"Famous Last Words"

No Royalty Deals (January 2007)

Dear Readers:

Two news items stood out in December:

Namco Bandai Says 500,000 Sales Needed For PS3 Profits: Namco Bandai president Takeo Takasu says any game the company makes for the PlayStation 3 needs to sell 500,000 copies before it will turn a profit. The high cost of development (an average of $8.6 million per game) resulted in the high sales target the company must reach.”

EA exec: Cost of games "crazy": General manager of Electronic Arts (EA) Montreal, Alain Tascan, says the cost of creating a video game is ‘crazy' and spending budgets are out of control. Spiraling costs will force companies to consider their business models. ‘I'm not sure that the model we have here will be the model in 15 years, and that the EA you know today will be the EA you know then," Tascan said. He went on to say he feels other companies are spending even more money than EA, and supports the idea of small teams working to create a game. "Small is beautiful," he said.

It is refreshing to see such candor in print.

But it forces us to ask the question: if a publisher must sell 500,000 units of a game to break even, and if a senior executive at such a well regarded company as Electronic Arts considers development costs to be “crazy,” when can a developer ever expect to see a royalty?

Namco's 500,000 unit sales threshold takes into account not just the $8.6 million in estimated development costs (at a whopping $17.20 per unit!), but the publisher's overhead, marketing and sales costs, cost of goods, Sony platform fees, and a piece of those games that were started but never finished, or did not sell.

Once Namco has broken even, unless the developer has negotiated some kind of “net profits” deal (extremely rare these days), no royalties would be paid until all of the $8.6 million in development costs had been recouped at the developer's effective royalty rate. Even if that rate, net of all reductions, is a generous $8 per unit, over 1 million full price copies must be sold for the developer to recoup! By that time, in the distant distant future, the game would be extremely profitable for Namco.

In the past, we have discussed the financial disadvantage of the developer who makes an advance and recoupment deal. It is a business model where the developer pays for development of a game with money taken from its own royalty stream. And at the end of the day, the developer has no ownership interest in the product it has paid to create.

Game sales are up. The industry frequently reports large month-to-month sales increases. And as three new console systems compete in the market, there appears to be an increasing amount of next-gen development work available for the most capable studios.

But given the economics of game sales, can anyone ever expect to reach a fully recouped royalty position?

Game developers must run their business operations with the same passion and skill that goes into game creation. The management skills that go into maintaining a 60-120 person studio are as critical to success as the creative and technical skills that go into game development, and the relationship skills that lead to dev opportunities.

With the likelihood of royalties drying up, a developer can no longer go “all-out” to develop the greatest game ever without regard for the financial consequences. Developers can not outspend their advances with the expectation of making it up in royalties.

As developers budget next-generation console products, it is important that the development work itself be profitable. All costs must be in the budget, including overhead, technology, hardware costs, a contingency fund, and mark-up. Just as no business works for cost, no developer should develop any product without taking into account its own profit as a business.

The economics of game production are in many ways moving toward a motion picture model. Many “above the line” contributors to a project may be profit participants based on the net profits of a picture. But “net profits” in the movies are as rare as royalties in game development.