Video games are not child’s play, having grown by a third in just five years, the industry is now valued at $80 billion (£59 billion) as of the end of 2017.
The numbers are staggering, with the best-selling game last year, Call of Duty: WWII, selling 800,000 copies despite only being released in November.
The size of the eye-watering profits that can be made has not gone unnoticed by investors, but for every blockbuster release there will undoubtedly be numerous duds. So how do you go about picking the winners?
Lindsell says the ideal scenario is to find companies that are able to build a successful franchise. ‘For some the barriers to entry are low – the technology needed to create a video game is widely available – but to build a franchise that can form the foundation of many successful games over many years is much more difficult and few have succeeded,’ he said.
While the technology is more accessible, the cost of producing blockbuster games has increased, with the biggest franchises employing Hollywood stars to voice over characters. Sports titles too have seen the cost of licensing and image rights continue to spiral.
Francesco Conte, Citywire A-rated manager of the JP Morgan European Smaller Companies Investment Trust, says faster processing and greater broadband capacity have also enabled games to become ever more sophisticated, adding in greater expense.
‘Today an “AAA” game costs at least $200 million to make and market. Since most companies can’t afford the cost of developing such expensive games, the market has been consolidating,’ he said. ‘The profitability of those companies that have survived is growing very rapidly as playing games online strengthens their franchises by giving the developers much better understanding of their customer base and therefore greater ability to sell additional content and updates.
‘Video game franchises have become more than games; they are almost communities. Looking to the future, technological developments will continue and in the future we can expect 3D and virtual reality amongst others to make video games an even more exciting form of entertainment.’
One company that has been able to thrive is French firm Ubisoft, the third largest developer in the world and the biggest in Europe. The company, which owns the popular Assassin’s Creed franchise, saw its share price more than double in 2017.
It is not just size that differentiates these companies; it is also their performance, as it is difficult to achieve success in both software and hardware. Lindsell has been a long-term holder of Nintendo, saying that none of its rivals have been able to emulate its success in both hardware and software. Most of Nintendo’s rivals are software developers, with only two competing in developing hardware platforms – Microsoft and Sony, he notes.
‘Both produce some dedicated software, but most games played on their platforms are developed by third parties,’ Lindsell said. ‘Although these businesses have built up communities loyal to the hardware, they are narrower than Nintendo’s and, reflecting the lower margins earned from selling hardware as opposed to software, neither company has been able to earn an adequate return on the investment committed.
As the cost of game production has increased, so has demand for the outsourcing of elements in its own right. Charlotte Meyrick, a UK equities fund manager at Aviva Investors, highlights Keywords Studios, the largest global player in outsourced technical services to the global video and mobile games industry.
‘They help game developers – the Nintendos, Ubisofts, and Electronic Arts of this world – tailor game content for different geographic markets or platforms by localising in-game text, audio, functional testing for game defects and the creation of graphical art assets for inclusion in games,’ she said.
‘While some might argue that the business services industry assisting game development is now well-penetrated (with approximately 50% outsourced), this is low compared to other content-driven industries like film and book publishing, where approximately 90% of the development process is outsourced.
‘I think the drivers for outsourcing remain compelling given there is no intellectual property nor competitive differentiation for game developers in the technical and support elements of a game, with the IP in the design and marketing segments of the game lifecycle.’
The market is also undergoing changes to how people access video games, with mobile gaming increasingly important.
‘The age range of video game players has increased dramatically from an average of 27 up to 35 as older gamer begin to play, meaning that you spend more years playing video games,’ said Rosanna Burcheri, manager of Artemis’ Global Select fund. ‘The amount of time spent playing video games has also increased dramatically as people carry their devices with them; on average gamers play six hours a day on mobile devices.’
This change has been difficult for traditional game developers, Lindsell said: ‘Nintendo struggled with the advent of the smartphone; the ability to play games on such devices diminished the importance of dedicated game platforms for Nintendo’s exclusive intellectual property.’