Is it time to say game over?
Electronic Arts' dominance of video games makes resistance futile for competitors
REDWOOD CITY, CALIF.--You have to feel some sympathy for the two workers planted in the lobby of the corporate headquarters of video-game maker Electronic Arts. Working there is like doing eight hours of sensory-overload hard time at an upscale arcade. The place is filled with plasma screens and projection TVs, all hooked up to game consoles playing EA's latest offerings such as Battlefield: Vietnam and The Lord of The Rings: The Battle for Middle-Earth, or giving sneak previews of coming releases such as Catwoman, based on the superhero film starring Halle Berry due out in July.
Don't feel too sorry for them, though. Even if the work environment is a bit on the cacophonously kinetic side, at least their job security ought to be pretty solid. Although much of the technology sector is only now recovering from the post-bubble downturn, EA--the dominant player in the $7 billion video-game software industry--is continuing to party, as the cliche would have it, like it's 1999. Except business is actually a whole lot better here than it was in 1999, when the tech sector was peaking.
Back then, the company had annual sales of $1.2 billion. With the industry set to gather next week for its annual E3 game show, EA last week released its fiscal 2004 report, posting sales of $2.96 billion. Earnings have risen from $73 million to $577 million. In 1999, EA had eight platinum, or million-plus-selling, titles. In the past year, it produced 27 of them.
Back then, EA possessed 10 percent of the North American game market. Today, it has captured 22 percent of it. (The next-closest rival is Nintendo, with 11 percent.) EA's stock, meanwhile, has soared from around $20 to over $50 a share, giving the company a market cap of nearly $16 billion. "It's been a terrific story from a number of angles," says Anthony Gikas, an analyst with Piper Jaffray in Minneapolis. "They have good management, best-in-class product, and a leading market share. You could have bought this stock anytime in the past decade and made lots of money."
Oh, and they just scored a big win over Microsoft, a claim not many companies can make. Last month, the planet's largest software developer announced that it was taking at least a year off from its Xbox sports video-game business. At the time, Kevin Browne, manager of Xbox's sports game division, admitted to an industry publication that "we fall short in a couple of areas to our competition." That competition would mainly be EA, which holds an already commanding 60 percent share of the sports game business, led by its FIFA soccer and Madden football franchises.
Bestseller. But EACEO Larry Probst, a get-to-the-point Rumsfeldian character you would never guess spends any time playing games (his current fave is EA's First Night ), claims there was no celebrating Microsoft's misfortune. "We don't celebrate our competition failing but our own products succeeding," Probst says, as he sits and chats in EA's main conference room--puckishly nicknamed the "Bored Room." If so, then there's probably been lots of partying going on. EA's The Sims is the bestselling PC video game of all time, having sold 15 million copies (with Sims 2 scheduled to debut later this year), while the FIFA series is the bestselling game ever, even making the Guinness Book of World Records. The entire series has sold more than 1.2 billion units. And last Christmas, 11 of the 17 titles EA released each went platinum.
Still, it's hardly game-over time for EA, even with the video-game industry entering its cyclical slow period. In fact, tougher times for the industry often mean better times for EA. For most makers of either game hardware or software, sales are highly dependent on where the industry is in the console cycle. (Software for game machines such as Sony's PlayStation, Nintendo's GameCube, and Microsoft's Xbox accounted for 63 percent of EA's sales during the past quarter versus 13 percent for PC software.)
Whenever the new generation of machines is introduced, sales of both hardware and software rise sharply for several years after. Then as the technology ages and the prospect of new machines appears on the horizon, sales growth begins to flatten. In March, software sales fell by 9 percent, according to research firm NPD, after a 10 percent gain in February. For the rest of year, analysts are looking for a sales increase of around 10 percent. Yet EA saw sales rise 29 percent in the quarter and is looking for total sales for 2004 to rise as much as 15 percent. So with sales continuing to be powered by its consistently popular movie, sports, and Sims franchises, EA's market share is likely to increase as the industry awaits the next-generation consoles in late 2005 or early 2006.
"That's our goal," says Probst. "To increase our market share . . . forever . . . in all categories--and to double the size of the company every four or five years." And when those next-gen consoles hit--with their upgraded graphics and greater computer power--the cycle should begin all over again. "These machines will represent a huge leap forward," says Don Mattrick, president of EA Worldwide Studios. "You will have more lifelike characters, with a huge increase in the fidelity of the imagery."
