2011: The Year in Video Games

It's been an interesting year for the video game industry. We've seen individual companies post record-breaking sales, but overall spending is still well below its 2009 peak. Moreover, the growth of social and mobile gaming has sparked a fundamental shift in the industry that may send investors in search of a new instruction manual. Let's take a look at some of the top stories from the year and what to expect from 2012.

Hardware's a mixed bag
Surprisingly, it was actually a pretty good year for home consoles. Microsoft's (Nasdaq: MSFT  ) Xbox 360 took the lead in unit sales among consoles and is poised to have its best year ever. Meanwhile, Sony's PlayStation 3 is also poised to have its best year to date -- which is impressive considering the negative press the system received after hackers took down the PlayStation Network.

Unfortunately, Nintendo (OTC: NTDOY.PK) didn't have the same luck. Demand for the Wii has plummeted, and initial sales of its latest handheld were so low that the company was forced to slash the price from $250 down to $170. After the price cut, sales of the portable picked up and have now surpassed the first year's sales of the original DS.

However, given that revenue from games on Apple's iOS and Google's Android now surpasses the combined software sales of Nintendo's and Sony's portables, I wouldn't expect the 3DS to repeat the success of DS over the next five years. Nintendo's loss of pricing power also doesn't bode well for Sony's upcoming PlayStation Vita, which, after you add in the expensive proprietary memory cards, will set gamers back a minimum of $280.

Software: An adventure in new business models
On the software side of things, Activision Blizzard (Nasdaq: ATVI  ) moved a record-breaking 6.5 million copies of Call of Duty: Modern Warfare 3 on the first day. Sixteen days later, the game became the fastest entertainment title in history to reach $1 billion in sales. However, during the last quarter, Activision's World of Warcraft game lost 800,000 subscribers, bringing its total subscriber loss for the year to around 2 million. This spooked investors who like the company because of the stable revenue provided by World of Warcraft subscriptions. As a result, the stock is currently down 4.6% from the beginning of the year.

Frankly, I think investors may have acted prematurely. Call of Duty: Elite -- a subscription service Activision launched with Modern Warfare 3 -- signed up more than a million subscribers in its first six days. Blizzard plans to create a real-money auction house for Diablo III to allow players to make a profit from selling the booty they pick up in-game in exchange for a small listing fee. The company has also revealed that it's begun working on a second MMO codenamed Titan. Even if WoW continues to lose subscribers, I'd be willing to bet that these new revenue streams will pick up the slack.

Overall, I think you'll see game developers drift more toward these recurring revenue models to supplement their cash flows. Electronic Arts (Nasdaq: ERTS  ) has moved pretty aggressively on this front. Since April, the company has purchased the casual game specialist PopCap Games, successfully launched The Sims Social on Facebook, created a subscription service for fans of its sports franchises, and developed an MMO based on Star Wars.

The rise of free-to-play
The other business model that gained a lot of steam this year was free-to-play -- or freemium. Under this model, the developer gives the game away for free and then makes money by charging for in-game power-ups and goodies. Perhaps inspired by the success of Zynga and Chinese game developers like Changyou.com (Nasdaq: CYOU  ) and Perfect World (Nasdaq: PWRD  ) ,which beat analysts' earnings estimates this summer, privately held Valve switched its popular shooter game Team Fortress 2 over to a free-to-play model during the summer, while Glu Mobile's (Nasdaq: GLUU  ) freemium smartphone titles helped the company increase revenue 9% year over year in the last quarter.

What to watch in 2012
I expect that developers will continue their push to turn games into more stable sources of revenue during the next year. I would keep an eye on the development and releases of Nintendo's Wii U. Investors have already written off the console as the next big flop, but I'm more optimistic. However, I do think that if it does fizzle, Nintendo will probably have a hard time bouncing back.

I would also watch Zynga's first year as a publicly traded company. There's no denying the popularity of its games. It currently holds the top five most-played games on Facebook. However, I worry about some of the company's less than desirable business practices as well as competition from developers like EA.

Finally, there's one company in particular that is poised to profit from both the growth of gaming in China and the increasing popularity of mobile devices. If you'd like to know what it is, then you should check out this special report: "The Next Trillion Dollar Revolution." It's free, so click here to download it today!

The Motley Fool owns shares of Microsoft, Activision Blizzard, Apple, and Google. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Microsoft, Activision Blizzard, Apple, Google, and Nintendo. Motley Fool newsletter services have recommended creating a synthetic long position in Activision Blizzard and creating bull call spread positions in Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Fool contributor Patrick Martin owns shares of Activision Blizzard. You can follow him on twitter @TMFpcmart03. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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