A choice is coming. One that will define the next era of gaming and who controls the future of the industry. Publishers and developers have an opportunity to take more power in how they reach gamers, or they can fall into the platform trap that has doomed content creators in video, news, and music. The AAA game publishers certainly won’t make the same mistake that the television networks did when those studios licensed their TV and movie assets for pennies to Netflix in its early days. Publishers will demand that Stadia and xCloud pay a fortune to license their games, but that money today is a siren song to their financial investors and not a long-term strategy. Cloud gaming is an opportunity for publishers to expand the market for AAA games, to release new types of games, and most importantly, to have a direct relationship with the people who play video games. The most significant challenge, however, is that building cloud gaming data centers around the world will require a massive capital investment along with the knowhow to make it happen. Publishers will struggle do this alone, leaving the strategic opening for the platform companies to siphon the users and build cloud gaming aggregation platforms akin to the Netflix of Gaming.
The challenge of building it on your own
Although it is in the best interest of each publisher to build and deliver their own cloud gaming products to reach new gamers and own the relationship with their customers directly, it will be an extremely challenging and expensive project. The largest publishers are some of the most advanced technology companies in areas such as networking (for online multiplayer) and graphics, but they’re ill equipped to manage millions of GPUs and CPUs in the cloud. Additionally, they can’t match the utilization and lease rates that the biggest cloud datacenter companies have, resulting in a higher cost to serve cloud gaming than Google and Microsoft have. This leaves the door open for new gaming platforms powered by the infrastructure-as-a-service companies (Azure, Google Cloud, and Amazon Web Services). These technology companies will have the ability to deliver gaming from the cloud, but unless they develop first-party content, they’ll need the games from the AAA publishers to get consumers excited. The publishers in turn should charge the platforms a fortune for their content, but that will tie them to the platforms as those platforms aggregate demand and supply. Microsoft is hedging against these high licensing fees and buying content studios at an unprecedented rate, more than doubling their first-party capacity last year alone. This is a familiar situation to the one that Netflix and movie studios faced in the early 2010s. At the time, the movie studios licensed their content to Netflix for pennies. Netflix built an enormous audience, aggregating the demand and supply of video content. Adding in their own original content while aggregating more content and customers resulted in the content creators becoming commoditized. Even though many studios are developing their own OTT products, they’re still licensing their shows (like Friends) to Netflix because they have no choice now. The only studio that really has a chance to compete on its own, Disney, has enormous scale and franchises that consumers love.
Disney goes direct-to-consumer with Disney+
Disney+ is a great example of what the game studios should aim for. With Disney+, Disney is going to, for the first time in its history, have a direct relationship with its movie customers. Previously, movie theaters and retail stores owned the relationship with Disney’s movie customers. In recent years, Netflix usurped that relationship. Disney+ gives Disney the direct connection to the customer, allowing the company to collect data on movie consumers and use that information to directly influence strategy across merchandising, parks, and future entertainment options. I believe that Disney+ will be successful because of its scale (Disney + 20th Century Fox owned 33% of movie market in 2018), but I don’t think it will negatively impact Netflix much.
Owning that customer relationship is the prize for game publishers in the next era of gaming, and ceding control to another platform is not going to help them get closer to the customer. With the games-as-a-service business model publishers are investing in, owning that relationship is even more important for monetization. Many of the largest studios have transitioned to a direct-to-consumer model in PC gaming via their installed clients and removing their games from distributors, like Steam. This gives the publishers access to more data on the customer, a direct relationship with them throughout their lifecycle, and eliminates the 20–30% fee that the distributor charges. With cloud gaming, publishers have the opportunity to capture that direct relationship with more customers and circumvent the distributor fees. The question remains, however, can they offer a direct-to-consumer cloud streaming product with operating costs lower than the platform fee?
Is it affordable to build a cloud gaming product?
Answering that question is difficult, but the stakes are high. First, the publisher would have to build or repurpose data centers in close proximity to major population centers around the world and develop the internal competencies to manage and operate these data centers at scale and at the lowest cost possible. To keep their operating costs as low as possible, the publisher needs to maintain high utilization rates of the hardware while maintaining enough capacity so that none of their customers are disappointed by a lack of access to a machine on peak days and times. If they can accomplish this, they’ll also need the technology to stream the games from the data centers without overwhelming the networking infrastructure between the datacenter and the last mile of the network.
Taking the most extreme case, Fortnite, where the average revenue per user is reportedly $55 and 70% of users play more than 6 hours each week, the economics of cloud gaming don’t work out well. If you were to estimate the overall hourly costs to operate a cloud gaming service at about $0.15 per hour of gaming (this is generous and assumes high utilization rates and low capital costs), capturing 6 hours of gaming each week would have cost Epic $28 per year per user or a 50% margin on a $55 ARPU. Now, one way to change the economics is to mix a subscription model for access to games with the free-to-play mechanics of upselling heavy users on in-game purchases. This model may work, but gamers will expect a low subscription price unless you’re offering a significant library of games. Morgan Stanley found that gamers are willing to spend about $16 per month on game subscriptions. With multiple publishers offering their own subscription services, this monthly rate would need to be split amongst them. This also ignores whether or not the core group of gamers that generate 70% of the revenue in the industry will even switch to cloud gaming. Unless there’s something uniquely valuable about cloud gaming that a gamer can’t get on local hardware, it’s unlikely they will switch in the near term. There needs to be a killer application/game that only the cloud can provide. Without millions of gamers already on the cloud, it’s unlikely a major publisher would take on the investment of building a game that is unique to the cloud.
The current realities of the economics may push the game studios into the hands of the platforms, but as those platforms aggregate more content, they’ll become more powerful. Aggregators end up dominating suppliers, and it will leave the game publishers in a precarious situation in a few years time. You can see this playing out today in television where many studios rely on Netflix more than Netflix relies on them. The major game studios could form a consortium akin to what TV studios did with Hulu to compete with Netflix and ensure that there would be at least one other platform negotiating for TV content rights. It would give them control, but it would still require building the core competency to manage the data centers. Microsoft and Google have that core competency today, but they don’t have enough content to entice gamers — Microsoft might be close with GamePass and they certainly know how to build, market, and sell a game platform to consumers. Game studios should do whatever they can to control the next gaming platform in the cloud and take control of the relationship with their customer. Unfortunately, it might just take too much capital and too much time to develop the core competency to deliver games from the cloud.