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First, you may well have heard that most console games make a loss and it is only the occasional hit that pays to keep the industry going. I have to tell you that this is absolutely true. Here are what the problems are for these games:

  • What you pay for the game doesn’t go to the publisher. The retailer and distributor take their margin (say 40%), the platform holders want their license fee, the actual plastic and cardboard of the game have to be paid for, there is the cost of shipping and finally there is the tax man’s share. I haven’t done the maths recently but you can see that the publisher is going to end up with between a quarter and a third of the money. Out of which they have to pay the developer, the marketing costs, their staff, etc etc.
  • This generation there has been a massive jump in the amount of content in games. Part of this is HDTV, part of it evolution and part of it bragging rights. Game content is ridiculously labour intensive and therefore expensive. This has rapidly brought us up to movie level budgets.
  • Also this generation, Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT) both moved to completely new CPU architecture. This put game development on a very expensive learning curve. And many development assets that had been used in previous generations of console had to be replaced.
  • Whilst the current generation of consoles are powerful, they still can’t run the sort of middleware needed to really simplify game development.
  • Unlike movies games only have one revenue stream, the sale of the plastic and cardboard item. Movies have cinema income, rental, pay per view TV, non pay TV, in flight movies, DVDs, etc etc. A whole plethora of revenue streams some of which go on for ever.
  • When you buy a game you aren’t just paying for your use of it. You are also paying for the use of it enjoyed by the person who buys it secondhand off you, and the person that buys it off them. And so on. The initial purchase has to compensate the publisher for all the users of the game. And each of those users can’t complain because they get part of their initial purchase price back.
  • Piracy. Currently only the PS3 isn’t cracked. On PC piracy levels for boxed games are 90+% and at times it gets just as bad for console games. So the honest people have to pay for the thieves.
  • Currency fluctuations, these have been massive over the last year or so. If your costs are in euros and your income is in dollars (for instance) then your business has changed completely and a healthy profit could well have become a substantial loss.
  • Marketing has become difficult as the media has fragmented. Television advertising is no longer the universal panacea. Now there are a huge number different media that have to be used. And used properly. This takes a huge jump in the skill and knowledge required of a marketing department. Which can lead to far higher costs.

Against this background we have the release, this autumn, of Modern Warfare 2, developed by Infinity Ward and published by Activision (NASDAQ:ATVI). This looks like being the defining game of this generation of consoles, surpassing Grand Theft Auto, Bio Shock, LittleBigPlanet, Halo, Braid and everything else. The level of anticipation out there is beyond belief. Activision have done a brilliant marketing job.

Now, Activision is in business to make money, so this is an opportunity to make shipping containers full of the stuff. And they are doing some clever stuff to make sure they get every cent possible. Activision isn’t the biggest game publisher in the world by accident. Her is some of what they are up to:

  • They have looked at the price elasticity of demand and realized that Modern Warfare 2 has such a high perceived value that they can charge a premium price. They would be fools not to because they won’t lose any sales. In fact it would be very interesting to know the price/demand curve for this game because I reckon that the most profitable pricing point is even higher. This game is a must have purchase to so many people.
  • Which is exactly why Activision are selling three different editions at three different price points. They call them Standard, Hardened and Prestige. In reality they are Premium, Super Premium and Super, Super Premium. This is clever stuff.
  • Finally, why just make a profit with the software? As is the fashion these days they are making a hardware peripheral to go with the game. This time it is night vision goggles, which are bundled with the Super, Super Premium version of the game. Activision could make a lot of money from selling millions of these.

This is fascinating stuff. The reaction out there in the community is begrudging acceptance. They know they have no option but to buy the game and the extra price over a “normal” game is not too high a price to pay. Activision have been extremely clever in challenging the industry pricing norms. Too many marketing people are guilty of “me too” pricing without ever really thinking about what they are doing.

Source: Activision's Modern Warfare 2 and Console Game Pricing