The increased interest in gaming should do wonders for EA's top line. "If EA can get to a 30 percent market share, you're talking about a $9 billion company at that point," says Keith Gay, analyst at San Francisco-based investment bank Thomas Weisel Partners. Including software and hardware sales, the game industry took in $11.2 billion last year. Gay thinks that by the peak of the next cycle, it could be a $30 billion industry--about the same size as the music industry today. (It already takes in more each year than Hollywood does at the box office, but that total does not include DVD sales and TV rights.)
Tuning out. Demographics are the reason for the industry's success. Every year the age group familiar with games--starting with the Atari junkies of the early 1980s--gets one year older. And that leading edge has more disposable income, which is why the average console buyer now purchases 15 titles per machine, three times as many as a decade or so ago. In addition, younger customers are more likely to see gaming as an alternative to TV for their daily entertainment choice. EA executives frequently bring up last October's Nielsen ratings, which showed that TV viewership among men from 18 to 34 fell 12 percent from a year before. And for the youngest segment of adult men, those 18 to 24, viewership fell 20 percent. When talking about competition with TV, EA execs like to use words like "devour" and phrases like "eating their lunch." As Probst puts it, "Even though the TV industry does their best to dispel this notion, everybody knows what's going on."
EA would like to expand on its dominance in the United States with marketing pushes in Europe and Asia. EA has roughly a 30 percent market share in Europe now, but Probst hopes to boost sales there during the next five years to 60 percent of company revenue from 50 percent currently. China is the big lure in the largely unexploited Asian market. "That is going is to be a billion-dollar business for someone someday," Probst says. Of course, the problem there is turning interest in gaming into actual sales. "If you go into Shanghai right now and go into a retail store right now, you'll see we have incredible market share and representation on the retail shelf--except that we get zero revenue from it because it's all pirated," he says. "It looks like EA and plays like EA, but it's not EA."
But EA's strategy isn't just about taking advantage of a growing market. It also wants to reap more revenue per gamer, so it's not just dependent on the $50 games themselves. And that's where online gaming comes in. Probst thinks that through a combination of next-gen consoles with built-in online capabilities and the greater penetration of broadband Internet access, some 15 to 20 percent of EA revenue should come from online gaming during the next console cycle. Of course, online is an area where EA suffered one of its greatest failures. In 2002, the company launched Sims Online, where players could interact with one another through self-created virtual people for $9.99 a month. Expected to attract 200,000 players in its first three months, so far it has lured just 70,000. It's a costly failure the company candidly blames on a boring game that cost too much to play. Probst guesses that future online gaming will follow the cable television model, where you will pay a subscription to access various "channels" of gaming services.
Another possible source of revenue is in-game advertising. Currently, product placement and sponsorship is worth about $10 million to the industry versus $60 billion for television advertising.
Given the expected huge increase in sales from next-gen consoles and the possibility of greater advertising revenues, Smith Barney analyst Jill Krutick speculates that "the diversified entertainment companies could increase their presence in video games." After all, EA has done well by turning popular movie franchises like Harry Potter and LOTR into successful games, so turnabout is fair play. Yet it's not a scenario that particularly concerns Probst. "The major media companies have been in and out of this business repeatedly for 20 years," he says, noting that Atari, for instance, used to be part of Warner Communications, itself now part of Time Warner. "None of them have had any sustained long-term success. They have treated the interactive entertainment business as an afterthought, something to create synergy--whatever that means."
Of course, movie studios do have decades of "intellectual property"--their films--to use as the basis of games. But Probst has his own attack strategy for the movie moguls: It is EA's goal to become a competitor to Hollywood. "Not make movies ourselves, but license out properties for a movie or a television show," says Probst.
And if EA's game competitors didn't have enough to worry about, it looks as if the company may be getting ready to re-enter the M-rated, or mature, category, which accounts for about 12 percent of the market. The company hasn't released a game in that segment since 2000, but at the E3 show, EA watchers expect the company to officially announce it has secured the license to develop games based on the Godfather trilogy. The family-friendly company's absence in the category has been a continual sore spot for many analysts. "Kids like blood, and it's a part of the market EA has been conceding," says analyst Michael Pachter of Wedbush Morgan Securities. Probst stresses that should EA again publish M-rated titles, any sex or violence won't be "gratuitous" or "sleazy."
So let's see here: EA is the major force in a fast-growing industry and--even better--looks to be making a power play in the one sector it doesn't dominate. Perhaps Probst should start holding meetings in one of the company's other conference rooms--the one nicknamed "Resistance is Futile."
This story appears in the May 10, 2004 print edition of U.S. News & World Report.