Emerging Trends in Games-as-a-Service Atul Bagga Senior Research Analyst, Lazard Capital Markets Agenda • Games-as-a-Service – Lines blurring between platforms; Tablets, Set-top boxes – Innovation by startups • Virtual Goods – Perfect Price Discrimination – Enhance Community/Curb Piracy – Higher quality of earning (a) Predictability, (b) Lifetime Value • Social Games – Vertical Games – Monetization (a) Conversion, (b) Advertising – Platforms dedicated for games • Mobile Games – Rise of persistent games – Mobile an extension of other platforms – Dominated by a few? Agenda • Games-as-a-Service – Lines blurring between platforms; Tablets, Set-top boxes – Innovation by startups • Virtual Goods – Perfect Price Discrimination – Enhance Community/Curb Piracy – Higher quality of earning (a) Predictability, (b) Lifetime Value • Social Games – Vertical Games – Monetization (a) Conversion, (b) Advertising – Platforms dedicated for games • Mobile Games – Rise of persistent games – Mobile an extension of other platforms – Dominated by a few? Top Companies By Revenue CAGR (2008-2010) 4 Top Companies By Revenue CAGR (2008-2010) 80% Gree Inc. 70% DeNA Co. Ltd. Zoo Entertainment Inc. 60% Gamevil Inc. Perfect World Co. Ltd. 50% mixi Inc. 40% NHN Corp. NetDragon Websoft Inc. 30% Tencent Holdings Ltd. 20% Neowiz Games Corp. Revenue CAGR (2008-2010) CAGR Revenue NCsoft Corp. 10% Netease.com Inc. ADS Changyou.com Ltd. 0% Kingsoft Corp. Ltd. 0% 20% 40% 60% Gameloft S.A. EBIT Margin Source: FactSet 5 Enterprise Value/Sales Multiple U.S. Video Game Companies Shares 7 ATVI 6 ERTS TTWO 5 THQI 4 3 2 1 0 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Source: FactSet 6 Emergence of Multi-Channel Games-as-a-Service Mobile Game Social Game Multi-Channel Games-as-a-Service PC Game Console Game Upfront Virtual Subscri Ads & Purchase LCM Research Goods ption Others Source: LCM Research 7 Emergence of Games-as-a-Service 2010E 2015E Games-as-a- Product Games-as-a- Service Source: LCM Research Video Game Market Size Estimate ($ Million) 70,000 60,000 50,000 Social 40,000 Online 30,000 Mobile Console 20,000 10,000 - 2009E 2010E 2011E 2012E 2013E 2014E 2015E Source: LCM Research 9 Video Game Market Size Estimate ($ Million) 60000 50000 Rest of World 40000 U.S. South Korea 30000 Japan 20000 Europe China 10000 0 2010E 2011E 2012E 2013E 2014E 2015E Source: LCM Research 10 Agenda • Games-as-a-Service – Lines blurring between platforms; Tablets, Set-top boxes – Innovation by startups • Virtual Goods – Perfect Price Discrimination – Enhance Community/Curb Piracy – Higher quality of earning (a) Predictability, (b) Lifetime Value • Social Games – Vertical Games – Monetization (a) Conversion, (b) Advertising – Platforms dedicated for games • Mobile Games – Rise of persistent games – Mobile an extension of other platforms – Dominated by a few? Price Discrimination Sources: Unless otherwise noted, images on this and the following slides are courtesy of the respective companies’ Websites. 12 Price Discrimination Source: Caroline Scott; http://www.explorecrete.com/gallery/album19/donkey http://www.smokymountainparkarabians.com/ 13 Price Discrimination 14 Traditional Models Represented Lost Economic Value . Traditional gaming models didn’t Some Customers Willing capitalize on the full spectrum of to Pay Higher Prices consumer demand Consumer Surplus = . Game satisfaction and status were Lost Revenue gained by beating levels with skill, not by personalization and Supply purchased status symbols All Customers Pay One Price . Consumers who were willing to spend more on games weren’t able to, outside of peripherals and $50 merchandise . Consumer surplus represented lost Price $ economic value for publishers Demand Quantity Source: LCM Research 15 Limited Editions and Map Packs Captured More Revenue . “Limited” and “Collectors” Edition games Halo 3: Map Pack made headway in price discrimination, Priced at $15 capturing additional revenue Hardcore gamers could spend . While this price discrimination resulted in incrementally more, if desired higher revenue, there were still relatively few Yet Still, Lost options available for hardcore gamers Revenue Supply . Further, these options came at a higher cost Halo 3: “Limited Edition” for publishers: Price(1) . Halo 3 “Legendary Edition” box included a $90 large, physical plastic helmet $75 . Map pack content has high production cost $60 . Yet the virtual model was proven: Map packs Halo 3: were only available digitally on XBOX Live, but Standard 25% of players purchased them(2) Pricing(1) $ Price . Map packs had PR hype equal to that of the Demand original Halo 3 release Quantity (1) Pricing is approximate. (2) Source: Microsoft. 