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Is your favorite game company ripping you off?

Why do games cost so much money? When you hand over $50 for the latest title,
are you getting a fair deal or are you getting ripped off?

Format wars come and go. v “Hot” topics burn themselves out in the heat of the spotlight: copycat violence, epilepsy, and addiction are just a few of the contentious issues to attach themselves to videogames in recent times only to be jettisoned after everyone got bored of the merry-go-round debates. There is, however, one question which is always lurking in the back of every gamer’s mind, one issue which just won’t go away: “Are videogame companies ripping you off?”

This constant question and controversy has dogged gaming from Space Invaders on Atari 2600 to Turok on Nintendo 64. At the heart of the issue is the concept of value; is a game worth the money you pay for it? The question is heavily loaded with all sorts of objective criteria, and consumers give different answers in relation to different games. To come to any sort of conclusion, we must ask specific questions with definite answers. Questions such as: How much do games sell for at retail? How much does it cost a publisher to bring a game to market (and therefore, how much profit does it make)? And how many units can a publisher expect to sell?

The average price of a new PC release is around $40. At the bottom end of the market, most major publishers have budget software, typically featuring products more than a year old which sell for between $15 and $25. PC software prices have risen by about $10 in the last five years, but there’s a good reason for this. Because the PC is an open format, and the market is not controlled by any one manufacturer, publishers have invested an enormous amount of development time and money. Chip manufacturers such as Intel and 3D acceleration and sound card manufacturers have driven hardware technology at such a pace it seems you can buy a PC in the morning only to find it’s out of date by the afternoon. Because of this phenomenon, software publishers have had to commit more time and money to products just to keep up with the pace of technological advances, and these investments are almost always passed on to the consumer.

Average Development Budget

Compared to the rise in games’ retail price, the average development budget of a new title on any format has sky-rocketed in the last five years because of increasing consumer demands for big production titles. In the early ’90s, a publisher would spend around $300,000 to develop a game for the PC, Super NES, or Genesis. Now the average budget is around $1 million — and it can be a lot higher. A few games have even passed the $ 10 million mark, Origin’s Wing Commander IV being one of the more high profile examples of recent times. But, as WC IV proved, big bucks don’t guarantee a good game. When budgets start spiraling towards eight figures, the publisher has usually made the decision to “go Hollywood,” incorporating lots of Full Motion Video (FMV) or other non-essential special effects into a game. This presents two different problems. First, if you want it to look good on-screen you have to use good writers, good directors, good actors, good artists, and a good technical crew. You also have to allocate a decent amount of time to a shooting schedule. This all costs serious money.

The second problem is that if a publisher does it cheaply, it shows. And the FMV can actually detract from, rather than enhance, a game. In fact, a growing feeling among consumers is that even well-done FMV can be little more than an intrusion on a game. And a game is what they want — if they want to see a movie, they’ll rent a video. There have even been a handful of companies over the past few years such as Digital Pictures that were forced out of business because of their heavy reliance on expensive, but unpopular, FMV titles.

Publishers have woken up to this and are generally shying away from the $10 million mark these days. But, while the ceiling has, for the time being, been lowered, the average cost of game development continues to rise. On top of the actual cost of development, royalty payments have to be given to the developers themselves. This is rarely the biggest expenditure, and few would disagree that the team that actually created the game deserves a piece of the pie. An independent third-party developer might get a non-refundable advance against royalties of, say, $2 million. It would then get different royalty rates for different formats. On the PC, a developer might receive anything from 15% to 30% of the profits depending on its experience and brand value. On a cartridge format it would get 6% to 10%, while on PlayStation the going rate is 10% to 15%. All figures generally apply to the wholesale rather than retail price.

The reason for the variations across the formats is, quite simply, that a publisher can afford to offer more to developers for PC titles than it can for any console title — and it has to offer more if it wants to attract the best talent.

No manufacturing premium exists on the PC and no royalty payment is owed to a format owner (more on that contentious little nugget later). A publisher working on a PC title can also use the funds saved on royalty rates to increase marketing or general productions costs. On any console format, a publisher has already paid anything from 40% to 60% of its wholesale price to Sony, Nintendo, or Sega just to get finished goods ready to roll out to retail and so has less percentage points left to offer developers. This is why, for instance, Sony, which doesn’t have to pay the manufacturing premium and royalty rate, can offer developers 30% on PlayStation — but then the developer must balance this offer against the fact that Sony will insist the game isn’t published on any other formats (in other words an independent publisher’s offer of 10% of PlayStation sales plus 25% of PC sales might add up to more than Sony’s offer of 30% of just PlayStation sales). Despite the potential hazards of single console publishing, titles such as Resident Evil from Capcom proved that this method is very capable of producing huge profits and that porting a game to multiple systems is not always the best option.

