Next Level Means Hard Work for Game Makers

The toughest part of most video games comes just as one level ends and another is about to begin.

For the companies that design devilish quirks like that, the real-world analog is the unpredictable transition between one generation of game machine and the next.

As the game industry gathers this week for the annual Electronics Entertainment Expo, known as E3, it faces just such a switch: Sony Corp., Microsoft Corp. and Nintendo Co. are vying for attention for their high-tech new consoles.

Despite the glitz and optimistic chatter at the Los Angeles Convention Center, 2006 will be a tough year for the $25-billion global games industry. Hardware makers like Sony and Microsoft are expected to lose tens of millions of dollars before they start turning a profit. Major game makers Electronic Arts Inc. and Activision Inc. last week forecast a lackluster year as they invest heavily in new games.

Michael Goodman, a game industry analyst with Yankee Group, said costs of developing for next-generation systems balloon by 50% -- sometimes to as much as $25 million a game. Software programmers have to develop the tools to harness the power of these complex machines and game designers must figure out how to use more advanced artificial intelligence, real-world physics and high-definition images to create a compelling game.

“The flip side of all this extra storage space and all this extra processing capability is somebody’s got to program all this stuff,” Goodman said. “When you’ve got a disc that’s so much larger, somebody’s got to fill all that space up. That’s time and money. You think about all the enhanced capability, but somebody’s got to do all that development. It’s taking longer to make games and bigger teams.”

And, at least for the first year or so, there are fewer people to play them. Most people wait to buy a new $400 game machine until one console gains traction.

About 16 million people will own a Microsoft Xbox 360, a Sony PlayStation 3 or a Nintendo Wii by year’s end, according to analyst estimates. New hardware is almost always in limited supply -- shrinking the potential market for the new generation of high-end games.

Complicating this year’s transition is that consumers have more choices than ever -- including mobile phones and hand-held game players.

“This transition is far more complex, far more challenging, and there are many more moving parts than any previous transition period,” said Larry Probst, chief executive of Electronic Arts, the world’s largest game publisher. “Go back to PlayStation 1 and PlayStation 2; basically what we had to do is get ready for a couple of new platforms. When we look at the list of things we have to add, the next-generation platforms are on that list. The mobile platform is on that list. Hand-helds are a more important part of the business than they were.”

These high-stakes market dynamics cause some independent developers to wait out the console transition, focusing instead on the 70 million people in North America who own older systems.

THQ Inc., the Agoura Hills game publisher known for its mainstream titles, such as the forthcoming “SpongeBob SquarePants: Creature From the Krusty Krab,” will let its rivals duke it out for market share.

“Launch is interesting. But it’s really just the dawn. It’s a lot more fun after the sun rises fully,” said Brian Farrell, THQ’s CEO. “You devote a tremendous amount of resources to have five, seven or three games at launch for the smallest part of the installed base. It doesn’t make a lot of sense.”

Other developers -- whose games appeal to the young men willing to sleep in lawn chairs to be among the first to buy a game system -- place heavy early bets on the latest gaming hardware, in hopes of dominating the console for the next five years.

“On the one hand, we have a lot at stake when we make games for the new generation, because the cost of development is higher,” said Laurent Detoc, executive director of Ubisoft Entertainment North America. “However, it’s a good opportunity to establish new brands, to give visibility to products that would otherwise be neglected because there were too many existing powerhouses.”

Game consoles account for the majority of the video game industry’s revenue, although a new consumer survey from Cowen & Co. found some ominous trends that could damp demand for next-generation hardware.

Hard-core gamers -- those who spend 10 or more hours a week playing games -- are spending less time clutching their controllers and more time playing online games or pursuing other forms of entertainment, such as joining social networks like MySpace or blogging. Even kids 12 to 17 are migrating from the console to hand-held game systems such as the Sony PlayStation Portable or the Nintendo DS.

Independent game publishers know change is coming -- which only adds to the complexity when deciding how to allocate finite resources of software programmers, artists and storytellers.

Redwood City, Calif.-based EA invested $680 million to acquire Jamdat Mobile Inc., a wireless game and ring-tone producer. But CEO Probst expects console games -- which represented 66% of the company’s revenue in 2005 -- to continue to account for “the lion’s share” of sales for the foreseeable future.

That’s why EA and other top independent game publishers, including Santa Monica-based Activision, will devote resources to exploit the unique features of each new console. None of this specialization comes cheap.

“You’re talking about potentially huge research and development costs,” said Doug Lowenstein, president of the Entertainment Software Assn., the trade group that runs E3. “And obviously, that places more of a premium on selling lots of units. So there’s a lot more pressure to produce a critically acclaimed and successful product.”

The game publishers will do what they can to limit costs -- Activision, for example, organized a central technology team of about 200 people to create tools that can be used across its development studios.

Robert Kotick, Activision’s CEO, is pushing hard to achieve early success on the new consoles, as the company did with the top-selling “Call of Duty 2” game for Xbox 360. The World War II game reminiscent of the movie “Saving Private Ryan” allowed Activision to gain market share.

“The best place for us to either gain share or manage through the transition, financially, would be to focus on a higher batting average on the new platforms,” Kotick said. “In the past, we never had double-digit share on new platforms.”