Video Games and their Brave New World
Source: Epic Games
When we first penned our thoughts on Gaming’s Next Level back in 2019, we observed what we thought were the early stages of a transformation in the business models of gaming studios, from single release games to the construction of metaverse-like environments that were constantly updated and built upon to create annuity income streams.
Some of that came to pass, but as it often turns out, that was just the tip of the iceberg. The past 2 years have seen immense degrees of innovation, especially at the business model level, upending a vast body of established convention about how gaming studios monetise their content. Convention once again gets put into the recycling bin, steamrolled by unrelenting waves of creativity – no one is safe, not even the industry giants.
We think we are at the precipice of what is possibly the biggest wave of creative destruction the gaming space has seen yet.
As the world of gaming has evolved over the past few decades so has the bar for quality been moving ever higher. Where gamers were previously beholden to large gaming production studios for content, that balance of power has shifted – gamers want the best of all worlds and developers must deliver.
Today the demands on gaming companies are enormous. They must be creative and “indie” (or even user generated), but at a AAA standard of an established gaming studio, with cross-platform compatibility for both the newest and the oldest platforms in the market, on both fast and less-fast internet connections (or even no connection!). Not to mention communities, player involvement in ongoing development and design, ongoing content upgrades, non-gaming in-game activities… the list goes on.
Yet as the list of demands grows, there is little room for negotiation. Gamers are squarely in control, and they dictate the rules. With few exceptions, they are demanding bosses. How the current incumbents of video gaming respond will determine their fate, at the same time as wave after wave of new developers emerge, experimenting with new business models like blockchain-based games and “Play to Earn” – all with little compromise on quality of content.
As with all things, context is critical: to understand the possibilities of the future, we must once again go back in history and understand how all the circumstances coalesced to make the world of games - mobile, console and PC alike, what it is today. Only then can we put the transformative forces we are currently seeing into the right context.
Gaming faces a brave new world, though it doesn’t need to be dystopian.
Memory lane
For decades, video games were largely an individual activity. The more engaging a game was, the longer the hours one could spend on it, but the reality was that once the main story was completed, and the difficulty levels were exhausted, there was very little reason to come back to a game. Likewise, “social” engagement around games mainly involved sharing strategies for beating games without cheat codes with fellow gamers. In the days before high-speed internet connections, the most social thing one could do was pop into a gaming café with some friends, jump onto the LAN and have a fun afternoon of multiplayer action.
Think back to the days of Atari, Sega Megadrive and the original Nintendo, the days of Doom and “iddqd” (or “idkfa”, for those for whom God mode was overdoing cheat codes a little), which were followed by the days of Warcraft, Command and Conquer and Diablo, some form of vehicle racing (bikes, cars, pod racers – you name it), or the souped up successors of first-player shooters like Doom, for example Half-Life, which itself spawned Counterstrike.
In a way, exploring the world of a single player RPG was like reading a storybook; and having an afternoon of Warcraft or Red Alert amongst friends was like 8-player chess. Enjoyable but nothing groundbreaking.
In that environment video games remained a niche, catering to demand from a very specific and somewhat quirky lot. Many of those franchises have since faded into obscurity, while some have attained near-legendary status largely by virtue of flawless, engaging storytelling (the Final Fantasy series, for example).
Finally, lest we forget, getting our hands on games usually involved going to a gaming shop (like Gamestop) and picking up a cartridge, CD and eventually DVD. Video games were very much like films – if it’s not visible, no one’s going to buy it, and only a cult review of some sort can save it. Even now, gaming releases are scheduled very much like films, spread out over the year to maximise engagement.
In short, this was the traditional recipe for a successful video games business: great storytelling and franchise IP, strong development team and top-notch physical distribution.
All that changed when high-speed internet became the norm.
Breaking the walls
Some argue that it was the advancement of computing capacity, especially in graphics processing, that made a lot of what we see now possible. At the top of that food chain is Nvidia, the undisputed leader in graphics processing units (GPUs), with AMD coming in as occasional challenger.