One way to avoid royalty payments to third parties is to develop products in-house. There are two ways a publisher can do this. The first is to grow an in-house team organically, paying high salaries to attract staff from rival companies and letting a department grow gradually. However, this approach can turn out to be as expensive as paying a third party and sometimes carries with it an even greater risk. One high profile publisher set up a 55-strong, in-house team two-and-a-half years ago. At its inception, four products were in the pipeline, and all were scheduled to be released within 12 to 18 months. So far, not one game has made it to market. If that development team has an annual wage bill of $1,650,000 (that’s an average of $30,000 per person), the publisher has already spent at least $4,125,000 maintaining a facility which has yet to yield any return. It amounts to a substantial investment — and while the team may go on to deliver classic after classic, the initial outlay is still a huge risk, and the publisher will look to reflect that in its retail prices.

Another way to have an in-house team is to buy one. But again, a tremendous risk is involved. In 1995, Acclaim Entertainment spent $100 million acquiring the services of Sculptured and Iguana as well as leading European team Probe. Other publishers such as Electronic Arts and, more recently, GT Interactive and Eidos have spent similarly large amounts buying talent. No one’s saying the teams involved aren’t worth the money spent, but it’s a gamble that will be reflected in the retail price of the products. Publishers who take big risks want big rewards — as soon as possible.

Narrowing the discussion to console formats only for a moment, the manufacturing premium and royalty payments charged by the format owners come into play. It is this “software surcharge’’ that keeps the price of console games so high — and is at the heart of the issue of value for money. It is a business model that was firmly established by Nintendo with the NES in the mid ’80s, and all the console companies, including Nintendo, still adhere to it today.

Here’s how it works: When a third-party publisher has developed a game, it must hand the code over to the hardware manufacturer who then charges to manufacture the finished discs and charges a royalty for every unit sold. On the Sony PlayStation, this charge amounts to around $15 per unit. On the Nintendo 64, it is more like $30 to $35. Part of this money helps the hardware company cover the R & D and marketing expenses involved in creating a console market. A hardware manufacturer spends millions of dollars developing, designing, and advertising its format around the world and could never hope to recoup its investment through hardware sales alone. This is because console manufacturers sell their hardware for the lowest price possible, leaving no room for profitmaking margins for either itself or retail. The hardware is almost like a loss leader, tempting the consumer into a market. This is why establishing a healthy installed base is so key to hardware manufacturers. Then, once a company has its machine in enough homes, the focus becomes maintaining control over the software market.

So Sony, Nintendo, or Sega gets a consumer to spend $100 to $300 on a machine and doesn’t make any profit on the sale. But the machine needs feeding — and that’s where the console companies make money. They do this by insisting that all software is manufactured by them (or by “approved” companies via them). They then charge publishers a fixed price for finished goods and a royalty rate on unit sales. So, every time Electronic Arts,Virgin, Acclaim, or any other independent software publisher sells a game for PlayStation, Sony makes money. Sega makes money on all Saturn sales, and Nintendo makes money on all Nintendo 64 sales — whether it has produced the game or not.

On top of this, the system also gives the in-house lineup of software a huge advantage. Because they don’t subject themselves to the manufacturing and royalty rate (they only have to pay what it really costs to make the software), Sega, Sony, or Nintendo can either charge less for their games or charge the same but spend more in the development and marketing stages. That’s why a third party could never produce a game like Mario 64 and sell it for $70. It simply couldn’t afford to. And that’s why Nintendo will continue to take a huge slice of the software market for its own machines.

The question of value for money in the console arena comes down to how much it really costs to manufacture software. Publishers we spoke to estimated that in an open market (one more resembling that of the PC), they could produce PlayStation software for around $3 per unit (20% of the $ 15 charged by Sony). The consensus on Nintendo 64 cartridges was that publishers could do the manufacturing job themselves for around 25% to 30% of the price charged by Nintendo. That would bring the cost of goods down from $30 or $35 to around $10. So, on consoles, the truth is that third-party publishers can’t afford to cut the price of their software independently. The only way they could move is if the console companies themselves charged them a more realistic price for manufacturing and duplicating. In other words the high prices of games on the Nintendo 64, PlayStation, and Saturn are down to Nintendo, Sony, and Sega respectively — and the power to change things is in their hands.

