State of Play: The Video Game Industry — with Joost van Dreunen

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0:53Welcome to a special episode of the Prop G Pod's Office Hours. In today's episode, we speak with Jos van Drun and my colleague at NYU Stern and the author of One Up, Creativity Competition and the Global Business of Video Games. Jos breaks down the state of play in the video game industry, including the major players and platforms and the latest around Activision, Blizzard and Microsoft. As always, if you'd like to submit a question to the pod, please send a voice recording to officehours at propgmedia.com. Again, that's officehours at propgmedia.com.

1:29yos where does this podcast find you finds me in brooklyn let's bust right into it give us the state of play in the gaming industry a 300 billion dollar industry i didn't even realize it was that big what has happened since we last spoke to you 12 or 18 months ago it's a good question uh the early pandemic got everybody excited about games everybody eager to get out of their own mind and out of their, I guess, domestic situation family, and they went online, started playing. So all boats went up, to put it simply. But since then, it's kind of come down substantially. Simply in numeric terms, North American game makers, after initially going up about 35 % in total market cap in the first year of the pandemic, have since then dropped to about half of what it was at the beginning of 2020, compared to the S &P 500, which has, of course, recovered mostly since then.

2:20So what was really like a big moment for gaming, it's kind of subsided and cooled. There's been this incredible momentum in terms of demand outstripping supply and publishers being unable to catch up. But as a result, a lot of new companies have entered into the fray. So there's been a lot of consolidation. There's been a lot of investments. There's been a lot of expansion into different categories. And so while the industry overall is cool a little bit, at the same time, I think it's now a mainstream form of entertainment and has cemented its position in a sort of broader cultural sense. So let's take a step back.

2:55That$300 billion number is staggering. I think total domestic box office is$10 billion. And we are something around$10 billion. And we obsess over that. And the video gaming industry is 30 times that, a third of a trillion dollars. Can you break down the components of that$300 billion? Who's making the money here? How does it disarticulate? But what's happened over the last decade or so has been this shift in power away from game makers towards the platform holders. Over the course of a decade, you see companies like Apple, Sony, Microsoft really gaining a lot of ground, historically relying on their own ability to, of course, convince publishers to put games on their platforms.

3:42they've now become so large that they set the tone in many ways of course you couple that with like the abundance of cheap capital the necessity for these game makers to reach audiences and it gives them incredible position so most of the money still goes to game publishers but the market power that's increasing is on the platform side so that's that's really one major takeaway immediately and break down the platforms uh the biggest ones and sort of give a little color on each in terms of market momentum or lack thereof? When it comes to the platforms, you see mobile finally having a harder time than it did before.

4:19Mobile gaming after this incredible run right around 2009, when it started all the way to a few years ago, it started to level off a little bit, mostly by its own flaws, because of its own greed, I would say. Apple making it harder for game publishers to target people and to acquire users has made things that much more expensive. And so it starts to subside a little bit. The efficiency starts to evaporate a little bit out of the market model. Console, at the beginning of the pandemic, came out with a new generation. So we had the PlayStation 5 and we had new to Xbox Series X and S. That gave a huge push into this whole new ninth generation of hardware.

5:05That's subsided now a little bit too, like that moment's gone, we're entering the second half of that hardware cycle, so that subsides a little bit. And then on the PC side, while that's been going really well, overall spending the time that we do in online worlds has become somewhat eclipsed with going back outside and just being in a normal social in-person setting. You said in the Wall Street Journal that, open quote, we'll see more blockbuster releases, but innovation and novel experiences are not likely to come from the legacy publishers. Everyone's becoming risk-averse. Say more about this.

5:42the response of the industry to the pandemic was very self-serving but they were also on the back foot right demand vastly outstripped their ability to supply and as a result they started to beef up their their production pipes because this glut of content that's now hitting the market what you see is this return to just consolidation and holding on to ip-based strategies as a result you know you just see companies that want to buy other companies and just eliminate any of the risk out of it because that's not the business they're in they're seeing the increasing cost of marketing they're seeing the challenges with distribution and just discovery on each of these different categories of platforms and as a result i just want to go with what works and so you see sequels across the board right so the success of activision blizzard during its earnings last quarter was really attributed to Call of Duty Modern Warfare 2.

