Playing the Spread

What hasn’t been said about the “stagnant” state of the game industry, with our reliance on licensed properties from other entertainment sectors and sequels galore? Where has all the innovation gone, and why is there no love for original ideas?

The always outspoken Scott Miller of 3D Realms never misses an opportunity to push the value of IP ownership and control, stating in a Gamasutra interview:

“For most studios, [developing licensed IP is] just not as fun as doing something original. … If the studio owns a valuable IP, then they have lots of leverage and clout. They can reap financial rewards, call their own shots and make better deals. It changes the game for them.”

Not wanting to retread the same arguments, I turned to NPD, the folks who track retail sales across the U.S. The first thing I looked at was the list of top 100 selling games over the past seven years, across all platforms.

I manually tagged each game as based either on “external” intellectual property (IP) (licensed from outside the industry, like Madden and Spider-Man) or “internal” IP (ideas and properties “born” from within the game industry, like World of Warcraft and The Sims). Additionally, I tagged games as either “new” if it was the first or only game (e.g., Halo, Gears of War), or “old” if it was a sequel or part of an ongoing franchise (e.g. Halo 2, Tony Hawk’s Pro Skater 4).

The internal vs. external IP distinction (instead of original vs. licensed) is an important one. It is easy to debate whether a game based on Mario should be considered “original,” or if it is in fact an “intra-license” within the industry. But no one would say the Mario IP wasn’t born within the game industry. Plus, the word “original” often gets intermingled with innovation, and it’s not fair to assume innovation can only occur in one form of IP.

In that context, I’m less interested in the debate over brand-new, “original” IP. Bigger picture, it comes down to a question of control and wealth generation for the industry. Assumedly, internal IP should offer greater economic potential. All things being equal, selling a million copies of Halo is more profitable than selling a million copies of Madden, since there’s no external license or royalty to pay on the Halo IP – it’s ours to begin with.

Rational economic behavior suggests companies would lean toward developing games with the greatest potential for profit. And they are: EA recently announced their plans to rely more heavily on their ability to generate internal IP. But that’s only one publisher, and even they aren’t completely abandoning external revenue streams.

Aside from comparing the sales results between internal and external IP more generally, I wanted to see if there was some overwhelmingly compelling economic motivation driving game industry execs to favor external IP. Put another way, were investors justified in loading up Brash Entertainment with $400 million in funding to primarily produce videogames based external movie, television and music properties?

A long-tail style plotting of the sales data (Graph 1) initially demonstrates a healthy picture for internal IP. The highest point on the internal IP line (~$303 million) is nearly twice that of the highest external IP point (~$168 million). We have to step down about six internal IP titles before we hit that external IP high point. Furthermore, it’s not until the very last internal IP title (74) that we drop slightly below the lowest point on the external IP curve (~$26 and ~$28 million, respectively).

When we split the data between new and sequel/franchise titles on top of internal and external IP (Graph 2), we see marked differences. While the internal franchise curve looks nice and meaty, the new internal titles don’t fare as well, which makes sense, given how it took GTA three iterations before it struck big.

So, what’s going on here? Why isn’t everyone on the internal IP bandwagon?

Crunching the raw numbers starts to tell a slightly different story (Table 1, Table 2).

OK, lots to explore here. First off, internal IP’s wealth contribution to the industry far exceeds what we’re generating from external properties. Though, when divided by the number of titles in each category to get an average-revenue-per-title amount, the difference is somewhat less striking – albeit still in favor of internal IP.

Finally, here comes the internal IP bandwagon, let’s jump on! But wait …

The key numbers in all of this are the standard deviations in each category. Generally speaking, standard deviation serves as a rough measure of uncertainty. As a representation of risk, the higher the number, the greater the potential variation a result is.

Looking back at Table 1, internal IP makes, on average, $4 million more (or 5 percent) than external IP. However, that extra money comes at a steep cost of additional uncertainty; the standard deviation is 19 percent higher. So really, when you’re making internally-created content, you’re 19 percent more uncertain you’ll make 5 percent more than going with an external license. And executives don’t like to gamble.

Jumping back to Graph 1, this means the tight clustering of the external IP tail is more attractive than the greater spread and unpredictability of the internal IP tail, even though the greater predictability of the external IP curve means you have no chance of reaching the sky-high numbers of the few internal IPs that hit it really big.

Reviewing Table 2, we can similarly evaluate the risk/reward disparities between the different categories. Interestingly, new IP of either variety is less risky, though less successful on average, than sequel/franchise IP. That does seem to speak to the especially hit or miss nature of long-running franchises.

Of course, gross sales numbers can’t tell the full story. The profit margin on games based on internal IP is likely higher in most cases, meaning it may be easier to hit your sales mark on external IP games, but it may cost you more to get there. However, there’s probably a counterweight when you factor the “free” marketing that comes along with riding the coattails of a major movie release.

So, do the suits have it right? As with personal investing, it comes down to a question of how much risk you are willing to bear along with your objectives. If you are super risk averse, don’t expect to make massive returns – T-bills do not the millionaire make. Fundamentally, this boils down to modern portfolio theory, using diversification to optimize a publisher’s range of IPs (internal and external, as well as new and franchise).

But, what’s the right mix? How many of each type of project makes for a sufficiently diverse portfolio? It all depends. My interpretation of the industry’s collective wail is publishers are too heavily invested in external IP. While this may satisfy the short-term demands of Wall Street, it does put into question the future wealth generation potential of the industry as a whole – both financially, as well as creatively. Should we be content to serve other entertainment sectors for more predictable, but overall less, revenue – a big portion of which exits the game industry? Hell no!

Jason Della Rocca is the executive director of the International Game Developers Association. (Opinions expressed do not necessarily represent those of the IGDA.) As a closet economist, you can find him crunching numbers at his blog, Reality Panic.