To some extent, the advancement in GPU technology and capacity enables a lot of the highly detailed and intricate graphics that draw the wows, oohs and aahs when it comes to showing off the latest gaming productions. As we’ve seen in Disney’s recreation of the late Peter Cushing’s Grand Moff Tarkin on screen in Rogue One, along with a growing list of examples, even rendering reality on-screen is a possibility.
To us, however, that misses the point. In our view, the main driver behind the evolution of business models for video games producers is still ongoing – and it has everything to do with the internet, not because more beautiful graphics can be streamed, but because entire games can be streamed.
Streaming broke the chokehold that the great gaming studios had on distribution. When Valve launched Steam, initially as a means of delivering updates to its games, including its debut title Half-Life which subsequently formed the base for the Counterstrike mod, it was hard to see how an update service could overturn the market. Fast forward 17 years since its launch and Steam is now a distribution behemoth: not only do players purchase their games on Steam, but they also play them on Steam, interact with their friends and even resell and exchange content on it. Steam is the first port of call for any new game launch, and notwithstanding their arguably onerous royalty fees, there is little alternative to selling into a global community of more than 120m monthly active players, with daily peak concurrent users clocking in north of 20m, operating across 28 different languages.
Even incumbent studios like Activision Blizzard and Electronic Arts, with their own long-established gamer networks (such as Blizzard’s Battle.net, which was launched in 1996, 7 years before Steam) can’t compete. A look at Steam’s catalogue shows headline titles like Call of Duty (Activision), Apex Legends (Electronic Arts) and GTA V (Rockstar/Take Two) being offered and played on it.
What made Steam successful? Many reasons obviously, and it was certainly not an overnight success, but our take is that they were the closest thing to an open, studio-agnostic community that gamers could find.
And gamers loved it. Studios pay Steam their cut for access to their community of gamers, and the reality is that just like any other network, the intangible asset in Steam’s crown is its community of gamers who spend their time chatting and interacting with each other, trying out new games as they come out together. Shared experiences – sounds like a corny AirBnB advertisement, but it really is what gamers seek.
Breaking distribution chokeholds raised the bar immensely for all game developers: their competition is now global, and any game made anywhere in the world can make a bid for the top spot. Brand pedigree starts to matter less, and the focus moves to the quality of the games, in a free-for-all colosseum of competition for gamers’ time and attention. Good games rise to the top, while poor ones fade into obscurity – the brand of the studio that developed it is irrelevant.
In a way, then, developers increasingly live and die by the quality of their work. Some find success outside the monolithic incumbents – for example, Japanese video gaming maestro Hideo Kojima, most famous for creating the Metal Gear series of games, split off from Konami in 2015 and in 2019 delivered, as an independent studio, the multi-award-winning game Death Stranding to critical acclaim.
Others find initial success from being independent, as Polish development studio CD Projekt did with the runaway success of their Witcher franchise, although the brutal reality of being an independent, one-hit-at-a-time studio soon dawned on them as their long-awaited release, Cyberpunk 2077, stumbled upon launch with serious playability and performance issues. The standards and expectations were high – and unfortunately, they failed to deliver, neither for their shareholders nor for their customers, with a release that was rushed. Building that trust and enthusiasm back after a fumble is now proving to be an uphill challenge. And when a hit that was almost 10 years in the making comes out as anything less than perfect, the disappointment is potentially fatal.
The bar is high: at a hardware and software level, there is no longer any excuse for games that don’t look absolutely stunning. AAA game releases are expected to be at a certain (high) level and anything below that level gets a studio sent straight to the doghouse.
And things aren’t getting easier.
A game in hand is worth many in the bush
Conscious of the growing challenges and competition within the AAA game space, many of the big development houses turned their focus to a different segment: the not-so-serious gamer.
The prevalence of smartphones, perhaps kickstarted by the first iPhone, meant that people were constantly in search of something to occupy their time, even when they had nothing better to do. Games like Bejewelled (from the old Palm Pilot days), Tetris and Scrabble were promptly resurrected and loaded up onto mobile devices, offering users hours of engagement.
