The Business Evolution of the Video Game Industry, Part 3: The Future of Gaming

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Updated on January 10, 2024

This version has been updated with more sources and source links, more recent data, minor corrections, and more ongoing trends.

Part 3: The Future of Gaming

The future of video games will continue to build from the trends of the past.

For consoles, this means creating the most attractive video game library. And the largest game libraries secure the future by linking the past—the ability to play older games on new consoles (backwards compatibility) will be a core feature of all future consoles. Gaming accounts that are created today can be transferred to the consoles of the next generation. The success of past consoles will carry into the sales of every console that comes next. Gamers who buy one company’s console will be much more likely to stick with the same brand.

The strategy that makes this possible is the increasing use of digital downloads. Game libraries are no longer made entirely with a physical shelf full of disks, but instead can simply be an account with a list of games associated with it (a “digital shelf”). The console knows which games the player owns, and they can download these games whenever they want to play. And a game that is fully digital can be designed to work with future consoles much easier than a game on a disk. When the account transfers to the next console, so does the player’s game library.

Digital downloads are also the future of the games themselves—selling the games through a digital distribution network has become the norm, but selling items inside a game is also a primary strategy that will never go away. No game is ever fully complete; it can be broken into thousands of pieces that are each sold individually, sometimes over many years.

But this main theme—a gaming industry that is more online and more digital—is overshadowed by the flashiest opportunity in the future of gaming: eSports. To understand what this means, let’s take one more peek into the past.

eSports Become Real Sports

Arcade tournaments have been around since the 1970s and 1980s. These were primarily competitions to see which players could achieve the highest score in specific arcade games. They were not directly playing against other players.

This changed in the 1990s, when fighting games allowed a direct competition between two players, rather than competing by high scores alone. As these games evolved in complexity and scope, and first-person shooters connected with computers through the Internet, eSports competitions became increasingly common (with increasingly higher payouts). The first professional gamers started with games like Doom.

But most of the organizations behind eSports in the 1990s were small and informal, and the types of sponsorships that exist for professional sports leagues were virtually nonexistent. It was the 2000s that began to see the rise of annual international tournaments and professional gaming leagues devoted to eSports. The founding of Major League Gaming (MLG) in 2002 marks the shift into corporate sponsorship.

In the early 2000s, the two most popular categories of eSports games were first-person shooters (FPS), real-time strategy games (RTS), and sports games.

The most widely played FPS eSports games include some familiar names:[1]

  • Quake, made by id Software in 1996, supported one of the first major professional eSports scenes. Its popularity faded within a decade, replaced by more modern games.

  • Counterstrike, released by Valve in 2000 as a spinoff of Half-Life, continues to be a popular series for eSports (a modernized version came out in 2012). Counterstrike has about 6,000 active professional teams and a total prize pool of more than $130 million.

  • Call of Duty, published by Activision, has been featured in MLG tournaments since 2008. Active team count is difficult to determine because the game is played on so many different types of systems, but CoD has a total prize pool of at least $50 million among three different games. MLG was purchased by Activision Blizzard in 2016.

  • Fortnite, developed by Epic Games in 2017, has quickly become a stable eSports category, with a prize pool of more than $110 million.

With RTS games, there is not as much variety. StarCraft, a series first started by Blizzard in 1998, remains the leading eSports RTS, with a prize pool of more than $40 million among two different games. EA’s FIFA series is the leading sports eSports game, with a prize pool of more than $15 million.

All of these eSports categories are dwarfed by a newer type of game: the Multiplayer Online Battle Arena (MOBA). A MOBA is a modification of an RTS. In an RTS, the player is commanding an entire army by themselves. In a MOBA, several players are each controlling individual characters within an elite army squad, facing an enemy team with the same number of players. There are two major MOBAs:

  • DOTA 2, which originated as a spinoff of an RTS game, was released by Valve in 2013. DOTA 2 has more than 2,000 active professional teams, with a prize pool of more than $310 million.

  • League of Legends (LoL), created by Riot Games in 2009, has more than 3,500 active professional teams, with a total prize pool of more than $100 million.

LoL (most watched), DOTA 2 (most prize money), and Counterstrike (most active professional teams) are considered the “big three” of eSports. If we stretch it to four, then Fortnite would come close. While CoD is easily the leader for console eSports, no other games have challenged the big three (or four) in their dominance of the PC eSports market. New games have been introduced with as much as $100 million of eSports investments, but almost all of them have quickly folded after failing to gain enough popularity to earn back the investment. [2]

It is difficult to build enough popularity to support new eSports. This market–even with continually high growth in viewers, increasing prize payouts, and major corporate sponsorships–may be reaching a mature stage, where most of the growth goes to the top games, and most of the top games are owned by the same companies. LoL was made by Riot Games, which is owned by Tencent. Tencent also owns a large piece of Epic Games, the maker of Fortnite. DOTA 2 and Counterstrike are both Valve games. StarCraft and CoD belong to Activision Blizzard (and Microsoft). Every major video game developer has made some investment into eSports, but only the largest video game companies have the resources to create their own.

eSports are a big deal, and they will continue to be a big deal. The eSports market is projected to grow from $1.5 billion in 2022 to almost $7 billion in 2030, a growth rate of more than 20% annually, while eSports viewership is projected to surpass 600 million viewers by 2025. And although eSports projections have been consistently over-optimistic, the potential is real.

