Consider how recently digital distribution took over the games business from the perspective of 2023. We now take it for granted that practically all games are released online, yet it wasn’t until 2012 when income from digital games surpassed sales from boxed games. The crossover in the console market did not occur until 2017. In the context of the video game industry, we are still in the early stages of the digital gaming era.
In the first decade or so of the digital era, a small number of platforms amassed enormous market power. Apple and Google’s mobile app shops, as well as Sony, Microsoft, and Nintendo’s console storefronts, have virtual monopolies on distribution on their respective platforms, while Steam has a slightly weaker monopoly on PC. Because 94% of game spending is now digital, these six platforms in particular have risen to a critical market position, allowing them to extract fees of up to 30% of sales from publishers who use their platforms. As a result, distributors are expected to earn $41 billion from publishers in 2022, according to Omdia.
Distributors are starting to face stiffer competition
Distributors can charge large fees since access to their platforms is essential for publishers and there is no effective competition. The three consoles and iOS are closed systems that Sony, Microsoft, Nintendo, and Apple have a total monopoly on software delivery. Android and PC are more open, with many stores in operation, but network effects make it incredibly difficult to threaten Google Play and Steam’s supremacy.
Nonetheless, a well-funded challenger is attempting to unseat the major incumbent in each case. Huawei hopes to make its App Gallery a legitimate competitor to Google Play outside of its home market of China, while Epic Games has put hundreds of millions of dollars into establishing the Epic Games Store as a rival to Steam. It’s fair to say that none of these projects has been a huge success, and both Huawei and Epic have their own motives for pursuing these longshot ventures.
But what makes these developments significant is that they occur in the context of a regulatory environment that is becoming increasingly hostile to anything resembling a monopoly in technology. This will make it much more difficult for incumbent players to put an end to challenges to their positions than in the past. The European Commission, for example, is investigating whether Apple’s monopoly on iOS software distribution violates competition law, with some reports suggesting that Apple is considering getting ahead of a potential ruling by voluntarily opening the door to third-party app stores. Given the parallels with their own distribution monopolies, any such development on iOS would be concerning for console platform owners.
The games market is evolving in ways that are hard for platforms to control
Perhaps even more dangerous than the emergence of new direct competitors is the deterioration of distribution platforms’ ability to control the revenue flowing into the games they host. Multiplatform games, in particular, are posing a significant difficulty. In most multiplatform live service games, an in-game purchase made on any device makes the purchased products or content available across all devices on which the game is played. The player’s choice of purchasing device is immaterial, however it does make a significant difference in how money is distributed between publisher and distributor.
This offers an incentive for publishers to push gamers to cheaper platforms with a higher revenue split, or even to buy straight from them via the web, eliminating the intermediary completely. Unsurprisingly, distributors are unhappy, and their unwillingness to give publishers this choice is at the heart of the Epic Games v. Apple legal battle.
Whether or if Epic wins in court (and it doesn’t appear that it will), this is going to become another area of concern for regulators and legislators who are increasingly wary of techniques that may be seen as suppressing competition. In-game purchases now account for about 85% of game content expenditure, therefore publishers would benefit greatly if they could easily avoid distribution costs for in-game material.
Another key market development that is unfavorable to distributors is the increase of in-game advertising. In-game advertising now accounts for more than a third of mobile game income and is likely to become increasingly prevalent on PC and console platforms as well. Omdia predicts that advertising will account for more than 40% of overall gaming income by 2027, based on current patterns. Because this revenue is generated by advertisers rather than consumers, it largely avoids distributors. Indeed, from the standpoint of publishers, this is one of the primary benefits of in-game advertising.
With advertising’s share of game revenue rapidly increasing, distributors may be tempted to try to find ways to capture a portion of the ad revenue earned on their platforms. However, in the current regulatory climate, any such attempt would be doomed, leaving distributors with little choice but to watch this market segment grow outside of their control.
Distributors will have to diversify
All of these factors—increased competition, the emergence of cross-platform gaming, and the rise of in-game advertising—combined with a far less favorable regulatory environment are already having an impact on distributors’ bottom lines. According to Omdia, their percentage of overall gaming income fell from 20% to less than 18% between 2018 and 2022, and is expected to shrink further to 12.5% by 2027. This is a significant shift in the income distribution in the games sector, with potentially far-reaching implications.
Publishers might anticipate to pay a lower percentage of their income to distributors than in the past, however this will not immediately translate into increased profitability. Some of the changes that reduce distribution costs have their own costs. This is especially true with the rise of in-game advertising, when adtech suppliers may and do claim a sizable revenue share. Increased adtech expenditure will absorb a significant percentage of publishers’ distribution fee savings, while other cost variables such as cloud service prices are also fast increasing.
Distributors will have to adapt as well. Many are expanding the range of services they provide in order to justify their costs to publishers. Some companies, such as Microsoft and Google, have the advantage of already having a wide range of tech services available to supplement their offerings. Others are building or acquiring skills in areas such as analytics, cloud services, and live operations tools. This makes sense: although distribution revenue is stagnant, investment on other game tech is increasing and, according to Omdia, will soon eclipse distribution revenue.
Diversification, on the other hand, will be difficult. While spending on games technology is increasing, these new markets are far more competitive than distribution has historically been. Sony, Nintendo, and Valve have all experienced this when they attempted to market game engine and middleware technologies in the past. Providing a broader range of services to complement their distribution platforms will mean facing stiff competition from the likes of Amazon and Unity, not to mention hundreds of potentially disruptive startups, implying that distributors will have to work much harder for their profits in the future.