The Prof G Pod with Scott Galloway - State of Play: The Video Game Industry — with Joost van Dreunen

Episode Date: July 12, 2023

In this special episode of The Prof G Pod’s Office Hours, we speak with Joost van Dreunen, a professor at NYU Stern, and the author of One Up: Creativity, Competition, and the Global Business of Video Games. Joost breaks down the state of play in the video game industry, including the major players and platforms, and the latest around Activision Blizzard and Microsoft. Follow Joost on Twitter, @joosterizer Learn more about your ad choices. Visit podcastchoices.com/adchoices

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Ready, set, grow. Go to ConstantContact.ca and start your free trial today. Go to ConstantContact.ca for your free trial. ConstantContact.ca Welcome to a special episode of the PropGPod's Office Hours. In today's episode, we speak with Jos van Droon and my colleague at NYU Stern and the author of OneUp, Creativity Competition, and the global business of video games. Yoast breaks down the state of play in the video game industry, including the major players and platforms, and the latest around Activision, Blizzard, and Microsoft. As always, if you'd like to submit a question to the pod, please send a voice recording to officehours at propgmedia.com.

Again, that's officehours at propgmedia.com. Yoast, where does this podcast find you? Finds me in Brooklyn. Let's bust right into it. Give us the state of play in the gaming industry, a $300 billion industry. I didn't even realize it was that big. What has happened since we last spoke to you

12 or 18 months ago? It's a good question. The early pandemic got everybody excited about games, everybody eager to get out of their own mind and out of their, I guess, domestic situation, family, and they went online, started playing. So all boats went up, to put it simply. But since then, it's kind of come down substantially.

Simply in numeric terms, North American game makers, after initially going up about 35% in total market cap in the first year of the pandemic, have since then dropped to about half of what it was at the beginning of 2020 compared to the S&P 500, which has, of course, recovered mostly since then. So what was really like a big moment for gaming, it's kind of subsided and cooled. There's been this incredible momentum in terms of demand outstripping supply and publishers being unable to catch up. But as a result, a lot of new companies have entered into the fray. So there's been a lot of consolidation. There's been a lot of investments. There's been a lot of expansion into different categories. And so while the industry overall is cool a little bit, at the same time, I think it's now a mainstream form of entertainment and has cemented its

position in a sort of broader cultural sense. So let's take a step back. That $300 billion number is staggering. I think total domestic box office is $10 billion, and we are something around $10 billion, and we obsess over that. And the video gaming industry is 30 times that, a third of a trillion dollars. Can you break down the components of that $300 billion? Who's making the money here? How does it disarticulate? What's happened over the last decade or so has been this shift in power away from game makers towards the platform holders. Over the course of a decade, you see companies like Apple, Sony, Microsoft really gaining a lot of ground, historically relying on their own ability to, of course, convince publishers

to put games on their platforms. They've now become so large that they set the tone in many ways. Of course, you couple that with the abundance of cheap capital, the necessity for these game makers to reach audiences, and it gives them an incredible position. So most of the money still goes to game publishers, but the market power that's increasing is on the platform side. So that's really one major takeaway immediately. And break down the platforms, the biggest ones, and sort of give a little color on each in terms of market momentum or lack thereof. When it comes to the platforms, you see mobile finally having a harder time than it did before. Mobile gaming, after this incredible run right around 2009,

when it started all the way to a few years ago, it started to level off a little bit, mostly by its own flaws, because of its own greed, I would say. Apple making it harder for game publishers to target people and to acquire users has made things that much more expensive. And so it starts to subside a little bit. The efficiency starts to evaporate a little bit out of the market model. Console, at the beginning of the pandemic, came out with a new generation. So we had the PlayStation 5 and we had new Xbox Series X and S. That gave a huge push into this whole new ninth generation of hardware. That subsided out a little bit too.

