"Famous Last Words"

The Tooth Fairy, Santa Claus, and Royalties for Developers (June 2004)

Dear Jim,

My company has been developing console games since 1997. In that time, we've had our share of successes and have been able to keep our team busy with some periods of down time between projects.

However, it seems like we never earn royalties on our games.

What are we doing wrong?

Dear Beef:

The game industry business model provides that developers get an advance that must be recouped from the royalty stream before royalties are paid.

What this means is that developers pay for development of their own games that they deliver to publishers, even though ownership of the game may be assigned to the publisher, and developers earn only a small portion of the sales of the game in royalties.

Publishers justify this model because they are the bank, and take the initial financial risk in underwriting development, marketing, inventory, and all the other costs associated with publishing a game.

As hardware generations roll out, the cost of development has increased exponentially.

When I worked on games for the Atari 2600, one designer could create a game without assistance in four to eight months at a cost of around $80,000. Sales of hit games regularly hit mid-six figures. You do the math. Substantial royalties could be earned.

These days, games can cost mid-seven figures. Retail prices are steady, not really all that much higher than in the Atari days, but publisher's profit margins have fallen due to platform fees, higher marketing costs, and much higher development costs. It is hard for publishers and for developers to make a profit.

Times will get tougher when the PlayStation 3 and Xbox 2 come out. I have heard development costs for AAA titles estimated at between $8-$15 million dollars. Once again, I cannot see retail prices going up for these games. Unless a greatly expanded audience comes forward, there will be even less possibility of a developer recouping and earning any royalties for their work.

.unless, that is, a new business model would be accepted in the industry.

In any financial model for any game, whether it was developed for the Atari 2600 or the Xbox 2, there are actually two break-even points.

The first is the publisher's, when all its product development, marketing, sales, and overhead costs have been recovered and the game becomes profitable.

The second is the developer's. By the time the developer has recouped, "broken even" as you might say, the publisher nearly always has long since gone into profit mode.

Since $8-$15 million budgets will make it all but impossible to ever receive a royalty under the old "advance and recoup" model, publishers must either accept the fact that developers must write a fair profit margin into their budgets, or roll back the concept of "recoupment" so that royalties begin to be paid once the publisher hits its true break-even.

Paying royalties after publisher break-even would be similar to the Hollywood concept of "net profits." However, in order for this model to work, a fair determination of when a game becomes profitable must be reached. Hollywood is notorious for never reaching net profits on any but the most wildly successful pictures. In a recent course book, the definition of "net profits" from a Hollywood contract ran 52 pages in length. Unless publishers and developers can work together in good faith to identify when a game reaches break even, and state it briefly and understandably in a development contract, adopting such a model may not provide an end result that serves the needs of both sides.

No game can be a hit without the determined efforts and dedication of a developer and the hard work and money of the publisher. Both parties have a right to share in the success of this collaboration. It's time to get rid of the of advance and recoupment model so that developers once again receive royalties for their successful titles.