By Benjy Boxer
Subscription gaming is coming. Ben Thompson’s articles on Aggregation Theory provide some insight into why and how this may impact the gaming industry. First and foremost, as a reader of our blog, you’re probably well aware that gaming is a huge industry — probably significantly larger than most people assume. Morgan Stanley reported that video games (console hardware + games) were a $160 billion industry in 2018 with an expected total market size of $240 billion in 2025. Increasing engagement with games is a primary growth driver for the industry. There’s been a 60% increase in average time spent playing video games per day in the US since 2013. Capturing a significant slice of this industry and protecting incumbent revenue are driving massive investments to build a game subscription that includes distribution and games. It’s rumored that Google’s big announcement at GDC will be a game subscription service; Xbox has a subscription service already through Game Pass; and many more companies are rumored to be working on similar initiatives (Amazon and Verizon). With a winner-take-all model, the “Netflix of Gaming” will have a significant impact on the types of games made, the way we access them, and what types of companies will dominate gaming.
Conserving Attractive Profits Is Forcing A New Model In Gaming
The gaming industry has moved through several business models in the past 40 years. The Law of Conservation of Attractive Profits from Clayton Christensen predicts that as elements of an industry’s value chain are commoditized, businesses will seek attractive profits somewhere else on the value chain. The gaming industry has followed this path.
When Nintendo released the NES, they sold a console and licensed the cartridges to a select group of game studios. They tightly controlled the supply until EA and Sega forced them to allow more games to be produced. This model continued in the console market uninterrupted until the Xbox 360 and Playstation 3 released their game stores. During this era, retail stores like Walmart, Target, Best Buy, and Gamestop controlled distribution and access to customers. This is also when we saw the major game studios and publishers emerge to dominate game production.
At the same time, the PC gaming industry was more of the wild west. Pioneering companies, like Id Software, used shareware and then the internet to distribute their games directly to customers. Eventually, Valve recognized the opportunity to provide an online distribution service for PC gaming, bundling DRM, purchasing, and distribution, and built the dominant PC gaming app store — Steam.
Meanwhile, during the second era of gaming, despite console makers starting the process of aggregating the hardware with distribution, retail stores still did well because internet speeds generally prevented Nintendo, Microsoft, and Sony from eliminating the CD/DVD/cartridge all together. That being said, the die was cast — distribution was now bundled directly with the hardware. Retail would eventually lose as the console makers aggregated consumer demand and distributed games directly.
Fast forwarding to the fifth generation of consoles (coming soon), and we’re starting to see a world where hardware to play games is commoditized via gaming PCs and powerful mobile devices. Xbox is the furthest along in its pursuit to bundle a different part of the industry. With Game Pass, they’re focusing on bundling distribution and games via a direct relationship with customers on any hardware. Based on announcements about xCloud, it’s likely we’ll see a bundle of games and distribution on a plethora of devices from Android (my guess is Apple won’t allow it), PC, and maybe even the Switch. Others are also focusing on bundling distribution with games via subscription game services. Nintendo and Playstation have done this with their back catalog of games, but only Xbox has leaned in so fully to deliver new games in an unlimited subscription with 100+ new and old games. EA has also moved to the left (in my graphic above) bundling their games with distribution via Origin Access on PC and EA access on Xbox. Arguably, games-as-a-service, like League of Legends, Fortnite, and World of Warcraft, are also subscription game services bundling content and distribution, but for one game at a time that continually updates making it feel like you’re getting a new game regularly. Either way, it’s clear that a new era is starting — companies are bundling games with distribution.
Building The Aggregator Of Gaming Is A Huge Opportunity
Aggregating distribution and games into a subscription service is a very big opportunity attracting both the incumbents and new entrants, like Google. In the end, I believe that either an incumbent or startup will win this market. It’s generally difficult for companies to enter new markets outside their core value chain, but anything is possible, and Google is going to spend a fortune trying. The one argument as to why Google may succeed is if they integrate the game subscription into YouTube Gaming. This newer element of gaming (broadcasting) belongs in my broader value chain with other social products. Discord is also using their social graph to create a bundle of social, games, and distribution via Discord Nitro.
