Activision's 'World Of Warcraft' - A Theoretical Exercise

Jan.10.13 | About: Activision Blizzard, (ATVI)

The "World of Warcraft" franchise (IGN Review) is perhaps the single greatest source of speculation for Activision Blizzard (NASDAQ:ATVI) investors. It represents a ton of revenue and is surrounded by a highly complex and rapidly changing market. I personally have come across a litany of theories relating to its future forecast, and felt it might prove useful to review existing models. In the paragraphs that follow I have identified several key models, and provided my own analysis for each. Finally, I attempt to combine existing models to create an integrative theory of the franchise.

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I am both a strong supporter of the company (as made clear in my previous article, "Success On Sale: Activision Blizzard") and a faithful subscriber to the game being covered (currently stealthed in Alterac Valley). I've been careful to write in a manner devoid of bias, but would never make the assumption that I've done this perfectly. If my writing provides nothing more than a venue for thinking, it has served its purpose well.

Dead Fish Theory

This theory states that the franchise has grown too old for its own good and will steadily lose subscribers at a fairly accelerated rate indefinitely. That "World of Warcraft" was a good game, but has over time become a dinosaur of its industry and is dying. Proponents of this theory cite outdated game mechanics and declining subscription numbers as evidence of the franchise's demise. The general consensus is that a subscription crash is imminent, and nothing can stop it.

Here's my take on the dead fish theory. The market for various forms of electronic entertainment and gaming is expansive, complex, rapidly changing, and highly competitive. The ability of "World of Warcraft" to have thrived in this type of market for nearly a decade now would seem sufficient evidence for its expansive, complex, rapidly changing, and highly competitive nature.

Perhaps one of the franchise's greatest advantages is the sheer size of its playable universe and player base. But this may also be one of the greatest limiting factors of the title. With such a large world, substantial changes in the game would be massive undertakings in their own right. And with such a broad player base, pleasing everyone with the latest patch or expansion proves impossible. For the game to truly be overhauled, a massive investment of time and capital would be required (or an army of staff hired), and that makes it an incredibly difficult project to run. Older mechanics and less vivid graphics are symptoms of this unique dilemma.

Subscriber Core Theory

This theory states that the churning and decline of subscription numbers is more or less the observed activity of non-core subscribers entering and leaving the game. That a solid subscription core exists, and that declines will stabilize as the "true" player core is approached. It introduces the concept of a semisolid bottom number, and implies heavy deceleration of subscription declines once this floor is reached. Proponents of this theory cite devoted fan bases and restricted subscription lows as evidence of their position.

The strength of this theory seems to be in its division of the player base. It accounts for a good deal of the "out of place" characters encountered during play, and takes into consideration the fierce dedication observed by other players. Rather than viewing "World of Warcraft" subscribers as a homogeneous blob, subscriber core shifts the focus to various classes of "World of Warcraft" consumers and how they respond to the game as individuals.

Free to Play Conversion Theory

This theory states that "World of Warcraft" is surrounded by a rising tide of free to play (F2P) titles, and in response to this shift (and changing gaming environment) must either convert to the F2P model or risk collapsing under its "outdated" pay to play (P2P) system. Key proponents of this theory cite the incredible popularity of titles like "League of Legends" (which offers free to play models of games similar to "World of Warcraft"). The consensus of F2P theorists is that "World of Warcraft" would be significantly less profitable as a free to play game, and thus would damage the future earnings of Activision Blizzard.

My take on the theory is this: "World of Warcraft" is an incredibly profitable (and successful) franchise. The fact that it has thrived as a P2P alone should encourage one to look into its prospects as an F2P. The "Real Money Auction House" or RMAH of "Diablo" could potentially be applied to "World of Warcraft"'s virtual economy (although I would suggest a simpler gold exchange system, rather than real money item sales), and other means of revenue churn via micro purchases could be established. Gold farming could thrive, and life would go on.

But with roughly 10 million people paying $15 a month to play the game, Blizzard is under little pressure to play by the same "rules" as other MMO developers. If subscriptions reach some kind of critical mass, I'm sure the franchise will convert. But that isn't going to happen until the P2P player base has been milked for all it's worth. And when this conversion does occur? The world's largest P2P MMO could see an explosion in player counts to compensate (at least partially) for the change in models.

Expanding Markets Theory

This theory assumes "World of Warcraft" would have strong appeal to new players. Essentially, it states that entering new markets (like those of developing countries) would solve the franchise's problems almost overnight. New subscribers would discover the game for the first time, and another cycle of success could be assured for a reasonable amount of time into the future. Proponents of this theory push for the game's expansion into new territories (such as India's gaming market), and demand greater focus on contracts with foreign publishers (such as China's NetEase).

My take on the expanding market theory is this. While new markets could very well provide growth opportunities for "World of Warcraft" and Activision Blizzard, the management and satisfaction of existing fan bases must take precedent. "World of Warcraft"'s expansion as a franchise is one of the very things restricting it as a title (as discussed in the dead fish theory), and taking on a larger and more diverse base may "poison the well" in terms of general user satisfaction. There is merit in growing, but it means nothing if it compromises the integrity of the game itself.

An Integrative Theory of the Franchise

"World of Warcraft" is an impressive and popular game, but has grown somewhat stagnant as expanded universes and player bases have made it difficult to manage. Aging mechanics relative to its peers has caused a degree of dissatisfaction in its user base, and keeping subscribers happy into the future will prove more costly going forward than it was previously. As key "on the fence" groups of gamers churn in and out of the game, general numbers in the base may decrease until a core of reliable subscriptions are discovered. Losses will slow as this core is approached, and the management of the game may even become simpler for the company (as a more homogeneous player base is established).

Expanding markets may provide additional players, with hard to foresee consequences for the games primary content over time. Should the rise of F2P games prove troublesome for the company, and result in an established threat of the player base, the franchise will convert to a free to play model driven by micro transactions for revenue. Considering its substantial popularity as a P2P game presently, this may very well lead to an explosion in the player base, and to its establishment as the largest (and most lucrative) F2P game in the market's future.

In Closing

Of course, these are nothing more than theoretical possibilities for the franchise. I personally wouldn't try using any one of them as a crystal ball. I wanted to introduce these theories as a thought exercise, especially for a topic currently considered so one-dimensionally. I encourage readers to post alternate theories and forecasts, and think we may be able to develop a pretty functional model by doing so. If nothing else, we could get a very solid idea of what current investors are thinking, and that could prove useful in its own sense. The only thing I insist any reader of mine do is think before they trade.

Disclosure: I am long ATVI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.