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Think Entertainment: Gaming
The Emergence Of Games As A Service
THINK SUMMARY:
Over the long term, we believe that gaming will emerge as a true multi-channel
Games As A Service, where players will be able to play games on multiple
channels with the game experience optimized for each of the channels and
profile information seamlessly carried across the platforms. In the meantime,
we expect strong growth in online gaming, social gaming, mobile gaming, and
alternative business models. A large population of Internet users and the
efficiencies of the digital channel will drive growth in online gaming, in our
opinion. We think that social gaming will be another growth area, driven by the
large reach and viral nature of the social networks. Similarly, we believe that
the ubiquity of mobile devices and the emerging devices and platforms will put
mobile gaming on a strong growth trajectory. With strong growth in the number
of gamers, gaming is fast becoming an attractive alternative media for
advertisers, in our view. We are also optimistic about the virtual goods model,
which we believe could get a boost from the Generation Y's comfort level with
Internet and virtual worlds.
KEY POINTS:
• Long term, we believe that gaming will emerge as a true multi-channel
Games As A Service, where players will be able to play games on multiple
channels (PC, gaming consoles, and mobile), with the game experience
optimized for each of the channels and profile information seamlessly carried
across the platforms.
• Given the advancement in technologies, today's PCs are robust gaming
machines, comparable to the dedicated gaming consoles. Also, we believe
the large population of Internet users (15-20x that of the gaming console
base) plus inherent advantages of online distribution make the Internet an
attractive gaming platform.
• We believe that the social networking sites not only create a platform for viral
distribution of games, but even more importantly, fundamentally transform
the gaming experience into more of a social experience for players to spend
time with their real-life friends, which we believe broadens the scope of
gaming to include non-gamers and presents an attractive billion-dollar-plus
market opportunity.
• Similarly, we are optimistic about the mobile gaming space. We believe that
the large penetration (2-3x that of Internet users and 30-40x the console
installed base) and the ubiquity of mobile devices positions mobile phones as
attractive gaming devices. We think that recent advancements in technology
(iPhone and Google Android) and emerging platforms for mobile applications
(AppStore) should overcome historical constraints and be catalysts for mobile
gaming.
• We believe that a broadening demography of games, coupled with a strong
growth in the usage level of games, positions gaming as an attractive
alternative media for advertisers that are grappling with the reducing
effectiveness of traditional media. We think that advertising could emerge as
a multi-billion dollar opportunity for gaming.
• We believe that Generation Y's comfort level with Internet and virtual worlds
could drive spending on virtual goods.
• We think the key success factors in the new world of gaming will be: a) a
focus on understanding consumer behavior (versus on AAA titles in the older
model), b) building communities (versus building IPs), c) managing virality
(versus large marketing campaigns), and d) monetization through alternative
models (versus price discounting).
Reason for Report:
Industry Update
Atul Bagga
415-249-6362, abagga@thinkequity.com
May 4, 2009
Industry Report
Page 2
May 4, 2009
Industry Report
The Emergence Of Game As A Service
Source: Getty Images
Atul Bagga
415-249-6362
abagga@thinkequity.com
GAME ON
are you ready to play?
Page 3
May 4, 2009
Industry Report
Table Of Contents
Section 1: The Emergence Of Games As A Service
Emergence Of Games As A Service ..........................................................................................................................5
The Digital Revolution.................................................................................................................................................7
Competitive Landscape Of Games As A Service.................................................................................................... 10
Take A Break: Time To Play Crossword Challenge ................................................................................................ 12
Online Games.......................................................................................................................................................... 13
Demand Drivers For Online Games ........................................................................................................................ 14
Emergence Of Social Gaming: Convergence Between Gaming And Social Media................................................ 18
Drivers For Social Gaming....................................................................................................................................... 19
Market Size Estimation For Social Gaming ............................................................................................................. 21
Mobile Games Coming Of Age................................................................................................................................ 23
Drivers For Mobile Gaming...................................................................................................................................... 24
Potential Market Size—Mobile Gaming................................................................................................................... 27
Weapons Of Price Discrimination: Free-To-Play, Pay-For-Items Model................................................................. 28
Drivers For Free-To-Play Model .............................................................................................................................. 30
Market Size Estimation Of Virtual Goods In Games................................................................................................ 34
In-Game Advertising ................................................................................................................................................ 35
Demand Drivers For In-Game Advertising .............................................................................................................. 39
Market Size Estimation Of In-Game Advertising ..................................................................................................... 41
Who Will Succeed: Characteristics Of Winners In Games As A Service ................................................................ 43
Take A Break: Time To Play Scramble.................................................................................................................... 45
Take A Break: Time To Play Word Search.............................................................................................................. 46
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May 4, 2009
Industry Report
Section 2: Interviews With The Leading Private Gaming Companies
Online Gaming: An Interview With The Founder And CEO Of Acclaim .................................................................. 48
Online Gaming: An Interview With The CEO Of Bigpoint........................................................................................ 52
Mobile Gaming: An Interview With The CEO Of Digital Chocolate ......................................................................... 56
In-Game Advertising: An Interview With The CEO Of Double Fusion..................................................................... 59
China Online Gaming: An Interview With The COO Of Ferry Game....................................................................... 63
Online Gaming: An Interview With The CEO Of Gaia Online.................................................................................. 67
Online Gaming: An Interview With The CEO Of K2 Network .................................................................................. 71
Online Gaming: An Interview With The CEO Of Kongregate .................................................................................. 75
Online Gaming: An Interview With The Co-Founder Of Metaboli............................................................................ 80
Online Gaming: An Interview With The Founder And CEO Of Miniclip.com........................................................... 84
In-Game Advertising: An Interview With The CEO Of Mochi Media ....................................................................... 89
Virtual Currency: An Interview With The Founder And CEO Of Offerpal ................................................................ 94
Social Gaming: An Interview With The CEO Of Playfish......................................................................................... 98
Online Gaming: An Interview With The CEO Of Turbine....................................................................................... 102
Gaming Suppliers: Interview With The CEO Of Vivox........................................................................................... 106
Social Gaming: Interview With The CEO Of Zynga............................................................................................... 110
Section 3: Private Company Profiles
Page 5
May 4, 2009
Industry Report
Emergence Of Games As A Service
“In the last five years, an Omni Media market has emerged in which everyone has become a gamer to some degree. They
are playing simple, convenient, and social games on a wide variety of new platforms including mobile phones, the Web,
smartphones, social networks, and online console networks like Xbox LIVE.”
Trip Hawkins, Founder & CEO, Digital Chocolate
Recently someone posted a question on LinkedIn—“How did you do job search pre-Internet days?” It should have been a
simple question to answer for most people of my generation who were born in the late ‘60s and early ‘70s, who, unlike
today’s generation, didn’t grow up on the Internet and who started careers before the world was connected like it is today.
But for some reason, I had difficulty even remembering how we searched for jobs without emails, job boards, alumni
Websites, LinkedIn, and Twitter. Then it dawned upon me how much we take the Internet for granted and truly how much
it has transformed our lives. It is difficult to even imagine life without Internet. How would people communicate in a world
without emails? How would a research analyst like myself perform due diligence in a world without Google? How would
we have any chance to find our old school friends in a world without Facebook?
The Internet has changed our lives by revolutionizing many industries, including music, video, software,
telecommunication, newspaper and publishing, project management and entertainment. Until about five years ago, CDs
were the dominant format for music delivery—almost 100% of music was delivered in CDs. Fast forward five years, to the
iTunes, Amazon Music, Wal-Mart world. CDs, as a delivery format for music, has shrunk to 30%, and digital music has
become the dominant medium of delivery (see Exhibit 1).
Exhibit 1: Evolution Of The Music Industry
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1999 2001 2003 2005 2007
Mobile
Digital
CDs
Cassettes
Source: Recording Industry Association of America
Similarly, the Internet has changed the way we watch videos—from DVDs to iTunes, to YouTube; from TV to Hulu, Joost,
and TV.com.
But it has not always been a revolution. For some industries, it has been a process of slow evolution. For such
transformation to materialize, there has to be some real tangible benefits for consumers, for vendors, or for the other
stakeholders. We believe these tangible benefits are the mandatory, but not the sufficient condition to make this change
happen. And that’s why in some cases, we have often seen a long process of evolution that involved multiple iterations of
business models and innovation in technologies. Take software for example. Software as a Service (SaaS) had to
undergo many iterations (client-server model, ASP model, hosted model) before it came into being as multi-tenant,
browser-based Software as a Service, as we know it today.
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May 4, 2009
Industry Report
Even if we have the right business model and the technology, it may take time and a catalyst to create sufficient
momentum that would spur wide adoption. Again, take the example of software. Even though the SaaS model has been in
existence for almost 10 years, until approximately five years ago, it was considered a fad; until a couple of years ago, it
was considered acceptable only for small businesses; and now it is well accepted by small, medium, and large businesses
alike and we expect it to grow more than twice as fast as the overall software industry and to become a significant portion
of enterprise software by 2012.
