Did Activision Just Frag Itself?

Fueling the fracas: The "rise and power of the elite developer"

The spat has all the plot points of a classic Hollywood throwdown: stars, studios, dueling lawsuits, secret meetings, and lots of money. Except this one isn't about movies. It's about video games.

On one side is Bobby Kotick, the outspoken CEO of Santa Monica (Calif.)-based Activision Blizzard (ATVI). On the other are two of his erstwhile prized game developers, Vince Zampella and Jason West. Kotick bought their studio, Infinity Ward, for $5 million in 2003. For a while it was a profitable relationship. Zampella and West created the $3 billion-plus Call of Duty series, the seventh-best-selling game franchise ever. The latest edition, Call of Duty: Modern Warfare 2, rang up $550 million in the first five days after its release on Nov. 10.

On Mar. 1, Kotick announced the firing of the two developers. On Mar. 3, West and Zampella sued Activision, accusing the company of "astonishing arrogance and unbridled greed." They said Activision conducted a sham internal investigation about their contact with rivals as an excuse to fire them and avoid making royalty payments on Modern Warfare 2.

A month after their termination, West and Zampella signed a deal with Kotick's Silicon Valley archrival, Electronic Arts (ERTS), the second-largest game publisher after Activision. On Apr. 8, Kotick countersued the duo, accusing his former employees of insubordination, withholding employee bonuses as a way to turn staff against Activision management, and taking a secret trip to Northern California to meet with an unnamed competitor. West, Zampella, and Kotick all declined to comment about the lawsuits.

Charges about secret trips and internal investigations aside, this battle is really over the future of the Call of Duty brand. Lines of fans bought Modern Warfare 2 at its special midnight release. Players have logged more than 1.75 billion hours of gametime—that's 200,000 years—on Microsoft's (MSFT) Xbox Live online system. The success comes at a time when hits are increasingly rare. In 2009, when industry sales declined 10%, Activision earned $113 million on $4.3 billion revenue. That's not bad considering that rivals EA and Take-Two Interactive Software (TTWO) lost money.

According to court documents filed by both sides, the once beautifully lucrative relationship began unraveling during the 20 months it took West, Zampella, and their studio to make Modern Warfare 2. West and Zampella said Activision emphasized "quantity over quality." Employees were made to work at a "breakneck pace" to deliver the game in time for its November release. During that period, said Activision in court documents, West and Zampella hatched their plot to leave the company. According to Activision's suit, a rival executive sent the pair an e-mail that read, in part, "glad to have super secret way" to communicate.

Activision, controlled by French conglomerate Vivendi, does have other big franchises, most notably World of Warcraft, a $1.23 billion-a-year subscription-based online game that's proved to be the company's most consistent earner. But WoW will soon face competition from a new EA online title, Star Wars: The Old Republic. Another big-money Activision property—the Guitar Hero music franchise—has begun to fade.

Kotick is no stranger to fights. To protect Guitar Hero, which he acquired in 2006, he tussled with the original designer, Harmonix, after it signed a deal with MTV Games and Electronic Arts to make Rock Band. Activision sued Double Fine Productions to stop the release of another music game, Brutal Legend, which starred the actor Jack Black.

The Call of Duty clash is a sign of the "rise and power of the elite developer," says Evan Wilson, an analyst at Pacific Crest Securities. That shift in clout makes the game industry more like films and books, where creators maintain more control over their intellectual property. The creative types are getting greater leverage because of the rising cost of games: The high-def sophistication of the current generation of Xbox 360 and PlayStation 3 consoles has doubled or tripled development costs for publishers such as Activision. Wilson says a complex, graphically rich game must sell more than 2 million copies to turn a profit. "Only those elite developers and elite franchises are profitable," he says.

Colin Sebastian, an analyst with Lazard Capital Markets, says the question is whether Kotick will be able to keep product quality as high as it was under West and Zampella so that fickle gamers will buy new Call of Duty versions. "Most gamers probably don't care that much" about who designs what, he says. "What they care about is the quality of the game. And that's why there is a lot of pressure on Activision."

Kotick says 400 to 500 people are working on the Call of Duty franchise and that the departure of two won't impede its success: "It's not about a single individual or one or two guys. Our commitment to quality hasn't changed." He adds that he's stepped up recruiting efforts, too. "If you want to make great games and be handsomely compensated," he says, "then the single best game to work on is Call of Duty."

The bottom line: Losing the talent behind Call of Duty stings Activision. It still has a steady earner in the subscription-game World of Warcraft.

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