Is Hearthstone Activision Blizzard's Next Big Thing?

The introduction of the next generation of video game consoles, Sony's PlayStation 4 and Microsoft's Xbox One, are continuing a trend toward larger, more elaborate games with bigger budgets. Each generation, budgets for the blockbuster games rise, and with the per-unit price relatively flat, there has long been fear that the model is unsustainable.

For good or ill, this is the route of the blockbuster game, and companies like Activision Blizzard (NASDAQ: ATVI  ) will have to play along. That means finding a way to make the annual releases of games like Call of Duty bigger and better, if only to keep up with the rising costs of their production.

But, Activision Blizzard is no stranger to this, and while it plays the annual blockbuster game as well as any of its competitors, the company's Blizzard subsidiary has repeatedly turned the industry on its head by taking existing niche business models and extending them in ways no one else has.

Starcraft and World of Warcraft are examples of innovation
In 1998, Blizzard released Starcraft, one of many real-time strategy PC games of the time. Most such games had a shelf life of one year, two at the most. Blizzard has kept Starcraft relevant for 15 years now. The game drove the creation of professional video game competition, and despite its age, competitive professional leagues are still going strong.

In 2004, Blizzard released World of Warcraft, joining what was at the time the niche market of massive multi-player games with monthly subscription models. At its zenith, World of Warcraft had over 12 million players paying monthly subscriptions, and nine years in it still has several million loyal subscribers, making it a healthy source of revenue that is likely to last for years to come. 

Both real-time strategy and massive multi-player games were around long before Blizzard found the perfect formula for memorable, and incredibly lucrative, success. The model of the day is "freemium" -- providing free games to players while selling premium content and access to them.

Freemium model hits the big time
The freemium model is a relatively new one, with small companies like Zynga (NASDAQ: ZNGA  ) making their names with such games as Farmville. Though other companies have attempted to get in on the idea, they have mostly marketed very straightforward copies of the Farmville model.

Blizzard's answer is Hearthstone, a game still in closed beta testing and scheduled for a 2014 release. The game breaks from the Farmville model by being, at its core, a collectible card game with digital cards and online multi-play. Players can play for free, but can also buy packs of digital cards online, as well as buy entry into online tournaments.

While the game's free play mode is entirely playable, building custom decks with unique play styles often requires the acquisition of "rare" cards. Getting such cards is no small task, and could require buying several packs of cards. This model has worked amazingly well for physical collectible card games, and replacing that with non-physical cards means the "cards" themselves cost virtually nothing for Blizzard to produce.

What else is in the cards for Hearthstone?
Packs of cards are likely to be a considerable source of revenue for Hearthstone, particularly early on. The long-term value of the game may well be buying entry tickets for tournaments with prizes. This model is still under development, but both Starcraft and World of Warcraft have shown that the creation of a big community of players lends itself well to competitive high-level play. If done properly, and history suggests Blizzard will find the right balance, this could keep players who already have all the cards they want/need (i.e. the big spenders) paying for access to premium competitions.

Hearthstone may fly under the radar in 2014, as the new video game consoles mean a lot of expensive games with short shelf lives will be competing with hundreds of millions of dollars on the line. There is no denying that the single-year revenue for several other Activision Blizzard games will be much larger. Yet, the uniqueness of the business model, and Blizzard's notorious ability to keep games relevant for several years, mean this game could be a significant high-margin revenue source for the company for years to come.

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