The Business Evolution of the Video Game Industry, Part 2: Software
/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 2: Software (Games)
To understand the software side of the video game industry, we need to start with the relationship between the hardware side and the software side. One of the earliest complaints about Atari, and later Nintendo, was that their market dominance in consoles gave them the ability to make expensive demands on independent game developers. Atari was annoying, but Nintendo was ruthless. To publish a game on the NES, developers were required to give Nintendo the exclusive rights for two years, and Nintendo controlled the supply of NES cartridges. If your team was not affiliated with the console manufacturer that dominated the market, then your games would not sell.
As a result, Nintendo became the target of an antitrust lawsuit that covered all 50 states. The company lost the suit, but was only required to pay $5 million in coupons. After this experience, Nintendo chose to allow third parties to make their own cartridges, likely influenced by the fear of further lawsuits.[1] Sony later proved that Nintendo’s aggressive approach was wrong; when Sony welcomed outside developers, its extensive game library attracted more players and led to the sustained success of PlayStation consoles.
The concept of an outside developer, known as a third-party developer, is defined by who owns the game developer that produces games. A first-party game is one that is made by the same company that makes the console. For example, all Nintendo-made games for Nintendo consoles are first-party games. Games made by first-party developers are almost always exclusive to that company’s console. A third-party game is made by an independent game developer and is usually available on many different gaming platforms.
The category of third-party developers is divided into two different responsibilities: developers and publishers. The best comparison is to imagine the difference between book writers and book publishers. For this part, we need a little more context.
Game developers do all of the programming to make the game. They have timelines and guidance to follow that is set by their publishers.
Game publishers advertise and distribute the game. They pay the developers a royalty based on the game’s performance.
In many cases, game developers publish their own games, or the developer is owned by the publisher.
The story of third-party developers is complicated and constantly evolving. Thousands of developers have been formed, bought out, shut down, and re-formed again. And only a few major independent game publishers/developers still exist today (in order of size: Electronic Arts, Take-Two Interactive, and Ubisoft).[2]
This is how they do business.
A Brief History of Third-Party Developers
The earliest third-party developers and publishers were founded by former programmers. The world’s first third-party game developer was formed in 1979 when a team of Atari programmers left the company to found Activision.[3] They were unhappy with their treatment at Atari (by then it was owned by Warner Communications), and they desired more flexibility on the type of games they were developing. Atari did not credit the developers who designed and programmed their games, and they were paid the same low wage no matter how well the game sold. But, as a third-party developer, these programmers would be credited for their achievements and paid for their performance. Activision opened the market for third-party developers.
Electronic Arts (EA) was founded in 1982 by Trip Hawkins, an early Apple employee. EA used Activision’s strategy for attracting good game designers and took it a step farther than giving more credit and more pay—EA treated them like rock stars. Backed by Don Valentine, the investor who funded both Atari and Apple during their early stages, and filled with talented programmers, EA was instantly successful.
The market blossomed, and more than 100 third-party game developers were in operation by the end of 1982. It was easy for new game developers to get funding from investment firms looking to capture a piece of the market, but the conflict of making good games vs. making money contributed to a flood of cheap, low quality games.
Consumers simply abandoned the market, and the video game crash of 1983 eliminated almost all of the third-party developers. Activision and EA both switched focus from console games to computer games, which were not as severely affected by the crash. Both companies also began to buy out their competitors and development partners. EA made it a central strategy of their business, but Activision struggled for years before getting rescued by Bobby Kotick in 1992.
The revival of the video game industry in the late 1980s and early 1990s saw another explosion of new video game developers. But these new game developers were much more conscious of emphasizing quality in their games, and console manufacturers had much higher standards.
It was the computer game market, however, that offered the most experimentation. Computers have always been more powerful and more customizable than consoles. It is easier to design a game for a computer, and computers bypass the complicated relationship that comes with console hardware companies. They also opened the market to players who would never consider a console.
Since the early 1990s, computer games have pioneered technology, gameplay, and new ways to make money. And each type of game contributed in its own way—we are no longer looking at a chronological story, but a categorical division.
For those who are not familiar with games, here’s a brief description of what we’re covering:
Casual Games: Simple games that are easy to learn and can be played for short periods of time. Mobile phone games are the modern version of casual games.
First-Person Shooters: Shown from the perspective of a warrior or soldier that shoots at enemies. This type of game is often the target of government inquiries about violence in video games.
