Mike Reynolds: Hi, I'm Mike Reynolds, a senior reporter covering the media industry with the S&P Global Market Intelligence tech, media and telecom news team. Welcome to "MediaTalk," a podcast hosted by S&P Global, where the news and research staff explore issues in the evolving media landscape. Today, I'm joined by S&P Global Market Intelligence Kagan research analyst Neil Barbour, who specializes in gaming and the metaverse. How are we doing today, Neil?
Neil Barbour: Hey Mike, I'm well. Thanks for having me on.
Reynolds: Appreciate you being here. Neil's going to share his thoughts on the gaming industry's performance in '23 while providing an early read on what we might expect in '24 and beyond. He's also going to assess where some of the key players stand. Let's get to it. I think it was a tough fourth quarter for Sony and Microsoft and their console businesses. Was that the case across the gaming industry, Neil?
Barbour: Yeah, so if you look at the console gaming segment from a top-line revenue perspective, bundling the software and hardware together, this still looks like a very healthy business. Sony and Microsoft and a lot of other players have exited a difficult period. Where hardware supply was constrained and some development projects were delayed by the pandemic, most of that's behind them and they've returned to growth. What's a little unsettling is that the newest consoles, the PS5 and the Xbox Series X, appear to have exited their growth phases a little more quickly than anticipated. This should have been a year where the PS5 solidly outpaced the PS4, but if you compare the first 13 quarters of sales for both, the PS5 is nearly 3 million units behind its predecessor. So that means as we move forward into the middle part of the console life, publishers are going to have a smaller addressable audience to sell into than they were hoping for.
Reynolds: So the customers and gamers just didn't take to the new offerings from the companies?
Barbour: That's an interesting question. It does appear that while Sony and Microsoft received positive reviews for the marquee software titles in the holiday quarter — and I'm thinking of Spiderman 2 for Sony and Starfield for Microsoft — they just weren't able to turn that into a ton of hardware sales. It's possible that the software on offer was of high quality but didn't resonate with consumers as truly next-gen, something that would compel them to spend $500 on a piece of hardware. What's interesting is that we've seen sales and inventory clearing over the past few months, but it may be time for console vendors to consider a more substantive reevaluation of the value proposition. There's been a sharp inflationary period since the consoles have come out, so the components are more expensive to make than they would normally be in a console's life cycle. So just wholesale reducing prices, that's a more difficult lever to pull than it may have been in the past.
Reynolds: Gotcha. Neil, Kagan research found that sales and revenue slowed in '23, but the companies were able to grow their margins.
Barbour: Yeah, that's right. The simple answer here is that they managed to cut costs more quickly than revenue declined. Publishers saw the surge in demand at the beginning of the pandemic, and they invested in new projects to keep that rally going. Unfortunately, the rally didn't keep going, so now they have to pull those costs back. They were successful in doing so in 2023, and it looks like some of that's going to persist into 2024 as well.
Reynolds: And some of that unfortunately comes with a human cost in the way of layoffs.
Barbour: That's right. You're seeing some of the biggest publishers — Microsoft, Sony, Electronic Arts Inc. — they've reported that they're closing studios, they're letting people go, and again that's following a significant expansionary period over the past two to three years.
Reynolds: But doesn't that put their longer-term growth at risk? Don't they need the human touch to come up with fresh ideas and games, or is artificial intelligence stepping into that mix?
Barbour: Yeah, these companies have the resources and the wherewithal to pull AI over to their development pipeline, and there's a good chance that some of that's already in place. But I'm not sure we can chalk this round of layoffs up to AI. Gaming companies found themselves in a position where they had overspent and they need to pull back. They're going to continue to focus on their proven franchises, their core intellectual properties, probably at the expense of more speculative bets. And they're just going to hope whatever they have left resonates with consumers and can maintain healthy margins.
Reynolds: So I guess we'll see some marketing in that direction.
Barbour: Yeah, particularly looking at companies or the consolidation that has occurred over the past few years. Microsoft buying Activision Blizzard in particular, they're going to put Call of Duty front and center for as long and as prominently as they can.
Reynolds: Neil, can you take us through some of the companies you spotlighted in your research, maybe starting with Nintendo Co. Ltd.?
Barbour: Yeah, Nintendo is an interesting case because they're reaching the end-of-life scenario for the Switch, which is their main console. So low-margin hardware sales are exiting their overall sales mix and higher-margin software is playing a bigger role. So they were able to carve out more margin in 2023. The bad news is that Nintendo is nearing the end of this dynamic as the Switch rolls off. They'll need to replace it with a successor console, at which point manufacturing, marketing costs will start to grow and Nintendo will have to hope that consumers are willing and ready to buy up to a new Switch.
Reynolds: EA saw revenue grow but margins decline, and soccer didn't exactly supply an assist there.
Barbour: Yeah. Believe it or not, EA can probably declare a small victory in 2023. The revenue trend suggests it was able to move its soccer simulation player base over to the new EAFC branding. But to get there, they had to spend a little more on marketing and development. You may remember that FIFA and EA parted ways last year. EA went ahead making the game they usually make, but with club and player licenses, and they had to eschew the international play. They were able to get away with that maybe in a way they wouldn't have if the tournament was in play, and then next year they can carry forward. Now that they've acclimated their player base to this new branding, it may not take as much marketing spend next year to keep that game going.