Exhibit 2: SaaS Versus Packaged Software Growth
0
500
1000
1500
2000
2500
3000
2002 2003 2004 2005 2006 2007 2008
RevenueIndex
SaaS
On-premise
Source: FactSet and ThinkEquity LLC
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May 4, 2009
Industry Report
The Digital Revolution
From To
Music has
Changed
Home Video is
Changing
TV has Changed
News Media has
Changed
Phone has
Changed
Communication
has Changed
,
Software is
Changing
Source: Company Websites
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May 4, 2009
Industry Report
The Internet changed all of these industries because of a few common themes: reduced cost of ownership, increased
convenience, and freedom from proprietary technologies. Consumers benefited by the ease of use, the ease of the buying
process, a lower upfront investment, the ability to buy in small sizes, and the ability to buy without making a long-term
commitment. Vendors benefited by streamlined supply chain, low friction sales model, satisfied users who become
evangelist of products, viral marketing, reduced costs for development and support. We believe that the same reasons will
transform the gaming industry from packaged software to Games as a Service business. We are at the dawn of multi-
channel-game-as-a-service.
What Is Multi-Channel Games As A Service?
We believe that today’s Internet generation is looking to stay connected with their friends at all times. With increasingly
capabilities and functionalities of the smartphones, users are connecting with their friends on their mobile devices while on
the move (think Twitter, Facebook Mobile, Google Latitude) and via computer while at work, school, or home. According to
Research In Motion (the maker of the BlackBerry), the MySpace BlackBerry application had 400,000 downloads within
one week of launch in October 2008 and Facebook BlackBerry application downloads surpassed the one million mark
within five months of launch in April 2008.
Gaming will be no different, in our opinion. We believe just like people want to stay connected with their friends on social
networks, players want to stay connected with their friends on virtual worlds/game environments too. With the next-
generation of gaming phones, we expect to see convergence between social gaming, mobile gaming, and online gaming.
We believe this convergence makes sense not only for core gamers who may want to track their guild activities, but even
for the casual gamers who may want to use the same avatar (a representation of the gamer in the game environment) on
all platforms to make progress within game levels and to share achievements irrespective of the platform.
The next-gen multi-channel games will let players enjoy the game at any channel of his or her choice and give the player
the ability to change the channel, but still pick up the game from where he or she left off. For example, “Jane” can play a
game on her console at home, and when she leaves for work, she can continue to play the same game on her mobile
device. While at work, she can check the stats, send a message to one of her guild friends, or even play the game on her
work computer without the need for a separate download and while using the same avatar that she used in her console or
mobile device. Not only will she be able to play the game on all channels, but the game play will be modified in all three
instances to make the best of available hardware and to maximize the gaming experience based on the players’ device
preference at that time.
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May 4, 2009
Industry Report
Exhibit 3: Emergence Of Games As A Service
FreeFree--toto--PlayPlay
Pay to PlayPay to Play: Upfront Purchase; Subscription
Virtual
Goods
Ads
Premium
Content
Subscription
Others – App
Install,
Incentive
Marketing
PC
Gaming
Console
Gaming
Mobile
Gaming
Online
GamingSocial
Gaming
Multi-Channel Games As A Service
Source: ThinkEquity LLC
Page 10
May 4, 2009
Industry Report
Competitive Landscape Of Games As A Service
Company Products Free to Play Pay to Play
Virtual Goods Premium Sub Ads Others License Fee Subscription
Online Gaming: MMO/Core Games
Acclaim 2 Moons
Activision Blizzard World Of Warcraft
CCP Games Eve Online
Cryptic Studios City of Heroes
Electronic Arts
Warhammer Online:
Age of Reckoning
Jagex Runescape
K2 Network Knights Online
NCSoft Lineage II
Nexon Maple Story
Perfect World Perfect World Online
Sony Online Entertainment Everquest
Square Enix Final Fantasy XI
THQ Company of Heroes
Turbine
Lords of The Ring
Online
Online Gaming: Virtual Worlds
Disney Club Penguin
Gaia Online Gaia Online
Linden Labs Second Life
Sulake Habbo
Continued…
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May 4, 2009
Industry Report
Company Products Free to Play Pay to Play
Online Gaming: Casual Games
AOL AOL Games
BigFish Games Bigfishgames.com
Disney Go Disney
Electronic Arts Pogo.com
iWin Hotel iWin
Kongregate Kongregate.com
Microsoft MSN Games
Miniclip Miniclip.com
Playfirst DinerDash
PopCap Bejeweled
Viacom AddictingGames.com
Yahoo! Yahoo! Games
Mobile Gaming
Cellufun
Digital Chocolate
Electronic Arts
Gameloft
Glu Mobile
Hands On Mobile
NgMoco
Playfish
Playfirst
Oberon
Zynga
Social Gaming
Digital Chocolate Tower Bloxx
Electronic Arts Scrabble
Playfish Pet Society
Playdom Mobsters
Serious Business Friends For Sale
SGN Fluff Friends
Zynga Texas Hold'Em
Source: ThinkEquity LLC
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May 4, 2009
Industry Report
Take A Break: Time To Play Crossword Challenge
Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
Page 13
May 4, 2009
Industry Report
Online Games
Online games have been in existence almost since the beginning of the Internet. Historically, online games could only be
played on PCs, but that changed with the launch of PS2 and Xbox, which allowed online play. And now, the next-
generation consoles come with enhanced online capabilities that allow players to find and connect with their friends online
such as Xbox Arcade, PlayStation Network, and Wii Virtual.
Online games include a gambit of genres and categories, from causal games to hardcore Massive Multiplayer Online
(MMO) and everything in between.
Casual games are games that are easy to play, require less commitment, and last smaller sessions like puzzle games,
time management games, racing games, arcade games, casual action games, card games, and word games. The biggest
driver for casual games has been the increased number of connected devices. While core games largely remained
confined to the bedrooms of core gamers who owned one or another console, casual games broadened the scope to
include just about everyone. Although a large percentage of the PC users and mobile phone users may not identify
themselves as gamers, various studies suggest that most of these users often indulge in some form of game play on their
PCs and/or phone (mostly casual games). Casual games open up the target market to about one billion Internet users,
and about four billion mobile subscribers—numbers that dwarf the target market for core games, limited to about 100
million console owners.
Massively Multi-player Online games are played between thousands of players and are generally targeted toward core
gamers. MMOs can range from role-playing-games (MMORPG), first-person-shooter games (MMOFPS), real-time
strategy games (MMORTS), sports games, and racing games. MMOs became immensely popular amongst the Asian
gamers because of the affordability, and in some cases, government regulations on availability of consoles. Another big
catalyst for the MMO games happened in early 2000, when some of the Asian companies started to experiment with the
free-to-play model to revive interest in some of the old catalog games. The idea of free-to-play games is that players can
play the game for free and pay smaller amounts to customize their avatar or to buy virtual weapons, maps, more levels, or
new cars that enhance their game play. The free-to-play model gave a new lease to some of the old and dying games,
and has now emerged as the dominant model for MMO in Asia, in our opinion.
Exhibit 4: Broad Categories And Target Audience Of Online Games
CORE GAMESCORE GAMES ADVANCED CASUALADVANCED CASUAL
GAMESGAMES
CASUAL GAMESCASUAL GAMES
AdventureAdventure
ArcadeArcade
WordWord
CardCard
SimulationSimulation
SportsSports PuzzlePuzzle
MusicMusic
Time
Mgmt
Time
Mgmt
ActionAction
MMORPGMMORPG
StrategyStrategy
BoardBoard
RacingRacing
ShootingShooting
Martial
Arts
Martial
Arts
Fantasy/
Action
Fantasy/
Action
Teens/Young MaleTeens/Young Male Kids/Kids/TweenTween
FemalesFemales
Source: ThinkEquity LLC
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May 4, 2009
Industry Report
Demand Drivers For Online Games
Online Gaming Opens Up Much Broader Market: Ubiquity Of PCs And Internet
Personal Computers are everywhere—home, work, during the commute on public transit, on vacations, on business trips,
on airplanes, and at airports. In contrast, consoles are mostly available at homes. The total population of PCs has already
surpassed the one billion mark and is expected to reach two billion by 2014, according to Gartner. The Internet has even
deeper penetration with more than 1.5 billion users worldwide and is expected grow at 15-18% over the next three years
(according to Internet World Stats). On the other hand, the worldwide console population is estimated at about 100 million
(260 million for the current and previous generations combined). Even within the U.S., the number of Internet users (at
about 250 million) far exceeds the number of the gaming consoles installed base of 48 million. PC gaming not only opens
up a bigger market, but it also expands the usage beyond the home. Players are not limited to playing the games only
within their living rooms, but now, the players can have the same gaming experience during breaks at work or in a hotel
room while traveling.
