Report: Games will see strong growth over next three years

Game publishers should be able to grow revenues 9 percent a year in the U.S. and Europe as they embrace digital content and find ways to extend the consumption of games for the current generation of game consoles, a new report says.
The market for console game software is expected to grow at a compound annual growth rate of 9 percent from 2009 to 2011, while hardware revenues will decline 25 percent a year due to falling prices, according to Michael Pachter and Edward Woo, the analysts who created the report for Wedbush Morgan Securities. All other entertainment is expected to grow zero to 2 percent in the same time frame, the report says. That’s a bullish report, given that game industry growth has turned negative in the past few months as the recession slows down demand.
The 210-page report details the size of the game industry as well as major trends within it and how they affect startups trying to find opportunities in the digital content portion of the game industry. As such, it provides some good insight into several game-industry issues I discussed in one of our most popular posts about the game business.
Games are the fastest growing entertainment market with a bright digital content future. In 2008, worldwide hardware and software sales were $44 billion, while US hardware and software sales were $19.5 billion. That compares to the combined US movie box office and DVD movie market of $22 billion and entertainment-related book sales of $9 billion. Right now, games are about 15 percent of the overall $75 billion in entertainment spending in the US. That percentage is expected to grow, since games are the fastest-growing entertainment sector. A reason for the growth is that gamers continue to play games even as they get older; the average age of gamers is now 35, compared to under 20 in the 1980s. There are also many more female gamers, who now account for 35 percent of the console market. In a separate report today, market researcher NPD said that females are a growing part of the console audience.
Beyond 2011, revenues from non-traditional sources — online games, casual games, mobile phone games, downloadable content, and in-game advertising — are expected to contribute meaningfully, offsetting slowing growth of packaged goods software sales, the report says. Over 10 years, digital content is expected to account for almost all of the game industry’s growth.
Nintendo holds the enviable position in the console and portable business. In past game console cycles, sales dipped in the transitions. Software sales in the U.S. were down 9 percent in 2000, for instance, and 3 percent in 2005. The current generation of consoles began when Microsoft launched the Xbox 360 in November, 2005. Portables, meanwhile, saw a renaissance that began in 2004 with the launch of the Nintendo DS. The launch of the Wii and the DS Lite in 2006 changed everything in Nintendo’s favor. Since 2005, overall software revenues have grown 60 percent, largely because of Nintendo’s success.
Nintendo’s Wii is expected to be the dominant console, with an expected 49 percent share of the U.S. and European markets at the end of 2009, compared to 29 percent for the Xbox 360 and 23 percent for the PS 3. But by 2011, Sony is expected to pull even with Microsoft in the No. 2 spot. Of the $44 billion worldwide sales in 2008, about 40 percent, or $17.7 billion, was hardware sales.
Hardware sales of consoles are tracking about the same as they were in the last generation of consoles. To date, high sales of the Wii are offsetting slower unit sales of the PS 3 and Xbox 360. The report says there were roughly 78 million current-generation consoles sold worldwide as of year-end 2008, with 16 million PS3s, 23 million Xbox 360s and 39 million Wiis sold. That compares to 78 million legacy consoles sold worldwide at year-end 2003, with 54 million PS2s, 12 million Xboxes and 12 million GameCubes.The report expects consoles per gaming household to stay constant at about 1.4.
Nintendo has essentially turned the tables on Sony. It succeeded in grabbing the mass market, while the Xbox 360 and PlayStation 3 snared the hardcore gamers with high-definition TVs. Nintendo started out with a low-priced console aimed at party gamers with the added twist of the unique Wii motion-sensing controller.
The Wii enabled much earlier and broader participation of the mass market than would otherwise happen in a console cycle.
Wedbush Morgan predicts that the console cycle is likely to last beyond the typical five-year mark, which begins anew in 2010. While Nintendo  may introduce a high-definition version of the Wii, the console makers are not likely to be motivated to introduce new machines in the near future.
Costs are going up, but digital distribution has promise. The cost of making games has gone up. In the last generation, the average console game required 18 to 36 months to finish and cost an average of $4 million. In the current cycle, console games take 24 to 36 months to develop. Average development costs are now $8-10 million. Those costs are starting to subside as developers learn how to make games better.
Online games, casual games and mobile are expected to grow steadily, while downloadable content and in-game advertising will really pick up once the consoles hit a higher penetration of overall households. Activision Blizzard is an exception, since a quarter of its revenue and half of its profits come from the online game World of Warcraft.
Online subscription and game-related downloads are expected to be a $3 billion opportunity as video games on demand services such as OnLive are launched. Wedbush Morgan predicts that OnLive will be a breakthrough success and will be widely adopted. But it will be a long time before such services take a big chunk of the market away from retailers.
Asia, meanwhile, is likely to be the market where massively multiplayer online games such as WoW take off. There are an estimated 10 million MMO players in Asia, generating monthly revenues of $500-700 million. Free-to-play games, supported by the micro-transactions such as the sales of virtual goods, are also a small but fast-growing part of the game market.
Digital downloads will eventually become a big market, but for now they are hampered by small hard drive space on the consoles (20 gigabytes to 80 gigabytes on an Xbox 360).
The iPhone and in-game ad opportunities are over-hyped. Cell phone games are roughly $2 billion overall, largely from downloads on older phones. But cell phone games are not expected to close in on console or portable game sales levels for some time, largely due to the hardware limitations of the devices. Cell phone games are viewed as a path to making casual gamers, particularly women, into more active gamers. But the market in terms of dollars is still small, since the average paid game is about $2, and overall iPhone game revenues in the first year are about $400 million.
In-games ads have been hyped in past years, but Wedbush Morgan believes that it’s a smaller opportunity, ranging from $2 -10 billion a few years from now, depending on the success of measuring user interaction with ads.