Role-Playing Games: Players act out the role of a character and follow a story, like an interactive movie or novel.
Sports Games: Sports like soccer, football, basketball, and baseball have become very popular as video games.
Strategy & Simulation Games: Strategy games and simulation games are different categories, but they both require planning ahead and managing resources. A strategy game might be a general commanding an army, while a simulation game could be a city planner designing a city.
Casual Games Become Apps
A casual game is easy to learn, easy to play, and does not take much time. The most popular casual game of all time was probably solitaire, which Microsoft first bundled with Windows 3.0 in 1990. Although Microsoft did not try to make money on solitaire, this short, time-wasting distraction of a game has long been a feature of office culture, and it led the way for the future of casual games. By the late 90s and early 2000s, there were many websites devoted to casual games. These websites had games that were free to play and made money by offering advertising space.
Near the end of the 2000s decade, more casual games appeared on social media websites. By 2011, Zynga, maker of FarmVille and CityVille (the latter of which peaked at over 100 million active users), had four of the top five social games, primarily connected to Facebook.[4] With social media games, the business model changed; the games were still free, but bonus items or extra time were offered for sale inside the game. These sales, called microtransactions, were part of a strategy called the “freemium” model. The freemium model means providing the games for free and making sales inside the game. As you probably know, this way of making money has followed the transition into mobile gaming.
Zynga, however, has not made the transition. The current leader in mobile games is King, maker of the extremely popular Candy Crush games.[5] King is a mobile game company that began as a website in 2003, expanded into social media platforms in 2011, and connected everything to new mobile games in 2012. In 2016, King was purchased by Activision.
First-Person Shooters Drive Distribution Methods
The most famous first-person shooter game of all time is probably Doom, a game franchise created by id Software in 1993 (Wolfenstein 3D, also by id Software, came first, but Doom is more well-known).[6] id Software, founded in 1991, used a form of game distribution called shareware.[7] The company would release a partial game for free, called the “shareware” version, that gamers were encouraged to share with their friends. Then, if players liked the shareware version, they could call the company to order the full version of the game.
This method of popularizing games was common in the 1990s. As the market evolved, new methods for distributing game software became possible. At first it was “expansion packs” that added substantial additional new content to a previous game, sometimes as much as an entirely new game. But these were still sold in boxes. It was not until the early 2000s that Internet connections became fast enough sell smaller pieces of content. This new innovation allowed selling individual items, or maps, or clothing, as one small package that could be downloaded. These products, called downloadable content (DLC), have continued to become an increasingly higher share of revenues for video game developers.[8]
As online features became more important, developers have adopted even more creative distribution methods. The next influential first-person shooter was Half-Life, released in 1998. It was created by Valve, a company formed by two former Microsoft employees in 1996. In 2003, Valve opened a new digital distribution platform that it called Steam. The initial purpose of the platform was for Valve to publish its games online where they could be sold and downloaded without visiting a store. But the platform became a way for smaller developers to publish their games and sell DLC content. This “indie” developer platform continues to flourish. Steam’s market share for PC downloads is about 75%.
Outside of Valve’s powerful platform, it was Activision that secured market dominance in first-person shooters. The Call of Duty (CoD) series, first published by Activision 2003, is by far the best-selling FPS franchise of all time, with more than 425 million units sold. The core advantage of CoD is that its enormous popularity generates more sales for the next game; primarily an online multiplayer game, gamers buy it for the game but stay for their friends. The longer these players continue playing, the more content that Activision can sell inside the game. And this content has continuously involved smaller game segments and smaller transactions. DLC has become microtransactions.
This trend was taken to the extreme with the FPS game Fortnite. Fortnite was released by Epic Games in 2017 as a free game. Instead of charging for the game, like CoD, Fortnite copied the freemium model of mobile games; the game is free, but players can buy special content inside the game to improve their game experience. In 2018, sales of this special content earned $2.4 billion, more than any other game has ever made in a single year.
Fortnite’s influence generated new ideas for game design that were shamelessly copied by Activision, and CoD continues to be the perennial giant of the genre.
