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Mobile gaming is big business, and the smartphone as a gaming device is a trend that's just starting to hit its stride. With the U.S. mobile gaming market expected to make $8 billion this year, everyone from game developers to in-app marketers wants a piece of the action. But which companies are making the most profits in the booming industry, and what challenges lie ahead?
Let the games begin
Between 70% and 80% of all mobile downloads are games. That's a huge playing field, considering more adults in the U.S. own a smartphone than have a college degree, according to research by the Pew Internet Project.
The obvious winners are the mobile platforms. Apple's (Nasdaq: AAPL ) iOS and Google's (Nasdaq: GOOG ) Android games now make more revenue from sales combined than all of the games sold for Sony (NYSE: SNE ) and Nintendo's portable gaming systems.
One reason behind the shift from handheld systems like the PSP to playing games on an iPhone or iPad is the cost of the game. The top 51% of games in Apple's App Store are free, while pay-per-download games are typically priced between $0.99 and $4.99. Buying games for Sony's PSP-device, on the other hand, can cost up to $40.
This new class of games also costs less to develop, which translates into greater returns for the game makers. However, Apple takes a 30% cut of sales revenue from creators whose games are purchased at its App Store.
Similar to Apple, Google's Android Market Place lets developers keep just 70% of a game's purchase price. However, in Google's case the remaining 30% is divvied up between mobile carriers such as Verizon (NYSE: VZ ) and payment processors.
Mobile gaming's formula for success has also attracted the attention of Microsoft (Nasdaq: MSFT ) , which aims to launch a Windows Store meant to rival Apple's Apps Store and Google's Android Market.
The PC maker's upcoming Windows Store plans to offer developers a larger cut of sales than what is currently paid out by Apple and Google. As my Foolish colleague Patrick Martin has discussed, Microsoft's mobile strategies also include bringing Xbox Live to its Windows Phone and Windows 8. Xbox Live is the online service offered on a subscription basis with Microsoft's Xbox 360 video game console.
Apps stores offer a new distribution channel for software that allows mobile users to purchase and play games wherever they are. The flexibility of this platform attracts a larger and more diverse group of users than traditional gaming consoles -- and more players equal more profits for game developers, OS owners, and mobile marketers.
Money in the bank
If providing free games doesn't sound like a profitable business, think again. More than 18 billion apps have been downloaded from Apple's iTunes App Store since it launched in 2008, and that number will only go up as more people become smartphone users.
On the side of free downloads, developers generate cash by promoting in-game virtual currency and other in-app purchases. Consider Zynga, the popular maker of social and mobile games such as Words with Friends and FarmVille.
Zynga plans to list shares on Nasdaq later this week in an offering expected to raise about $925 million, which would make it the largest IPO of an Internet company since Google's $1.7 billion debut in 2004. Not bad for a company that offers some of its games for free.
In fact, the freemium revenue model has surpassed paid games in revenue earned. Mobile analytics company Flurry estimates that nearly two-thirds of revenue earned by the top 100 selling iOS games came from the free-to-play model.
This explains why businesses behind free-to-play games are being purchased by larger more traditional entertainment companies. Look at Electronic Arts' (Nasdaq: ERTS ) decision to buy PopCap Games, the maker of Bejeweled, for a whopping $750 million in cash and stock.
At the time of the acquisition, PopCap was making more than $100 million in revenues per year, with over 80% of those returns coming from mobile.
Another way businesses are cashing in on the mobile gaming craze is through in-app advertising. Mobile ads that preview within apps now account for nearly 5% of total mobile ad spending. While that's not a huge percentage, it continues to climb as developers find more ways to intertwine ads into games.
By 2015, revenue generated from ads on mobile games is expected to reach close to $900 million globally, according to Juniper Research. Revenue from mobile apps and advertising has grown by 17 times in just three years, with no sign of slowing down.
Platform operators have launched programs such as Apple's iAd -- making it easier for ad networks and mobile marketers to optimize the performance of their in-app advertisements. These programs turn the gaming experience into a branding experience for businesses.
Apple recently lowered the buy-in cost for brands looking to advertise on its platform. Apple now charges clients $400,000, down from $1 million when iAd launched last year. Seems pricey, but in terms of mobile advertising revenue the iMac maker falls behind Google and Millennial Media.
The split looks like this:
Source: IDC report.
Get in the game
There are increasingly more ways for developers to make money from games, which means we can expect more Internet start-ups like Zynga, and PopCap racing to IPO in the coming year.
So while I'd like to say the developers are reaping the benefits of their popular games, the real winners are the companies behind the platforms. That's because the Apples and Googles of the mobile gaming world control nearly every aspect of the process and take a profit for it at every turn.