Ongoing Trends

Beyond eSports, there are several consistent trends in the industry. Decades of development have transformed the video game industry from a chaotic group of startups into a stable group of corporate giants. It has also become more online, more continuously supported, more monetized, more competitive, more casual, and more mobile. These massive changes make an industry that would be unimaginable from the technology that started it all. Even the comparison from one generation of consoles to the next generation reveals an impressive leap in technology.

And the transformation continues. The future of the gaming is influenced by many of the same features that affect every other technology company.

Market Concentration

The most successful video game developers do one of three things. All of these three things contribute to a more concentrated industry:

  • They put their competitors out of business with superior financial resources.

  • They buy out smaller competitors that have proven to consistently make popular games.

  • Or they sell themselves to larger companies.

Even Activision Blizzard, once the largest independent game publisher—made from the combination of three very successful companies—was itself swallowed by Microsoft. And EA, the next largest independent publisher, uses acquisitions as a central strategy. But the biggest gaming company is actually Tencent, the Chinese technology conglomerate that owns a little bit of everything.

The shift in concentration is focused on Asia in general and China in particular. The Asian market represents about one third to one half of the global video game market (depending on how you measure it), while China has more video game players than any other country in the world. And the most effective way to get into China is to partner with Tencent.

Mobile Gaming

The biggest growth market for games is mobile phones—mobile gaming already represents 50% of all video game revenue, and is projected to grow by more than 15% annually over the next decade.[3] Mobile games are popular among people who are not traditional gamers, such as women and older people, and are extraordinarily popular in Asia.

Almost all mobile games are monetized through advertisements and/or microtransactions. Tencent, Activision Blizzard (Microsoft), and Take-Two are all investing heavily in new mobile games. Nintendo continues to avoid mobile gaming on phones and focus more on its own handheld consoles.

Digital Sales[4]

The “middle man” of retail stores has consistently become less important in the video game industry. In 2022, 90% of all video game sales were digital—15 years earlier, it was less than 20%. Digital download platforms like Valve’s Steam service have captured most of this change, but the video game developers also make more money on digital sales. The cost of selling one more download is much less than manufacturing a disk and using shelf space inside a store.

There is still a place for physical sales, especially when it comes to buying a new gaming device like a console. Console owners also like to have physical disks that they can re-sell or share with friends, but the industry prefers to be digital.

A consequence of digital distribution is how games are becoming perfected over time. The biggest video game companies have released a few games that sold well in the beginning but were quickly abandoned by the players. Gamers know what they like. And if they don’t get what they like, then they walk away.

In the past, substandard games would become a black mark on the company’s reputation. But now these mistakes can be fixed. The Internet enables development to continue after the game has already been sold (sometimes included with a monthly fee). The company can add new features or fix broken features until the game is good enough to match the high standards of their fans.[5] It can also extend the life an old game for a long time after it would normally stop selling.

This is a controversial trend. Games should be ready when they are released, and not just after the customers complain. But it’s better for the industry when mistakes can be fixed, and it’s better for the gamers when their favorite games continue to be supported. The video game crash of 1983 showed what happens when too many bad games flood the market and gamers abandon the industry.

Another part of the digital theme is the increasing use of cloud systems for gaming, where the games are played from the cloud. I have been skeptical of this concept for many years, but it has proven useful for the right context—when a gaming system is not powerful enough or doesn’t have enough storage space for a game. Microsoft, Sony, and NVIDIA all offer options for cloud gaming.

The last—and most important—part of digital sales is the increasing use of microtransactions. The idea of selling things inside a game is a feature of both universal Internet connections and the spread of mobile games. Most mobile games are free play and make money by selling things inside the game. But paid games can have microtransactions too.

Industry data on microtransactions is inconsistent, but Valve’s Steam platform represents a good proxy, and about 75% to 80% of all Steam sales are microtransactions. This is another controversial trend. Most gamers are willing to accept the ability to pay for cosmetic changes. But being forced to buy something that should be included in the core game, or being forced to “pay to win,” are deeply unpopular features in the gaming community.

So far, most video game developers have respected gamers’ demands to not be exploited by excessive microtransactions, but EA has come dangerously close to crossing the line where regulation affects the industry. Some of these systems are designed to be as addictive as gambling, and in some cases there is functionally no difference between a microtransaction payment and a slot machine.[6] This is a serious ethical concern that will become more significant as regulators gain a better understanding of the industry—lawsuits about the use of microtransactions are already common.

Virtual Reality

Progress in Virtual Reality (VR) has been slow, but it has grown into an independent category of gaming. The first VR gaming systems were developed in the early 1990s, but Nintendo’s Virtual Boy VR console was the most serious attempt at commercializing the technology for video games. Released in 1995, it was a commercial failure. And commercial failures for VR systems continued for the next 20 years.

