tony Hawk skateboarding game (which is played with a real skateboard). But Activision is delaying its highly anticipated auto racing game, Blur, to give its team more time to fine-tune it.

The question hanging over the industry is whether the game business will rebound once the recession lifts. Activision's Kotick insists it will when the next generation of game consoles arrives and draws new gamers. All the same, he says, Activision and its rivals will need to make "significant investments in creating compelling" titles. As in a video game, only the strongest may survive.

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