The success of PlayStation has put Sony in a unique position. Having recently announced price drops in hardware and first-party software, a break may soon be coming for third-party PlayStation publishers. Sony reportedly told publishers that the R & D and launch marketing costs of PlayStation had now been “expensed out.” This could mean a reduction in the royalty charged to publishers which could then be passed on to retailers and, subsequently, consumers. Economies of scale are also coming into the equation for PlayStation as the machine’s global installed base is now well past 10 million (and will probably be at least double that by Jan I, 1998). The company might also want to accentuate its one true advantage over Nintendo 64 — software price. Some pundits predict that the average price of a new release on PlayStation could drop to as low as $35 or even $29 over the next year or so. Certainly the recent announcement to put a $49 cap on first-party titles and create a line of budget software points to Sony’s desire to take advantage of this strength.

One of the regular fall-back arguments that publishers use to defend high prices is that when you compare the amount of time spent playing a game to the amount of time spent playing a CD or watching a film, you’re actually getting good value. A Nintendo spokesman commented recently: “Nintendo 64 games can take over 100 hours to complete. You’d expect to pay more for a festival lasting two days than for a concert lasting two hours. Longer train journeys cost more than short train journeys.” But this is chillingly cold logic. If we carry on the comparisons with other entertainment industries (discounting railway travel for a moment), there are people whose views, personalities, and lives have been shaped by Catcher in the Rye, Exile on Main Street, or Citizen Cane — each one a “product,” for want of a better word, that can be returned to again and again over decades.

These outstanding works of 20th Century art have been literally invaluable to people, but it still doesn’t mean anyone should pay much more than $20 for a book, $15 for a CD, or $7.50 to see a movie. It’s a question of what feels right. We are talking about games. Games are little things, fun things, and relatively inexpensive things. A $70 price tag just doesn’t sit right on something called a game. Perhaps that’s why those operating within the game market now refer to it as “the interactive entertainment industry.” Bottom line: they can call it neuro-bio-astro-cybertronics or they can call it Brad, the only thing players care about are good games — and very few people feel comfortable spending over $50 on a game.

However, gamers may have to. By now, the economics of game development, while not set in stone, aren’t very flexible. Are game companies ripping you off? No, not really. Not as long as “interactive entertainment” remains outside the mass market. While it may not feel right to spend over $50 for a game, in most cases it’s the consumers who are making things rough on the game companies. With each new generation of software, gamers are demanding more and more “magic,” and that magic costs money to produce. Are game companies making a profit? Yes, some of them are, but there’s a difference between making a profit and gouging consumers. Considering the enormous financial risk required to join the game market, it hardly seems unreasonable for them to expect a healthy return on their product.


WHERE DOES YOUR MONEY GO?

From your pocket to the developer, who takes a slice of the money on the way?

Let’s take a new PC game selling for $45 as an example.lt was developed by a third-party team but has no license attached. lt was backed by a worldwide marketing budget of $2 million.

   •    The consumer buys it from the retailer for $45.

   •    The retailer buys it from a distributor for $33.

   •    The distributor buys it from the publisher for $30 (this is the wholesale price).This means that 66.6% of the consumer’s money finds its way back to the publisher, but that doesn’t mean that this is all profit.

   •    The development team gets a royalty rate of 30% of the wholesale price. This equals $9 per unit.

   •    The cost of goods (including disc, packaging, instruction manuals, and so on) is about $4.50 per unit.

   •    The worldwide marketing spend also works out at around $4.50 per unit.

So, the development, manufacturing, and marketing costs take $18 dollars from the publisher’s $30, leaving $12 as profit. But there are still bills to be paid.The publisher might have spent $1 million over 18 months in order to complete the production of the game. That figure has to be subtracted from the nominal profit figure of $12 x Total Sales. Publishers also have operating costs. The biggest publishers such as Electronic Arts and Virgin employ thousands of people in dozens of offices around the world which equals a serious amount of overhead. And then finally there are corporate taxes to be paid.

The publisher is left with about $3.50 to $4 per unit of pure profit.

