The video game industry's shift to a digital distribution strategy is not only helping game companies expand margins, but it is also helping companies generate revenue more consistently throughout the year instead of relying on holiday shoppers in December.
In a previous article, I examined the progress Activision Blizzard has made to generate year-round revenue. Now, let's examine the seasonality of Electronic Arts' (NASDAQ:EA) financial results over the last seven years.
Up through the fiscal year ending in March 2010, the most important quarter of the year for Electronic Arts was the fiscal third quarter ending in December. EA generated 34% of its annual revenue in that quarter in FY 2010. In fiscal 2010, EA had just started to lay the foundation for the industry shift to digital distribution, which was about to take off. That year, digital revenue -- including full game downloads, extra in-game content, mobile games, subscriptions, and ads -- totaled only 16% of EA's annual revenue. But as digital revenue climbed over the last seven years, the amount of annual revenue generated in the holiday quarter (Q3) dropped to 24%, making EA less dependent on holiday shoppers.
|Percentage of revenue generated in Q3||24%||24%||25%||23%||24%||31%||29%||34%|
|Digital as percentage of total revenue||59%||58%||49%||50%||44%||36%||23%||16%|
EA management recognized the shift to digital distribution early and was already well-positioned heading into calendar year 2010 with 48 mobile games available -- more than the total number of console games EA developed for Xbox 360 and Playstation 3 combined. In fiscal 2012, other digital revenue categories -- including extra content for console/PC games -- were starting to contribute in a big way. This led to EA being less reliant on holiday quarter sales, as extra content spending helped EA generate more revenue over the summer months, which is a slow period for new game releases.
|Digital Revenue by Type||2017||2016||2015||2014||2013||2012|
|Full game downloads||$724||$502||$419||$316||$214||$221|
The growth of extra content revenue shows how the business of making video games has changed. No longer do game companies produce a game, sell it for $60, and that's it. Today, game companies sell a game, and that's just the beginning of the revenue opportunity. For example, EA offers an in-game feature for FIFA and Madden NFL called Ultimate Team, where players can purchase in-game virtual card packs that unlock real life sports stars that players use to build their dream team. These fantasy teams can then be taken online to compete with other players.
Ultimate Team is a fast-growing business for EA. The feature was first introduced in FIFA 09 in 2008 and had over 1 million users generating $8 million in digital revenue. In fiscal 2017, Ultimate Team across FIFA and Madden NFL generated 17% of EA's total revenue. Ultimate Team has been so popular with its sports titles that EA management is evaluating how the feature could apply to other non-sports games, potentially the popular first-person shooter Battlefield. EA is already planning a similar Ultimate Team-style mode for Star Wars: Battlefront 2 releasing this fall.
Growth of digital revenue is juicing margins
As digital revenue has grown, EA's profit margins have exploded, as you can see in the following table.
|Net income margin||19.9%||26.3%||19.4%||0.2%||2.6%||1.8%||(7.7%)||(18.5%)|
Sales of digital content cost EA relatively little to produce compared to the cost of creating games, which is a reason why margins have expanded so much in the last few years. Margins will continue to expand, as full game downloads only make up about a third of EA's annual sales, and management expects more gamers to continue migrating to this method of purchasing games. Also, management is just beginning to pursue the opportunity to spread the Ultimate Team feature to its non-sports titles, such as Star Wars: Battlefront and potentially Battlefield.
The bottom line
EA has become less dependent on holiday shoppers over the last seven years as a result of year-round revenue opportunities from digital sources. This gives management greater visibility for year to year revenue and net income, which provides greater flexibility with planning future projects, as well as providing the company more cash to invest in new franchises, and potentially acquisitions, share repurchases, and/or dividends.
John Ballard owns shares of Activision Blizzard. The Motley Fool owns shares of and recommends Activision Blizzard. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.