This segment of gamers was of a completely different nature to those playing AAA games: these were casual players, playing games to pass the time, perhaps during a commute or over a coffee break. They didn’t have exacting standards for storyline complexity, orchestral score composition or stunning graphics rendering – all they wanted was to keep themselves occupied, rather than deal with boredom. Simple games worked best, with as short a TTF (time to fun) as possible while still maintaining a decent degree of complexity and demanding a certain level of skill to be challenging. Think Angry Birds and Candy Crush – easy to get the hang of, impossible to beat.
And then came the monetisation: rather than charge a large sum up front for a game, these games were often free to download and get started with, with perks like power-ups and extra lives available for a small added fee to be paid via in-app purchases made possible by Apple and Google on their app stores. It was pay-to-win at its most aggressive, or at least, pay-to-carry-on-playing.
Activision’s acquisition of Candy Crush maker, King Digital, in 2016 was perhaps one of its greatest strategic moves as a studio, buying for itself the one thing it could never have while attempting to churn out an unending series of blockbusters: steady, annuity-like income. One need only look at their historical financials to see the magic of the King Digital acquisition.
At the top line:
And likewise at the operating income level:
Of course, forgetting that they are servicing very different types of consumers within the same business has serious consequences too. The pay-to-win mentality that powers a large proportion of the so-called freemium business model in casual games was something which, when attempted to be used to further monetise AAA games like Call of Duty, ended in disaster – the so-called “loot box controversy” which saw gamers stage a revolt against the practice.
The industry ultimately settled on selling cosmetic items only – no paying to win but paying to “flex” and look special was perfectly fine. Such was the ethos applied in the likes of PUBG and Fortnite, but once again, the players called the shots and won.
Revenge of the casual gamer
Up till recently, it seemed once more that the “casual” gamer, or at least the “casual games” segment of the market, was the cash cow for gaming studios, another case of taking advantage of the hapless everyday gamer, slicing off a dollar here and there and milking them dry.
Unfortunately, we might need to call time on that business model.
Again, the confluence of blockchains, crypto and traditional business makes for a fascinating interaction. For those who are unfamiliar, let us introduce you to a game called Axie Infinity. We’ve written about Axie before, but things are really exploding upwards now.
In the game, players assemble teams of creatures called Axies and participate in quests and battles. Success in their quests and victory in battle gains them an in-game potion called Smooth Love Potion (SLP), which is then used when breeding Axies with each other. The aim is to breed Axies with favourable traits which allow them to win more battles with their team, although each subsequent breed of an Axie requires more and more SLP.
Players purchase their Axies on a marketplace and can also purchase land plots and other items within the game world.
The “Pay-to-keep-playing” model would suggest that the gameplay should be free of prerequisites (i.e., get players in quickly), while monetising to maintain their attention (i.e., sell them SLP in bundles for a couple of dollars each). That would’ve made Axie Infinity just another game.
The developers at Sky Mavis, the studio behind Axie Infinity, however, took things the other way round. They made SLP tradeable between players, allowing players who had surplus SLP and little intention to use it to sell it off, not for another in-game item, but for cash. Cold, hard cash.
SLP is tradeable as a crypto token on exchanges like Binance, and this particular move turned Axie Infinity into an income source in a largely unexpected market: the Philippines. In essence, players who have abundant time, but little means of making a living thanks to COVID restrictions were journeying through the daily quests and winning battles, earning SLP and selling them off for cash. Axies can also be sold off by players on a marketplace, with a fee taken by the marketplace for every sale.
Once this flywheel started spinning, the rest, as we say, is history: good Axies win more battles, hence earn more SLP; SLP helps to breed good Axies, so SLP demand goes up; as SLP demand goes up, SLP price goes up, further increasing demand for good Axies that can win and earn more SLP…
And thus, “Play-to-earn” as a business model was born – a model which allows individuals who are time-rich and cash-poor to make a mutually profitable trade with players on the other side of the world who are cash-rich and time-poor. Axie Infinity, in particular, has dominated headlines in recent months, not only in terms of how they have provided people in less-affluent countries a means of earning a meaningful income, but also in terms of the success of the game so far.