Exhibit 5: Internet Users Far Outnumber The Gaming Console Users
-
200
400
600
800
1,000
1,200
1,400
1,600
million
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Consoles Installed Base (Two Most Recent Generations)
Internet Users
Source: NPD, www.Internetworldstats.com
With recent advancements, we believe technology is not a barrier anymore.
Not only are PCs everywhere, but today’s PCs are powerful gaming machines. Historically, there has been a large gap
between PC hardware and console hardware and, therefore, for a high-quality, 3D gaming experience, someone has to
have a dedicated gaming console system. The line between the PCs and the gaming consoles have blurred with the
recent advancements and democratization of specialty hardware, in our opinion. Today’s PCs are powerful machines
capable of playing high-definition 3D rendering, removing the need for a dedicated game console. In addition, increased
adoption of online gaming and falling hardware prices have helped accelerate the pace of innovation in PC gaming
peripheral technology—like a motion sensor controller (similar to that of a Wii remote), which makes the digital experience
more real and interactive.
Exhibit 6: Development In PC Peripheral Bringing PC Gaming Closer To Console Gaming: CyWee Z Controller for
PC Games—in the straight position (for tennis, golf games), in the gun position (for shooter game), and in the
wheel position (for racing or aviation games)
Source: CyWee
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May 4, 2009
Industry Report
In addition, the increasing speed and ubiquity of broadband makes it easy to transfer high-resolution graphics over pipes,
enabling gamers to have an immersive 3D experience without noticeable lags. The new technology is now enabling
gamers to have immersive 3D experience even within browsers, i.e., without the need for a client download, which should
further reduce friction for online games.
Exhibit 7: Sample Of The Immersive 3D Experience With Online Gaming
Source: Company Websites (clockwise from top left): World of Warcraft by Blizzard, Warhammer Online: Age of
Reckoning by Electronic Arts, Gaia Online, and Vivaty Scenes for Facebook by Vivaty
Reduced Cost Of Ownership For Consumers
If you are like most gamers, you will want to play at least 20-30 different games per year, you will want to own all the
major consoles, and you will need to buy a new generation console every three to four years to play these games in their
full glories. That works out to an annual spend of about $2,000-2,500 per user on gaming, which might be out of budget
for many gamers. Even more importantly, although the marginal entertainment value of every next game for a user is
arguably lower than that of the previous game that he/she owned, the marginal cost remains the same. And, as a result,
most gamers end up buying about four to five titles (about $250-300) per year. Since Game as Service enables players to
pay as they go, a player doesn’t have to buy all 30 games (that she wants to play) at $60 a piece. Rather, the user can
play all the games only as much as he/she wants to play and pays only for as much as he/she plays. Game companies
should benefit as many players, for who a marginal $60 investment for the 10
th
game didn’t make sense, will now be
willing to open their wallets for not only the 10
th
best game but also for 11
th
, 12
th
, and all the games that they would not
have bought.
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May 4, 2009
Industry Report
Avoid Buyer’s Remorse
“For the premium [subscription] offer, they [subscribers] play ten different games a month; for the basic offer, they try or
play four to five games a month. … They try them, and concentrate on those they really like, which is the interest of this
service. Our customers don't have the stress to choose one game among the others in the shelves, which is a bet,
because every gamer has made several times the wrong choice. A game is very personal; the packaging does not tell you
what is really inside the box, and the game reviews, and friends' recommendations, only limit the risk to make the wrong
choice.”
Thibaut de Robien, Cofounder of Metaboli
And then there is always the case of buyer’s remorse, players getting stuck after buying a game because the game was
not really their type. The problem is exacerbated for kids games, as these players arguably have a lower attention span.
Exhibit 8: Buyer’s Remorse: “Those WERE the droids I was looking for…”
Source: www.pbase.com/joony/image; www.flickr.com/photos/24973901@N04/2762458387/
With Games as a Service, players are paying only for their playtime and, therefore, avoid buyer’s remorse. Not only that,
Games as a Service enables the vendors to offer “Try and Buy”—the idea is to offer a free trial for a limited time, and if the
player likes the game, she can either buy unlimited play or enroll in some other form of game subscription. By offering a
free trial, the vendor can cast a wider net and players who otherwise may not have bought the game, may now try the
game and eventually convert to become paying customers. Furthermore, since the players have already tried the game
before making a monetary commitment, the buyers’ remorse is limited, resulting in fewer returns and fewer customer
service calls.
Improved Efficiency With Digital Distribution
“There's a shift and a disruption going on in the games industry that had for so long relied on producing very expensive,
high budget games, and when these big budget games fail, developers go out of business. The times are changing. Now
solo game developer and hobbyists can develop a game in their spare time and find an audience through sites like
Miniclip and they don't have to get involved in this very complex, hierarchy of distributors and publishers.”
Robert Small, Founder & CEO, Miniclip.com
In the traditional packaged game distribution channel, since the shelf space is limited, the retailers are willing to assign the
premium shelf space only to the super-hyped, highly anticipated, AAA games. As a result, most of the smaller or second
tier titles are either left out for non-premium shelf space where they have limited visibility from walk-in customers, or even
worse, these titles may not get any distribution deals. This creates a Catch-22 situation for smaller titles—since they don’t
have the fire power of an AAA title, they cannot get the premium shelf to get players attention, and since they don’t have
the players’ attention, they have even less chance to succeed. Not only that, larger gaming companies mostly focus on
AAA titles that may appeal to broader mass markets, ignoring the needs for smaller niche markets, which creates
inefficiency in the market.
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May 4, 2009
Industry Report
Digital distribution by definition breaks the barrier of limited shelf space, which makes the distribution to the niche markets
financially viable. With digital distribution, vendors can publish titles focused on the smallest of the niche; and use guerrilla
marketing or viral marketing to reach the desired segment efficiently. Digital distribution may also help expand margin for
vendors—as vendors save on the cost of medium, packaging, and slotting expenses.
Exhibit 9: Digital Distribution Enables Reaching Out Long Tail
Rhapsody
Wal-Mart
Amazon.com
Barnes & Noble
Netflix
Blockbuster
Source: “The Long Tail” by Chris Anderson
Viral Growth
“We don't really spend any money on marketing….Our growth is from friends recommending games, friends challenging
each other to games, so it's word of mouth and virality.”
Jim Greer, Founder & CEO, Kongregate
“We acquire all our customers through word of mouth. We’ve never done any marketing in the history of the company.
Even within our game, there are very few places that you will see us advertising membership. …In many respects, it is
one of the world’s best kept secrets.”
Mark Gerhard, CEO, Jagex
Viral marketing refers to users promoting an application to other users without getting directly paid for the same. Online
gaming vendors utilize viral marketing to expand reach and create buzz. With online games, players challenge their
friends by emailing links or by embedding links on their profile pages, and help vendors reach new audiences without
spending any money on customer acquisition. A number of online gaming vendors like miniclip.com, Jagex, Big Point, and
Kongregate have been able to build significant audience without reportedly spending any money on digital marketing.
Ability To Respond To Changing Consumer Demands
“It [online gaming] is more similar to a Web 2.0 business model than a pure video gaming business. The traditional video
gaming business companies are in a retail business where you ship games and then it's a one-off sale until there is a next
expansion or sequel. … We have a large number of experienced, dedicated, full-time employees whose job is to interact
with our gamers and generate revenues. We get gamers' feedback, their needs and wants and desires, and we funnel that
information directly toward our developer and then we update the game on a regular basis.”
Joshua Hong, CEO, K2 Networks
Gaming is largely a hit-driven business, and predicting a hit or miss before a game launch is not an accurate science—it is
more of a guessing game. In the traditional video gaming business model, after a game is launched, there is a little that
the gaming vendors can do to fix issues with the game or make changes based on the users’ response. The traditional
gaming vendors rely a lot on focus group studies and consumer behavior studies conducted during the product
development stages and before the game launch.
Unlike traditional gaming vendors, online gaming vendors have the ability to make regular updates to their games based
on the players’ behavior/demands. Sophisticated gaming companies spend considerable resources in gathering and
analyzing implicit and explicit consumer feedback to update their games, which reduces the risk profile of the business.
735,000 Songs
2.3 mil Books
25,000 DVDs
39,000 Songs
130,000 Books
3000 DVDs
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May 4, 2009
Industry Report
Emergence Of Social Gaming: Convergence Between Gaming And
Social Media
“What makes social gaming particularly interesting…not only the viral distribution of games, but also the ability to create
game play where the game knows who your real world friends are and let you play with them…the emotional drive to play
is not to kill time or escape but rather to socialize, communicate and express, much like why we play board games, ball
games or card games in real life.”
Kristian Segerstråle, CEO, Playfish
“For the first time ever, we're letting them [users] engage in games with their real friends in their real social networks.
Gaming is a fundamentally social experience, not a single-player experience, and not a technology experience. We are
bringing gaming back to its roots.”