16 Virtual Goods Enable Perfect Price Discrimination . While virtual map packs and Limited Edition physical media enable partial With the true cost of virtual price discrimination, virtual goods goods close to zero, there is enable perfect price discrimination effectively no “supply” curve – goods are readily supplied at all for social games and MMOs price points . Some “hardcore casual” gamers willing to spend $10k+/month on Supply virtual goods . There is no “price” for the game . In complex virtual economies, virtual goods (e.g. a $100k space station in Entropia Universe) can generate significant revenue for their owners, representing more of an asset than Price an expense $ . Justifies high end purchases Demand Quantity 17 Source: http://www.dealbreaker.com/images/entries/Pistol%20Pirate%20Bust.jpg http://socialjusticenow.files.wordpress.com/2009/01/world-connect-people-community-international.jpg 18 Build Community 80 70 60 50 40 30 20 10 0 World of Cityville The Sims Angry Birds Warcraft Social Source: Company Reports, AppData, LCM Research 19 EveryoneEveryone pays pays PAY ARPU Monetization line Big spenders $100+ 1 X Paying Users $15 10 X Ads $1 Sponsors Free Users 20 Source: Acclaim Longevity & Stickiness: Average Chinese Gamer ARPPU (RMB/Qtr) 80 70 60 50 40 30 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 Source: IDC, LCM Research 21 Game Spend As Percentage Of Per- Capita Income Games Spend as % of Per-Capita Income Games Spend as % of Per-Capita Income - ex-Food 0.35% 0.50% U.S. 0.30% 0.45% China 0.40% 0.25% South Korea 0.35% 0.20% 0.30% 0.25% 0.15% 0.20% 0.15% 0.10% 0.10% 0.05% 0.05% 0.00% 0.00% 2003 2004 2005 2006 2007 2008 2009 2010 2003 2004 2005 2006 2007 2008 2009 2010 Source: LCM Research 22 Players Willing To Spend More… Games As % of Per Capita Income 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% U.S. South Korea China Source: National Bureau of Statistics of China, Korea Game Development Institute, EuroMonitor International 23 …And The Vendors Are More Profitable 120% Operating Margin ROE 100% 80% 60% 40% 20% 0% -20% -40% SNDA GA PWRD NTES CYOU ERTS ATVI THQI TTWO Source: Company Reports 24 Legend of Mir 2 • 2D MMORPG, Martial Arts, Adventure • Developed by Wemade, operated by Shanda • Launched in China in 2001 under subscription based model • Converted to free-to-play model in 2005 • PCU ~400-500K 25 Mir 2 Revenue’s Growth After Model Change 450 400 350 300 250 200 Revenue ($ Million) Revenue 150 100 50 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year Source: Company Reports 26 …And ARPPU Growth After Initial Kneejerk 400 350 300 250 200 150 ARPU RMB/Quarter ARPU 100 50 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Estimated ARPPU Source: Company Reports, LCM Research 27 ZT Online • 2D MMORPG, Martial Arts, Adventure • Developed and Published by Giant Online • Launched in 2007 • Free-to-play, pay for virtual goods model • PCU: 1 million+ 28 70%+ Higher ARPPU Compared to WOW 180 160 140 120 100 80 60 ARPU ($/Year) ARPU 40 20 0 World of Warcraft ZT Online Source: Company Reports, LCM Research 29 Top Players Pay 20x of WOW ARPU $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Top 5% Players 15% Players 80% Players WOW Source: Company Reports, LCM Research 30 ARPPU Distribution Curve of ZT Online 160 140 120 100 80 60 ARPu ($/Month) ARPu 40 20 - - 500 1,000 1,500 2,000 (20) Users ('000) Source: Company Reports 31 Examples of Monetization • Game Design (System for marriage, breeding, parenting, balance between males/females) • Special In-game Events (Valentine’s day, New Year’s day, Sports) • In-game Promotions • Treasure Chest – Special Bonus for Opening Most Chests • Chat & Response 32 Virtual Goods: Global Market Size Estimate ($ Million) 25,000 20,000 15,000 Mobile Social Network 10,000 Online (off-Social Networks) 5,000 - 2010E 2011E 2012E 2013E 2014E 2015E Source: LCM Research 33 Virtual Goods: Global Market Size Estimate ($ Million) 25,000 20,000 Rest of World U.S. 15,000 South Korea Japan 10,000 Europe China 5,000 - 2010E 2011E 2012E 2013E 2014E 2015E Source: LCM Research 34 Agenda • Games-as-a-Service – Lines blurring between platforms; Tablets, Set-top boxes – Innovation by startups • Virtual Goods – Perfect Price Discrimination – Enhance Community/Curb Piracy – Higher quality of earning (a) Predictability, (b) Lifetime Value • Social Games – Vertical Games – Monetization (a) Conversion, (b) Advertising – Platforms dedicated for games • Mobile Games – Rise of persistent games – Mobile an extension of other platforms – Dominated by a few? Mid-session vs. Persistent Games 100% 90% 80% 70% 60% Persistent 50% Mid-session 40% 30% 20% 10% 0% AppStore Facebook - Facebook- Now May, 09 Source: AppData, LCM Research 36 Console Games: U.S. Market Size 12,000 40% 35% 10,000 30% 25% 8,000 20% 15% 6,000 10% $ million $ 5% 4,000 Growth Y/Y 0% 2,000 -5% -10% 0 -15%