That moment's gone. We're entering the second half of that hardware cycle. So that subsides a little bit. And then on the PC side, while that's been going really well, overall spending the time that we do in online worlds has become somewhat eclipsed with going back outside and just being in a normal, social, in-person setting. You said in the Wall Street Journal that, open quote,

we'll see more blockbuster releases, but innovation and novel experiences are likely, are not likely to come from the legacy publishers. Everyone's becoming risk-averse. Say more about this? The response of the industry to the pandemic was very self-serving, but they were also on the back foot. Demand vastly outstripped their ability to supply. And as a result, they started to beef up their production pipes. Because this glut of content that's now hitting the market, what you see is this return to just consolidation and holding on to IP-based strategies. As a result, you just see companies that want to buy other companies and just eliminate

any of the risk out of it because that's not the business they're in. They're seeing the increasing cost of marketing. They're seeing the challenges with distribution and just discovery on each of these different categories of platforms. And as a result, they just want to go with what works. And so you see sequels across the board, right? So the success of Activision Blizzard during its earnings last quarter was really attributed to Call of Duty Modern Warfare 2. You know, that's a title that's been going on for a long time.

You see IP that works really well for a lot of players. Harry Potter, Hogwarts Legacy, 15 million copies sold, a billion dollars in sales. So that's all very tried and true intellectual property. And those are all very risk-averse strategies. And we're going to see more of those. With respect to Microsoft and Activision, you wrote a post called Activision's Death by 418 Cuts. Walk us through what you meant by that. The arguments by the CMA and by the FTC against the acquisition of Activision Blizzard has long centered on this notion that Activision Blizzard publishes Call of Duty. Call of Duty is this shooter title that is the most popular shooter titled in the console

space and giving one console manufacturer microsoft ownership completely over this franchise would have a huge disadvantage in the space particularly for sony um and that's true right if microsoft owns that franchise and if they want to they can totally make life hard for sony that's that's not the point i would argue um what i would argue is that that became sort of the one thing that everybody focused on right and so the regulators they looked at this and say okay well should we do this um over time then they start to change their opinion right the ftc did the same thing but the increasingly opaque policy environment in which large mergers take place. And this is something that's coming both from the people in favor of mergers and the people not in favor of mergers. The FTC, for instance, has been under the leadership of Lina Khan, have been making a lot

of progress in terms of cutting through the deadwood. And so, you know, you see these different ways that regulators are responding to large transactions and saying we need to make this simpler more transparent because we need to get a handle on these things what happens in the uk with the competition of markets authority is that they release this impenetrable document explaining how they think they see the market clearly displaying a lack of understanding of its fundamentals, and then issuing a decision accordingly. So in my mind, what needs to happen for all these large mergers, whether they have merit or not, to be evaluated properly is also

a simplification of the policymaking process around it. Also, it appears that aren't the biggest players are real formidable competitor Chinese-owned companies? It seems as if you're sort of, I don't want to say, it feels like we're shooting ourselves a bit in the foot in the West, no? Agreed. The absence in these conversations of a discussion around, say, Tencent or NetEase, I think, speaks volumes with regards to the, let's call it the width of the horizon that we're using here. Tencent is by far the largest game company in the world, $33 billion globally per year. It is, of course, deeply rooted in China and, as a consequence, has deep relationships with the

Chinese government. And the Chinese government has been both an accelerant or an expediter of its ambitions, as well as a great limiter. In the last few years, we have these instances where Tencent is constantly curtailed by the Chinese government because of all these rules and regulations. You cannot, in China, as a miner, play more than a few hours a week of video games because they consider it a sort of gateway to gambling and so it's heavily regulated and so that is a a very prosperous market that tencent now can't access because of the government there naturally they look to developing a global strategy they've been buying up bits and pieces of Ubisoft. They have a bunch of different positions in a wide range of companies like Epic Games and so on.

These mega companies that are really transformative. And they're looking to move into the European and the North American market in a big way. They can do a lot in Europe and North America what the, let's say, domestic platform holders are not allowed to do, right? Satya Nadella says it's perhaps in a slightly different version thereof.

