Do you know how big the gaming industry really is?
In 2022, approximately 40% of the global population were gamers, with over 900 million people watching others play video games. The global gaming industry is estimated to be worth around 240 billion US dollars, which is twice the combined size of the film and music industries. Moreover, this industry is experiencing a continuous growth rate of over 10% annually.
Microsoft's recent acquisition of Activision Blizzard for a staggering 68.7 billion US dollars has thrust the gaming industry back into the spotlight. Interestingly, seven out of the top ten global tech companies by market value are heavily involved in gaming and have been accelerating their investments in recent years. This begs the question: What is the allure of the gaming industry? Why are these giants so eager to get a piece of the action? Is it purely for profit?
This article aims to provide a comprehensive understanding of the gaming industry's framework and the strategic landscape of major players. By the end, you'll have a bird's-eye view of this fascinating and rapidly evolving landscape.
The Evolution of the Gaming Industry
Two to three decades ago, the gaming market was straightforward. Developers created games, and publishers distributed them across various platforms. These three entities operated independently, collaborating without encroaching on each other's territories.
However, over time, game developers faced increasing development costs and longer production cycles, making it challenging to thrive independently. Capitalizing on their proximity to consumers, major publishers and platforms gradually absorbed developers, leading to vertical integration within the industry. This consolidation gave rise to the traditional gaming giants: Sony, Nintendo, and Microsoft.
In the early days, Sony and Nintendo dominated the market. The top ten best-selling game consoles in history are primarily dominated by these two companies. Nintendo's Game Boy and Sony's PlayStation 2 achieved global popularity. Owning a Game Boy in school was akin to holding ultimate power.
Sony, in particular, excelled at building a formidable ecosystem around its PlayStation console. They strategically signed various exclusive deals to solidify their dominance in the gaming world. It's undeniable that Sony consistently delivered high-quality games, enabling them to maintain this ecosystem effectively.
Once a certain level of market share and content richness is achieved, subscription-based membership models become a viable option. Sony introduced PlayStation Plus, charging a monthly fee for access to hundreds of games. This membership model deepened Sony's moat, incentivizing players to stay within their ecosystem and fostering user stickiness.
Today, all major global gaming platforms, including Microsoft, Nintendo, Apple, Google, Nvidia, EA, and Ubisoft, offer subscription services. This has become the primary battleground for many platforms, reminiscent of Netflix's global dominance through streaming subscriptions. Consumers are increasingly embracing this model of automated, recurring payments, highlighting its convenience and stickiness.
The Rise of Mobile Gaming and New Business Models
While Sony excels in console sales, hardware revenue constitutes a relatively small portion of their overall gaming revenue. The lion's share comes from the ecosystem built around games: selling games and membership fees.
While Sony and Nintendo represent the traditional giants built on console gaming, the industry has witnessed a dramatic shift in revenue streams from different gaming devices. While consoles have maintained a steady market share, mobile devices, primarily smartphones, have experienced exponential growth since the early 2000s, now accounting for approximately half of the market.
This wave of mobile gaming has given rise to globally popular mobile games, with Tencent emerging as the biggest winner and currently the world's largest gaming company.
Even before the mobile era, during the PC gaming boom, Tencent had already become China's highest-grossing gaming company by 2009. This was the era of massively multiplayer online role-playing games (MMORPGs) like World of Warcraft, which propelled the growth of Korean and Chinese gaming companies.
While not the earliest player in China, Tencent shifted its focus from MMORPGs to casual competitive games after an initial setback with the introduction of "Pristontale" from Korea. They found success with titles like "CrossFire," "Dungeon & Fighter," "QQ Speed," and "QQ Dance," later dubbed their "four masterpieces," and solidified their position as China's gaming leader by supporting and publishing "League of Legends."
However, it was Tencent's astute monetization strategy in the smartphone era that truly cemented their dominance, eclipsing even the success of their previous "four masterpieces."
Tencent's Winning Strategy
Tencent's success in mobile gaming cannot be attributed solely to the surge in smartphone users. Their strategic acquisitions played a pivotal role in their global expansion.
Starting over a decade ago, Tencent invested heavily in numerous gaming companies, often at very early stages. Their most significant investment was in Riot Games, the company behind "League of Legends," in 2008. Other notable investments include Supercell ("Clash of Clans"), a 40% stake in Epic Games, and Krafton (PUBG), among others.
By 2013, at the dawn of the mobile gaming era, Tencent had already invested in companies across ten countries and regions. This vast network of investments facilitated rapid exploration of mobile game projects and paved the way for overseas expansion.
More importantly, as a strategic shareholder, Tencent gained a significant advantage in localizing and introducing successful overseas games to the Chinese market.
The Rise of In-App Purchases and GaaS
The past decade has witnessed a significant shift in the gaming industry's business model, beyond the simple transition to mobile devices. The way games generate revenue has undergone a fundamental transformation.
Before 2010, most gaming companies relied on a retail model, selling physical copies of games. This one-time purchase model proved unsustainable for maintaining and expanding games as live service experiences.
