Tobold's Blog
Sunday, September 21, 2014
The next video game crash

Kotaku last week had an article asking whether we are on the cusp of another video game industry crash. I think that is very much possible. It isn't just everything mentioned in that article, like people having huge libraries of unplayed Steam games. But there is also the economic side to consider. I consider Microsoft buying Minecraft for $2.5 billion to be a sign of weakness, not strength, of the industry. Not only will they never get their money back (Mojang has $290 million of *revenue* per year, not profit. The time it would take to make $2.5 billion on the profit of that means Minecraft would need to remain as popular as today for the next 20 years.). But also Microsoft is essentially saying that if they were to put $2.5 billion of money on the table anywhere else, they wouldn't be able to make a game as profitable as Minecraft. Too much money chasing too few opportunities for profit is usually a sign of an upcoming crash.

Now crash doesn't mean that video games are about to disappear. The financial industry crashed hard 6 years ago, but there are still a lot of banks and other financial institutions around. But if you look at the video game industry overall, from the big companies to the indie developers, it appears pretty clear that there are too many people working on too many (usually derivative) games. There are price wars: Steam sales, Humble Bundles, and mobile platforms on which a $5 game would be considered "expensive". And there isn't all that much potential of market growth any more, because everybody who is the least likely to play a video game already has at least a mobile phone with games on it.

Of course there will always be a few people and companies that make money. Markus Persson becoming a billionaire is likely to remain an exception, but there will be a number of people at least able to stay in business because their games sell for more than it cost to make them. If we are talking crash, we are talking about how many people in the industry and how many game companies are *not* making a profit. We are talking about the pork cycle of video games, where many companies around the same time discover that they spent too much money on developing video games that are not going to make their money back. We are talking of indie game developers deciding that they'll earn a better living flipping burgers. We are talking investors pulling out of the industry. And because of the way that capitalism works in boom and bust business cycles, we are talking about a lot of bad news of that kind happening around the same time.

The recent gamer culture wars aren't helping. Already a lot of people who work in the game industry are exploited, working more because of their love of games than for financial reasons. Disillusion those people, and you'll get a mass exodus. Game developers are usually young, creative, and have a good set of computer skills, not the kind of people who'll stay in the industry because they can't find any other job. A combination of gamers disappointed in the latest games reducing their gaming spending and game developers becoming disappointed of their customers' ungratefulness could well produce a video game crash as early as 2015.

I'm not sure that Microsoft won't make profit from Minecraft soon. Minecraft is a genius idea with horrible implementation. I couldn't play it because it's so terribly ugly.

Give it a graphics facelift to make it look like 2014 (hell, just to make it look like 2004), a good tutorial, central servers, achievement system and off you go to cash in.
The market is over-saturated right now, and the industry on all sides (AAA, Indie, GOG, you name it) doesn't know how to stand out from its own sea of product anymore. Old veteran gamers are burned out and have serious backlog to catch up on, while new gamers are not flocking to the newest product because why would they, when they aren't wealthy and you can find thousands of hours playing games from the last decade for pennies on the dollar in pricing?

So many other issues contributing to this crash....but I predict 2015 will be a very rough year for video game sales.
I agree with most of the post.

However, I don't think the indie game developers' desire will be reduced all that much by mere reality. At least for programmers, it sure seems like it is extremely suboptimal, financially, to work in games. Yet many people passionately want to and that probably won't change much. OTOH, the amount of capital to fund video development probably will drop a lot.

While not "true gamers" as certified by your and fansites' commenters, there are hundreds of millions of smartphones being added each year, so it is not clear that the potential market has peaked. (In the broader game market, mobile, biggest problem is probably that there are nearly a million apps in the Apple store, the majority of which are games and there is not great discovery mechanisms. )

I can't see a AAA Western MMO after EQN.

Microsoft probably overpaid but there have been far worst purchases.
I'm pretty confident that Microsofts will make back their money, at least and them some. One of Microsofts big problems is positive name recognition, and owning Minecraft gives them a very large potential to fix that. Minecraft's revenue may not be pure profit but I would wager that the profit margin is very high and will continue to stay high because licensing Minecraft products, and pushing your small software downloads is cheap as hell.

I've heard a lot of talk of Minecraft having hit market saturation but I know a lot of children that play, and they are hooking other children, they are literally a growing demographic. As they get older they will likely introduce siblings and more friends, and once they get significantly older their Minecraft nostalgia will be a lucrative cash spigot for Microsoft.

The dated looking default graphics is actually a selling point to part of the customer base. Even though those textures are crude they manage to produce an often beautiful environment. And if the low pixel count really bothers you there are any number of HD texture packs with different looks and smoother aesthetics. The mechanics and the literal sandbox feel is what makes the game sell like hotcakes anyways.