Mark Pincus, CEO, Zynga
We define social gaming as games that are played on a social network or virtual worlds between friends. Social networks
could be existing networks (e.g., Facebook, MySpace) or networks designed especially for gamers (e.g., Arcadia). Social
games bring a fundamental shift in the video games—away from a single player shooting aliens or killing monsters to a
fun activity where one is playing with one’s real life friends in a virtual environment. Social gaming enables players to play
against their real life friends and provides a place to hang out in a gaming environment thus taking the games back to its
roots of fun activity.
We believe social networks have been the hottest trend in 21
st
century, exhibiting the fastest growth of any media.
According to industry sources, more than two-thirds of online users have participated in a social network over the past
year, and this number is expected to rise. The trend is not limited to the young users anymore, and people ages 35-54
years have shown the highest growth of any demographics.
Exhibit 10: Time To Reach 150 Million Users/Units
89
38
14
7 5
0
10
20
30
40
50
60
70
80
90
Years
Telephone Television Cellphone iPod Facebook
Time to Reach 150 Million Users/Units
Source: Portio Research, CNN Money
Games are one of the most widely used and fastest-growing categories of applications on social networks. Most of the
social games are based on a free-to-play model and monetize users through premium subscription, in-game ads, virtual
item sale, incentive marketing, and application installations. We do not expect the vast majority of the users to directly pay
for the games, and believe gaming companies will be monetized through in-game ads, while a small percentage of the
players (10-15%) will convert to paying users either through subscribing to premium content or regular buyers of virtual
goods.
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May 4, 2009
Industry Report
Drivers For Social Gaming
Large Underpenetrated Market
Today’s generation is connected on social networks. According to comScore, more than two-thirds of Internet users are
also on social networks, and the number is still growing. The popularity of the social networking sites is not just limited to
the Y generation, more and more people 35 years of age and older are also joining these social networks. The latest
statistics regarding Facebook users show that the number of users in the 35-54 years of age population has increased
10x versus 88% growth for the 18-34 years of age group since October 2007. Not only are more people joining these
social networks, but they are also spending more time on these social networks. According to Hitwise, the average user is
now spending approximately 27 minutes/day, up 71% Y/Y.
We believe the reach and the demographic of the users on these sites make the social networks fertile ground for the
game vendors to acquire users, build awareness, and create buzz through viral marketing. We believe that the penetration
of games on social networks remains less than 10% and suggests significant room to grow.
Exhibit 11: Comparison Of Internet And Social Networking Growth
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
2007 2008
Internet Users
Social
Netowrking
Users
Consoles
Installed Base
Source: NPD, Internetworldstats.com
Viral Marketing
“Over 95% of our growth is viral. In fact, when we launched our first title a year ago, we started by inviting 100 of our own
friends and we've grown from there to over 60 million registered players across our games organically.”
Kristian Segerstrale, CEO, Playfish
The other day, I got a message on Facebook, “Pamela (real name substituted with a similar sounding name) thinks that
you would cheat on your wife. See what else Pamela is saying about you.” I knew very well that it was a bait to lure me to
add another time waster application, but it was coming from Pamela, my old school friend, and I just couldn’t resist finding
out what she was saying about me (and seriously, I had no idea that Pamela could have said such things about me for the
promise of some measly virtual goods). Funny part was that the application was fun and I ended up saying some nasty
things about my other friends, and I am sure that, just like me, my friends must have received the notification (such as Atul
thinks you are a liar. See what else Atul is saying about you); and probably they must be checking out this application and
saying nasty things for their friends and so on. All of these people checking out the application and evangelizing the
application without a single penny out of the company’s pocket, now that is the power of viral marketing.
A person can see viral marketing in action if he/she plays Playfish’s Who has the Biggest Brain on Facebook. After the
player completes the game, it will ask the player to send his/her brain-weight score to friends who have never played Who
has the Biggest Brain, inviting them to play and compare their brain-weights with that of the player (user acquisition) and
send a tout to friends who have already played this game (repeat players); and, of course, as one can imagine, the friends
the player touts will most likely beat the player’s score and tout the player and others back.
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May 4, 2009
Industry Report
Viral marketing refers to users promoting an application to other users without getting directly paid for their efforts. For
online gaming vendors, social networks offer an inexpensive way of marketing their games to new users and improve
stickiness through viral distribution. We believe that social networking sites level the playing field for small developers to
compete with large companies like Electronic Arts (recall the success of Scrabulous, developed by two brothers in remote
corners in India, which became a rage on Facebook through viral marketing).
Exhibit 12: Example Of Viral Distribution
Source: Playfish’s Who has the Biggest Brain on Facebook; Playfish’s Who has the Biggest Brain invites you to send a
tout (Who is your Daddy Now!) to your friends on Facebook, whose score you have beaten.
For social networking sites, games provide an easier way to monetize their users, in our view.
Despite significant size, strong community, and solid ecommerce platforms, most social networks have struggled with
monetizing their users. With ARPU hovering in the range of $0.10-0.25/month for most of the social networks versus as
high as $150/month for some of the online games, social networks do look under-monetized. Most social networks rely
largely on banner and text ads for user monetization, but, given low conversion rates (less than one-tenth of a percent),
display ad rates for most social networks hover at about $0.10-0.25 cost per thousand (CPM) versus as high as $35 for
video ads and $8 for display ads for in-game advertising. We believe online games provide a natural way for the social
networks to monetize users through in-game advertising and more importantly through virtual goods sales.
Games can also help social networking sites strengthen community bonding among their users.
We believe that not only will games help social networking sites monetize their users, but they will also help to increase
the stickiness of these social networking sites. Games are known to bring communities closer, to encourage user
interaction and active participation (e.g., more than two million user-generated content on Spore, and more user-
generated content on Halo than YouTube videos produced in a month), which is the lifeblood for social networking sites.
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May 4, 2009
Industry Report
Market Size Estimation For Social Gaming
Exhibit 13: Addressable Market Size Estimation For Social Networking
2008
2011E
Best Worst Base
Population (million) 337 368 368 368
Internet Penetration 74% 80% 74% 77%
Internet Users (million) 248 295 273 284
Social Network Penetration 53% 80% 60% 70%
Social Network Users (million) 131 236 164 198
Gamers on Social Network 25% 50% 25% 40%
Gamers on Social Network (million) 33 118 41 79
Paid Users
(Virtual Goods, Premium Subs) 2% 10% 2% 5%
Paid Users (million) 1 12 1 4
ARPU - Paid Users ($/month) $2 $10 $2 $5
Market Opportunity - Paid Users
($ million) $16 $1,414 $20 $238
Ad Supported Users 98% 90% 98% 95%
Ad Supported Users (million) 32 106 40 75
Hours Game Play/Week 5 5 5 5
Ads Served/Hour Game Play 20 20 20 20
Total Ads Served (billion) 167 551 208 392
CPM $0.30 $5.00 $0.50 $2.00
Ad Revenue Opportunity
($ million) $51 $2,757 $104 $784
Effective ARPU ($/month) $0.17 $2.95 $0.25 $1.07
Addressable Market Opportunity
($ million) $66 $4,172 $124 $1,023
Source: ThinkEquity LLC estimates
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May 4, 2009
Industry Report
16 Of The Top 50 Applications On Facebook Are Games
Rank Game Developer Monthly
Active Users
(in thousands)
Reviews
7 Texas Hold’Em Poker
Play Texas Hold'Em with your fb friends. Get free chips every day that you
play.
Zynga 12,330 5,047
8 Pet Society
In the world of Pet Society you and your pet can have a great time! You can
play games, decorate your house, and even bring gifts for your friends
when you visit them. Play now and share the fun with everyone!
Playfish 10,567 70,431
9 Mafia Wars
Start a Mafia Family with your friends, do Crime Jobs for cash, buy
Powerful Weapons, and Fight!!!
Zynga 9,494 9,394
18 YoVille
YoVille is a world where you can buy new clothes for your player, purchase
items for your apartment, go to work, and meet new friends. Join YoVille
today for free!
Zynga 5,347 3,496
25 Geo Challenge
Geo Challenge takes you on a tour around the world as you put your
geography knowledge to the test!
Playfish 4,051 494
28 Word Challenge
Word Challenge is the addictive new word game featuring vivid animations,
40,000+ words, 20 vocabulary types, a bonus game mode and weekly,
monthly, and all-time top scores.
Playfish 3,531 1,846
29 Who Has The Biggest Brain?
Think you are smart? Play this highly addictive brain training game to prove
it! Ever wondered Who Has The Biggest Brain amongst your friends? Play
and invite your friends to find out!
Playfish 3,517 2,300
31 MindJolt Games
Play over 500 games. At MindJolt Games you can play any of the Arcade,
Puzzle, Strategy, and Sports games we offer for free.
MindJolt 3,220 388
33 Bowling Buddies
Go bowling with your friends! Featuring stylish 3D graphics, easy controls,
tons of achievements, customized characters and challenges against your
friends.
Playfish 3,685 2,125
36 Street Racing
Pimp your rides, start a crew with your friends, and race! "It don't matter if
you win by an inch or a mile. Winning's winning." - The Fast & The Furious
Zynga 2,690 5,300
39 Vampire Wars
Drink the blood of the innocent and tear your enemies limb from limb in
Vampires!