Role-Playing Games (RPGs) Introduce Monthly Subscriptions
The all-time best-selling RPG franchise, by far, is Nintendo’s Pokémon series. But that’s a first-party, console-based game that you can only find on Nintendo consoles. The third-party giants of the RPG genre are Square Enix (developers of the Final Fantasy and Monster Hunter franchises) and Bethesda (developers of The Elder Scrolls and Fallout). Both companies entered the video game industry shortly after the video game crash of 1983, and both have slightly different development strategies. Square Enix is more of a console developer, and generally chooses to release its games to largest console of the current generation. Bethesda is more of a computer game developer; Bethesda releases its games on every system that will allow it (and re-releases them as many times as possible).
The reason these franchises have done so well is not just because they’re good games. It’s partly because there are so many of them. More than 100 Final Fantasy titles have been released or re-released over the past 30 years. The more impressive RPG developers take a long time to develop their games, about five to ten years, and aim for selling a massive game that can break individual game sales records without reaching the top of the franchise records.
This is the strategy for Blizzard Entertainment, with its Diablo franchise.[9] Blizzard, founded in 1991, came in at the ideal time for developers interested in producing a high quality computer game experience. Computers were becoming more powerful and more popular, and the technology advancements of the 90s made it possible for developers to keep pushing the edge of computer power.
In 1996, Blizzard released its first Diablo game. It was an unexpected success, becoming the best-selling computer game for the first half of 1997. And it maintained extraordinary popularity through the end of 2000, when Diablo II was released. Diablo II was even more successful. It won several “game of the year” awards, and is considered one of the best games of all time.[10]
By sales numbers alone, these are obviously great games, but one of the most influential features of the Diablo franchise is the Battle.net service that came with it. Battle.net allowed Diablo players to play the game with each other over the Internet (an ambitious feature for a game from 1996). The service was free, and it gave the series longevity that would not have existed as a single-player game alone.
Blizzard translated this online experience into a new game, World of Warcraft (WoW), that it released in 2004. WoW is an online game categorized as a Massively Multiplayer Online Role-Playing Game (MMORPG). It is an extension of one of Blizzard’s other franchises, the Warcraft series, but the model of an online game was directly influenced by Battle.net. It became the best-selling PC game of 2005 and 2006, and peaked at 12 million subscribers in 2010. WoW is still the number one game in its category, and has made more than $10 billion for Blizzard since it was first released. Blizzard merged with Activision in 2008 to form Activision Blizzard.
WoW was not the first MMORPG (there were several others that came before, with varying degrees of popularity), but it had one of the most consistent and engaging stories, and the game was carefully designed to encourage social interaction within that world. WoW, and the other MMORPGs like it, have become RPGs that charge a monthly fee for access—they are now a subscription service (sometimes called “Games-as-a-Service” or GaaS). Instead of buying the game once and playing it forever, players have to buy the game and continue paying for it every month for as long as they want to play.[11]
Sports Games Become Big Brand Names
Sports games have been around for a long time. The very first sports game (sometimes recognized as the very first video game) was a tennis game designed for a radar screen in 1958. Over time, these games have become more realistic and more complex, but we’re skipping to the 1990s, where 3D graphics and professional sports licenses began to dominate the market.
The longest-running sports game franchise is Madden NFL football, first developed by Electronic Arts in 1988. Madden was exceptional among sports games for two reasons: it was as realistic as computers of the time could handle; and, after 1993, accelerated the trend of licensing professional sports leagues to create video game content. Since the first game was released, the franchise has sold over 130 million copies, but it’s a distant second from the top game.
FIFA, first released in 1993, was EA’s natural extension of the professional sports licensing strategy. This soccer franchise, more popular worldwide, has sold over 325 million copies, more than twice as many as Madden. Both FIFA and Madden have become yearly best-sellers with numerous features and items for sale inside the game.
Other sports are less concentrated. Take-Two Interactive often has the leading baseball and basketball games. But they are not as popular and not as well-branded, and the licensing deals are not as profitable. EA offered to buy Take-Two in 2008, but the deal was rejected.
Strategy & Simulation Games as Buyout Candidates
Major game developers are always involved with many different types of games and multiple franchises inside the same type of game. But smaller developers generally specialize in one type of game, and sometimes only one franchise. There are thousands of small developers. And when they become successful, they have to make a choice: continue developing games as an independent company (and retain the creative vision), or sell out to a larger company (and gain access to more resources).
Every successful business is constantly choosing between those two options, but game development is unique. It is very similar to the biotech world, where smaller companies are all working on their own unproven drugs, and larger companies are waiting to buy out the ones that are proven to be successful. The smaller game companies have the freedom to test their concept, but they may not have the resources to continue developing new games; on the other side, the larger companies can allow someone else to take the risk of a failed game, and make investments in what is already successful.