Minecraft in a lot of ways is like WoW was, in that it draws in huge amounts of people from all kinds of demographics. I think the demand for the game is still pretty high and as evidence of that I would point to the fact that you never see it included in bundles or sold on the cheap. If sales were flagging it would have been priced much lower by now, hell I've bought a Legendary Skyrim edition on steam for cheaper than Minecraft.
$2.5B purchase for $290M annual revenue is a Price/Earnings ratio of 8.6. That's a very good number, and a very standard price for a company.


Of course, you can argue that $290M is the high water mark, and it is only going to go down from there. But that is a reasonable judgement call. I mean we're still playing something called Warcraft 20 years later.
The whole Minecraft thing is intriguing.

They are no doubt looking further ahead than simply how much money Minecraft will earn.

They stopped Sony buying it for a start...

They can use it as a system seller and whilst I don't see them withdrawing the current version from rival platforms I think we can all imagine what will happen with Minecraft 2 (in what ever form that takes).

I just think of the possibility of creating Star Wars or Batman themed variants. Kind of like the Lego games but with true control over environments.

Anyway I am not as pessimistic as Tobold. There are a lot of good games coming out next year that I am anticipating. 2013 was a classic year and 2014 has been pretty good for me. No shortage of great games to play. I am buying them way faster than I'm completing them but the devs get paid whether I finish them or not.

The big AAA's seem to be doing pretty well, as are the next gen consoles that have been selling like hotcakes.

Kotaku have their own agenda and I would not take much notice of what they say.
You might want to consider U.S. tax law concerning the sale. Microsoft had all that money just sitting around that it could not bring back to the U.S. So if Mojang's profits are greater than the interest the money would accrue just sitting in the bank, then someone could consider it a good investment that increases Microsoft's income.
The non-gaming, business page commentary that I read suggested Microsoft have no interest whatsoever in Minecraft as a game. They paid 2.5 billion for access to a particular demographic (I believe it was 9-16 year olds) which apparently is extremely desirable for megacorps in general and to which they Microsoft in particular have struggled to attract. I think the idea they bought it for the direct profit potential of Minecraft qua game is somewhat romantic.

As for a "another" video game crash... did we already have one then? I must have missed it. I can't recall there being too few video games at any point in my adult life. Too many, possibly.
I think the last crash was in the late seventies early eighties. So before I was playing video games very much. It was largely a console crash. The technology was progressing so fast that the manufactures couldn't produce a console without it becoming nearly worthless in a matter of months. Games were pretty rudimentary by today's standards and there were companies based exclusively on ripping off successful games with clones that were much cheaper to develop because copy protection was very weak. Anyways you can read all about it here.
I think that in today gaming business only the big company names are still profiting very well from game's production because they can produce what most gamers love in all of their released games and the most important also they have the budget to make it happen so they are ruling the game's industry and other companies can't compete with them. Check This
Part of me is not concerned about a crash. It has happened before and it will happen again and a good shake-out of the game industry is probably no bad thing in the long run.

The one thing I guess I am concerned about is that either Steam or Gog could go bust. Losing either of those would wipe out a huge chunk of gaming history.
$2.5B purchase for $290M annual revenue is a Price/Earnings ratio of 8.6. That's a very good number, and a very standard price for a company.

Revenue is not equal to earnings. Very approximately, in this example earnings will are equal to profit.

P/E ratio is not a good way to calculate this business exchange. It requires that the purchased company be sustainable. Mojang, as an operation with a single game and limited assets is effectively has very poor potential without development of further revenue and product streams. That isn't to say it is a bad deal. I expect Microsoft to mke their money back in a couple of years from licencing and it will probably use the Minecraft model in a few new products.
Games seem to be very similar to oil companies. You'll get a couple of execs set themselves up a start-up, get a $50m "kickstarter" from the stock exchange. Use that to buy some exploration plots. Sink a test well. The lucky ones then sell to a big oil company for a big pile of cash, the rest vanish (after paying the execs nice large salaries for a couple of years).
The only difference is two fold.
a) The game co "execs" only do well if they strike it lucky
b) Creating a game doesn't require millions of dollars.

The economics is unsustainable and based on a series of one-off events as opposed to continual operations but that doesn't mean it cannot work and a crash is inevitable. Starting a game/oil company is like buying a lottery ticket. As long as there is a chance to win a big prize there will be people doing it.
Hey Tobold, nice article.

Honestly I agree with most of what you said. But I believe there is a market crash coming in general. the past year has been in an economic slump starting from GPD, to job creation, inflation, and even first time home buying.

However, as for the banks and other financial instutions being around, they're only around because the government and FED bailed them out. But by doing so, they created another bubble one that will be bigger than 2008. But tis time the FED has exhausted all their options.

To get out of the next bubble the FED will have to re-establish a higher QE (rather than raise interest rates) to keep the economy from going into a recession or depression. But of course this will ultimately sacrifice the dollar.

I wrote a post on my blog about why America maybe become the next nation of gold farmers which pertains to this. Check it out, I'd like to hear your others comments.

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