It's very interesting to see that Sony gets such a prevalent role in the conversation about what Microsoft can and cannot own, yet somehow Microsoft has very little market share in Japan, where Sony is from, of course. So you start to see this sort of large global dynamic between these platform holders and these companies. And perhaps maybe shooting yourself in the foot is a little stronger, but it's like you are discouraging and disincentivizing these companies from really

moving into a competitive space. So let's speak specifically about Sony. In another newsletter you wrote, different from Microsoft, which develops operating and application software, and Nintendo, which considers itself a toy maker, Sony has long focused on building high-quality media devices. What did you mean by that? So the DNA of a company like Sony historically comes from consumer electronics. They make boxes, headphones, microphones, TV sets, audio equipment. And in addition to that, they have developed over the years this incredible content library across music, across film and video games, so that you will have something to do and something to see

and something to listen to when you buy their equipment. So those are all complementary business units for them. Over time, of course, the industry has shifted a little bit. They too are now realizing that the value of services and the value of intellectual property far exceeds their ability to manufacture new cool devices, right? That never-ending hunt for the new Walkman that made them famous in the early days, you know, eventually is going to run out of steam and they have to start to focus more on becoming a media empire of sorts. But that's a very different proposition than, say, Microsoft,

which is building data centers around the world with its Azure technology and trying to figure out how to pipe, you know, its Game Pass offering effectively to all these different countries. So it's a very different approach where, you know, a consumer electronics company like Sony out how to pipe its Game Pass offering effectively to all these different countries. So it's a very different approach where a consumer electronics company like Sony or like Apple, for that matter, they love this idea of walled gardens, whereas perhaps a software platform is more in the business of breaking some of those walls down and making things accessible and available to everybody out there that wants to play. The final thought on that is, very simply put, just to give you the sense of it,

when Fortnite really reached its pinnacle right at the start of the pandemic, large platforms were all collaborating so that anybody on any platform could play against anybody else in the Fortnite universe. Sony was one of the last holdouts. Sony is also one of the companies that has the least developed multiplayer components. one of the last holdouts. Sony is also one of the companies that has the least developed multiplayer components.

They acquired Bungie recently, really, you know, the subsidiary to develop their multiplayer components and capabilities. So they're really sort of in an isolated walled garden mindset still

because they're a consumer electronics firm as opposed to an operating system developer or a software company at large. So I wanted some exposure to the space, so I bought some secondary shares in Epic, just as a means of disclosure.

But give us your thoughts on Epic. Good for you, by the way. That's a good investment. Epic is a privately held company that makes both games as well as the software that makes games called the Unreal Engine. And then they have the Epic Game Store. So the most popular and most well-known is, of course, Fortnite. This massive universe makes $5 billion a year, has all these different users.

And that is, I think, in many ways, the shape of things to come. Playing so often, particularly playing online, as we learned during the pandemic, is mostly an excuse to hang out with other people. You don't really go for the informational value. And it's not really a ritual so much as just a socialization. It's a playground that's just in the cloud or somewhere online that you can visit. And that's where your friends are. And that's slowly developed over the years, and I think Fortnite is really that sort of forum,

that online environment where we can hang out and just do goofy stuff and have a good time. Its ability then to sell its Unreal Engine, and it's now in its fifth iteration, its fifth version, that's really the big play for them. They're trying to get their software technology into not just gaming, but also in the film industry, where you see the Mandalorian being shot against the background of landscapes rendered by the Unreal Engine. And that's for Epic a really good way to get into that broader universe of saying,

what we can do today with this software creation engine that they have with the Unreal Engine, that's a really important part of their strategy, because then they can be that middleware engine, that middleware supplier. And then finally, the Epic Games Store, you know, they, and I know you know this well, they've been fighting tooth and nail against Apple because of the Apple tax, because the App Store costs involved, and they argue that that's not fair. They've done that not just with Apple. Previously, they did it with a company called Valve, which is a digital PC distributor, very famous, very well known, also very private. And they had to come down with their percentages because Epic started making a lot of noise. So that was really the pretext to the lawsuit with Apple, as I see it. They're

