Regulation May Alter MMO Landscape, Part 2

Includes: ATVI, EA, PWRD, TWX
by: Troy Racki

<< Return to Part 1

Free-to-Play Hooked on "Gacha"

Prior to the development of the "gacha" mechanic, the free-to-play business model was regarded as economically flawed and relegated to bottom-tier games. How could you possibly turn a profit when you give your core product away for free indefinitely? The early free-to-play games were distinctly small budget, low graphic, niche fare supported only by sales of cosmetic or "fluff" virtual items. Many doubted the business plan's viability. However, interest in the model took off after Turbine Inc.'s fantasy game "Dungeons and Dragons Online," part of the Time Warner (NYSE:TWX) conglomerate, successfully reinvented itself.

Originally launched with the hope of competing against Activision Blizzard's (NASDAQ:ATVI) "World of Warcraft," the game fell short of expectations and spiraled toward oblivion. In a last-ditch effort to save itself, "Dungeons and Dragons Online" switched from a subscription model to a free-to-play system, where customers could enjoy the core product for free but later acquire expansion products for a price if they remained entertained. New customers took interest in this unending free trial and many since went on to purchase the content expansions. It should be noted that "Dungeons and Dragons Online" has not relegated itself to the "gacha" mechanic, but instead continues to sell new game content, with the next major expansion due in June.

As the success of "Dungeons and Dragons Online" has begun to lead other developers to take the plunge into free-to-play, the online gaming community is beginning to change its expectations from pay subscriptions toward free play. This free-play trend is likely to gain increasing demand and will put intense pressure on subscription-based games to capitulate. Remember when you had to pay to have an email account? Now email is expected to be free. Back when "World of Warcraft" first launched, could you imagine being able to play for free up to a certain level? The free-to-play market drive has been so powerful it has influenced even the top-tier games, such as Electronic Arts' (NASDAQ:EA) "Star Wars: The Old Republic" and "World of Warcraft" to offer a free trial periods. If Electronic Arts' "Star Wars" continues to lose players at the rate it has been recently, there may very well be a shift toward a continuous free-to-play, albeit limited function, model.

Games economically driven by content expansion sales are a very tough row to hoe. When expansions fail to meet player expectations, sales fall and servers teeter on the verge of shutdown. Enter the "gacha" mechanic, where huge revenue can be generated from relatively little effort. After all, how much effort does it take to create a few prizes vs. a new digital region to explore online? Imagine if Darth Vader's digital lightsaber could be had for only one chance in one hundred -- just imagine the response. However, the dependency on the "gacha" mechanic to generate profits when all else fails is creating an MMO (massively multiplayer online game) industry that rewards gimmicks over quality content development. But what if the proverbial golden goose comes under regulation and is jerked away? Will the free-to-play model continue to thrive?

Content vs. Gimmicks

The question of financial viability of content over gimmicks will be answered sooner than you think. Once again, "Dungeons and Dragons" is going to be center stage in determining the direction that future free-to-play MMOs will take. This winter, Turbine's "Dungeons and Dragons Online" will face off against Perfect World's (NASDAQ:PWRD) new release "Neverwinter," an online game that utilizes the same source material, though in slightly different universe. By using essentially the same material, the two games will split the same player community in a massive tug of war between "content" and "fluff," as it is likely to be expected that "Neverwinter" will utilize the mystery package mechanic.

While at this time it is unknown whether any brand can support two separate games, one thing is certain: Whoever emerges the financial winner will very likely set the tone for the movement of future MMO economies. Odds are likely that "Neverwinter" will be tough to beat given the immense popularity of the mystery package on Perfect World's other properties. But if regulators take action against the "gacha" mechanic, Perfect World may have a very difficult time moving forward.

Siren in Summary

Currently, the free-to-play model appears to be the siren song for players in the highly competitive video game industry. More and more online properties are beginning to consider a business model where players can enjoy part, if not all, of a product they desire without paying. Slick marketing has made much of this possible through sales of a lottery-like product, one which developers are becoming increasingly dependent on. The quest for lucrative profits, however, has turned consumer against producer. In Japan, "kompu gacha" became so overly abusive to its customers that it led to government regulation that may change the MMO landscape. Rumor has it that Denmark is also investigating possible actions. MMOs would be wise to try to get ahead of this and find a middle ground.

If regulation were to occur, certain online game developers would see a dramatic impact on their bottom line, especially those highly dependent on the "gacha" mechanic. Investors would be wise to reconsider their positions in companies such as Perfect World, which may struggle to adapt to a changing environment. Online players also may see a downturn in the free-to-play business model if loss of the mystery mechanic results in the closure of some games. Consequently, high-quality subscription-based games such as "World of Warcraft" would then see an increase in sales as players would accept the change and return to the pay-for-play model.

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