VR technology has continued to mature. Dozens of VR systems have been introduced since 2015, each with a slightly different design—some are attached to consoles or PCs, some are independent consoles, and some hold mobile devices that can use VR software. Generally, these systems require a large open space to operate safely, and many gamers have trouble using VR for long periods of time, so adoption relies on overcoming technical challenges.

But the market has been established, and it is expected to explode. The market for VR headsets is projected to grow by about 30% every year through 2030. And like other consoles, it will be the combination of technical features and game library that determines which headsets become the most popular.[7]

VR Headset manufacturers are mostly made up of very large companies that bought the technology from somewhere else (like Facebook’s acquisition of Oculus) or developed it on their own (like Sony). But this market also includes firms that develop the games, the platforms to buy the games, and businesses that build the technology used by VR devices.[8] I still consider it to be in the early stages.

Back Catalogues

We will certainly have more powerful computers and more powerful consoles, and more carefully crafted games, but there is also a movement for appreciating the great games of the past. Every video game company has a “back catalogue” of old games that still have value. “Remastering” by improving the old games, and re-releasing for modern systems, brings the classics back to life. Nintendo is currently one of the most prolific users of a back catalogue, releasing several original NES and SNES games for the Switch, but other companies have used their back catalogues more profitably by updating the games to look more modern. Electronic Arts released a remastered version of the original Command & Conquer game in 2020, and Blizzard followed in the same month with a remastered version of its iconic Diablo II game. These games will continue to be valuable for as long as people are willing to buy them, and I expect that to be a long time.[9]

End of Part 3

The remarkable growth of eSports rivals the popularity of “real” sports. And with that popularity comes the opportunity for significant new sources of revenue. Since this part of the video game market requires a large investment and is already concentrated among a small number of very large companies, the current industry leaders are likely to capture most of this growth.

The other ongoing trends in the industry are more open to smaller companies, because these trends mostly describe a shift in how businesses make money. The two most important themes have been the switch from physical disks to digital downloads and the rise of mobile gaming (both of which make it easier to sell games in the massive Asian markets). Ten years ago might have been a good time to invest in these themes, but it’s not too late to think about it, because they will continue to be influential over the next ten years as well. And VR gaming is growing into the mainstream, although it is also dominated by the largest companies in the industry.

How these major themes develop might be unpredictable, but the concentration of the market ensures that the current leaders will continue to be powerful, even if they are temporarily surprised.

Conclusion

The stability in the video game industry has evolved from decades of innovation. Each generation of consoles is more powerful and more complex, and requires a bigger R&D investment each time. But the attraction of console technology is secondary to the game library available for each console—a powerful console is exciting, but it must have the right price and the right games.

The investment required to build a good game library prevents new entrants from surprising the console market, but it also ensures a more stable and predictable console cycle. Expectations about future consoles are set years in advance by companies that have a long history of proven success. With such careful planning, we are unlikely to see the dominance of an Atari or a Nintendo of the past, but we are also unlikely to see a spectacular collapse.

The market for video games has also become more stable and predictable, but in a different form. There are still large games produced by massive developers, but the rise of digital distribution methods has enabled small developers to reach a wider audience. It has also made this part of the industry more profitable for every gaming company, encouraging new sources of revenue such as downloadable content and microtransactions. But moving online to digital downloads is just a shift in strategy. The biggest growth markets for games over the past few years have been in mobiles games and the Asian video game market. Both are now large portions of the video game market, and both are targets for video game companies of all sizes.

Beyond these major markets, there are other reasons to be excited about the video game industry right now. In the long-term, we have eSports and virtual reality, the next major growth markets for large video game companies (and maybe a few small developers).

From an investor’s perspective, investing in this industry is a challenge because it has become so concentrated that the best video game businesses are almost always subsidiaries of larger companies with other lines of business. Any successful “pure plays” on the industry are all potential acquisition targets, because it is clear that the video game industry has evolved into a mature business with well-understood standards. But it still has opportunities to continue evolving as a valuable form of entertainment. Video games are not just for kids.

Andrew Wagner
Chief Investment Officer
Wagner Road Capital Management

[1] Team count and prize pool numbers come from Esports Charts. Prize pool is the amount of money paid out from tournaments since 2017.

[2] Mobile games have started to climb up the list of most popular and biggest-paying eSports title.

[3] Visual Capitalist has a great source of data demonstrating the rise of mobile gaming.

[4] Gameopedia has an excellent article on how game storage media and sales have changed over time.

[5] A recent example is CD Projekt Red’s Cyberpunk 2077, a game that had so many problems it forced Sony and Microsoft to offer refunds to anyone who bought it on release. It took about three years of updates to be considered a great game.

[6] Intelligent Economist has a good summary of microtransactions and the psychology behind how they work.

[7] As VR technology improves, I expect the game library to be more important.

[8] Newzoo has an excellent summary of how the VR ecosystem is constructed.

[9] One of Microsoft’s motivations for purchasing Activision Blizzard was access to a healthy back catalogue of games that the company can remaster or re-release.

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