6:39You know, that's a title that's been going on for a long time. You see IP that works really well for a lot of players. Harry Potter, Hogwarts Legacy, 15 million copies sold, a billion dollars in sales. So that's all very tried and true intellectual property. And those are all very risk averse strategies. And we're going to see more of those. with respect to microsoft and activision you wrote a post called activision's death by 418 cuts walk us through what you meant by that the arguments by the cma and by the ftc against the acquisition of activision blizzards as long centered on this notion that activision blizzard publishes call of duty call of duty is this uh shooter title that is the most popular shooter titled in the console space and giving one console manufacturer microsoft ownership completely over this franchise would have a huge disadvantage in the space particularly for sony and that's true right if microsoft owns that franchise and if they want to they can totally make life hard for sony that's that's not the point i would argue what i would argue is that that became sort of the one thing that everybody focused on right and so the regulators they looked at this and say okay well should we do this um over time then they start to change their opinion right the fdc did the same thing but the increasingly opaque policy environment in which large mergers take place and this is something that's coming both from the people in favor of mergers and the people not in favor of mergers the fdc for instance has been under leadership of lena khan have been making a lot of progress in terms of cutting through the deadwood.

8:22And so you see these different ways that regulators are responding to large transactions and saying, we need to make this simpler, more transparent, because we need to get a handle on these things. What happened in the UK with the competition of markets authority is that they released this impenetrable document explaining how they think they see the market, clearly displaying a lack of understanding of its fundamentals, and then issuing a decision accordingly. So in my mind, what needs to happen for all these large mergers, whether they have merit or not, to be evaluated properly is also a simplification of the policymaking process around it.

9:06Also, it appears that aren't the biggest players or real formidable competitor Chinese-owned companies It seems as if you're sort of, I don't want to say, it feels like we're shooting ourselves a bit in the foot in the West, no? Agreed. The absence in these conversations of a discussion around, say, Tencent or net ease, I think, speaks volumes with regards to the, let's call it the width of the horizon that we're using here. Tencent is by far the largest game company in the world,$33 billion globally per year. It is, of course, deeply rooted in China and as a consequence has deep relationships with the Chinese government.

9:47And the Chinese government has been both an accelerant or an expediter of its ambitions as well as a great limiter. In the last few years, we have these instances where Tencent is constantly curtailed by the Chinese government because of all these rules and regulations. You cannot in China as a miner play more than a few hours a week of video games because they consider it a sort of gateway to gambling. And so it's heavily regulated. And so that is a very prosperous market that Tencent now can't access because of the government there. Naturally, they look to developing a global strategy. They've been buying up bits and pieces of Ubisoft.

10:25They have a bunch of different positions in a wide range of companies like Epic Games and so on. these mega companies that are really transformative and they're looking to move into the european and the north american market in a big way they can do a lot in europe and north america what's the uh let's say domestic platform holders are not allowed to do right um such an adela says it's perhaps uh in a slightly different version thereof um it's very interesting to see that Sony gets such a prevalent role in the conversation about what Microsoft can and cannot own, yet somehow Microsoft has very little market share in Japan, where Sony is from, of course.

11:08So you start to see this sort of large global dynamic between these platform holders and these companies. And perhaps maybe shooting yourself in the foot is a little stronger, but it's like you are discouraging and disincentivizing these companies from really moving into a competitive space. So let's speak specifically about Sony. In another newsletter you wrote, different from Microsoft, which develops operating and application software, and Nintendo, which considers itself a toy maker, Sony has long focused on building high-quality media devices. What did you mean by that? So the DNA of a company like Sony historically comes from consumer electronics.

11:44They make boxes, headphones, microphones, TV sets, audio equipment. and in addition to that they have developed over the years this incredible content library across music across film and video games so that you will have something to do and something to see and something to listen to when you buy their equipment so it's a those are all complementary business units for them over time of course the industry has shifted a little bit they too are now realizing that the value of services and the value of intellectual property far exceeds their ability to manufacture new cool devices, right? That never-ending hunt for the new Walkman that made them famous in the early days, you know, eventually is going to run out of steam and they have to stay, started to focus more on becoming a media empire of sorts.

12:33But that's a very different proposition than say Microsoft, which is building data centers around the world with its Azure technology and trying to figure out how to pipe, you know, its Game Pass offering effectively to all these different countries. So it's a very different approach where a consumer electronics company like Sony or like Apple, for that matter, they love this idea of walled gardens, whereas perhaps a software platform is more in the business of breaking some of those walls down and making things accessible and available to everybody out there that wants to play. The final thought on that is very simply put, just to give you the sense of it, when Fortnite really reached its pinnacle right at the start of the pandemic, large platforms were all collaborating so that anybody on any platform could play against anybody else in the fortnite universe sony was one of the last holdouts sony is also one of the companies that has the least developed multiplayer components they acquired bungie recently really you know the subsidiary to develop their multiplayer components and capabilities so they're really sort of in an isolated walled gardens mindset still because they're a consumer electronics firm as opposed to an operating system developer or software company at large.

