Video Game Makers Go Hollywood. Uh-Oh.

The interesting thing to me about the following article, from The New York Times, is how quickly this "conversion of the games industry" to the Hollywood model has happened. Secondly, how durable the film production model is for producing "entertainment content." The same struggles for good independant content that typifies the film business today will now be a fixture in the video game industry. Whatever happened to the game industry transforming the way films, or entertainment in general, gets made!

Video Game Makers Go Hollywood. Uh-Oh.
By EVELYN NUSSENBAUM

Published: August 22, 2004

OVIE producers are often criticized for running at the sight of original ideas, preferring instead to milk plays, books, news events, toys and even video games for their screenplays. Now the video game industry is returning the favor, and then some. Seeking to establish the medium as a mass market form of entertainment instead of a niche technology, the game industry has taken the playbook of the movie business.

The results have been movie-based games, Hollywood-quality special effects, professionally composed soundtracks, celebrity voices - and even Hollywood-style economic problems, including ballooning budgets and a greater reliance on monster hits.

"The entire industry is looking more and more like filmed entertainment," said Edward S. Williams, who follows video game makers for Harris Nesbitt, the investment banking firm. "Soon a handful of hits will drive the entire industry."

Video game executives say they have no choice if they want to make their $11 billion industry as mainstream as the movie business. Whether they can achieve that goal remains to be seen, but their embrace of Hollywood-style production values has already made it much harder to turn profits.

Game publishers have always been subject to a nerve-wracking business cycle, which forces them to essentially reinvent their software every five years. That's roughly how often Sony, Microsoft and Nintendo introduce new consoles, which require new software formats and render most older games obsolete.

Bigger budgets and more complicated effects have made the process even dicier. The movie industry's rule of thumb is that just 2 out of 10 movies make a profit. Video game executives say their industry now has about the same batting average. A game that costs $10 million to produce - the industry average - and another $10 million to market has to sell a lot more units to make money than games made in the late 1990's, when the average production budget was closer to $3 million.

The numbers can go much higher for some new games. Atari spent $20 million on its "Enter the Matrix" game last year, an amount that is about one-third the average cost of a feature film.

As a result of the changes, game publishers are less willing to take creative chances, people in the industry say. They make fewer games and rely more on movie tie-ins and what they consider sure-fire sequels. But the smaller number of bets can make publishers walk the kind of financial high-wire that has long been part of the hit-driven movie business. At Activision, 40 percent of publishing revenue last year came from two sets of games, "Tony Hawk's Underground" and "True Crime: Streets of L.A."

At first glance, the Hollywood-style strategy has paid off, because the video game industry is still expanding. The number of video game players is growing, in the United States and abroad, and adults as well as teenagers are playing the games. Sales of game software for the Big Three consoles - the PlayStation from Sony, the Xbox from Microsoft and the GameCube from Nintendo - rose 4 percent in the first half of 2004, versus a year earlier, according to the NPD Group, a marketing consulting firm. "We had a 35 percent return on invested capital last year," said Robert Kotick, chairman and chief executive of Activision, the No. 2 game publisher. "You won't find a movie studio that comes close to that.''

But industry numbers have masked what looks like the beginning of a shakeout. While big competitors like Electronic Arts, Activision and THQ become bigger, some smaller rivals are flailing. Midway Games, which had huge hits in its "Mortal Kombat" and "SpyHunter" games, has had 18 consecutive quarters of losses. Acclaim Entertainment, maker of "Shadow Man," just staved off a bankruptcy filing. And Eidos, the British maker of the "Lara Croft Tomb Raider" series, just put itself up for sale.

Finding a way to hedge risks won't be easy for the video game business. While movie studios have a reputation for profligate spending, they have always had a cushion the video game business lacks - ancillary revenue. Home video rentals, DVD sales, broadcast rights for television, toy spinoffs and licensed video games all help movies that bomb at the box office eventually make profits.

And movies can generate profits for years: "Finding Nemo," the hit animated film that first appeared in theaters two years ago, is still making money for Pixar.

Video game makers, by contrast, have traditionally had one window for making money: the first three to six months after their products hit the shelves. If they don't sell fast enough during that period, retailers mark them down from, say, $50 to as little as $19. "We're in the land of legitimate entertainment, rivaling the movie box office now," said Steve Allison, the chief marketing officer for Midway Games. "But we're a little crippled when it comes to the secondary opportunities the movies have."

To combat the problem, publishers are - again, in Hollywood fashion - scrambling to develop secondary revenue streams. One is online games: selling subscriptions to play on the Internet, often against other players. Another is advertising: the industry's biggest company, Electronic Arts, for example, has a small but aggressive advertising team that calls on Fortune 500 companies, pitching in-game advertising as an alternative to television commercials. Clients include Burger King, Dodge and Procter & Gamble. Activision is working with the Nielsen ratings company to develop an advertising rate card like that used in television.

At Microsoft, the company's Xbox game division is planning a marketing juggernaut modeled after a "Star Wars" movie release for its "Halo 2" game. Selling the $54 CD is just the start. There is also a $5.99 monthly fee to play in "Halo 2" tournaments online; action figures for $14.99; a DVD with movie ads and a guide to playing the game for $19.99; and three novels based on the game. A soundtrack CD is due in November.

At Midway Games, developers are trying to turn the movie license game on its head, creating games that movie studios might like to buy from them. Mr. Allison, the chief marketing officer, calls them "movieable franchises" and says his company is in talks on three or four projects.

VIDEO game executives tend to be cautious about these initiatives, and with good reason. At Electronic Arts, which probably has the most sophisticated divisions for generating new revenue, subscription-based Web sites contributed just $50 million of its $3 billion in revenue last year. Advertising, licensing and programming revenue came to $33 million.

Chip Lange, vice president of EA Online, said his company was not trying to "milk every source of revenue." He said it was just as important that Electronic Arts not be caught flat-footed if a smaller rival got the jump on a new technology or business model.

That makes sense, because Electronic Arts is big. Last year, 27 of its games went platinum, meaning that they sold a million copies; no other publisher came close. Electronic Arts wants to keep its edge, particularly if the industry is headed for a consolidation that leaves just five or six survivors.

Some people in the business think that the industry's consolidation will go beyond the pattern of big publishers devouring the little ones. Entertainment conglomerates have begun eyeing the video game industry again. Warner Brothers, part of Time Warner, recently bought the game developer Monolith Productions. Viacom's chairman, Sumner M. Redstone, has a controlling interest in Midway.

Alternatively, a cash-rich publisher may decide to add a movie studio to its portfolio.

The right combination, of course, would capture the best of both worlds, cushioning a hit machine with a safety net.