Zynga 2,641 7,054
42 Kidnap! is an international game of Nap or be Nap’d! Pick your favorite city
in the world and cram all your Friends inside! Time is running out. With
Nappers popping up across the globe, it’s literally you against the world!
Context
Optional
2,494 598
44 Friends For Sale!
Buy and sell your friends as pets! You can make your pets poke, send gifts,
or just show off for you. Make money as a shrewd pets investor or as a hot
commodity!
Serious
Business
2,151 2,801
45 Mob Wars
Join the Mafia, and start your own mob. Band together with your friends to
become the most powerful force in the elite criminal underworld of
Facebook.
Mob Wars 2087 18,174
46 Poker Palace
Play for FREE in the best poker game on Facebook! Fun & Easy!
Trevor
Smith
1,917 362
48 Minigolf Party
Get your golf on and join the fun with Minigolf Party! This crazy collection of
courses takes you on the minigolf ride of your life.
Playfish 1,866 553
Source: Facebook as on 04/21/09
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May 4, 2009
Industry Report
Mobile Games Coming Of Age
We define mobile games as the games played on mobile phones, and smart phones (not including games played on the
handheld consoles like the PSP or the Nintendo DS). Games started making their appearance on the cell phone almost
from the time commercial cell phones were launched. The first mobile game was Snake (launched in 1999) that came pre-
installed in Nokia phones and has been reportedly played more than a billion times.
Exhibit 14: Evolution In Mobile Phones
Source: Company Websites (from left to right): Motorola DynaTac launched in 1983; Screenshot of “Snake,” the first
mobile game launched in 1999; iPhone (launched in 2007); and Electronic Arts games on T-Mobile G1 aka gPhone
launched in 2008
With improving hardware, increasing ubiquity of broadband on mobile devices, and increasing affordability, we believe
mobile gaming is quickly coming to the mainstream in the United States. The audience for mobile games is not just limited
to core gamers, but has expanded to include professionals looking for easy stress busters between meetings or while
traveling, and teenagers who are now increasingly mobile. Mobile games (such as Snake) can come pre-installed with
phones, or can be bought through mobile operators’ e-stores or, more commonly, now from third-party stores (e.g., Apple
AppStore). Players can play these games by themselves or they can play against their friends.
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May 4, 2009
Industry Report
Drivers For Mobile Gaming
Ubiquity Of Cell Phones
Cell phones can be found almost everywhere, in our opinion. The number of cell phone subscribers in the United States
has grown almost 10x to 262 million in 2008 from 28 million in 1995. Worldwide, the number of mobile subscribers has
more than quadrupled over the last seven years to 4.1 billion in 2008 and is expected to reach 5.2 billion by 2011,
according to Infonetics Research. The number of mobile users far exceeds the number of gaming consoles (about 100
million for the current-generation consoles, 260 million for the current- and previous-generation consoles combined) and
the PC population (about 1 billion) or Internet users (about 1.5 billion) combined.
Exhibit 15: The Number Of Mobile Subscribers Has More Than Quadrupled In The Last Seven Years
-
500.0
1,000.0
1,500.0
2,000.0
2,500.0
3,000.0
3,500.0
4,000.0
4,500.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
MobileSubscribers(million)
Source: International Telecommunication Union
Not only do mobile subscribers outnumber the PC users and gaming console users, we believe mobile phones are almost
everywhere. While someone cannot carry a console or a PC all the time, a person is almost always carrying a cell phone.
Therefore, when boredom strikes, people are more likely to reach out to their cell phone for a quick game, which we
believe makes the cell phone an attractive candidate as a game console.
Hardware Reaching To Age
“The iPhone is the archetype and the inflection point, but Apple alone cannot supply all the demand. Hence, we now have
a clone industry making things like the Google Android and many manufacturers and all carriers and channels will get in
on the act. It will take a few years to build industry capacity, but we are now officially in the go-go growth phase.”
Trip Hawkins, CEO Digital Chocolate
Not only are phones becoming ubiquitous, phones are also increasingly becoming more sophisticated. Some of the next-
generation phones promise to deliver a gaming experience comparable to that of a gaming handheld device (like a
Nintendo DS or a PSP) or even that of a gaming console.
Exhibit 16: Potential Upcoming Mobile Phones
Source: Company Websites (from left to Right): Nokia Concept Phone, Nokia n81, Anycall 5200, and Samsung SPH-
B5200
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May 4, 2009
Industry Report
We believe that the inflection point in mobile gaming truly came with the launch of the iPhone. With its 3.5” color screen,
multi-touch capability, robust processor, 3-D graphics capabilities, and accelerometer, the iPhone was the first mobile
device capable of playing full-fledged games, such as Sim City 3 and Spores. And people have taken note of it, they are
using iPhone as a gaming device and they have even ditched their gaming handheld device in favor of the iPhone.
According to ComScore, 32.4% of iPhone users have downloaded a game, compared with a market average of 3.8%.
The success of the iPhone has attracted a number of iPhone clones, and also some serious players that are positioning
mobile devices as video game players.
Increasing Affordability
We believe that falling hardware prices plus an alternative revenue model for games make mobile gaming within reach of
the masses. Especially in the emerging markets where the PC or console penetration is low, mobile devices offer a good
gaming platform and with affordable revenue models (combination of premium subscription, ad supported, virtual goods),
mobile gaming could be one of the cheapest sources of entertainment for a big population. The Asia/Pacific region is
already the largest mobile gaming market, estimated at $2.3 billion and expected to reach $3.4 billion by 2011, according
to Gartner.
Increasing Broadband Speed On Mobile Devices
With increasing wireless data speed on mobile devices, players can easily find and play against their online friends.
Increasing broadband speed allows players to play online games with no lags within an immersive 3D environment.
Exhibit 17: Broadband Speedometer
Broadband Speedometer – Maximum Download Speeds
Wireline 2.5 G Wireless 3G Wireless 4G Wireless
Cable
Modem
768kbps
30Mbps
56kbps
144kbps
144kbps
384kbps
2Mbps
3Mbps
3.6Mbps
2Mbps
Dial-Up
ADSL
IXRTT
GPRS
EDGE
EVDO UMTS /
WCDMA
HSDPAEVDO
Rev. A
WiMAX
20Mbps
FiOS
30Mbps
3Mbps
1.5Mbps
ADSL
ADSL
15Mbps
5Mbps
FiOS
FiOS
NottoScale
Source: CTIA Website
Lucrative Business Model For Wireless Operators And Platform Vendors
In our view, gaming provides an attractive revenue stream for mobile operators in the form of accompanying sale of data
plans and also revenue share with game developers. Although the revenue from gaming remains pretty small compared
to the overall mobile business, it could start to look as an attractive way to grow a company’s ARPU as it struggles with
falling prices and slowing growth. Not only is the opportunity lucrative for carriers, we believe that it makes a lot of sense
for gaming vendors, as the incremental cost of porting existing games on a new platform is minimal and, therefore,
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May 4, 2009
Industry Report
incremental profit margins substantial. According to an article in The Wall Street Journal, Simon Jeffery, the U.S. president
of Sega said he believes that [despite 30% revenue share with Apple] "games sold via the AppStore are the most
profitable in terms of any of the formats.”
Emerging Standardized Platforms For Gaming
Historically, non-standardized phones, varied carriers specifications, and multiple operating systems meant that the
mobile gaming companies had to port their games on a number of platforms and support hundreds, if not thousands, of
SKUs, which involved significant upfront costs and maintenance costs and stifled innovation. With the emergence of the
iPhone (although a proprietary platform, given the high reach of iPhone, it eliminates the need to support multiple
platforms to achieve similar penetration), Google Android, and Nokia Ngage, the mobile gaming market, in our opinion,
will concentrate to a few standardized platforms, which should make the job of maintaining and supporting versions of
mobile games easier for the developers and encourage innovation.
Easy To Use And Consumer-Friendly eStores For Games
We believe that improving user experience for buying and installing of mobile games will drive adoption of mobile gaming.
Historically, most people played only those games that came pre-installed with the mobile phone, given that the process of
installing games on the phone has been pretty complex. Apple changed that with the launch of AppStore, which made the
process of browsing, searching, downloading, and installing games very easy and user-friendly. The popularity of
AppStore can be gauged by the fact that since it opened in July 2008, and there have already been over 500 million
applications downloaded on 17 million iPhones, i.e., about 72 apps/year/iPhone versus 2.5 apps/non-iPhone smartphone
owner (Source: MMteric 1/31/08 Survey of U.S. Mobile Owners).
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May 4, 2009
Industry Report
Potential Market Size—Mobile Gaming
Mobiles games have come a long way since their humble beginning as a “Snake” in 1999. Gartner estimated the
worldwide mobile games market at $4.3 billion in 2007, and expected it to grow at 22% over the next five years. In the
U.S., mobile gaming was estimated at $717 million, with an estimated growth of 24%. The Asia/Pacific region is the
largest mobile gaming market, with revenues estimated at $2.3 billion in 2008.
