From the April 1997 issue of VideoGame Advisor.

Growing Pains for Online Games

By David English

Online gaming is expected to grow dramatically over the next few years, forcing the online game networks to rethink their market strategies. Can they move from their base of hard-core gamers to a truly mass-market audience? Can they forge a working relationship with retail? And what kind of pricing will ensure their profitability?

Jupiter Communications, a New York City-based research firm, estimates that revenues from online gaming will reach $1.6 billion by the year 2000, with nearly 10 million households accessing online games through Web sites, private dial-up networks, and online services. That will represent 11.2% of overall online revenues, which will total more than $14 billion. Online games represented just 2.5% of 1996 online revenues, or $90 million of a total $3.5 billion online market.

The Interactive Digital Software Association (IDSA) is only slightly less optimistic about the potential for online gaming revenues. It predicts that online games will account for $1.4 billion of a $9.6 billion interactive entertainment market in the year 2000. The IDSA claims that online gaming will grow four times faster than the other segments of the entertainment industry during the next three years.

What does this mean for software developers, especially companies that have built their business on CD-ROM games? InfoTech, a Woodstock-based research firm, predicts that online revenues in the year 2000 will account for about 25% of the total revenues for CD-ROM game publishers. That compares with online revenues accounting for only 2% of total revenues for CD-ROM game publishers in 1996.

This dramatic growth is being fueled by online gaming's primary appeal: socialization. "Air Warrior is all about community, " says Ted Pine, an analyst with InfoTech. "People go there to hang out--it's a big chat room. If you're an Air Warrior fan, that's where you live your life." Jeff Leibowitz, president of Engage, adds that "what appeals to people is people--much more so than software, games, or anything else." A spin-off of Interplay, Engage's highly-anticipated online gaming network was scheduled to launch at the end of March. Just as chat and e-mail bring a human connection to the Internet, Leibowitz argues that people play online games in order to connect with each other. "You want to sign on when everybody knows your name," he says.

"The game itself seems to be more of an excuse for gathering with your friends online," says Chris Holden, CEO of Kesmai. "We'll see that become more and more important, with the best multiplayer games pushing the social aspect even further than has been achieved up until this point." Kesmai developed some of the first online games, virtually inventing the category 16 years ago. The company is best known for Air Warrior, the online flight simulator that first become popular in 1987 on GEnie.

Online gaming's communal qualities have attracted a loyal group of hard-core gamers. "We fondly and affectionately refer to them as 'the lunatic fringe,'" explains Holden. "In some cases, they spend 100 to 200 hours a month playing the game. We love these people--though the flat rate pricing does change that dynamic a bit." When Leibowitz worked for the Imagination Network, he noticed that some subscribers were using the service 300 hours a month. "We used to privately call them the 'get-a-life people,' but it turns out that many of them had lives," he explains. "They were bridge fanatics or some other thing, and the minute they got home, they turned their computers on. They stayed on until 4 in the morning--every single day. They logged on at 7 in the morning on Saturday and didn't get off until 9 at night on Sunday."

Leibowitz warns that there's a lot of interest in long-term gameplay, so the online networks will have to control it somehow. "Even with unlimited bandwidth, there are computers and other resources that cost too much. It's very difficult, if not impossible, to well-support unlimited game play. Some sort of pricing structure will continue to be in place." Leibowitz predicts that flat-rate pricing won't become established with online gaming until advertising becomes sufficient enough to offset the hard-core gamers.

David Cole, an analyst with the San Diego, CA-based research firm, DFC Intelligence, isn't sure that America Online's all-you-can-eat pricing will work for the online gaming companies. "That's a broadcasting model," says Cole. "A broadcast network can send out a television program to 100 million people just as cheaply as it can send the program out to one person. It's a lot different with an online service, where you have modems, servers, and online time that cost money. There's an incremental cost to each one of those. That makes it tough."

Cole thinks the online networks are lowering their prices and experimenting with advertising because their customers don't want to pay a lot for the services. The online networks may also be looking to the future when larger companies will be attracted to the new medium. "When larger companies decide this market is big enough that they want to enter, they'll have to make a buy-or-build decision," says Cole. "If the online networks have built up their services, they're more likely to be bought out."

Until then, online game developers may need to be more creative about pushing their products into the marketplace. Holden suggests they'll look for additional revenue streams, "while the business model settles itself." He thinks online games could be sold for promotional purposes, as well as being offered at retail. "We might take a multiplayer poker game and talk to someone like Budweiser about having a Budweiser poker tournament on their site."

To reach the larger group of casual game players, game developers and the online networks are attempting to broaden the appeal of their products. Holden predicts that we'll see "more games with a lower learning curve, that don't require a Ph.D. and an investment of a hundred hours of game play just to become comfortable in the game." He also expects to see more "low-end product that's quick and easy to get into and appeals to a very large group of people."

Leibowitz points out that while Engage has focused 80 percent of its efforts at the hard-core gamer, the network has been adding content with broader appeal, such as Caesar's Palace Online Gambling (for simulated betting), The Improv (for comedy-related entertainment), and Billboard Live (for music-related entertainment). Hasbro Interactive has successfully placed its general-interest games online, including Monopoly, Scrabble, Battleship, and Trivial Pursuit. "We recognize that there are hard-core gamers, and there are also soft gamers," says Tom Dussenberry, Hasbro Interactive's CEO. "As a mass market company, we think that the soft-gamer group is probably the most viable one for us to pursue."