offering their titles and the developers on their platform much lower percentages, and that's going rather well. It's unclear if that's going to be the ultimate king of the hill, but it certainly gives these incumbent distribution platforms a run for their money. So they're disruptive, they have really popular content and they have tools and the bandwidth or the financial runway to see this through. So I think your investment is well warranted in that one. We'll be right back. I just don't get it. I just wish someone could do the research on it. Can we figure this out. Hey, y'all. I'm John Blenhill, and I'm hosting a new podcast at Vox called Explain It To Me. Here's how it works. You call our hotline with questions you can't quite answer

on your own. We'll investigate and call you back to tell you what we found. We'll bring you the answers you need every Wednesday starting September 18th. So follow Explain It To Me, presented by Klaviyo. So virtual reality, I know that's a pretty broad term, but it strikes me, and I have some confirmation bias here because I predicted that VR was going to be this enormous thud, but it feels like headsets, as it relates to VR, have been a disappointment. What are your thoughts? So when it comes to the devices that we use to access virtual reality, I think the last 30-40 years have been a lot of borrowing from the future but under-delivering in the present.

By which I really mean, you know, there's an extensive history going all the way back to the Nintendo Virtual Boy, where the device itself is wildly underwhelming. The content library that we find or the usefulness and applications are also widely underwhelming. And as a result, people sort of see this as a nice to have, and we're always expected and asked to believe in this future that's clearly not coming anytime soon. what team Tim Cook has cooked up for us, we end up with this glass shell with lots of expensive cameras in it, allowing for the small price of $15,000 a family of four to watch a movie together in VR. And so in many ways,

it seems like that is a little disconnected of what would be, in my mind, a more practical use case. I have a two-year-old and a 10-year-old at home. They would break this within minutes of me strapping it to either of their foreheads or cover it at least with peanut butter. And so it just seems kind of designed out of touch with what an average person would use these things for.

In the absence of a clearer user solution, while I'm excited about the virtualization of media and content where we can build more immersive experiences, the way that a lot of these tech companies tend to think about it is in line with their own interests. Their corporate interests are such that they must have a device where they can dominate. Facebook, at the time, got into this by buying Oculus for $2 billion because they did not want to miss out on another platform transition. They had missed out on mobile, and now they really wanted to be into the VR space. And so Mark Zuckerberg whips out a big checkbook, and off he goes. I think Tim Cook might be similarly motivated, at least in part, to not be the last one left behind when apple doesn't really have a clear strategy

around this budding new technology and so when it comes to this promise of virtual reality i'm all in it for i want to live in that future but so far they've delivered on none of it that's exciting and so that's um i think an ongoing skepticism that's it's hard to get rid of any thoughts on the intersection or is there any between web3 and the gaming industry oh many um decade ago people were very afraid of free to play economics giving your game away for free only to then become successful financially and in other ways that was out of reach for everybody right right? That didn't exist. And now that's by far the most dominant revenue model. When it comes to things like cryptocurrency,

I do think that there has been a lot of mistakes in that space. I think a lot of game companies have made what they call the financialization of fun. They've committed that and it's terrible. And a lot of the gameplay is awful. The idea that you would have some sub layer of super fans that don't just want to play the game but they want to have easier access they want to have a digital wallet that connects them to multiple things and as they leave a game they

can take everything they've accumulated inside the game with them i think that there is a case to be made for that but so far most of the intentions behind it seems to have been uh you know funded by people in finance as opposed to game makers never mind that the blockchain technology is still very rudimentary and inefficient my hope and some of the hopeful things that i see in the horizon is game makers like nexon which is a big deal in korea a 10 billion dollar company in korea makes MapleStory and other games. They are now transitioning some of their IP onto the blockchain.

