Games * Design * Art * Culture

Friday, July 06, 2007

Analyzing the Analysts

Mutter, mutter.

GameDaily Biz quotes Lazard analyst Colin Sebastian as saying publishers will flock to the Wii because of "favorable economics":

Why is Wii so attractive? According to Sebastian, the answer's simply in the economics: "Based on the typical front-line retail price for Wii titles, we estimate that publishers need to sell approximately 300,000 units per title to break even. Specifically, using $49 front-line software pricing, the wholesale price is about 80% off retail, or $39. Third-party software publishers pay royalties and disk and packaging costs of approximately $9, with license and distribution fees costing another $7 to $9, leaving a contribution profit of $22 to $23. Assuming development and marketing expenses of about $7.5 million, we reach the estimated break-even unit total.

That's by contrast to a predicted break-even point of 600,000 for PS3/XBox 360 titles.

You know, when I do a back-of-the-envelope for a Wii title, I get to a roughly 300,000 break-even, too. But the specifics of Sebastian's analysis are so wrong that it needs to be looked at in detail.

"$49 front-line software pricing"--but with a $7.5m development AND marketing budget? That's a high premium price to pay for what is not a AAA title. But okay, let's assume a $49 price point.

"The wholesale price is 80% of retail.." leaving $39 to the publisher. Yes, except: this neglects MDFs (market development funds), what Dan Scherlis calls "channel bribery"--the upfront money publishers pay for store placement. It's not unusual for retailers to make more off MDFs than they do off the retail discount. So a better assumption is that another 20% goes away in MDFs, leaving $29 to the publisher.

"Third-party software publishers pay royalties and disk and packaging costs of approximately $9..." In what universe? Look, actual cost of goods--that is, the disc, the plastic case, a small manual--is probably $3 or less. Zero royalties are paid to the developer until development funding is recouped, so we can absolutely neglect royalties to developers; they only start earning some money after we've already reached breakeven (actually, usually until long after we're in profit, but never mind). In other words, for a pure breakeven calculation, developer royalties are neglectable.

Now there may be some royalties due other folks for use of an engine or other software, but no way in God's creation this adds up to $6 a disk. And of course there's assembling and shipping, so adding all this to cost of goods, maybe we get $4 total per unit, bringing the publisher's gross to $25 per unit.

"Assuming development and marketing expenses of about $7.5 million..." I don't know where this comes from. $7.5m is a modest development budget these days; marketing would be on top of that. I think you need to budget $10m total.

Under my assumptions, then, you have to sell a tad over 400k units--not that far from the 300k from Lazard. But the point, really, is that the whole business model is much friendlier to retailers than his analysis suggests--and must less friendly to developers.

The question (not clear from the article) is why Sebastian thinks this favors Wii over other platforms; my impression is that he's saying development costs are lower for the Wii. That's probably true, if only because it's comparatively under-powered, and therefore you don't need as complex and detailed graphic assets as you do for Xbox 360 and PS3. But if you're making that argument, the retail dynamics are irrelevant, because the retail dynamics are basically the same for all three platforms--same retail discount structure, same basic cost of goods, comparable platform royalties. The only advantage Wii could have in this scenario is development cost.

Of course, it's easier to do a cross-platform game if you're developing for Xbox 360/PS 3, because their controls and processing power are similar, so a Wii project probably has to be Wii-specific, meaning you can't easily amortize your risk over multiple SKUs--something that works against the Wii.

In reality, when you come down to it, the real thing publishers look at when deciding what to develop for is simply user base plus tie ratio--that is, how many boxes each manufacturer ships, and how many titles the average user buys for that box. This, and not a putative cost advantage for Wii over other platforms, is what's working in Wii's favor at the moment--it's selling better than its competitors. And while historically the tie ratio for GameCube was lower than for PS 2 and the original Xbox, this was largely due to the paucity of third-party games for GameCube--and the fact that many GameCube buyers were buying it as their second platform specifically to play Nintendo titles, and tended to play crossplatform games on their primary device. I expect there will be a flood of third-party games for Wii, that the advantage PS 2 and Xbox had over GameCube in this regard will not be true for the current generation: the tie ratios will look much more similar.

posted by Greg at 12:49 PM 34 comments

34 Comments:

k, you mention that royalities are not $9. But when you are developing Wii / 360 or PS3, there are cetainly licensing costs per unit. These can easily range from $5 min to maybe $10. The DS licensing costs to Nintendo, depend totally on size of memory cartidge and backup memory. These are paid to Nintendo / Sony / MS.

