Since the creation of the iPhone, game developers have emerged offering thousands of games users can download for free and play right on their phone. The problem for these developers is just this: for free. While there are of course apps that people have to pay for, the vast majority of games particularly on Google (NASDAQ:GOOG) Android are free to download. Even "expensive" games cost only a few dollars. A recent analysis found that these games on average only make a few thousand dollars. While this is nice for an independent game maker, this pales in comparison to the billion dollar franchises owned by some of the big game developers like Electronic Arts (NASDAQ:EA) and Activision (NASDAQ:ATVI).
The problem for many game developers is how you monetize games that you have to give away for free just to get people to use. The vast number of games available on smartphones is great for consumers, but spreads the income generated among thousands of developers rather than to just a few major companies as is the case in other parts of the gaming industry. This is changing the business model and marketing strategy behind the games. Instead of trying to drive purchases of the outright game, as is the case with video and computer games, developers drive downloads to build a massive user base.
A few companies have found really interesting ways to make lots of money. As the industry matures, I am sure we will see even more ways to monetize these games in ways that drive greater revenues for the few who master this art. For now, a few developers, and even a large company, have come across a ways to monetize "free" games.
The most obvious way to make money off "free" is of course advertising. Google has done a great job facilitating advertising for developers on its Admob platform, making it easy to put advertising on smartphone applications. The problem with this method though, as with Internet advertising on most websites, is that without billions of views, the amount of money one can make is relatively low.
Another common moneymaker is upgrading to premium versions where users pay a few dollars and can play more levels, unlock new features, or get rid of advertising. This form of monetization begins with a free version of the game and then quality of the gameplay must convince people to upgrade to the "premium" version. This works very nicely in reducing the cost of trial to the user to just the cost of waiting for the app to download. Yet, again, the issue is that even with the upgrades, the cost to upgrade is only a few dollars. This pales when you compare it to $50 or $60 for a game on video game consoles.
One company, Stick Sports, does a good job with this offering premium upgrades for different parts of the game. Their game Stick Tennis offers several different tennis tournaments and competitions that a user has to pay for separately.
The Old Guard
Electronic Arts has also done a good job bringing its video game franchises to smartphones, yet unlike the "freemium" model used by others, Electronic Arts charges outright for its games. Its "Madden Football" and "Fifa Soccer" games are on smartphones. While the total gameplay is limited compared to the video on gaming consoles, they do a great job filling the desire of users to have EA games on smartphones, and filling the gap before possible competitors could capture it.
The challenge for them is that video games can generate $60 each, while a download on a smartphone only brings in $5. So far, EA has been able to keep its video game versions relevant, as there is much more gameplay and depth to the video game versions. Also, many smartphones still have limited processing power and graphics, so the performance level of the smartphone versions is still imperfect.
An interesting new method is in-game purchases. Countless companies are using this across the space and when you go on the "Top Grossing" section of the Play Store, many of these games support in-game purchases. Some games are designed in a way that users can speed up the time it takes to reach a new level, gain access to unique tools, or do cool things they could not otherwise. Others allow users to send virtual gifts to each other. People pay for this.
Zynga (NASDAQ:ZNGA) is a great example of a company that has mastered this. Their games like Draw Something and Words with Friends allow a certain amount of gameplay free before users must pay either for the game itself or for extra "coins" to play. Some games take this a step farther and integrate a very social influence where users can buy virtual gifts to send to other users. The key is to get people "invested" in the game first; it is then easy to sell users these kinds of goods.
Age of Empire, a game in which you build a "city-empire," has done a great job of this by not interrupting gameflow with these purchases but clearly illustrating that a user can improve the game with purchases. With the game, users have to wait for some of their actions to be completed as well as to gain resources. By purchasing coins, a user can speed up this waiting time or even gain advantages. The developer sells these coins right in the application. They have done a great job integrating the coin concept into the actual gameplay without making it overly inhibiting, which would turn off many users.
With this new gaming medium, we've seen companies build multi-million enterprises. Glu Mobile (NASDAQ:GLUU) is a prime example of a company developing games with graphics as good as on computers for the smartphone platform. Their games utilize some of the highest quality graphics I have seen on smartphones. Most are free to play, but users pay to buy certain items in the game that add to the gameplay. While still losing money, this is a company to look out for in the gaming space.
The Holy Grail
Probably the Holy Grail for app makers to make money is turning a game into an enterprise. Two examples come to mind. Rovio's Angry Birds is the best example of this. Since releasing their Angry Birds game, they have had millions of people pay for the premium version, developed a television show around it, and made millions selling Angry Birds merchandise. This is a franchise leveraging its characters in every possible way.
Disney (NYSE:DIS) is also seeing great success using this franchise method, utilizing its brand and creativity to create new characters and franchises that they can leverage across multiple mediums. Their strategy has always been to integrate its creatives. The Lion King movie brought Lion King rides at Disney parks and merchandise you can purchase in its stores.
Interestingly, Disney is trying to create characters on smartphones. Its "Where's My Water" game is one of the highest grossing applications and I would not be surprised to see its character "Swampy" in stores or as part of rides sometime soon. Its other games have also been incredibly successful,, and Disney now has five on the Play Store. The great thing about Disney is that it keeps with its focus on kids and does a very good job creating games that kids enjoy (and adults as well).
The Best (So Far)
It seems at this point that the two major profit centers for the majority in smartphone gaming are in-game purchases and virtual goods, and launching premium offers that allow users to upgrade. The best outcome for developers is, of course, to create a franchise just as Rovio and Disney are doing but for the majority of companies, this will not necessarily be possible.
Yet we have not seen the full scale and potential in smartphone gaming. The companies in this field are still young and the possibilities for making money are still being created. Money making opportunities are limited purely by app makers' ability to identify them. In a few years, the list of ways to make money in gaming will grow, as will the companies that figure this out, like Rovio and Zynga. Though some of these companies are still private, keep your eye on the "Top Grossing" section of the Play Store and you may find yourself happily surprised by your investments.
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.