CCP, the maker of EVE Online, one of the longest standing subscription-based sci-fi games out there, sort of a cooler version of World of Warcraft, if you will. They just raised $40 billion to build a blockchain-based game. Sony applied for a patent to accommodate NFTs and digital collectibles in its ecosystem. And so I start to see these larger companies and these companies with some miles on their meter that could possibly push this into a better space.

So I continue to be optimistic about it, but there's been a lot of mistakes around this. Gaming and crypto, they have a natural intersection, I think, but we need better captains on these boats. And if you had to make any predictions about the remainder of 2023 in the industry, what do you see happening? The prediction for 2023 will be continued consolidation. One of the big questions that has arisen from that is as companies like Embracer which is now the largest by market cap European game publisher worth about 11 billion dollars you know this is basically this amalgamation of like 250 different studios and subsidiaries funded to no insignificant degree by Saudi investment money you have to start thinking a little bit like okay all this consolidation is going to move the gravity point in the industry right where

historically you see japan and north america are kind of competing and then europe being a distant third and everything else is sort of out of reach now we start to see so much money coming into the ecosystem because gaming is an industry that doesn't really require a lot of big industry. You don't need to have a lot of factories to set it up. All you need is just a pipeline and a bunch of clever people making games. So if you want to set that up in Saudi Arabia, you can totally do that. It's going to change the politics a little bit, though, right? In the same way that the Chinese companies 10 years ago were relatively insignificant and are now dominating the space um you know you start

to see this shift in geopolitical relevance and i think consolidation will be a major topic for the remainder of the year who owns who and who gets to tell them where they set up their studios and and do you really want to have your children play games that are made in a country where they shoot and execute journalists? And is that a fair question to ask? So I think that larger conversation will kind of trickle down into creative agendas. So that's one thing that I'm excited to have that conversation because it kind of puts games on a higher profile. And that's something that we should be talking about. And then, of of course it's

business as usual right so we have uh you know activision we have take two and electronic arts they are going through the next iterations of their existing franchises um are they continuing to do well or we're going to start to see them slow down the last two quarters have been a little like schlumpy except for activision and so I suspect that for the remainder of the year, it will be soft, but the upside will be for those companies that by the end of this year and starting next year will have a solid online presence and an active multiplayer community centered around them.

So those are two of the main trends I see. Do you see Saudi money the same way it's kind of come into large hotel brands or even football leagues do you see it and are they about to become the biggest investors in gaming and then move headquarters to riyadh the is it the public investment fund in saudi arabia is yeah piff is already the largest uh non-domestic shareholder in Nintendo, owns billions of dollars of Activision. I mean, there's a whole list on their portfolio. Some of it is through their subsidiary Savvy, which is the more experimental group, of course.

But they've taken both positions in public equity as well as privately held companies. That's going to, I think, ultimately make people aware that this is now the new regime in charge, right? That's where the money comes from. We see, for instance, over the last 10 years, companies desperate to enter the Chinese market because it came online, because it's so many people. You see Activision collaborating with its biggest competitor, Tencent, for half of what it could make in China,

because it has to work with a local partner, and it has to change a lot of aspects of its games. It can't have skeletons and sort of like these weird regulatory aspects of it. But they do so because they don't want to miss out on that market. And so if the money's there, they'll follow, but they're going to have to compromise or make compromises along the way. And I'm very curious to see who's going to make what compromise to get there and last question yes what two or three players have the most wind in their sails versus those with the most wind in their face who's got good or poor momentum right now players platforms game makers specific companies in my mind the companies that are poised to do well are the ones that can rely

on extensive intellectual property and that have, over the last years, used a lot of access to cheap capital to build out their assets. A company that immediately comes to mind is Nintendo, which coming off of its billion-dollar box office success with the Super Mario movie, has also been building theme parks and so they are clearly in the space where they are looking how to take their existing business of making games and game consoles into a much broader ecosystem of activities and experiences people want to go see this people are excited to go do sort of a real life mario kart thing in the you know with their friends and family so i think that that is a company that has,

