The Biggest Threat To Activsion Blizzard

| About: Activision Blizzard, (ATVI)

Over the last couple of years, F2P games (free to play games) have become a lot more popular, and while this trend isn't receiving much attention in the broader public, it is in my opinion a very alarming threat for an established gaming company such as Activision Blizzard (NASDAQ:ATVI).

ATVI has become a multibillion dollar company by profiting from popular "pay-to-play" games such as "Call of Duty," "Starcraft," "Diablo" and the subscription-based "World of Warcraft." However, with the recent popularity of F2P games such as "Leagues of Legends," "Dota 2" and "World of Tanks," the gaming company needs to rethink its business model. Why would consumers continue to pay a one-time fee for a game they haven't even tried yet? The F2P business model offers a much higher correlation between the utility consumers are getting from playing the game and the money they are willing to pay for it.

The problem with this trend (for Activision Blizzard) is that it reduces the entrance barriers to the industry. ATVI has a large marketing budget and a great brand value. Each game it releases receives a lot of attention from the media combined with a lot of pre-sold copies. Smaller companies are not capable of competing straight up with Activison Blizzard unless they are offering a superior product. However, developing superior games requires a lot of resources, which results in very high entrance barriers. Thus, for many years ATVI has been able to function as a monopoly in the gaming business.

The F2P trend allows gaming companies with smaller budgets to release games that emphasizes the social experience. With F2P games you can play together (or against) all of your friends. With the pay-per-copy model, you can only play together with people that have also bought the game.

Thus, it is not surprising that F2P games such as Leagues of Legends and World of Tanks are having a much larger player pool than Blizzard's "Starcraft 2." The problem is accelerated by the fact that Blizzard is attempting to maintain Starcraft as an e-sport (competitive gaming) giant, but with a smaller player base comes a smaller viewer base. This reduces the amount of money professional players can earn, which results in fewer competitive players playing "Starcraft 2" relative to the F2P games. Further, the new "Command and Conquer" (expected release date: late 2013) will also be F2P, and if the game turns popular it may be the final deathblow to Starcraft 2 as an esport.

Given the strength of F2P games, one could wonder why Activision Blizzard doesn't turn all of its games into F2P. I see two strong arguments against that;

  1. Even though we are seeing some F2P games being relatively successful, it is important to note that it isn't a guaranteed success by any means. For instance, Age of Empires Online failed quite badly.
  2. F2P games should mostly be used for gaming franchises that have relatively poor/mediocre sales figures. For instance, turning Call of Duty into a F2P game would be very unwise as it would almost be impossible for the franchise to be any more profitable than it is now.

So it is a bit problematic for Activision Blizzard; The F2P games makes it possible for smaller companies to compete with ATVI, and ATVI can't really transform most of their own games into F2P as well.

However, that doesn't imply that it can't experiment with the F2P business model with new franchises where it has relatively little to lose. The new card game, "Heartstone: Heroes of Warcraft" is its first real attempt at experimenting with the F2P business model. If it turns successful, then we can't rule out the possibility of ATVI transforming some of its less popular franchises (perhaps Diablo and Starcraft) into the F2P business model a couple of years from now on.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.