We believe that the potential opportunity for mobile games could be more than $2 billion in the United States alone.
Exhibit 18: Market Size Estimate For Mobile Gaming
Number of Mobile Subscribers (million) 225
Penetration of Games 25%
Potential Market (million Subscribers) 56.25
Average Spend/Day $0.10
Potential Market Size ($ million) $2,053.13
Source: ThinkEquity LLC estimates
Our assumption of $0.10/day for mobile games is based on the average pay for other mobile services commonly
available.
Exhibit 19: Average Cost Of Mobile Value Add Services ($/day)
$0.00 $0.05 $0.10 $0.15 $0.20 $0.25 $0.30 $0.35
SMS (200/month)
Wikimobile
MobiRadio
Weather Channel
Games Service (Our
Assumption)
Source: ATT Wireless
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May 4, 2009
Industry Report
Weapons Of Price Discrimination: Free-To-Play, Pay-For-Items Model
Imagine yourself as a game publisher working on the latest and the greatest game. As a game marketer, you know that
your audience is composed of roughly three core segments:
• Core Gamers: These players will play your game five hours a day, seven days a week. They will be waiting in the line
from early morning on the day of release to get their hands on the first copy of the game.
• Ex-Core Gamers: These used to be core gamers, but now because of the work/family pressure, they don’t have the
same time commitment for the games as they had before. Nonetheless, their love for the latest games is not lost, and
they are willing to make-up their lack of time by spending extra on the games.
• Price-Cautious Gamers/Students: These love to play games as much as core gamers, but don’t have enough money
to buy all of the latest games. They will probably wait for someone to sell a used game or worse they will be
downloading a “crack” copy of the games.
In a traditional business model, a company can price its game at about $40-60 and capture a part of the first two
segments, and if the game is successful, the company will come up with a sequel, charge full price, and offer the previous
release at a deep discount in hopes of capturing the last segment. However, by charging a fixed price, it may be leaving
money on the table as its top customers in the first and the second segment might be willing to pay much more than the
list price of the game (and in many instances they are already paying to black marketers for the first copy of the game or
to gold farmers to advance them in the game). What if there was a way to capture more value from the top two segments
and also capture some value from the third segment, without antagonizing your core customers?
In contrast to the traditional model where companies charge a fixed price to all of the prospects, the “free-to-play” (FTP)
model allows customers to self select the segment they belong to and pay accordingly. In addition to offering price
discrimination, the FTP model also enhances the community around the game (lure of free to play), increases longevity of
the game, and helps increase the game’s stickiness. FTP games can be monetized either through ads (more on this in the
next section) or through the sale of virtual goods.
Virtual goods are digital goods that people will buy using real money in order to get additional functionality (e.g., virtual
currency), more power to their avatars (e.g., better swords, more powerful weapons), to customize and improve their
avatar’s look (e.g., cool sunglasses, designer jeans), or as a token of appreciation to other players (e.g., virtual flowers,
birthday cake). The virtual goods model has been very successful and is the most-dominant model in Asia. We believe
that with the increasing popularity of online gaming and with the Y Generation’s comfort level in expressing itself via the
Internet, the virtual goods model is likely to take off in the U.S. and other Western countries too. Taking a cue from the
success of the virtual model with companies like Sulake, Second Life, Facebook, Gaia Online, K2 Network, Nexon,
Acclaim, and Aria, we believe that more online gaming companies will experiment with the virtual goods model in the
West.
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May 4, 2009
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Exhibit 20: Examples Of Virtual Goods
Source: Games Screenshots (clockwise from top left): Webkinz, Disney’s Club Penguin, Sulake’s Habbo, Puzzle Pirates,
Zwinky, and Nexon’s Maple Story
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May 4, 2009
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Drivers For Free-To-Play Model
“…some of the old players will continue to play subscription-based MMO, or console games, but the younger audience is
different, they start right from the free-to-play experience and once you get the taste of it, then there's no going back. Why
would you want to pay $50, get a game that you don't even know whether you're going to like it?”
Joshua Hong, CEO, K2 Networks
Effective Way To Control Piracy And Build Community
Although the lure of converting pirated copies into legal copies by effective anti-piracy measures may seem lucrative, a
couple real-life examples suggest that the conversion rates remain insignificant (as low as 0.02%) with anti-piracy
measures. On the other hand, anti-piracy measures generally cause inconvenience and, thus, user dissatisfaction for
legitimate buyers, which risks the popularity of the games. For example, Electronics Arts’ “Spore” was one of the top
ranked games, but was also a highly pirated game. As Electronic Arts put stringent anti-piracy controls into place, the
number of illegal downloads was reduced, but so was the ranking. However, the free-to-play model enables vendors to
build community and momentum without worrying about piracy. We believe the question that game vendors will have to
answer is, are they willing to sacrifice community around the game and potentially jeopardize the popularity of the game to
be able to sell an insignificant number of titles or can they find alternative ways to monetize users who wouldn’t want to
pay hard cash for the game? We believe that vendors (especially the newcomers, without the legacy of owned IPs) will be
willing to eschew the loss of upfront sale and embrace the alternative monetization models such as virtual goods.
Virtual Goods Model Enables Price Discrimination
Unlike fixed fee-based models (such as subscription or outright purchase), the virtual goods model allows the vendors to
price discriminate the customers by letting players choose the value they assign to the game. By making the games free-
to-play, vendors are able to attract a larger audience. Players with free time on their hands (like students, cost-cautious
players) will spend time/effort to advance levels in the games, while players who need instant gratification of moving up
the ladder (like ex-core gamers and core gamers) would rely on virtual goods. While we acknowledge that some of the
players who would’ve spent $60 for the game may not spend the equivalent amount in the free-to-play model, we argue
that the free-to-play model will encourage some otherwise non-paying players to spend on the game and some hardcore
players to spend much more than what they would’ve spent with the fixed fee model.
Exhibit 21: ARPU Distribution Curve Of ZT Online, A Free-To-Play Game By Giant Interactive
(20)
-
20
40
60
80
100
120
140
160
- 500 1,000 1,500 2,000
Users ('000)
ARPu($/Month)
Source: Company Reports and ThinkEquity LLC
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May 4, 2009
Industry Report
Perfect Price Discrimination: “Holy Grail” Of Producer’s Pricing
Source: ThinkEquity LLC
P1
P2
P1
P2
P3
P4
P5
P6
Shown on the left is a typical supply-demand curve in a
normal functioning market. The demand curve is represented
with the red line and the supply curve is represented with the
blue line. Equilibrium occurs at a price point where marginal
cost equals marginal revenue, i.e., where the demand and
supply curve intersect. However, at the equilibrium price
point, a number of customers benefit as they only have to pay
the market clearing price, which is lower than their perceived
value of the goods. The amount that these consumers (with
low price elasticity) end up saving is called consumer surplus
(represented by the red shaded region).
Producers use a variety of price discrimination techniques to
minimize consumer surplus and maximize producer surplus.
Simply speaking, price discrimination suggests that producers
can offer the identical goods or services at different prices.
The simplest form of price discrimination is used by retailers
in the form of discount coupons. With the simplest form of
price discrimination, a demand curve is divided into two parts
and a higher price (P1) is charged to the consumers with low
price elasticity while a lower price (P2) is charged to
consumers with high price elasticity.
The “Holy Grail” for the producer is to achieve perfect price
discrimination, i.e., charging every consumer the price that he
or she is willing to pay, thus fully eliminating consumer
surplus.
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May 4, 2009
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Increase Longevity And Improve Games’ Stickiness
Unlike a fixed fee game, where players are only putting in efforts to advance levels, in the virtual goods model-based
games, players advance levels though efforts as well as through spending hard cash on virtual goods. And so, with every
virtual goods purchase, players are increasing their investment in the game and thus increasing switching costs for
themselves, increasing the longevity of the games. In addition, the free-to-play model attracts more users (lure of free)
and the larger community itself becomes a draw for new players.
This was evident in the example of Shanda, a Chinese gaming vendor that was able to grow revenue and increase useful
life of its games by converting the business model from a subscription model to free-to-play model.
Exhibit 22: Annual Revenue Contribution From Shanda’s Legend Of Mir 2
$0
$50
$100
$150
$200
$250
$300
2004 2005 2006 2007 2008
Year
Revenue($million)
Source: Company Reports (Shaded area represents the game was converted to free-to-play model)
Emergence Of New Payment Channel
Players under 18 years of age account for 25% of video games sales and likely account for a much-higher percentage of
the online gamer population. Being underage, these players usually do not have access to the popular payment methods
like credit cards or PayPal. In the past, gaming vendors struggled with the issue of accepting payment from the younger
players. Gaia Online, which has a large percentage of users in this demographic, has full-time personnel who open
envelopes to collect cash mailed by their players to purchase virtual goods.