In markets where there’s a true aggregation play, each marginal customer costs the aggregator $0. This creates a winner-take-all situation. This didn’t occur in the console gaming market, but arguably did in PC gaming via Steam’s bundling of distribution with DRM and payments. In the console market, the marginal cost of each new customer was not $0. It costs a lot of money to win each customer. You have to build hardware and distribute it. In PC gaming, Steam’s marginal customer cost them $0, and they grew to dominate PC gaming. The only competition was from game studios that have a large enough customer base and brand that they can refuse to sell their games on Steam and have built their own distribution platforms (EA, Riot, Blizzard, and now Epic). Even without games from these major studios, as of 2017, Steam’s domination has reportedly earned the company billions of dollars per year and enabled them to reach nearly 300 million PC gamers.
How Aggregation In Video Games May Impact The Industry
In Thompson’s, Aggregation Theory, he outlines the situation that a winner-take-all aggregation play creates.
Once an aggregator has gained some number of end users, suppliers will come onto the aggregator’s platform on the aggregator’s terms, effectively commoditizing and modularizing themselves. Those additional suppliers then make the aggregator more attractive to more users, which in turn draws more suppliers, in a virtuous cycle.
This means that for aggregators, customer acquisition costs decrease over time; marginal customers are attracted to the platform by virtue of the increasing number of suppliers. This further means that aggregators enjoy winner-take-all effects: since the value of an aggregator to end users is continually increasing it is exceedingly difficult for competitors to take away users or win new ones.
Now that the aggregation includes games and distribution, the suppliers, game developers and publishers, will likely be commoditized. Once this happens, the industry could follow the path of Netflix (the only studio that matters is the original content studio at Netflix) or Spotify (diminishing profit for everyone), but I think it’ll look different from either due to consumption behavior and free-to-play games (more on that later). Although Steam hasn’t taken the final step to create a game subscription, the last couple of years might be a glimpse of what’s coming to the whole industry. Despite accelerating growth in users on Steam, the number of games have increased (they’re becoming commodities), total ownership per game and price per game have decreased.
This shows that, based on gaming consumption behavior, if there’s a growing catalog of games controlled by the aggregator, anything that’s in the catalog will see less attention while the whole catalog sees increasing engagement. I worry that this could hurt long-term innovation and make it impossible to build the next EA, Ubisoft, Blizzard, Activision, etc…
One Game Pass To Rule Them All
Microsoft’s Game Pass is the closest product to bundling distribution and games and becoming the aggregator that rules them all. Microsoft isn’t going to rely just on third-party content, like Spotify did. They have been very active in acquiring studios. This initiative is important enough to Microsoft that the CEO, Sataya Nadella, brought it up on a recent quarterly investor call.
We acquired two new studios this quarter, bringing the total to 13 and more than doubling our first-party content capacity in the past 6 months.
Microsoft isn’t playing around. They’re gearing up to build an aggregated platform on Game Pass that will ride along the coattails of Xbox Live. Today, they have 400 million Xbox Live connected devices. In the future, Nadella claimed that over 2 billion devices worldwide will be connected to the Xbox ecosystem. He’s not talking about Xbox consoles, he’s talking about phones, PCs, OTT hardware, and anything else that Xbox can connect to Game Pass. Xbox 5 (or whatever they call it) will still run games locally, but any of these other 2 billion devices will have access to a catalog of games through a subscription service that is powered by game streaming + Game Pass + Azure. They don’t care about the hardware; they care about the distribution + games. It has a significantly higher profit margin and will lead to diminishing marginal costs per user.
Recent data released in an interview demonstrates the argument that Game Pass is making to the big studios. If your game is on Game Pass, overall engagement will increase. With DLC and digital goods, monetization in gaming is more about time engaged than anything else, so this argument will get the largest studios excited. Each minute a player is playing is another monetization opportunity for EA or Activision. The game studios know that it’s significantly cheaper to monetize an engaged audience with a game they already play than trying to build a new game and selling that for $60. If game subscriptions become the norm, studios will release fewer games and focus even more on monetizing through engagement.
This is the early innings of the subscription gaming world. Although the shorthand for this has been the Netflix of games, I believe it will eventually look different. Game consumption behavior is significantly different from movie/TV consumption. Gamers play a few titles each year for 100s of hours; whereas, viewers watch dozens of movies and TV programs each year. That means a large catalog is more important in video streaming than it is in game streaming. If you cover the major genres and maybe even create your own games to satisfy gamers with endless interactive experiences, you may not need more than a few hundred games in a catalog, leading to a potential collapse in long-tail game content and fewer new games each year.