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Analysis: What Happens When Activision's 'Oil Well' Dries Up?

Analysis: What Happens When Activision's 'Oil Well' Dries Up? Exclusive

August 25, 2011 | By Nicholas Lovell




[Games Brief's Nicholas Lovell compares Electronic Arts' "oil exploration" business with Activision's "oil exploitation" business, stating, "If the well runs dry, EA has options. Activision doesn't."]

In Activision's second-quarter results reported earlier this month, journalists were unanimous: the big story was that 37 percent of Activision's revenue -- $423 million -- is now coming from digital sales.

The digital business has not been a major part of Activision's strategy. It has been content to allow Electronic Arts to snap up businesses such as Playfish, Chillingo and PopCap. It has increased its reliance on its two major franchises , Call of Duty and World of Warcraft, not least by mothballing the Guitar Hero franchise. It has said publicly that it believes the future of games is in a very small number of AAA games.

Does this strategy add up to a successful long-term future for Activision, or are they evidence of a deeper malaise?

The Future Of The Games Industry

I broadly agree with Activision's view of the games industry. It is in three parts: big AAA games, persistent worlds, and successful indie games that can emerge from nowhere in this new era of digital distribution.

I also agree with the importance of digital distribution. I suspect that Activision's massive focus on this segment has been partly driven by the investor relations team telling management that they need to have a clear and successful digital strategy to maintain a premium rating on their shares. The fact that digital products have a better margin will have been a major factor too.

I can't help but feel, though, that the great news from Activision's digital activities is masking a deeper and more worrying trend.

What If Activision Were An Oil Company?

Bear with me a moment as I offer up an analogy: the games-as-oil metaphor.

How do you make money from oil? If you've got a well, it's pretty easy. There are clear costs associated with pumping the oil, refining it and distributing, but those are known, manageable costs. Provided you don't cut corners too much and have a horrific, preventable accident, your business will make lots and lots of money until the well runs dry. You are an oil exploitation business.

If, on the other hand, you don't have a well, or fear your existing well will run dry one day, you have to explore. Oil exploration is tricky. You never know what you're going to find, or indeed if you are going to find anything at all. You have to invest in new technologies, new experts, new regions as you wrestle to get oil out of deep undersea wells, from environmentally-damaging tar sands or from unstable regions. You are an oil exploration business.

Of course, most companies do both. The high margins of oil exploitation are offset, at least partially, by the enormous costs and uncertainty of oil exploration. If you really want to maximize your margins, though, you should stop drilling: you will have high margins and short-term investors will love you.

Until your wells run dry.

Applying The Oil Metaphor To Games

I'm sure you can see where I am going with this. Activision is in the exploitation business. It has two massive franchises that it continues to milk, publishing massively successful sequels, adding new DLC and creating a new subscription model.

World of Warcraft is the gift that keeps on giving. Activision is also looking to Blizzard to find new successes with the Diablo and StarCraft franchises.

Meanwhile Electronic Arts, previously the arch-exploiter, is in full-on exploration mode. New intellectual properties, new business models, new platforms -- nothing seems off the radar of the Redwood Shores executives.

Which Is The Better Strategy?

Activision isn't exploring. It's running down its old IP. Historically, that was OK. It could just buy a new up-and-coming AAA development studio with the first game of a new console IP under its belt. Only there are now fewer of them, as startups focus on platforms and business models that are less risky and more profitable.

Electronic Arts, meanwhile, is struggling to maintain its AAA publishing strength while also investing heavily in new platforms. The two skills are very different, and very challenging.

Electronic Arts is investing for the long term. Activision is making hay while the sun shines. If the well runs dry, EA has options. Activision doesn't.

I hope that Activision has a plan for finding new wells. If it doesn't, the slightest wobble in its key franchises will see investors deserting the company in droves.

I wouldn't want to be in charge of Activision if that happens.

[Nicholas Lovell makes a living helping people make money from games. He is the author of How to Publish a Game and blogs at www.gamesbrief.com.]


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