Nexon changed that with its Maple Story pre-paid cards. Pre-paid cards are popular in Asian countries. The idea of a pre-
paid card is that the users pay in advance to buy prepaid cards and enter the code to their online account to get credit for
the value of the pre-paid cards. Since the pre-paid cards are available at retail locations, younger players can use their
allowance to easily buy the cards from the retailer and use the credit to play games. Increasing acceptance and popularity
of the pre-paid cards could cause more vendors to experiment with the virtual goods model.
Generation Y’s comfort level with virtual worlds will likely translate into increased popularity of the virtual goods
model, in our opinion.
“A lot of old gamers, who grew up playing console games, may not be comfortable with this model, but the younger
generation is very comfortable with it. We have already seen the changing consumer preferences transform businesses
like Facebook and Twitter.”
Howard Marks, Founder & CEO, Acclaim
While some may snicker at virtual goods, others, especially those from generation Y, who are comfortable at expressing
themselves via social Internet sites such as Facebook and Twitter, seem to also like virtual goods (e-greetings, e-flower,
e-pet) as a way to express themselves in a similar way others find it natural expressing themselves by wearing a certain
brand of clothes or jewelry. Having grown accustomed to the connected experience of the social networking and virtual
goods in social sites, these users find themselves at ease with virtual goods in games that can help them advance levels.
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May 4, 2009
Industry Report
We also have the precedence from the example of the Chinese and Korean gaming industries where a number of users
(mostly first-time gamers who didn’t have any preconceived notion about a virtual goods model) readily embraced the
virtual goods model, making it the most-dominant business model in those countries. We believe that the generation shift
will accelerate popularity of the virtual goods model in the Western countries as well.
Ability To Grow ARPU
The virtual goods model, by definition, delimits ARPU. Unlike the subscription model or outright purchase model where
users pay a fixed fee for one-time purchase or monthly (or hourly) subscription, users in virtual goods pay based on their
engagement level with the game—the more they are engaged, the more they value the game, the higher their spending is
likely to be. The virtual goods model gives vendors the ability to link customers’ perceived value with the price of the
game. It’s no surprise then that smart companies can do a perfect segmentation of the market and optimize the price-
demand curve of their product.
Exhibit 23: Game Spend As A Percentage Of Per-Capita Income
Games Spend as %of Per-Capita Income
0.00%
0.02%
0.04%
0.06%
0.08%
0.10%
0.12%
0.14%
0.16%
2003 2004 2005 2006 2007
China
U.S.
South Korea
Source: ThinkEquity LLC
Virtual Goods Model = Unpredictable Cash Flow? We don’t think so.
A common misconception around the virtual goods model is that the revenue stream under the virtual goods model is
unpredictable since the virtual goods purchases are largely driven by the whims of the players. Although we acknowledge
that the rules of the game in this model change and the vendors have to be more proactive with updates and other
reasons to encourage players to spend, we believe that gamers who are engaged with the game will continue to pay for
the game as long as they see the right reason and value in spending. In fact, most of the Chinese gaming companies that
work on the virtual goods model have seen their ARPU at a very consistent level after rising in the early stages.
Exhibit 24: ARPU Of Chinese Gaming Companies (US$/Month)
-
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
1Q06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08
SNDA - Casual
SNDA - MMO
PWRD
GA
GIGM
Source: Company Reports
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Market Size Estimation Of Virtual Goods In Games
“Micro-transaction is essentially a form of pricing model and will have a meaningful share of the market in the U.S.
because it provides more options to players.”
Joshua Hong, CEO, K2 Network
“The market [free-to-play, virtual goods based] is already a few hundred million dollars revenue per year...could easily be
a billion dollar market.”
Heiko Hubertz, CEO, Big Point
“Virtual goods have only recently gone mainstream, and for every publisher that currently sells virtual goods, there are
probably another five or six that are planning to do so soon. As consumers become more accustomed to virtual goods,
and as the payment systems for acquiring those goods become more ubiquitous, the size of the market will expand
exponentially.”
Anu Shukla, Founder and CEO, Offerpal
We estimate the total addressable opportunity for virtual goods model games to be in the $2 billion range in the U.S. Our
estimate is based on the assumption of $14 ARPU per month per paying player, which we believe is reasonable
considering most of the virtual-goods-model-based online gaming companies that we talked to reported ARPU of $10-
25/month/paying user. For our market size estimate, we are assuming 10% penetration (active paying users to the
addressable gamers i.e., 15-45 years of age and an Internet User), which we believe seems reasonable compared to the
22% average for the Chinese gaming industry.
Exhibit 25: Addressable Market Size Estimate For Games Based On The Virtual Goods Model
China U.S.
Total Population (million) 1330 337
Internet Users (%) 22% 73%
Internet Users (million) 298 247
Population 15-45 Years Of Age (% of total) 41% 44%
Addressable Population (Internet Users And 15-45 Years Of Age
(million) 122.2 108.7
Paying Online Gamers (million) 27.1 10.9
Paying Online Gamers (%) 22% 10%
ARPU/Month/Active Paying User $5 $14
Per Capita GDP $6,000 $47,000
ARPU/Per Capita GDP (basis points) 7.9 3.0
Market Potential for Virtual Goods ($ million) $1,540 $1,839
Source: IDC, InternetWorldStats, ThinkEquity LLC
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In-Game Advertising
In-game advertising refers to advertisements that are made either within a game or used as a wrapper around games. We
believe that with broadening scope and increasing ubiquity, games are emerging as a new media just like newspaper, TV,
and Internet. While the effectiveness or the reach of the traditional media is declining—the conversion rates on Internet
remain at very low levels, newspaper readership, and TV viewership continue to dwindle and TiVo complicating the ad
delivery on TV-game play time has continued to increase. We believe the amount of time and energy that consumers
spend playing games are too big to ignore from a marketer’s perspective. In-game advertising was traditionally limited
because of non-availability of technology. Our view is that with the recent advancement in in-game advertising technology
(ability to insert ads at any stage of game’s life-cycle, ability to serve ads dynamically) and ability to verify and measure
effectiveness of in-game ads, the marketers will be more amenable to embrace the idea of in-game ads. Like Internet
advertising, in-game advertising is measurable and accountable (unlike the effectiveness of advertising in traditional
media, which is difficult to measure). We believe that sophisticated marketers are already taking notice of games as a
media (see Exhibit 26 on President Obama’s presidential campaign ads in-games). Games give marketers a captive,
targeted audience who most of the time is willing to watch ads in return of the value provided for free.
Exhibit 26: President Obama’s Presidential Campaign Ads In Games
Source: Screenshots from Electronic Arts’ Burnout Paradise and NBA Live
In-Game Advertising For Consoles Games
Consoles are emerging as media devices capable of playing not just games but also watching movies, downloading
music, and surfing the Internet. Similarly, publishers are increasingly looking to monetize their games with ancillary
revenue streams such as licensing for movies, character dolls, and increasingly in-game advertisements. Given
measurability, accountability of in-game ads (as compared to TV), and a more highly targeted audience, and high brand
recall (30% ad recall after six months for in-game ads versus typical 10% ad recall for traditional ad campaign per a study
by Nielson), in-game ads for console games offer compelling value proposition to marketers, in our opinion.
In-game advertising for the console game was popularized by Massive Incorporated (now part of Microsoft). The
competitive landscape for in-game advertising is mostly limited to Massive, IGA Worldwide, and Double Fusion. While
Massive is mostly focused on ads on the Xbox platform, IGA Worldwide and Double Fusion work with Sony Play Station
Console games.
• Static In-Game Advertising: The first generation of in-game ads, static in-game advertisements refer to
advertisements that are hard-coded in the game environment. These ads can be in the form of product placement
(e.g., Coca Cola vending machine in Splinter Cell), billboards (Sprite bill board in Splinter cell), or even as the part
of the game play (Ax Deo Glowing Wall as an obstacle that players need to overcome in Splinter Cell). However,
since static ads are hardcoded, they cannot be removed, altered, or tailored according to gamers
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demographics/preferences. Furthermore, these ads should be available even before the game is published (which
makes it a difficult proposition—success of the game unknown). We believe most ads are now moving to second-
generation dynamic in-game advertising.
Exhibit 27: Example Of Static In-Game Advertising—Sprite In Ubisoft’s Splinter Cell
Source: egamemarketing.com
• Dynamic In-Game Advertising: Unlike static ads, dynamics ads can be delivered based on the players
preference/demographics, and ads can be changed over time too. Game developers build “hooks” in the game
environment (receptor of in-game ads) and no advertisement is hardcoded. Ads are delivered on these hooks via
the Internet when the gaming device is connected to the Web. Dynamic ads also allow the publisher and
marketers to track the ad performance metrics and make tweaks accordingly.