This is a central strategy for Electronic Arts.[12] EA has made more than 40 acquisitions, and a primary reason behind their interest in an investment is often one very successful franchise.[13] Two of the most successful targets were pioneers in strategy game and simulation game development. Maxis (founded in 1987 and purchased by EA in 1997), and Westwood Studios (founded in 1985 and purchased by EA in 1998).
At the time of EA’s acquisition, Maxis was known for its SimCity franchise, a series of city management simulation games with no winning objective. Maxis attempted to develop other types of games, but these investments destroyed the company’s finances, and EA stepped in to save it. EA allowed Will Wright, the genius behind Maxis, to extend the SimCity universe into a new franchise of games called The Sims.
The first Sims game became the best-selling computer game for the year in 2000 and 2001, and became the best-selling computer game of all time by 2003. The Sims franchise still ranks near the top of the list for the best-selling computer game franchise of all time. EA closed Maxis in 2015, after all of the original Maxis team had left and the games were no longer meeting EA’s ambitious standards (although EA later relaunched the brand to develop more Sims games).
Westwood Studios was a similar story. When EA bought Westwood Studios, it was already a subsidiary of a much larger video game company, but a series of failed games led to the breakup of the parent company. From the wreckage, EA got Westwood, known for its real-time strategy franchise called Command & Conquer.
Under EA’s direction, Westwood released several new games for the Command & Conquer series. The games continued to be popular but suffered from impossible expectations. Like many developers that get acquired, the corporate culture shifted from making video games as a passion to making them purely for profit, and quality suffered. EA shut down Westwood Studies in 2003, only five years after the acquisition.[14]
End of Part 2
The software side of the video game industry has consolidated over time. Most of the major publishers have either collapsed or have been absorbed by a larger company. Even Activision Blizzard, once considered “too big to buy,” was acquired by Microsoft in 2023. However, major publishers are known for developing “AAA” titles. There are still hundreds of smaller developers and publishers creating video games, and there is still room for them to make money in the industry without making a huge investment. It only takes one exceptionally successful game for an unknown company to become big.
Sustained success is still rare. While smaller publishers and developers can get by without a big budget, they still need to make a popular game, and they still need to turn that popularity into profit. Fortunately, monetization has become easier over time, with several strategies for making money in this business:
Digital distribution through platforms like Steam.
Selling products inside a game or advertising inside a game.
Downloadable content that extends a game’s lifetime.
Monthly subscriptions that create consistent revenue.
These methods have emerged from years of evolution in the industry, but business strategy is not the only change. The games themselves are becoming more accessible, more online, and more expandable.
They are also becoming more competitive.
Andrew Wagner
Chief Investment Officer
Wagner Road Capital Management
[1] This story is featured in the book The Ultimate History of Video Games. Background information for many of the companies in this section was also sourced from that book.
[2] Activision Blizzard was originally part of this list but has since been acquired by Microsoft.
[3] Steve Jobs, founder of Apple, is Atari’s most famous former employee, but the Activision founders are also former Atari programmers.
[4] FarmVille, CityVille, Words With Friends, and Mafia Wars.
[5] Candy Crush has had remarkable longevity and profitability for a mobile game. Even in the first half of 2023, more than a decade after it was first developed, Candy Crush and its variants add up to be the top mobile game for the year.
[6] A game franchise is a series of games that share the same world and history. It works the same way movie franchises work—for example, the Star Wars franchise is a set of movies that take place in the same universe.
[7] Masters of Doom by David Kushner is a great book about the history of the company.
[8] EA first tested the idea of DLC in 1998.
[9] Take-Two Interactive also uses the same development strategy for its Grand Theft Auto and Red Dead Redemption franchises. These two games are typically not classified as RPG games because they are missing many essential RPG elements, but they follow the same plan of having one major release every few years, rather than introducing a new title each year.
[10] Diablo III, released in 2012, was even more successful. Diablo IV was released in 2023.
[11] Some MMORPGs use the freemium model described earlier.
[12] Microsoft has also been active buying developers to build its game library.
[13] There is an entire Wikipedia page devoted to cataloguing EA’s numerous acquisitions.
[14] EA eventually brought back the Westwood team to remaster the original Command & Conquer game, which was released in 2020. Updating old games for modern systems is an increasingly popular strategy.
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