This short documentary on “Play-to-earn” as a phenomenon is a must-watch to understand how profoundly the concept has changed lives.
Player guilds are popping up, offering “scholarships” to players who cannot afford to buy their own Axies to start, giving them an opportunity to effectively “rent” a team of Axies and play, in exchange for the guilds taking a cut. Where global tournaments in games like League of Legends, Fortnite and Dota2 draw the crowds and huge prize money, Play-to-earn brings in steady income for everyday players.
And we’re not talking pocket change here. As a result of the 4.25% marketplace fee and breeding fees, the Axie Infinity treasury is growing earnings at a stunning annualised run rate of about $1.2bn a year (probably more, by the time this piece hits our blog), with more than 2.5m Axies bred already (even though the 1m mark was crossed only about a month ago). Not to forget that Axie Infinity, as a game, isn’t even at a public beta stage yet – this is very much still an Alpha release.
Axie Infinity may well run its course in due time (although, not for the foreseeable future), and its struggles with server capacity in the recent week or two are a foretaste of the costs (and risks) of success.
The next phase of play-to-earn could be explosive. With the success of Axie Infinity, challengers will be well funded by excited VCs. We can see a time in the not-too-distant future where blockchain gaming projects offer cascading competitive incentives for players to choose their games. We have seen this unfold many times before in the world of burn and grow, everywhere from online food delivery to ecommerce as the winners there were the consumers. Now the winners will be the gamers who will cherry pick from a growing selection of games which ones offer the best incentives (and entertainment). Everyone wins. Right? Right?
Most importantly, what Axie has done is bring play-to-earn into the mainstream narrative.
We believe that it is only a matter of time before gamers, casual and hardcore alike, all around the world will start asking why they are paying to be occupied when they could be paid to do the exact same thing: play.
And when that happens, Play-to-earn probably becomes the norm, rather than the exception.
The other angle on this (and especially if our crystal ball above plays out) is that lower income “workers” could transplant themselves into the metaverse rather than eke out their physical daily grind. We have seen it in the Philippines already. If the VC funding race hots up, it is not unimaginable that these “unskilled” people could be in heavy demand and face competing incentives. What a win for them this would be!
Press <Start> to continue
There is so much more to discuss in the world of gaming, especially if we start down the lines of user generated content within multiverse-like environments like Fortnite and Roblox, and how these intersect with ecosystems like Axie Infinity and other blockchain games. But one thing is for sure: gaming studios churning out commoditised remakes of the same concept of game and scalping for customer dollars are facing existential risk.
How the incumbents react to this will determine their long-term success. On one hand, they can choose to resist, insisting that this is just a fad which will die off soon enough once the hype dies down – the same way financial institutions dismissed crypto in its “currency” and “DeFi” stages. On the other, they could embrace it and start looking at how their business models can be adapted to better engage their communities, so that they can be on the front foot when it comes to disruption.
Ultimately, the bargaining power of the gamers, hardcore and casual alike, are likely going to converge into demand for high performance, high quality games that also allow a balanced ecosystem for earning and spending. These demands will spur further innovation, so to expect a blockchain-based, community-owned game that’s at the standard of Fortnite or Call of Duty isn’t something that is beyond the realm of possibility even in the near term. Illuvium, another play-to-earn game that is currently under development, runs on Epic’s Unreal gaming engine – where Axie Infinity involves cute, animated creatures, Illuvium is designed to be AAA quality, and we are watching with great interest to see what they come up with.
Is it farfetched to therefore envision a version of World of Warcraft that’s “Play-to-earn”, where players with lots of time take on the grind of farming for items and gold which can be sold for cash (as opposed to buying packets of in-game currency from Blizzard itself)?
Sure, there would be lots of people who love it. But those that have the power to make this a reality need to be willing to give up all that easy money, and potentially also give up control of the intellectual property and decentralise their business to their community.
For the incumbents, born and forged in the previous age of video games, that might be one demand too many.
But for those who decide to take the plunge and embrace the incoming tide, it might all be for the best in the end.