Emergent Mergers in Video Games Industry

Playstation 3. Nintendo Wii. Xbox 360. Nintendo DS. Sony PSP. The popularity of these consoles is sustained largely by the hit software gamers can play on them, and the Japanese game software industry is currently undergoing a major reorganization. Squaresoft and Enix Ltd, two bitter rivals in the video game industry, merged in 2003, while publisher Atlus acquired Takara. Sega and Sammy merged in 2004. 2005 saw the mergers of Namco and Bandai, Takara and Tomy, and Konami becoming a majority partner and parent company to Hudson Soft. In 2006, Squaresoft and Enix, now called Square-Enix, acquired The Taito Corporation, making it a wholly owned subsidiary. Are all these mergers and acquisitions a sign of the video game industry strengthening from within, or slowly devouring itself? And what will it all mean for the US video game market?

The main goal of company mergers in the video game industry is to use each company's existing properties and game content more effectively, and establish companies large enough to bear the rising costs of developing titles for next-gen systems. For example, when Makoto Iwai of Namco Bandai America was asked in an interview with GameDailyBiz what the merged company was looking for in its future, he answered "... ways to utilize both companies strengths-Namco for its strong development and well known franchises and Bandai for its long list of anime and toy licensed franchises". Size alone doesn't determine the success of a business, however, so why would one video game publisher merge with another? As Iwai himself put it, "[W]e no longer want to be thought of as two companies that came together, we are now one company with a ton to throw on the table... you need to diversify your properties to ensure you're maximizing their potential". According to a report issued by the Yano Research Institute, the console game market as a whole is in a slight decline, while new markets like online gaming, cell-phone games, and the portable game market continue to rise. So, in order to survive, video game publishers must diversify not just what they sell, but how they sell it.

In Japan, hardware makers have historically taken the lead in establishing product distribution networks, as well as setting prices. Video game publishers have had to devise their own strategies for developing products for other devices, such as cell phones, PCs, and portable systems. This was often accomplished through mergers or acquisitions. Over the past few years, several video game publishers have allied with, or bought outright, a number of overseas software publishers, added new locations overseas, or reorganizing existing operations. According to the Japan External Trade Report Organization, alliances between foreign companies are usually related to online and mobile games, which are increasingly popular worldwide.P>

For a video game company to be successful in the interactive entertainment business today, it must operate on a worldwide basis. The need to expand on a worldwide basis is critical because of the soaring cost of video games. Video games today have entire teams of programmers, graphic artists, game designers, producers and audio technicians. Many games have expensive licenses, utilize Hollywood talent and have high-quality soundtracks. The average development costs of publishing a video game title reached $5 million dollars last year, according to industry analyst group DFC. Five years ago this was not the case, and some companies could do well focusing on a single market such as the U.S. or Japan. According to a Software Entertainment Group report last year, in recent years, the importance of the Japanese market has declined and much of the industry's market growth has come from North America, Europe and emerging worldwide markets. Sony, with the PlayStation, was the first company to build a solid business in all three core regions (Japan, North America and Europe). The next growth challenge for interactive entertainment companies will be to expand into emerging markets while maintaining growth in core markets. Emerging markets include South Korea, Taiwan, Singapore, mainland Asia, Australia, and Eastern Europe. According to The Digital Content Association of Japan's 2006 Digital Content White Paper, Japan's video game hardware and software markets have shown increased sales recently, due to growing demand for PC games, online games, cell phone games and portable console games. The paper forecasts that the Japanese game market as a whole will grow in 2007, including increased sales of online, cell phone games and portable games.

While industry forecasts show the Japanese market leading to an increases in sales due to company mergers, does that necessarily mean what will be sold will be of the same quality? Not necessarily, says JC Bennett, a game developer in Japan. While mergers are a sign of change, he says what really needs to change is "[T]he way game development is run," perhaps along the lines of per-project freelance approach that is employed by Hollywood studios, because mergers "...simply allow for the status quo to run a little longer. Companies can't grow by themselves for various reasons, and lack of good staff is one of them. Programmers, especially, are hard to find, and merging is a way of expanding the pool of talent within a company". P>

What of the US market? Some third-party companies have also opted to strengthen tier position in the marketplace through partnerships and acquisitions as well. Through a strategy of mergers and acquisitions, Electronic Arts (EA), has become the world's largest third-party publisher, with a net revenue of over $3 billion according to the Securities and Exchange Commission. In addition to studios located all over the world, EA has also made licensing deals that include an exclusive agreement with the NFL, a 15-year deal with ESPN, and a 6-year licensing deal. Take Two Interactive brokered a similar exclusive licensing deal with Major League Baseball.

While licenses and franchises play a large role in the growth of the industry because they allow publishers to base games on content they are familiar with and want, there is also a demand for original content that larger, companies may not be able to justify spending money on. And established licenses are no guarantee of profitability. Some large licenses have declined in sales and popularity in the gaming world, such as Harry Potter. It is rare to find intellectual property that maintains strong popularity across various media such as film, games, tv, books, and comics. The emergent trend of mergers in the US shows just why independent game studios are needed now more than ever, according to Binu Philip, co-Founder & Biz Guy of Austin's Edge of Reality. . Speaking at development conference SXSW last year Phillip said, "Independent studios generally have smaller teams. With smaller teams comes better communication and greater clarity of vision and focus. Team members feel much more ownership of their portion of the game. Smaller studios have more freedom to do research and innovate because they don't have to ask permission from a corporate parent. Larger teams ...are at the mercy of the whims of upper management which is usually off site and often not in a position to make the best decisions about a particular project..." In fact, just as important as diversifying content and distribution, he feels that, "... established independent studios are extremely important to the future of the industry" as well.

And just how healthy is the US video game industry? According to market research group NPD, the US game industry's total 2006 game sales were $6.5 billion, a 6.4 percent increase over 2005, with portable game sales experiencing pronounced growth of 18.8 percent to $1.7 billion and console game sales up a more modest 2.6 percent to $4.8 billion. "If anyone in the industry still doubts that the video-games market has recovered from its downturn ... [these results] should lay that concern to rest," said NPD analyst Anita Frazier.

Sources: Japan External Trade Report Organization; Digital Content Association of Japan's 2006 White Paper; Media Create's 2006 Video Game Industry White Paper.