Electronic Arts: Lost in an Alien Landscape

John Riccitiello saw the crisis coming. In August 2007, soon after becoming CEO of video game maker Electronic Arts (ERTS), he gathered 160 lieutenants in New York and warned them that the $20 billion industry was headed for trouble. The major players were clinging to the model of selling shrink-wrapped games for $60 a pop, while users were turning to far cheaper online games. Only by "jumping into the abyss," he said, and radically changing itself could EA survive the looming shakeout.

The abyss proved to be deep. EA has lost money for 11 straight quarters since Riccitiello became CEO, and the stock is off 68% over the same period. The company has come up with lower-priced online games, but users have continued to flock to cheaper or free alternatives from upstart rivals. EA stunned Wall Street in January by slashing its outlook for the fiscal year ending in March, then again on Feb. 8 by providing a fiscal 2011 outlook that trailed some analysts' expectations. The company now expects to lose $197 million to $295 million for fiscal 2011 on sales of $3.45 billion to $3.7 billion, under standard accounting practices. "Management's credibility is nonexistent right now," says Patrick E. Becker Jr., chief investment officer of Portland (Ore.)-based Becker Capital Management, which holds about 1 million shares. (EA prefers to use nonstandard accounting that excludes certain charges, under which it expects to earn $165 million to $231 million for fiscal 2011.)

The question is whether EA and its boss will end up as casualties of the upheaval. Riccitiello, 50, doesn't sound defeated. EA, he says, has begun to roll out its strongest slate of games in years and supplement store sales with offerings for online and mobile phones. "You see a six-foot hole that we're in," he says. "I'm telling you that we were in a 20-foot hole and we've climbed 14 feet out of it."

Virtual Golf Clubs

EA still gets about 80% of its revenues from traditional shrink-wrapped games, such as Madden NFL, the football tacklefest. But the company will make some major titles available online for free for the first time, beginning this year with four games including Tiger Woods Golf and FIFA Soccer. (Revenues will come from selling gamers virtual goods, such as digital golf clubs.) It's also preparing its most ambitious massive multiplayer online game, based on Star Wars, which will compete with the popular World of Warcraft beginning early next year. And EA may rework its Sims virtual world game to be played on social networking sites as an alternative to hits like FarmVille, from newcomer Zynga.

The trick—a considerable one—is to do all this without hastening the decline in traditional game revenue. EA's digital business brings in only $575 million now, and it's unclear whether Riccitiello can get it growing fast enough to replace losses in the traditional business. Investors may not have the patience for any more missteps. "[The earnings miss in January] was strike two," says analyst Michael Pachter of Wedbush Morgan Securities. "Shareholders will revolt if there's another strike."

Riccitiello had been EA's president until 2004, when he left to found the private equity firm Elevation Partners with former Apple finance chief Fred Anderson and U2's Bono. At Elevation, Riccitiello studied the music industry's rocky transition away from compact discs and saw scary similarities in games. When he rejoined EA in April 2007, he worked out a two-year plan to manage the shift to digital. But the economic meltdown and increased frugality of gamers trashed it.

"Project Ten Dollar"

Riccitiello reworked his strategy last fall at a brainstorming session with his executive team. One major goal: Grab back some of the revenue EA and others were losing as consumers flocked to used games. The secondhand market now accounts for about a third of all games sold in the U.S., or $2 billion annually, says Pachter. At the meeting, Riccitiello green-lighted "Project Ten Dollar," a coupon program to reward people who purchase a new game with downloadable content and upgrades. People who buy used games pay an extra $10 or more for the same goodies. To create online products quickly, EA cut a deal in November to buy Playfish, which makes free games for social networks.

Still, the fundamental challenge remains. "While it's possible EA can make the extremely difficult transition from providing a shiny disc in boxes to [leading] in digital, history suggests it's rather unlikely," says Eric Goldberg, a managing director at Crossover Technologies who consulted for EA in the past.

Riccitiello contends EA can succeed in both boxed and digital games. In the traditional sphere, the company's new Mass Effect 2 war game sold more than 2 million copies in its first few days, and the new Madden product will redefine the way people play video football, he promises. Meanwhile, EA is making more games available on more devices than ever before, from game players like the Xbox to PCs and mobile devices like the iPhone. "We stumbled some," he admits. "The stumbling is gone, the execution is there."

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