Enormous budgets for tentpole titles have become one of the biggest challenges to the video-game industry. High-profile games such as Microsoft's (NASDAQ:MSFT) Halo and Take-Two's (NASDAQ:TTWO) Grand Theft Auto can cost tens of millions of dollars to create. In response, companies in this sector must squeeze as many dollars from gamers as possible.
That's no easy task. After spending a ton of money on hardware, few consumers want to lay out even more cash for games. A recent Reuters article discussed how publishers are selling "add-ons" through Microsoft's Xbox Live platform to siphon a bit more discretionary income from gamer's wallets. That might sound unsavory, but it could be a good business going forward.
Suppose you buy a new title from Activision (NASDAQ:ATVI), THQ (NASDAQ:THQI), or Electronic Arts (NASDAQ:ERTS). With Xbox Live, those companies can now keep selling you supplements to their games -- new characters, levels, equipment, or other bonuses -- even after you've shelled out for the initial disc. It's a win-win situation for both Microsoft and the publisher; Mr. Softy takes a substantial cut of this high-margin revenue, which costs much less for publishers to create.
While I'm bullish on the video-game sector, I'll concede that the awe-inspiring development capital needed for today's games constitutes an ongoing risk. Gone are the days when a single person spent several months hacking out a bunch of eldritch, mnemonic-based code for a 4K ROM cartridge. Today's games are interactive digital movies, and they don't come cheap.
Try telling that to consumers, though. How many times have you heard a friend say, "I'll wait till that game comes down in price"? Even an avid gamer friend of mine, one of the most hardcore hobbyists I know, always waits for price reductions.
Hit games can pay off big time -- Halo 2 grossed $125 million in sales in its first 24 hours of release, handily beating the records of even the biggest blockbuster movies in history. But development costs keep rising, and not every game can be a smashing success. To recoup its budgets, the industry needs to charge premium prices for software.
On an anecdotal level, I'm detecting increasing resistance to higher prices among gamers, especially for titles that aren't blockbuster-quality efforts. As the Reuters piece stated, many gamers also balk at paying for downloads, believing that any add-ons should be free. In a post-Napster age, when many Web surfers are used to getting digital content for free, this makes a sad bit of sense.
Industry observers paid considerable notice to the $59.99 price point for next-generation software, and I hope that publishers aggressively guard that premium level. They do experiment with add-ons at the retail level, charging more money for collector editions that come with DVD-like extras, but I think they could do more to test the elasticity of top-tier software. I'd love to see Microsoft charge, say, $69.99 for the next Halo game, to see how far hardcore gamers are willing to go to get their next fix of the sci-fi epic.
Microsoft has to recoup all that money spent on its Xbox franchise and bring the segment firmly into the black; it'll need higher prices to offset all that investment. Sony (NYSE:SNE) knows this problem as well. Unfortunately, it might have to cut the price on its slow-selling PlayStation 3 system earlier than it probably would've liked.
Besides pricing, companies are turning to advertising to recoup development spending. They'll need ad sales and download revenue alike to keep profits and R&D spending at the levels shareholders demand.
Video games offer a great investment thesis, but for the businesses involved in them, the game is becoming increasingly expensive to play. I like Microsoft's use of its Xbox Live platform to promote incremental revenues, and however much gamers may gripe, I hope to see this strategy further explored.
Play around with some more video-game Takes:
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Fool contributor Steven Mallas owns shares of Activision. As of this writing, he was ranked 4,508 out of 29,173 investors in the CAPS system. Don't know what CAPS is? Check it out. The Fool has a disclosure policy.
