Perspectives on the Year 2000

Every year DFC Intelligence interviews key executives in the interactive entertainment industry to get their take on market conditions.  In early 2001, we released the results of the most recent interviews in the report “Executive Interview Series: The State of the Game Market 2001.”  The following excerpt from that report summarizes the view of the interviewees on the performance of the interactive entertainment market during the year 2000.  This excerpt concludes with the DFC analysis tha,t although 2000 was very difficult from a profit making standpoint, market conditions are actually very healthy.

From Executive Interview Series: The State of the Game Market 2001 (April 2001)

The consensus among respondents to our survey was that 2000 was a tough year for the game industry.  Even though unit sales were up slightly in 2000, it appears the majority of publishers lost money.   The industry in 2000 was fueled by a narrow range of titles/franchises; such as Pokemon, Tony Hawks, WWF products, Madden Football, Zelda, Final Fantasy, The Sims, Who Wants to be a Millionaire and Rollercoaster Tycoon.  There was also a great deal of activity for older, back catalog product that was priced at a deep discount.  According to LucasArts, the catalog product was quite strong and the company was able to offset some of the revenue reductions by increased sales across its library products.  However, in 2000, there was not a lot of room for introducing new franchises.  Publishers without very strong franchises really felt the squeeze. 

The only company that seemed really happy about 2000 was Activision.  Indeed, driven by Tony Hawks products, Activision had a great year, becoming the number three software publisher behind Nintendo and Electronic Arts.  THQ was also a strong performer that was able to grow both market share and revenues in what CEO Brian Farrell classified “a fairly difficult environment.”

While 2000 may have been a bad year for most publishers, the result was not unexpected.  It seems there is a solid understanding that this is a time of market transition.  Sales were expected to be down in 2000.  This is different from the market attitude in the 1984-1986 and 1994-1996 timeframes when, for many, the future of the entire interactive entertainment business was in doubt.  Going into 2001, no one seems to feel that a stagnant market is a sign that the market has permanently peaked.  

For the past several years, DFC Intelligence had predicted a stagnant market in 2000 and 2001, to be followed by significant growth in 2002.  So far, the results have beared out our predictions.  According to sales data from the NPD Group, overall U.S. interactive entertainment software sales revenue was flat in 2000, even though unit sales were up 5%.  In terms of specific market segments, PC game revenue was flat while unit sales were up 8%.  Video game software revenue was down 4%, but unit sales were up 2%.  The only true star performer of 2000 was the portable (or, in this case, Game Boy) market.  Portable software sales were up 26%.

These numbers were unspectacular, but they were also completely expected.  DFC Intelligence’s predictions for the year 2000, which were made before the fact in 1999, came within 10% for all individual platforms.  Furthermore, in some cases, the market actually exceeded our projections.  PlayStation software revenue actually declined 18% in 2000.  However, DFC had projected a decline of 28%.  In terms of our projections for the new 128-bit game systems we were right on the money.

There was a great deal more disagreement on the outlook for 2001.  Some interviewees think that 2001 will be a very strong year, while other interviewees think that 2001 could be another year of painful transition.  For what it is worth, DFC Intelligence has, for some time, been predicting a difficult year in 2001, followed by robust growth in 2002.  Over the next year, there is a great deal of uncertainty over the new platforms:  when they will be released, the amount of hardware units available etc.  There is also likely to be a significant decline in the 32/64-bit market.  Meanwhile, the new systems will still have a relatively small (although rapidly growing) installed base.  All these factors create an environment where making a profit will be difficult. 

Despite the fact that 2000 was a rough year, and the outlook for 2001 is very uncertain, most publishers were very bullish on the new game systems.  Respondents described the current market as a period of transition between hardware platforms.  Everyone seemed to have no doubts that one or more of the new game systems would take the market by storm over the next few years.  However, it was pointed out by several executives that the new 128-bit systems are not yet as compelling to consumers as their predecessors: “there is no ‘next generation’ game that is driving consumer demand the way the new 3-D environments of early PlayStation and Nintendo 64 games did.  I believe that had their not been a hardware shortage of PlayStation 2, we might be talking today about Sony’s failure to deliver a compelling hardware product and software lineup at launch.”  Another executive echoes similar sentiments saying that in the 32/64-bit transition games like Super Mario 64 were able, for the first time, to demonstrate convincing 3D game play.  However, with the 128-bit game systems,  “there is no remaining leap to 4D, or any other new graphical paradigm.”

Another issue, that only a few respondents touched on, is the general shape of the overall economy.  Even though executives were disappointed with 2000, consumer spending on games remained strong.  This could change if the economy starts to go into a recession.  Games are a highly discretionary purchase, especially buying a new game system to replace a still functioning system.  Macroeconomic trends could have a major effect on the game industry.  

What the Interviewees Said:  Comments on 2000

• Overall 2000 was disappointing for the industry.
• For the industry, 2000 was not such a good year.
• 2000 was bad and 2001 should be bad too.
• In 2000, the market was flat and most publishers lost money.
• I think there are only a handful of companies that were actually making money in this business in 2000.
• The year 2000 was a transition year for the industry as overall software revenues fell.
• 2000 was a good year in terms of unit sales, however it was challenging managing the decline in prices while trying to maintain the same margins publishers had enjoyed for the previous couple of years.
• 2000 was a transition year and as such publishers and retailers were forced to balance the mix of retail products and manage inventory through another transition year.
• Market growth, was not what anybody expected across platforms with the exception of the Game Boy Color.
• Publishers hurt themselves by putting out too many games in 2000 and by reducing prices on both old and new games.
• Consolidation costs, rising development costs to support new technologies, and a decline in software prices placed tremendous financial pressure on companies to meet their financial objectives.
• It was another year of publisher consolidation and platform guesswork.
• While there was growth in all entertainment software segments, in many segments that growth was fueled by a narrow line-up of hits, or sequels to hits, and strong back catalog.
• Everything was going fine until Sony dropped the ball.  Had PlayStation 2 hit promised numbers, it would have been a prosperous year, but now we will barely make our forecast numbers.
• Sony ran out of PlayStation hardware and stopped marketing the brand for seven months.
• The shortfall in PlayStation 2 hardware affected the industry materially, especially over the holiday season.
• Retailers hurt publishers by reducing stocking quantities.
• Overall, the industry remains extremely healthy.  While total revenues fell by 5% last year, Game Boy sales increased by 26% and all observers expect strong growth up to 15% this year. 

DFC Intelligence Analysis:  Are Market Conditions Truly Bad?

• From a consumer demand perspective this still appears to be a very healthy market.  Companies may have trouble making money and there may be too many products, but this is a transition period between platforms.  Consumer spending trends look very positive given that this is a transition period.
• Average unit sales on the PlayStation and Nintendo 64 were down, but it was not a steep drop-off like that which occurred with the 16-bit market.
• The “declining” 32/64-bit systems are doing much better than the 16-bit systems did five years ago.  The average unit sales performance of software in the PlayStation’s fifth year did just as well as all combined 16-bit software during the period from December 1995 to December 1998.
• Dreamcast first year sales compared favorably with PlayStation first year sales.  In its first year, the Dreamcast had 9 titles that sold over 200,000, compared with only 4 titles for the original PlayStation.  Average unit sales of Dreamcast titles were over 400,000 units, compared with average unit sales of first year top ten PlayStation titles of 230,000 units.  Sega simply did not have enough money to compete in the long term.
• The PlayStation 2 is on track to well exceed the first year performance of the original PlayStation.