13:46So I wanted some exposure to the space. So I bought some secondary shares in Epic, just as a means of disclosure, but give us your thoughts on Epic. Good for you, by the way. That's a good investment. Epic is a privately held company that makes both games as well as the software that makes games called the Unreal Engine. and then they have the epic game store so the most popular most well-known is of course fortnite this massive universe makes five billion dollars a year has all these different users and that is i think in many ways the shape of things to come uh you know playing so often particularly playing online as we learned during the pandemic is mostly an excuse to hang up with other people you don't really go for the informational value and it's not really a ritual so much as just a socialization right it's a a playground that's just in the cloud or somewhere online that you can visit and that's where your friends are and that's slowly developed over the years and i think fortnite is really that that sort of forum that that online environment where we can hang out and just do goofy stuff and have a good time its ability then to sell its unreal engine and it's now in its fifth iteration its fifth version that's really the big play for them they're trying to get their software technology into not just gaming, but also in the film industry, where you see the Mandalorian being shot against the background of landscapes rendered by the Unreal Engine.

15:16And that's for Epic, a really good way to get into that broader universe of saying what we can do today with this software creation engine that they have with the Unreal Engine, that's a really important part of their strategy because then they can be that middleware engine, that middleware supplier. And then finally, the Epic Game Store, you know, they, and I know you know this well, they've been fighting tooth and nail against Apple because of the Apple tax, because the App Store costs involved. And they argue like that's not fair. They've done that not just with Apple. Previously, they did it with a company called Valve, which is a digital PC distributor, very famous, very well known, also very private.

15:56And they had to come down with their percentages because Epic started making a lot of noise. So that was really the pretext to the lawsuit with Apple, as I see it. They're offering their titles and the developers on their platform much lower percentages. And that's going rather well. It's unclear if that's going to be the ultimate king of the hill, but it certainly gives these incumbent distribution platforms a run for their money. So they're disruptive. They have really popular content. And they have tools and the bandwidth or the financial runway to see this through. So I think your investment is well warranted in that one.

16:34We'll be right back.

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17:40So virtual reality, I know that's a pretty broad term, but it strikes me, and I have some confirmation bias here because I predicted that VR was going to be this enormous thud, but it feels like headsets as it relates to VR have been a disappointment. What are your thoughts? So when it comes to the devices that we use to access virtual reality, I think the last 30, 40 years have been a lot of borrowing from the future, but under delivering in the present. And by which I really mean, you know, there's an extensive history going all the way back to the Nintendo Virtual Boy, where the device itself is wildly underwhelming.

18:21The content library that we find or the usefulness in applications are also wildly underwhelming. And as a result, people sort of see this as a nice to have. And we're always expected and asked to believe in this future that's clearly not coming anytime soon. so when it comes to devices a validation of course that everybody's been waiting for is apple's announcement around the vision pro now that we see you know what team tim cook has cooked up for us we end up with this glass shell with lots of expensive cameras in it you know allowing for the for the small price of fifteen thousand dollars a family of four to watch a movie together they're in VR.

19:05And so in many ways, it seems like that is a little disconnected of what would be, in my mind, a more practical use case. I have a two-year-old and a 10-year-old at home. They would break this within minutes of me strapping it to either of their foreheads or cover it at least with peanut butter. And so it just seems kind of designed out of touch with what an average person would use these things for. In the absence of a clearer user solution, while i'm excited about the virtualization of media and content where we can build more immersive experiences the way that a lot of these tech companies tend to think about it is in in line with their own interests their corporate interests are such that they must have a device where they can dominate facebook at the time got into this by buying oculus for two billion dollars because they did not want to miss out on another platform transition they had missed out on mobile and now they really wanted to be into the vr space and so mark zuckerberg whips out a big checkbook and off he goes i think tim cook might be similarly motivated at least in part to not be the last one left behind when apple doesn't really have a clear strategy around this budding new technology and so when it comes to this promise of virtual reality i'm all in it for i want to live in that future but so far they've delivered on none of it.

20:25That's exciting. And so that's, I think, an ongoing skepticism that's hard to get rid of. Any thoughts on the intersection or is there any between Web3 and the gaming industry? Oh, many. A decade ago, people were very afraid of free-to-play economics, giving your game away for free, only to then become successful financially and in other ways. That was out of reach for everybody, right? That didn't exist. And now that's by far the most dominant revenue model. When it comes to things like cryptocurrency, I do think that there has been a lot of mistakes in that space. I think a lot of game companies have made what they call the financialization of fun.