How much money it makes is then down to how well the game sells. Only one or two games per year sell as many as 1 to 2 million units. A dozen or so very good titles sell 300,000 to 500,000 units. Then 500 or so sell 100,000 to 200,000. But this ridiculously overcrowded market still leaves room for literally thousands of PC titles to sell much less than 100,000 worldwide, which means, because of up-front expenses and non-refundable advances, games probably create a loss rather than a profit for the publisher. If the model is moved into the console market, the significance of the manufacturing premium and royalty payments becomes obvious.

On PC, a wholesale price of $30 led to a retail price of $45, but on Nintendo 64, a publisher could be charged as much as $35 for the manufacturing and packaging process.The wholesale price still has to account for factors such as marketing and development costs, so the publisher can easily end up selling the game to distributors for over $50. Reasonable margins added on by distributors and retailers then result in a $70 price tag for the consumer. If this is a rip-off, the trail of culpability leads back to the manufacturing premium and royalty rate imposed by the format owner.


JUST LIKE THE MOVIES?

People often compare videogames to movies when talking about price. But this isn't a fair comparison. Here's why:

The game market is most commonly compared to the film business. Obviously, a great deal of crossover exists between the two art forms. Both are largely visual, plot-driven, character-based, and reliant on technology and special effects. There are also many shared skill-sets such as those of directors, writers, and animators.

Initial comparisons between the financial models of each market would seem to back up the argument that games are a rip-off. After all, movies cost far more to make, but the biggest blockbuster can still be seen for around $7. The average development budget for a studio picture is probably around $20 million, nearly 20 times that of an average-sized game. And major movie studios continue to push production costs higher.

One of the most expensive movies ever made is WaterWorld with a total cost of $ 175 million. Game publishers point out, however, that the film industry’s audience is virtually limitless and truly global, with very few countries remaining untouched by the hand of Hollywood. Software can only be bought by consumers with the relevant hardware. This immediately puts a very definite ceiling on sales. Games also tend to be bought mostly by 12- to 24-year-old males, and movies appeal to a much larger audience. These parameters aren’t fixed, but they have been truisms of gaming for over a decade and even now are only showing small signs of shifting. Certainly, no single format can be called a worldwide standard. The PC comes close, but many still use it strictly for business and not for games.

One global hardware standard would help enormously (and would be welcomed warmly by publishers and developers). It would reduce risk, reduce cost and, eventually, reduce prices. But it just isn’t going to happen. There’s too much money to be made by deeply entrenched rival manufacturers.

While game companies may complain about the comparison of movie prices and game prices, the game industry has pushed the comparison whenever possible in an effort to legitimize itself. If this has lead to unfair comparisons in the pricing models — then the industry has no one to blame but itself.

Hollywood can afford to spend over $100 million on a movie because of the worldwide marketplace.


THE DREAM SUCCESS...

Every game publisher dreams of the one big mega-hit that will make its fortune

The In-House Development Plan
From a publisher’s point of view, the “dream game” is a PC title with relatively low production costs and no added extras (license, royalty fee, and so on). It nevertheless sells in blockbuster numbers. Ideally, the development team would be in-house and, therefore, salaried with no expectations of large royalty payments. The problem is that the best software often comes from independent teams earning royalty rates on sales.

The Up-and-Coming Development Team Plan
An alternative dream game comes from a relatively unknown team with no cache (and therefore no high price tag) attached to its name. Populous from Bullfrog is a good example. The team has become one of the most respected (and well-rewarded) in the business, but they were once the new kids on the block, willing to accept a smaller advance and lower royalty than an established team would. So in a case like this, the publisher gets the rights to an AAA title for a relatively small amount up-front and a royalty deal as low as 10% (or less) of the wholesale price. The game then gets developed for a reasonable sum such as $600,000. It is then published on the PC, with the cost of finished goods working out to about $4.50 rather than the $ 15 to $35 it would cost on a console.

The Reasonable Marketing Plan
With expectations low, the publisher isn’t likely to commit to a global marketing budget of more than $1 million. If the game takes off this could amortize out to about 4% of the wholesale price of each unit compared to the 30% that some publishers have spent in the past.

The Word-of-Mouth Blessing
The key is the quality of the game. If the press hail it as a breakthrough title and word of mouth creates momentum, then a publisher can have a million-seller for initial expenses of less than $2 million and around 40% of the $30 wholesale price as profit (compared to an average of less than 10%). This means $12 profit for every unit sold. If the game sells a million, that’s $ 12 million profit for very little original outlay.

Not bad business. But the Dream Game is more than counterbalanced by...