Also on that a $7.5m dev budget for a Wii title is nearer the high end, most likelt $2-5m. For the 360 / PS3 the budget may be nearer $10-15m.

Then after you take into the licensing costs paid to Nintendo or who ever, you then need to look at the developer / publisher share, after any middlewear has been taken.

By Anonymous, at 5:42 PM

Ah, no curmudgeonly business analysis post is complete without a Dan Scherlis quote.

I think publications like Gama and Next-Gen need to exert more of an editorial grain of salt when quoting these people. Their jobs are to know specific publically traded companies well enough to advise hedge-fund managers and the like, they have authority, there, they don't really have authority to make broad sweeping projections. Case in point, a year ago PS3 was widely projected to be the top seller, with Wii coming in 3rd.

Of course, the economic are better, but they're still not great. WiiWare could perhaps be more forgiving, but it doesn't look like Nintendo will be adopting the sort of robust network where non-sales business models can play anytime soon (or for that matter, get adequete supply of dev kits out). Of course, even that proposition carries undesire-able implications, as you've discussed.

By Patrick, at 6:20 PM

Hmm, I'll have to respectfully disagree with this. First of all, are most publishers really putting in $7.5 million into a Wii game? I'd be pretty surprised.

Next, it might be true that tie-in ratio is important, but you really should think about the difference of the tie-in ratio compared to the difference of development costs.

If the development costs are half as much for the Wii, then the tie-in ratio needs to be half as much or more. If that's the case, the Wii is actually better to develop for. You're spending less time/money per game, so the cash flow is better, and your tie-in is giving you the same chance per dollar as the other consoles.

I see your point - halving the development costs won't get you anywhere closer to break even if your game doesn't have a chance of selling copies in general. I really don't think this is the case for the Wii.

The problem is just that publishers don't care enough about the Wii to make appealing enough games for the Wii's market.

Also, if publishers are relying on tie-in to make decisions about development, they damn well better take into account downloadable games when calculating these tie-ins. That would at least give more evidence to whether or not the tie-in is because the Wii owners are types that don't buy many games, or because they're waiting for third parties games that don't suck.

My guess would be the latter.

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By Anonymous, at 9:27 PM

Greg, one the things that marks you as a gentleman is your habit of giving credit to your sources. Thanks for that.

In fairness, calling MDF "channel bribery" is a bit harsh, implying that the publishers and distributors are taking initiative to corrupt the retain channel. That initiative is the retailers', so I think MDF is better defined as "channel shakedown."

I apologize to any publishers who felt slighted by me.

BTW, my favorite retail-channel historian tells me that such fees far pre-date our industry. They became prevalent for constrained spots such as freezers, and called "slotting fees," back in the day.

Also, I wonder what portion of publishers now use 3rd-party distributors or reps, in which case another 20% or so goes off the top as a cost.

- - Dan Scherlis

By Dan, at 10:51 AM

Thinking as a Wii owner with a 9 year old kid and a wife who actually likes the Wii and not as a product manager, the biggest problem I have is the $49 retail price point.

The reason we bought a Wii was Wii sports (i.e. party games) and the lower price point. The lower price point isn't currently carrying over on games, I don't think that is sustainable. We're playing more and more flash games with the Wii and have been underwhelmed by most of the things we've rented.

I'd spend $40-50 for a browser update that upgrades the Flash version, allows the Wii to remember controller to keyboard mapping on a per URL basis and gives some cookie/local storage to flash. At that point, it's damned unlikely I'd ever bother buying another Wii platform game.

By Jonathan, at 12:11 PM

Greg, Tim. Tim, Greg.

By Gary Farber, at 2:58 PM

One thing that this editorial and the comments attached to it has taught me is that console business is not where creative talents can come to market.

Indy developers are going to have to have a PC channel for anyhting out of the ordinary. Then they can sell it to console people if they make a hit.

By Anonymous, at 2:49 PM

Jonathan,

I think you have the best comment here. Why would you pay $49 for a casual game if you're a casual gamer? (I hate that casual word)

Nintendo needs to increase their tie ratio, and budget buyers who pick up their system are not going to drop $50 several times a year for something they can get on their computer. Games truly unique to Wii can arguably may make sense for $49, but as more publishers port popular casual games to the system, they're going to have to get to a more casual price.

Maybe that's the goal of Wii Ware.

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