21:06They've committed that, and it's terrible, and a lot of the gameplay is awful. The idea that you would have some sublayer of superfans that don't just want to play the game, but they want to have easier access. They want to have a digital wallet that connects them to multiple things. And as they leave a game, they can take everything they've accumulated inside the game with them. I think that there is a case to be made for that. But so far, most of the intentions behind it seems to have been funded by people in finance as opposed to game makers. Never mind that the blockchain technology is still very rudimentary and inefficient.

21:41my hope and some of the hopeful things that i see on the horizon is game makers like nexon which is a big deal in korea a 10 billion dollar company in korea that makes maple story and other games they are now transitioning some of their ip onto the blockchain ccp the maker of eve online one of the longest standing subscription-based sci-fi games out there sort of a cooler version of world of warcraft if you will they just raised 40 million dollars to build a blockchain-based game Sony applied for a patent to accommodate NFTs and digital collectibles in its ecosystem. And so I start to see these larger companies and these companies with some miles on their meter that could possibly push this into a better space.

22:26So I continue to be optimistic about it, but there's been a lot of mistakes around this. Gaming and crypto, they have a natural intersection, I think, but we need better captains on these boats. and if you had to make any predictions about the remainder of 2023 in the industry what do you see happening the prediction for 2023 will be continued consolidation one of the big questions that has arisen from that is as companies like embracer which is now the largest by market cap european game publisher worth about 11 billion dollars you know this is basically this amalgamation of like 250 different studios and subsidiaries funded to no insignificant degree by saudi investment money you have to start thinking a little bit like okay all this consolidation is going to move the gravity point in the industry right where historically you see japan and north america are kind of competing and then europe being a distant third and everything else is sort of out of reach now we start to see so much money coming into the ecosystem because gaming is an industry that doesn't really require a lot of big industry.

23:35You don't need to have a lot of factories to set it up. All you need is just a pipeline and a bunch of clever people making games. So if you want to set that up in Saudi Arabia, you can totally do that. It's going to change the politics a little bit though, right? In the same way that the Chinese companies 10 years ago were relatively insignificant and are now dominating the space, you start to see this shift in geopolitical relevance and i think consolidation will be a major topic for the remainder of the year who owns who and who gets to tell them where they set up their studios and and do you really want to have your children play games that are made in a country where they shoot and execute journalists you know and is that a fair question to ask so i think that larger conversation will kind of trickle down uh in the creative agendas so that's one thing that i uh I'm excited to have that conversation because it kind of puts games on a higher profile.

24:28And that's something that we should be talking about. And then, of course, it's business as usual. So we have Activision, we have Take-Two and Electronic Arts. They are going through the next iterations of their existing franchises. Are they continuing to do well or are we going to start to see them slow down? The last two quarters have been a little slumpy except for Activision. And so I suspect that for the remainder of the year, it will be soft, but the upside will be for those companies that by the end of this year and starting next year will have a solid online presence and an active multiplayer community centered around them.

25:06So those are two of the main trends I see. Do you see Saudi money the same way it's kind of come into large hotel brands or even football leagues? Are they about to become the biggest investors in gaming and then move headquarters to Riyadh? Is it the Public Investment Fund in Saudi Arabia? Yeah, PIF. PIF is already the largest non-domestic shareholder in Nintendo, owns billions of dollars of Activision. I mean, there's a whole list on their portfolio. Some of it is through their subsidiary, Savvy, which is the more experimental group, of course. But they've taken both positions in public equity as well as privately held companies.

25:48going to, I think, ultimately make people aware that this is now the new regime in charge, right? That's where the money comes from. We see, for instance, over the last 10 years, companies desperate to enter the Chinese market because it came online, because it's so many people. You see Activision collaborating with its biggest competitor, Tencent, for half of what it could make in China because it has to work with a local partner and it has to change a lot of aspects of its games. It can't have skeletons and sort of these weird regulatory aspects of it. But they do so because they don't want to miss out on that market.

26:26And so if the money's there, they'll follow, but they're going to have to compromise or make compromises along the way. And I'm very curious to see who's going to make what compromise to get there. And last question, Yost, what two or three players have the most wind in their sails versus those with the most wind in their face? Who's got good or poor momentum right now? Players, platforms, game makers, specific companies? In my mind, the companies that are poised to do well are the ones that can rely on extensive intellectual property and that have, over the last years, used a lot of access to cheap capital to build out their assets.