Cole says pricing has to be "way down there to appeal to the mass market, but the main thing is it has to be a lot simpler to use." He thinks the online gaming networks are still too difficult for the typical computer buyer. "There are a lot of bugs to shake out," says Cole.

Paul Matteucci, CEO of Mpath, one of the leading online game network companies, argues that trial and error will create better online games and gaming environments. "Those with the ability to take risk--which are basically companies with [the financial] room to experiment and startups with little to lose--will give it a shot," says Matteucci. "1997 will be a year of experimentation with a small chance for a breakout online product or two. I think it will be 1998 before we have online-only mega-hits with 300,000 or more regular users."

If Matteucci is right about the possibility of an online-only hit in 1998, why aren't the established game developers rushing to create online-only games? "A lot of the online services are talking about the need for developers to develop online-only content," says Cole. "But the developers don't want to do that because there's no proven business model for doing that." He says most game developers view online gaming as a way to spur retail sales, and they're going online only because their customers are demanding it. "It's not enough to justify an online-only game and forego the retail version," says Cole. "For the next several years, that's how it's going to be."

Leibowitz thinks that over the next few years CD-ROMs will include three different versions of the game in the same box. A solitary play version would help users practice or learn the game. A head-to-head play version would work modem-to-modem, allowing two users to play against each other over the phone--either locally or with a long distance call. And a network play version would work with online gaming networks such as Engage or Mpath's Mplayer. "With those three elements in any game, consumers have the best possible choice," says Leibowitz. "They can choose what they want to do and how they want to do it."

While limited bandwidth makes it too costly to deliver CD-quality games over the Internet, Matteucci sees that possibility on the horizon. For the next two or three years, he sees consumers continuing to buy games on CD-ROM--with updates, added levels, and added characters delivered online. He estimates that CD-quality downloads could be available by the year 2005.

While many reference-title software publishers are betting their business could move entirely to the Internet, most game developers are taking a more cautious approach. "The game guys don't believe the packaged goods business is going to go away, because of the bandwidth issue" says InfoTech's Pine. "They look at the Internet and realize that they can't deliver a Pandora Directive on it--not on a 28.8 line. The best they can do is a hybrid product." Cole agrees that hybrid product is the model for the near term.

Cole thinks that it's in their own interest for game developers and retailers to work together. "With an online-only product, a consumer has to seek out the product," explains Cole. "Where with retail, you're bringing the product to the consumer. The whole idea with any type of entertainment product is to get it in front of the consumer in as many places as possible." He points out that grocery stores that carry home videos and computer-based games generally put them by the checkout counter so people will see them while they're waiting in line. "Companies in the entertainment business have learned that you have to be everywhere to grab the customer," says Cole.

Leibowitz points out that just as mail order catalogs haven't eliminated retail stores, online games won't eliminate box games sold at retail. "Victoria's Secret sells through a catalog, yet there are also Victoria's Secret stores," he explains. "There are times when a consumer wants to talk to a human being--especially when you're talking about a technical product where you may have problems."

The industry's relationship to retail could change if online-only games become a major factor. Because Kesmai develops its games specifically for online play, its view of retail could be a preview of things to come. "A retail SKU is an acquisition mechanism for us," explains Holden. "We make our money online, so we don't focus on generating heavy-duty revenues at retail with box versions of our games. We would much rather get our disks out there and get people into our online environment, where we can hook them on our particular brand of drug for a very long time."

One of the main obstacles to successful online-only games is latency. Latencies are the delays that occur when Internet data is split into smaller portions and moved from location to location across the Internet. Holden says it's not the latencies themselves that are the problem, but the variability--or unpredictability--of the latencies that cause the headaches for online game designers. "You can deal with it if it's predictable and constant," says Holden.

Leibowitz points out that latency is mostly a problem for "twitch-type games," and the most popular games on the Internet are MUDs and social-environment games that don't suffer from these factors. He argues that companies with large resources are working to solve the problem. "AT&T, MCI/British Telecom, Sprint, and everyone else is feverishly working to get latencies down and to increase bandwidths--because that's how they make their money. Within a year and a half-maybe two years at the outside--and I wouldn't be surprised if it happened at the end of this calendar year--virtually every network available will be what we today call a low latency provider."

Taking a less optimistic view, Matteucci thinks we're further from solving the latency problem. "If you look at certain kinds of [online] experiences, they can only be played over a very short geographic distance," he explains. "Other experiences can be played coast to coast. Very few experiences survive very well internationally--yet the Internet is international. I think it's not: Today, we have a latency problem; tomorrow, it's solved. I think it will improve over the next eight to ten years, and that somewhere in that time range, we'll be playing highly interactive games worldwide."

While today's online gaming is primarily a PC gaming experience, Cole thinks it's only a matter of time before the console companies jump in with both feet. "The market will really grow when the console systems can really support it," he says. "But there are issues of local storage and the need for more RAM on those systems. You're probably looking at the next generation of systems that will start hitting the market in force around the turn of the century."

Matteucci thinks that over the next five to eight years, consoles will evolve into living room appliances that let people play games with other people online. "The distinction between the console and PC will--after a while--fade relative to online gaming," he says. "You'll be able to reach [online games] from many different platforms by the early part of the century."

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