Apple's Attempt to Reinvent the Game Business: Selling the Razors Edition

I read this article a while ago about the entire game business fearing Apple, and I thought it was kind of silly. Then the next day I saw this one proclaiming Apple's dominance over all others and started to think I was wrong when I said Steve Jobs' reality distortion field would not extend into the game business. Then I closed my macbook, took a deep breadth of fresh open air and realized, as tempting as it is to say Apple figured it out and is going to save the day, just like they did for music. But the articles are falsely equating the music business with the game business, and they are really wrong – and we should be happy.

In the New York Times article, Yoichi Wada, CEO of Square Enix was called for a new business model. “The next breakthrough in gaming is not going to be in hardware,” Yoichi Wada, president of a top Japanese game maker, Square Enix, told Game Show participants. “It’s going to be in how to create a successful business model.” The implication is Apple's golden touch is addressing the need. If Apple has its way, this statement is poetic foreshadowing of our industry’s doom. Sure, being afraid of the iPod only to see it save the day would be pretty consistent patterns established in the past. Every new media was feared by existing media and ultimately expanded the content market. Film studios feared television, videotape and DVD's. All expanded the market. Television feared videotape and DVRs, but they turned out to be a pretty useful. Now we are even seeing potential for Hulu and other on line distribution teeing up to expand the market. With Apple spamming mainstream media with game ads, it should only be a good thing. The iPod simply joins the handheld market, which has been around for years, and introduces a new point of monetization, expanding amortization opportunities of production costs and giving publishers an opportunity to make more money and larger games . . . right? Not if the plan succeeds. We only have to look to the music and video businesses to realize Apple is walking us to the precipice of a slippery slope.

Apple’s business model threatens content creators. You know, the one that allows creators and publishers to make money. For years, our business, like scores of others, has operated under the razor/razorblade model pioneered by King Gillette at the turn of the 20th century. Give away the razors, and sell the blades. We are blade makers. We in the game business benefit from the sale our games into allegedly subsidized consoles. The console manufactures make their own games and receive their vig on the manufacturer of each game, and we were all happy. Until Apple, no one ever thought to turn the model on its head. Apple knows content is very risky and wants to be free, so it avoided the content model fray in video and music by charging for the razor and commoditizing the blades.

Before Apple, hardware pioneers made sure the content was a available by creating, or subsidizing it. RCA supported television and phonographs with NBC and Victor, Sony owned record labels and studios and game console manufacturers publish first party games. In the music businss, Apple found a chaotic market loaded with pre existing popular content, and under attack by piracy. By simplifying access, securing delivery, aggregating popular content and setting the price at a break even level, Apple was able to leveraged the long tail – the phenomenon defined as creators make a little money over a long period of time and aggregators make a lot in a short time- without spending any risk capital on content creation. By creating a safe harbor in a world of rampant uncontrollable piracy arising from the failure of the gatekeeper model, Apple got the labels to jump on board before they realized the content was commoditized. As the company grew to the largest music store on the planet, the labels lost leverage over promotion, pricing, distribution and just about everything that makes them a label, except the requirement to spend risk capital for new music. When Universal said they didn’t like the pricing, Apple said “too bad, leave”. They didn't. After Apple did the same thing in the video business and NBC didn’t like the pricing, Apple said “too bad, leave,” and they did . . . only to come back. There is no profit in the content, but Apple doesn’t care, they make their money on the razors, not the blades. No single content creator has power - and none of them make as much money as Apple either. Now, Apple is setting its sights on games.

Apple is promoting games in the largest marketing campaign to ever hit the game business, but consistent with the attack on the other industries, consumers don't know which games they are. I saw the cool three way soccer thingy and the roller coaster stuff, the racing with the bumping was neat, but I don't know any of their names. If I wanted to find them, I have to dig through the app store, which someone in a meeting described as "Wal-Mart, all in a single aisle, ten miles long." This plan worked for music and made Apple the number one store, but it is not going to work in games. They just don’t get the market.

The first hint of Apple’s misunderstanding of the business comes in the uncharacteristically tone deaf advertising tag line “Next level fun.” It sounds like it should be bundled with a Brady Bunch Box set. It breaks the cardinal rule of not sounding like something your mom would think of and makes Sony’s weird baby ads and goat sacrifice look ingenious. Apple app store is doing a bang up business on the mainstream side and perhaps even attracting some of the 30 million Farmville subscribers, but they are promoting games for the hardcore and they aren't buying. Madden launched at number 1, but within a month fell to 38, while Bejewled has been in the top 20 for over a year and there are only three games in the top 100 selling for more than USD 3. The number of potential Madden buyers will always be smaller on the iPod than Nintendo or Sony devices. Every single one of the 110 million people who bought a DSi or dozen who bought a PSP - I am kidding there are about 40 million - bought it to play games. Only a subset of iPhone and iPod buyers purchased the hardware for games. Even though Apple doesn’t care about how much people pay for games game makers care deeply.

Music and video do not have to be ported to the iPod. The same music file plays on your stereo in your car, in your living room and over the PA at a stadium. While a film may feel different in a theater, no design or technical adaptation is required to digitally deliver it to the iPod. So even though the owners of this other media are marginalized, they did not make any specific investments in content for the iPod. It is simply another release window. Games are a very different animal. Madden cannot just be just delivered to an iPod. The game had to be redesigned and built specifically for the device. Even if it is a port from a handheld device, it still requires investment. In fact, games are the only entertainment application tailored specifically for the device. Because content sells hardware, the investment mean something. As we saw when Bobby Kotick threatened to pull Actard off the PS3, if publishers fail to see an adequate return, they will not support a platform.

Rather than creating a new window, as it did in the music and video business, Apple created a new market in which overhead laden publishers are forced to compete on an equal footing with the garage creator of iFart. If they have not already, EA will soon realize, that the subset of app consumers who move beyond downloading the free games are downloading a ton of USD .99 games rather than USD 6.99 and USD 9.99 costly builds. Sure iFart man will make some money and a few creators will make quite a profit, but putting a roof over iFart man’s head is very different from moving the revenue needle for EA. Is it better for EA to focus on trying to figure it out and end up losing money, or waiting until a profitable winner emerges, the market rationalizes, and buy the creator at a premium? Once publishers understand they realize a better return by investing a bit more on an XBL game for delivery into a hardcore base on a platform with higher barriers of entry as well as an ability to leverage existing technology, they will relegate iPhone development to their mobile, casual, family, value or other similarly situated ancillary division of the company. In other words, the divisions only heard from at annual retreats.

The other reason, and perhaps more significantly, the game business has alternatives. When Apple extended the helping hand and offered a safe harbor, the music business was under attack. Napster turned into Gnutella and more, making it impossible to protect value let alone recoup investment in new artists and there was Apple with a way to fix it. We don’t have the same problem. While many publishers are losing money and piracy is an issue, installed base growth creates a light at the end of the tunnel. There is a profitable, protectable console business, an exciting new PC transactional business and the innuendo of direct distribution on the horizon. Other than a new console with similar economics to what we have, Apple is really offering nothing new.

While this is great news for independent developers, in the near term, it should illicit no more than a yawn from Nintendo and Sony. Maybe the next Jordan Mechner is building his Karateka for iPhone and will take the business to a new level and make him rich along they way. But it will be many years before anyone can wrap a business around it to compete with console publishers and before that happens, they will be an attractive acquisition target. The iPod is a great platform and the technology is great, but when we consider our leverage on the existing platforms relative to where the music business sits today, I think it is an offer we can refuse.