27:03A company that immediately comes to mind is Nintendo, which, coming off of its billion-dollar box office success with the Super Mario movie, has also been building theme parks. And so they are clearly in the space where they are looking how to take their existing business of making games and game consoles into a much broader ecosystem of activities and experiences. People want to go see this. People are excited to go do sort of a real-life Mario Kart thing with their friends and family. So I think that that is a company that has, never mind that it's been around for 125 years or so, they have an extensive legacy when it comes to building contemporary and acute experiences that are interesting to people another one that has some upside in front of it is is sony in spite of this turmoil around everything that's happening with microsoft acquiring activision and it's claiming that that's somehow detrimental to its position in the market sony has a vast library across multiple categories not just games but also of course music and film you can see how they can leverage this in a massive way and build this out on all these different platforms so i believe that they are going to transition away a little bit from trying to reinvent the walkman to becoming something that's a little bit more focused on you know that's more akin to a media empire where they take their intellectual property and just spread it across different aspects of it and don't forget also that they also are the leader when it comes to japanese animation like anime and manga very strongly grown categories that are very popular with younger audiences sony plays a significant role in that market as well so they have all the parts and pieces to really do well for themselves if they can let go of uh you know trying to tether themselves to the hardware too much so those are sort of the two examples of media companies or entertainment companies with both a hardware and a software component when it comes to platforms i think you know the economics still apply where the winner takes most right apple and google they're sitting on the top of the food chain they're going to continue to grow they're going to continue to expand because there's nowhere else to go for companies the only thing that's really going to diminish their ability to do well is you know maybe a more competitive uh plug-in by way of say microsoft getting access to mobile through the activision acquisition maybe regulators in the eu can give them a few of them a haircut by charging them maybe a little bit more than just a few billion a few million dollars in in fees and raise that to like three commas and beyond to really make him feel like hey look you have to build these ecosystems less aggressively and so the platforms will overall do well but you can see a growing momentum towards people getting skeptical where you have the academic literature just investigating very aggressively like what's going on really how does this impact labor what does it mean when one platform holder controls most of the labor in a particular category in a particular region or even in a town right so those are some of the questions that are emerging and it's going to be incredibly difficult to write policy for those kinds of companies purely because they operate as you know nation states more than anything else so platforms do well and then it's when it comes to re for the losers i'm sad to report that that's going to be a lot of european publishers particularly embracer which sits at the top of the food chain in europe quickly accumulated over 200 or so different projects by acquiring all these different studios and now it's at this moment where you know its debt structure is starting to collapse on top of itself it can no longer afford to not do really good deals you know they missed out on a two billion dollar arrangement right before earnings had to be reported and so they're coming up short and their share price starting to tank and they're going to start running out of runway because their acquisitive strategy is sort of coming to a natural conclusion and now suddenly we have to start cutting back on resources and logistics and infrastructure i think it's going to not just sour the sentiment around embracer as a company it's going to also have an impact on the european game development market where all these people will now be let go there's going to be a souring of investors and so they're not going to invest in the startups right the vcs are going to be a lot more hesitant for this because there is not a natural path and that's too bad because i really believe that you know what the European market has shown historically in games, but also in other cultural industries, that they have a unique voice, that they have something to show that we can't get anywhere else.

31:36And so, you know, even CD Projekt Red, like there's a lot of upsides to be had, but they're having an increasingly difficult time. And that kind of is, unfortunately, the sad part of all this, right? I'm hoping they recover, but likely they're going to end up in the chopping block and get sold for parts and pieces here and there. So that's, the Europeans will be the losers in this. the North American companies will do well, and particularly the Asian companies like Sony, Nintendo, and the Tencent of the world, they'll continue to prosper as well. Yost van Drunen teaches at the NYU Stern School of Business and is the author of One Up, Creativity Competition and the Global Business of Video Games.

32:15Previously, Yost was co-founder and CEO of Super Data Research, a games market research firm which was acquired by Nielsen in 2018. Yoast also serves as a startup advisor and investor and publishes a weekly newsletter on gaming, tech, and entertainment called Super Yoast Playlist. He joins us from Brooklyn. Yoast, it's always a pleasure to speak with you. Appreciate your time. Thank you, Christoph. Thank you so much.

32:47This episode was produced by Caroline Chagrin. Jennifer Sanchez is our associate producer and Drew Burrows is our technical director. Thank you for listening to the Prop G Pod from the Vox Media Podcast Network. We will catch you on Saturday for No Mercy, No Malice as read by George Hahn and on Monday with our weekly market show. Support for this show comes from Salesforce. Today, every team has more work to do than resources available. But digital labor is here to help. Agent Force, the powerful AI from Salesforce, provides a limitless workforce of AI agents for every department. Built into your existing workflows and your trusted customer data, Agent Force can analyze, decide, and execute tasks autonomously, letting you and your employees save time and money to focus on the bigger picture, like moving your business forward.

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