never mind that it's been around for 125 years or so, they have an extensive legacy when it comes to building contemporary and acute experiences that are interesting to people. Another one that has some upside in front of it is Sony. In spite of this turmoil around everything that's happening with microsoft acquiring activision and it's claiming that that's somehow detrimental to its position in the market sony has a vast library across multiple categories not just games but also of course music and film you can see how they can leverage this in a massive way and build this

out on all these different platforms so i believe that they are going to transition away a little bit from trying to reinvent the walkman to becoming something that's a little bit more focused on you know that's more akin to a media empire where they take their intellectual property and just spread it across different aspects of it and don't forget also that they also are the leader when it comes to Japanese animation, like anime and manga, very strongly grown categories that are very popular with younger audiences. Sony plays a significant role in that market as well.

So they have all the parts and pieces to really do well for themselves if they can let go of trying to tether themselves to the hardware too much. So those are sort of the two examples of media companies or entertainment companies with both a hardware and a software component. When it comes to platforms, I think the economics still apply where the winner takes most, right? Apple and Google, they're sitting on the top of the food chain.

They're going to continue to grow. They're going to continue to expand because there's nowhere else to go for companies the only thing that's really going to diminish their ability to do well is you know maybe a more competitive uh uh plug-in by way of say microsoft getting access to mobile through the activision uh uh acquisition uh maybe regulators in the eu can give them a few of them a haircut by charging them maybe a little bit more than just a few million dollars in fees and raise that to like three commas and beyond to really make them feel like, hey, look, you have the academic literature just investigating very aggressively like what's going on really how does this impact labor what does it mean when one platform holder controls most of the labor in a particular category in a particular region or even in a town right so those are some of the questions that are emerging and it's going to be incredibly

difficult to write policy for those kinds of companies purely because they operate as you know nation states more than anything else so platforms do well and then it's when it comes to read for the losers um sad to report that that's going to be a lot of european publishers particularly embracer which sits at the top of the food chain in europe quickly accumulated over 200 or so different projects by acquiring all these different studios. And now it's at this moment where its debt structure is starting to collapse on top of itself. It can no longer afford to not do really good deals. They missed out on a $2 billion arrangement right before earnings had to be reported. And so they're

coming up short and their share price starting to tank. They're going to start running out of runway because their acquisitive strategy is sort of coming to a natural conclusion. And now suddenly we have to start cutting back on resources and logistics and infrastructure. I think it's going to not just sour the sentiment around Embracer as a company, it's going to also have an impact

on the European game development market where all these people will now be let go. There's going to be a souring of investors. And so they're not going to invest in the startups, right? The VCs are going to be a lot more hesitant for this because there is not a natural path. And that's too bad because I really believe that what the European market has shown historically in games,

but also in other cultural industries, that they have a unique voice, that they have something to show that we can't get anywhere else and so you know even cd project red like there's a lot of uh upsides to be had but they're having an increasingly difficult time and that kind of is is unfortunately the sad part of all this right i'm hoping they recover but likely they're going to end up in the chopping block and get sold for parts and pieces here and there and so that's the europeans will be the losers in this the north american companies will do well and then particularly uh you know the asian companies like sony nintendo and the ten cents of the world they'll continue to prosper as well yosan drunen teaches at the nyu stern school of business and is the author of One Up, Creativity Competition

and the Global Business of Video Games. Previously, Joost was co-founder and CEO of Super Data Research, a games market research firm which was acquired by Nielsen in 2018. Joost also serves as a startup advisor and investor and publishes a weekly newsletter on gaming tech and entertainment called Super Joost Playlist. He joins us from brooklyn yost it's always a pleasure to speak with you appreciate your time thank you thank you so much this episode was produced by caroline shagrin jennifer sanchez is our associate producer and drew burrows is our technical director. Thank you for listening to the Prop G Pod from the Vox Media Podcast Network.

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