Reynolds: Whereas Take-Two Interactive Software Inc. work continues ahead of what's expected to be a big launch in '25.
Barbour: Yeah, Take-Two is a prime example of a company that cut costs to find healthier margins. And this is particularly relevant because they did so after acquiring Zynga, which was not a particularly high-margin business when it was purchased. So they were able to combine the business and bring margins up a year afterward. The issue is that they have Grand Theft Auto Five coming out sometime in 2025 or 2026, and GTA is notorious for being a very expensive franchise to develop. So as they enter what is known in the industry as crunch, which is the final year where they're throwing all the resources and time they can at making sure they hit an advantageous ship date, we would expect it to be difficult for them to find significant cost savings.
Reynolds: It was a mixed bag for Playtika Holding Corp. in 2023?
Barbour: Yeah, this is one of the first mobile developers to really publicly articulate that the growth was getting harder to come by, and it was more expensive. And then at the current climate and in the near term, maybe the juice wasn't worth the squeeze. So they really pulled back on marketing and new development projects. And so they were able to put that cost-cutting plan in place and saw the benefits in 2023.
Reynolds: Roblox Corp. continues to trend in the wrong EBITDA margin direction. Is that right?
Barbour: That's right. Yeah. Roblox is the big outlier here. So Roblox is pushing into the metaverse. So they're developing a metaverse hub experience, and that's where you have one character and set of characteristics that can travel across multiple game modes. And there's an emphasis on giving creators and users tools to shape those modes and experiences. And so, standing that up on a broad scale has proven to be a pretty costly endeavor. They're also working with new advertising opportunities in gaming that we haven't really seen before, so maybe that's adding costs that other developers don't have to deal with, but bottom line is that they're losing money. There's indications that spending will slow and revenue gains will fall more clearly to the bottom line, but they have a pretty deep hole to dig out of.
Reynolds: Okay. We're getting to the end here. Let's talk about Walt Disney Co., which seemingly is in business everywhere. But I thought Disney was backing out of the metaverse. Now it's back in seemingly with the $1.5 billion investment into Fortnite publisher Epic Games Inc. Neil, can you please give us a bit of a tutorial about what Fortnite does?
Barbour: Yeah. So Epic is now playing in the same space that Roblox is. So they have a competing metaverse hub with Fortnite. Fortnite used to be largely centered around its core Battle Royale shooter mode. That game was free to play and users were given the opportunity to buy cosmetic items to change their appearance. The game is still free to play and now what's happened over the past year is that they're adding different modes. Some are user-created, some are created by small developers. And then there's this other one that was created by Epic in tandem with Lego called Lego Fortnite. That was the result of an investment made by the KIRKBI A/S. That mode merges the iconography of Lego with the business model mechanics of Fortnite, and that's the kind of collaboration that Disney is looking for.
Reynolds: Your sense for what they're looking to get here? Are we talking about immersive elements? Could there be commerce components?
Barbour: What Disney is looking for is about meeting kids where they are, which is video games. And Disney has tried to make their own games in the past, and it's been a mixed bag. If you think about the investment into making a new triple A video game, that can be $200 million to $400 million.
Reynolds: Really?
Barbour: Yeah. And some of the bigger cases, this investment is even larger than that, but what they're investing in is a long-term project with proven developers serving us a built-in audience. I think selling physical goods in digital space is definitely in play here. Key metaverse stakeholders have long promoted the metaverse as a new vector for e-commerce. That hasn't really taken root, but this is the kind of tie up that could make it happen.
Reynolds: So what are we thinking here? Star Wars, Marvel, Mickey and friends?
Barbour: Yeah. So if you look at the KIRKBI investment between the investment announcement and the go-to market, it was about 18 months. So I would expect some of that to show up in 2025, but it's worth noting that Fortnite has already had some crossover with Star Wars and Marvel. They've signed smaller deals in the past so that you could play as various Star Wars and Marvel characters inside of Fortnite. So, they could conceivably build on those smaller investments and assets that already exist in Fortnite and stand up smaller experiences. And the short-term and then build up to a larger footprint over the long term.
Reynolds: Interesting. You've noted in your research that the pandemic was an accelerant for gaming, and we were all stuck indoors. Did COVID-19 artificially inflate industry performance, and can gaming generate a new significant rise in the years to come?
Barbour: Yeah, I think the revenue pressures are directly linked to a drift back to pre-COVID engagement levels. And the amount of time and discretionary spending that was made available to gaming may have been a once-in-a-generation event. So I would expect the top line to continue to gravitate back toward 2019 before it finds substantive growth, but that said, gaming is a hit-driven business. If someone comes up with a new game or new model or new device that captures consumers' imagination, things could turn around quickly.
Reynolds: Yep. That concludes this episode of "MediaTalk." I just wanted to thank Neil for spending a lot of time sharing his views on the industry and how things may shake out in the years ahead. Appreciate you spending time with us, Neil.
Barbour: Great. Thank you, Mike.
Reynolds: This is Mike Reynolds. Thanks to all of you for listening. We'll catch up soon on the next edition of "MediaTalk."