...AND NIGHTMARE FLOP

If money can't buy love, it also can't guarantee a blockbuster videogame hit

The Expensive License Plan
The Nightmare Flop usually starts with an expensive license from a major new movie like, say, WaterHawk co-directed and produced by Bruce Willis and Kevin Costner. The film studios are often reluctant to sell off their properties in pieces, so publishers have to buy the worldwide electronic entertainment rights across all formats. This could involve a non-refundable down payment of up to $5 million and royalties of 5% to 10%. The initial payment and the royalty rate demanded by studios have come close to doubling over the last few years.

To produce a strong game that won’t ruin the publisher’s relationship with the studio, a big-name, third-party developer is retained to write the game. The developer demands a royalty rate of 30%. The game goes on to cost $5 million to develop. The publisher also green-lights a massive marketing campaign with a worldwide budget of $10 million.

It decides to release the game first on a cartridge-based console. The console manufacturer needs six months to turn the code into finished product and so the publisher has to estimate how many units it needs for the launch long before the game is ready. Lacking enough stock to fulfill demand is a major fear (if the publisher doesn’t have enough product it will take the console company another six months to turnaround reorders, by which time the demand will have disappeared), so the publisher orders big, 500,000 units at $30 a pop. The payment is due up-front and is non-returnable. Before it’s even released, the company has now spent $35 million on the game.

Then, the sure-fire hit movie misses and misses big. The license is now more of a stigma than a benefit. And the big-name developer who made its name while lean and hungry has grown flabby and complacent and delivers a dog of a game which then receives the reviews it deserves.

The aftermath is that the publisher’s warehouse is full of copies of a game it wants to sell to retail for about $50, but that retail knows it won’t sell at half that price.This is the risk a publisher faces every time it commits to a big game. It makes the game market a dangerous place and creates a climate of fear in which taking a risk on pricing is far from the top of publishers’ agendas. And this threat of financial ruin is what keeps the games market in a constant state of cannibalization.


BREAKING ALL THE RULES

Mario 64 defies both traditional gameplay and business models

Super Mario 64

Mario 64 is said to have cost Nintendo $30 million to develop. This makes it the costliest game ever produced. Yet, for many different reasons, the game isn’t such a significant landmark in the budgets or prices of videogames. To start, Mario 64 was developed at the same time as the Nintendo 64 hardware, so it’s not clear how much extra R & D cost was incurred by writing to a machine that didn’t actually exist. Secondly, Mario 64 doesn’t have to make money for Nintendo. It just has to be good. It’s primary job is to show just how fantastic the N64 experience can be, providing consumers with a reason to buy and other developers/publishers with a standard to aim for.

Undeniably, it’s done its job brilliantly and if $30 million could kick-start a market that could be worth billions of dollars to Nintendo within two years, it’s money well spent. Also, Nintendo can afford to commit such funds to a software project because, unlike third-party publishers, it doesn’t have to pay a premium price for manufacturing and duplication once the code is complete.

If an independent software house presented Nintendo with a game as big as Mario for N64, it would probably sell for around $100 just to break even, let alone make any sort of profit in order to recoup the $30 million development budget.


SO WHO'S GETTING RICH?

Need final proof you're not getting ripped off? Check out the publishers' accounts

One argument that defends publishers in the face of “rip-off” allegations is that very few of them are making serious money at the moment. In fact, some of the biggest and best known are losing an awful lot of money.

Acclaim, for instance, posted staggering losses of $221 million for the year ending September 30, 1996. MicroProse lost $40 million for the year ending March 31, 1996, and Mindscape lost around $50 million during the 1996 calendar year. Viacom recently announced it is putting Virgin Interactive Entertainment up for sale. VIE lost $14 million in 1995 and is expected to announce similar losses for 1996 shortly. Time Warner has also divested itself of the majority of its game market interests over the last 18 months.

Some of the world’s largest media companies were tempted into the market partly by the high retail prices charged for software. Many are now exiting the industry in a big hurry after finding that, despite price tags of $45 to $75, it’s actually very difficult to make money from games.

Conversely, the only company to regularly make good money from computer and videogames over the past five years is Electronic Arts, a publisher with a critical track record second to none and possibly the last company any consumer would accuse of ripping people off.

In the end. it may seem that game companies are faced with no greater problem than counting their money, but reality suggests a much more dismal picture. Making money in this business is tough, and no gamer should begrudge the money you spend — as long as you believe its worth it.

/ NEXT GENERATION, vol.3 30, June 1997 /


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