To address this, various revenue models emerged, including subscription-based models, in-game advertising, and microtransactions. MMORPGs like World of Warcraft adopted a multi-pronged approach, charging monthly fees while offering expansion packs for additional content.
However, it was the "In-App Purchase" model, championed by Chinese gaming companies like Tencent, NetEase, and miHoYo, that emerged as the most successful in recent years. This model allows players to download and play games for free, with the majority of content accessible without spending money, thus significantly expanding the player base.
However, to enhance the gaming experience, players can purchase cosmetic items, in-game currency, or unlock additional content. This model effectively balances player experience with revenue generation, creating a win-win situation for both parties.
In 2022, consumers spent a total of 167 billion US dollars on Apple's App Store, with two-thirds of that spending attributed to games. Notably, 98% of game spending was on in-app purchases, with only a negligible 2% attributed to upfront game purchases.
This shift towards a recurring revenue model, where players continuously contribute to revenue streams as they play, is known as "Game as a Service" (GaaS). Similar to Software as a Service (SaaS), GaaS has become a dominant business model in the gaming industry.
The Importance of Game Engines
Among Tencent's many investments, Epic Games stands out. While Epic's "Fortnite" has been one of the most successful games globally in recent years, generating over 5 billion US dollars in annual revenue, it's their game engine, Unreal Engine, that holds immense potential.
Game engines are software frameworks used to develop video games. They provide pre-built components and tools that developers can use to create their games without having to build everything from scratch. Essentially, the engine provides the foundation for the game world, allowing developers to focus on creating the gameplay, story, and characters.
Unreal Engine, alongside Unity, dominates the gaming industry, powering a significant portion of games worldwide. While their revenue from game engines might seem insignificant compared to other revenue streams, their potential is vast.
Game engines are essentially the "picks and shovels" of the gaming industry. Beyond gaming, these engines have the potential to become essential tools across various industries. Their ability to render highly realistic graphics in real-time opens up a world of possibilities.
For instance, Unreal Engine is being utilized in filmmaking. By surrounding actors with LED screens displaying real-time rendered environments, filmmakers can achieve more natural lighting and reduce costs. This technique, known as virtual production, has been employed in shows like "The Mandalorian" and "Westworld."
Furthermore, industries like aerospace and aviation are exploring the potential of game engines. NASA and Epic Games announced a collaboration to create Martian simulations using Unreal Engine 5. China Southern Airlines utilizes Tencent's game engine for pilot training, simulating realistic airport runways and weather conditions.
While current applications might seem niche, the potential of game engines extends far beyond gaming. As the lines between virtual and real worlds continue to blur, game engines are poised to become indispensable tools across various sectors.
This explains the rapid rise in the valuations of Epic Games and Unity. In 2012, Tencent acquired a 40% stake in Epic Games for 330 million US dollars. By 2020, Sony invested 250 million US dollars for a mere 1.4% stake, indicating a more than twentyfold increase in Epic's valuation in just eight years.
Similarly, Unity's valuation soared during the metaverse hype of 2021-2022, briefly exceeding 50 billion US dollars despite generating only 1.1 billion US dollars in annual revenue.
While these valuations might seem excessive, they highlight the market's confidence in the future potential of game engines.
Microsoft's Cloud Gaming Ambitions
In any discussion about the gaming industry, Microsoft deserves special attention, especially after its acquisition of Activision Blizzard. With this acquisition, Microsoft's gaming revenue surpassed Sony's, trailing only Tencent.
Microsoft's journey in gaming has been intriguing. While their Xbox console initially operated as a separate entity from their core business, CEO Satya Nadella recognized its potential, overruling attempts to sell the Xbox division over a decade ago.
Since then, Microsoft has doubled down on gaming, exemplified by the acquisition of Activision Blizzard. While securing popular IPs like "Call of Duty" for their Xbox Game Pass subscription service was a significant driver, Microsoft's ambitions extend far beyond consoles.
Recognizing the declining market share of consoles, Microsoft aims to establish a strong presence in mobile gaming, seeing it as an opportunity to challenge Sony's dominance. Additionally, gaming provides a valuable training ground for AI development, as evidenced by OpenAI's early success in training a Dota 2 AI capable of competing with professional players.
However, Microsoft's ultimate goal is to create a "comprehensive gaming service" or "universal gaming service," transcending device limitations. Their vision is to enable seamless gaming experiences across various devices, from Xbox and PC to mobile phones, with devices acting merely as interactive terminals.
The Future of Gaming: Cloud Gaming and Beyond
Cloud gaming is at the heart of Microsoft's vision. By offloading computationally intensive tasks to the cloud, cloud gaming reduces hardware requirements, allowing players to enjoy high-quality gaming experiences on less powerful devices. Furthermore, cloud storage enables cross-device gameplay, allowing players to seamlessly switch between devices without losing progress.
While still in its early stages, cloud gaming holds immense promise, with Microsoft projecting significant growth in the coming years. However, technical challenges remain, including latency issues and the need for robust internet infrastructure.
