Games are Not a Fad: Of Life Cycles, Price Drops and The Next Big Thing

The video game and PC game business is a difficult industry in which to consistently make money. Even with strong overall industry growth this is unlikely to change. However, make no mistake about it, this is a rapidly growing industry. Believe it or not, DFC Intelligence still talks to many in the investment community that worry that electronic games are just another "fad." Therefore, before one can engage in a discussion about the problems in the industry, it is necessary to note several key points about consumer demand for interactive entertainment.

1. The most important trend to note about the overall game industry growth is the lifecycle of hardware systems. Generally a hardware system has a lifecycle of about five years before it is replaced with a more advanced system. Sales in the game industry thus tend to be cyclical, with revenue declines in periods of transition between game systems. This is very basic stuff familiar to anyone with even a rudimentary knowledge of the game industry. The key point to note about industry cycles is that each new generation of game systems tends to boost overall industry sales to a higher level. No matter how often it is heard, this is an important point to make about game industry growth.

2. The launch of the 128-bit game systems has seen a significant increase in the amount of money consumers are willing to spend on hardware systems. In the past, game systems did not reach true mass-market status until their price dropped to the $150 range. The PlayStation 2 had record sales at $300, and at $200 has yet to drop into a traditional mass-market price range. On top of that are sales for the Xbox and GameCube, which many consider a disappointment. However, consider that at a comparable point in its lifecycle, the PlayStation, the number one system of the 32/64-bit generation, had sold 2.7 million units in the U.S. Meanwhile, the Xbox and GameCube are well over 4 million units and growing.

3. So far in the 128-bit market, the strongest sales have been for systems that target an older teenage and young adult gamer. Of course, this is best represented by the top titles of the 128-bit market, Grand Theft Auto III and Grand Theft Auto Vice City. Compare this to the 32/64-bit generation when 9 out of the top 10 titles were games for the Nintendo 64 targeted towards a younger audience (Super Mario 64, Mario Kart 64, etc). The only PlayStation title on this list was Gran Turismo Racing, at number 10. This leads to the question: where are the younger consumers?

At DFC we have argued that many younger consumers, the traditional heart of the game industry, have yet to buy a new game system. This could be a reflection of how the slow economy has hurt sales. However, we would also argue that the market of 8- to 14-year-olds will eventually become extremely active purchasers of 128-bit systems. This will result in continued strong sales.

4. The one area of the interactive entertainment industry that has not seen large sales growth is with PC games. Overall sales of PC games have been stagnant. However, as significantly fewer titles are being published, sales of top individual titles are still very strong. Indeed, sales of a top PC game like The Sims, now rivals sales of the top console games. The PC game market is an example of how industry consolidation created a more reliable business even in the face of slowing sales.

5. The European market has traditionally been the last region where a new game system is launched. In addition, prices have tended to be higher and this combination means that overall game sales are probably not what they could have been. Going forward, we think the hardware manufacturers will be more aggressive in the European market. This is likely to be led by Microsoft, which is not as strong in Japan. We think that Microsoft may stop the traditional trend where a game system is launched first in Japan, then in the U.S., finally in Europe. In its first year on the market, Microsoft has already had three price drops in Europe. The end result will likely be increased sales for the European region.

6. Sony and the PlayStation 2 have been absolutely dominant in the video game console market in 2001 and 2002. Sony is expected to continue to be the market leader through 2007. However, its market share has almost nowhere to go but down. We forecast as many as 50% of PlayStation 2 owners will eventually buy an Xbox or GameCube. One of the interesting trends in the game market is a willingness among gaming consumers to buy multiple hardware systems.

David Cole (dcole@dfcint.com) is the founder and President of DFC Intelligence, a strategic market research firm focused on the interactive entertainment industry. Recent DFC Reports include Worldwide Market Forecasts for the Video Game and Interactive Entertainment Industry (April 2003) and Market Leaders in the Video Game and Interactive Entertainment Industry (February 2003).

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