Microsoft's interest in cloud gaming aligns perfectly with their existing strengths in cloud computing. Their Azure cloud platform already dominates the cloud market, generating significantly more revenue than their gaming division. While the success of cloud gaming remains uncertain, any opportunity to leverage their cloud infrastructure is worth exploring.
Interestingly, even Sony, with its PlayStation 5 console, has embraced cloud gaming, partnering with Microsoft's Azure cloud platform to power their PlayStation Plus Premium cloud gaming service. Similarly, Amazon, the cloud kingpin, launched its Luna cloud gaming subscription service, although it has yet to gain significant traction.
However, the current leader in cloud gaming is neither Microsoft, Amazon, nor Sony, but Nvidia. Their GeForce Now service boasts over half of the global cloud gaming market share, with millions of subscribers worldwide.
The takeaway here is that regardless of who wins the cloud gaming race, cloud providers like Microsoft and Amazon stand to benefit significantly. Moreover, both AWS and Azure rely on Nvidia's GPUs, making Nvidia the ultimate winner behind the scenes.
The Silent Giant: Nvidia
Despite not directly competing in the gaming market, Nvidia has been a constant presence, quietly profiting from the industry's growth. Every gaming platform, regardless of its form factor, requires a graphics processing unit (GPU), Nvidia's core product.
For the first decade after its founding in 1993, Nvidia focused solely on selling GPUs, which still account for over 40% of their revenue. Their relentless pursuit of GPU optimization not only propelled the gaming industry forward but also positioned them as a leader in AI computing.
While Nvidia's GPUs were primarily associated with gaming, they have become essential components in various fields, including AI, data centers, and even cryptocurrency mining. This diversification has propelled Nvidia's market value beyond a trillion dollars, securing their position among the top ten global tech companies.
Apple and Google: Gatekeepers of the Mobile Gaming World
Despite not traditionally being recognized as game developers, Apple and Google have become major players in the gaming industry, primarily by leveraging their control over mobile app stores. Their revenue from mobile games, mainly through app store fees, has already surpassed traditional gaming companies like Nintendo and Electronic Arts.
This dominance has led to conflicts, such as the highly publicized legal battle between Epic Games and Apple over Apple's 30% app store commission. This lawsuit highlighted the significant revenue generated by games on Apple's App Store, prompting Apple to launch Apple Arcade, a subscription service offering access to hundreds of high-quality mobile games.
Apple's foray into gaming, with both a dedicated "Games" tab and the Apple Arcade service on their App Store, demonstrates the importance of gaming to their user base. Similarly, Google's Google Play Pass subscription service and their short-lived Stadia cloud gaming platform underscore the significance of gaming in their overall strategy.
The Spillover Effect of Mobile Gaming
The widespread adoption of mobile gaming has had a significant impact on the smartphone industry. As games are among the most demanding applications on smartphones, manufacturers have been compelled to optimize their devices for gaming performance, leading to advancements in display technology, processing power, and battery life.
For instance, high refresh rate displays, once a niche feature, have become commonplace in smartphones, driven by the demands of mobile gamers. Similarly, features like variable refresh rate displays and ray tracing, a graphics rendering technique, have made their way to smartphones, enhancing the mobile gaming experience.
The point is that while gaming platforms generate substantial revenue, they also drive innovation in hardware and software, creating a virtuous cycle of technological advancements.
The Future of Gaming: VR, AR, and Beyond
While still in its infancy, virtual reality (VR) and augmented reality (AR) hold immense potential to revolutionize gaming and beyond. These immersive technologies are expected to become the next major computing platform, blurring the lines between the virtual and real worlds.
Major tech companies, including Meta, Apple, and Microsoft, are investing heavily in VR and AR headsets, recognizing their potential to transform how we interact with technology and each other.
Meta, in particular, has gone all-in on the metaverse, a concept that envisions a persistent, shared virtual world where people can interact with each other and digital content in immersive ways. While Meta's metaverse efforts have yet to gain significant traction, their investments in VR headsets have solidified their position as a leader in this space.
Apple, known for its cautious approach to new technologies, has also entered the VR/AR race with its mixed reality headset. This move signifies Apple's belief in the transformative potential of immersive technologies.
While VR/AR gaming might seem niche today, its potential to become a dominant form of entertainment and interaction in the future is undeniable.
Conclusion
The gaming industry has evolved from a simple entertainment medium to a complex and intertwined ecosystem of technology, business, and culture. It's no longer just about creating games but about building platforms, ecosystems, and experiences that extend far beyond the traditional definition of gaming.
The influx of tech giants into the gaming world is driven by several factors, including the industry's profitability, its potential to drive innovation in other sectors, and its strategic importance in shaping the future of computing.
Gaming has become a testing ground for cutting-edge technologies like AI, cloud computing, and immersive experiences, making it a crucial battleground for tech giants looking to shape the future.
As technology continues to evolve at an unprecedented pace, the gaming industry will undoubtedly remain at the forefront of innovation, blurring the lines between the virtual and real worlds and shaping the future of how we live, work, and play.