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Exhibit 28: Examples Of Dynamic In-Game Advertisements
Source: Screen Shots from (clockwise from top left): Electronic Arts’ Madden NFL, NBA Live, Battlefield 2142, and
Need for Speed
Advertisers clinch deals with console manufacturers to publish ads on their platforms, clinch deals with game publishers to
place ads in their upcoming titles by offering either upfront fixed fee or revenue share (with some minimum revenue
guarantees), and sells the inventory to its clients (brand managers). In effect, ad networks have to manage the risk of
game success. The typical CPM range is approximately $25 to $35, which likely will come down as more inventory
becomes available.
Since most of the console games are targeted toward core gamers, mostly males within the 18-34 years of age group, the
scope of in-game advertising is primarily limited to brands that cater to this demographic. The scope of in-game
advertisement on consoles is further limited because a number of games may not be appropriate for advertisement, i.e.,
marketers may not want to associate their brands with violent games, and, many times, ads may not make sense given
the gaming environment such as a fantasy realm.
In-Game Advertising For Online Games
Online games are probably the easiest target for in-game advertising since these games, by definition, are all always
online. Ads can be delivered within the game environment or as pre-rolls. In-game advertising for casual games is more
akin to other advertising on other Internet properties rather than in-game advertising on consoles games. In-game ad
networks typically work with game developers, ad enable their games, maintain inventory on a large number of ad-
supported games, publish these games on third-party publishers (such as Yahoo! Games, Real Arcade, etc.), and serve
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ads on these games. Most ad networks are focused on causal games, given the extremely large number of small game
developers in that space and strong demand from gamers for these games.
Exhibit 29: Examples Of In-Game Advertisements In Online Games
Source: Screenshots from (clockwise from top left): Miniclip.com, Kongregate, Second Life, and Gaia Online
We believe that online games could be the bigger segment in in-game advertisement for the following reasons:
- Much Bigger Player Base: Unlike console games that are sold for a fixed price, many online games are launched
in a free-to-play model (supported by virtual goods, premium subscription, incentive marketing, and/or ads), which
broadens the player base.
- Casual gamers also come from broader demographics. In contrast with core gamers who tend to be largely 18-34
year old males, casual gamers encompass a wider demography that includes women, elderly, and younger
players.
- Captive And Engaged Audience That Values Free Content And Is Willing To Listen To The Message:
Furthermore, casual gamers may be more receptive to watch ads as compared to core gamers. Core gamers who
spend hundreds of dollars on consoles and another $50-60 on games may view an advertisement as an intrusion
into their gaming environment versus casual gamers who may be more willing to watch ads. By nature, casual
gamers are interactive and a playful audience that can be lured into game-advertisement and interesting ads
(people watching Super Bowl ads after the game).
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Demand Drivers For In-Game Advertising
Gaming Emerging As A New Media
“Gaming is now becoming a major medium. Research by Nielsen has shown that there has been a 12 percent decrease in
prime television viewership in the demographic of males aged 18 to 34 years vs. a 20 percent increase in the times spent
playing video games for the same group. So the advertisers and their dollars have to follow where the consumers are
going.”
Justin Townsend, CEO IGA Worldwide
Just like the Internet, television, and newspaper, gaming is emerging as a new medium. As the older media are
increasingly becoming less effective (reduced readership of newspaper, reduced viewership of television complicated by
the TiVo effect), advertisers are looking for new ways to reach their target audiences. With the increasing popularity of
online gaming, gaming seems to be promising new media for advertisers to reach young users. The popularity of casual
games has broadened the scope of gaming beyond just the young males to include females and older males and made
games more ubiquitous. As ad buyers are becoming more familiar with the notion of gaming becoming a mainstream
media, we believe in-game advertising growth will continue to accelerate.
Technology Coming To An Age
“To a large part, it's the availability of technology for dynamic in-game advertising which hasn't been available until now—
this technology opened up the possibility for advertisers to once again reach the gaming audience effectively through
standard media buys.”
Jonathan Epstein, CEO, Double Fusion
Strong ROI
“We have a number of case studies that have shown positive results for the programs that our advertisers have done.”
Jonathan Epstein, CEO, Double Fusion
“The research proved that brand recall for ads in games eclipses that for traditional media, as high as 30 percent after six
months vs. less than 10 percent for traditional ad campaigns.”
Justin Townsend, CEO, IGA Worldwide
“Our click rates are …much higher than what you would typically get in any kind of an Internet ad. And to some extent
that's a function of the medium because if somebody's playing a game—they're more engaged, they're focusing on the
window that the game is playing in, and they're more attentive. Whereas, if you're looking at content on a Web page,
you've got ads around the top, bottom, and sides of the page but you're really focusing on the content in the middle.”
George Garrick, CEO, Mochi Media
“Our advertisers have had a lot of success on our site and a lot of those advertisers keep coming back and re-buying. We
leverage our gaming community and the fact that our users are addicted to achievement.”
Jim Greer, Founder & CEO, Kongregate
Unlike traditional media, new media (such as Internet and games) lets the advertisers reach the target segment more
effectively. Using behavior targeting, advertisers can personalize the message for each segments. Using A/B testing and
multi-variate testing, advertisers can see the impact of the message on the fly and tweak and optimize the message. We
believe that in-game advertising offers all the advantages of the online media plus offers more engaged users. While
strong increase of online advertisement has led to “banner blindness” reducing the user engagement and therefore
effectiveness of the banner ads; games offer engaged users. Unlike Internet users, gamers are pretty engaged since they
want to advance to the next level, since they want to win and since they want to share their achievements with their
friends.
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Measurability Of In-Game Ads
“Other forms of display advertising, such as TV, print, and radio may have high reach but lower accountability and one
cannot really determine the ROI on advertising in these means…[our advertising] is also very accountable because our
software sits inside the games and we can measure and report back the effectiveness of the campaign to our advertising
clients.”
Justin Townsend, CEO, IGA Worldwide
Not only are the ads on the games more effective but also measurable, unlike traditional media ads, which improves the
value proposition of in-game ads to today’s sophisticated ad buyers who are looking to see a measurable ROI on their ad-
spend.
Improving Advertisers’ Sophistication Level With In-Game Advertising
“I think for most advertisers, it's still considered a new media at this point. They're spending real budgets, but they
probably are still looking at it as the new medium that they haven't fully figured out yet.” There's a lot of things that
advertisers don't know yet, just because there hasn't been enough time to observe in enough different situations. So we're
getting significant ad buys but we haven't had any million dollar ad buys yet.”
George Garroick, CEO, Mochi Media
“This industry has evolved at a rapid pace…As for the advertisers, we have come a long way in the past two years and I
think the next three to five years, it's going to be a steep upward trend. In the early years, in-game advertising budgets
were mainly from experimental budgets. Now it's coming from the digital budget itself, and in many cases we're seeing
reallocation of budgets from outdoor advertising, print advertising, TV, and other traditional media that opens a big
opportunity for us.”
Justin Townsend, CEO, IGA Worldwide
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Market Size Estimation Of In-Game Advertising
“Look at the size of the videogame market and then look at the size of the TV market. What's interesting with online
games is that we cover both. We're more of an online media company. To understand our potential, look at the value of
Google! Now, where do people spend most of the time online? Is it on searching for things or is it entertaining
themselves? If it's entertaining, then our industry is worth more than what Google is worth.”
Howard Marks, Founder & CEO, Acclaim
We estimate the total addressable opportunity for console games advertisements to be in the $1 billion range. This
estimate is based on our assumption that 40% of the consoles are connected to the Internet and that CPM will stabilize at
about $10.
We believe that the opportunity for ads on online games could be bigger than that for ads on console games. We have
assumed a CPM rate of $2 for ads served on online games.
Exhibit 30: Addressable Market Size Estimate For In-Game Advertising In Console Games
2008
2011E
Best Worst Base
Three-Year CAGR in Console Gamers 10% -2% 5%
Console Gamers (million) 73 97 69 85
Hours Game Play/Week/Player 8.2 9.0 7.0 8.2
Hours Game Play Year (million hours) 31,161 45,522 25,037 36,073
Percent Of Ad-Friendly Titles* 38% 38% 38% 38%
Ad-Friendly Game Play (million hours) 11,763 17,185 9,451 13,618
Consoles connected (%) 20% 50% 30% 40%
Ad-Friendly Game Play on Connected
Consoles (million hours) 2,353 8,592 2,835 5,447
Ads Served Per Hour of Game Play 20 20 20 20
Total Ads Served 47,054 171,846 56,708 108,941
CPM $10 $15 $5 $10
Market Potential for In-game
Advertising ($ million) $471 $2,578 $284 $1,089
Source: NPD, ESA, and ThinkEquity LLC estimates
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* Ad Friendly Video Games By Units (%)
Genre Units % Ad Friendly Ad Friendly
Action 22.3%
Family Entertainment 17.6% 50% 8.8%
Sports Games 14.1% 100% 14.1%
Shooter 12.1% 50% 6.1%
Racing 8.3% 100% 8.3%
Role Playing 7.6%
Strategy 4.7%
Fighting 4.5%
Adventure 4.3%
Children's Entertainment 1.0%
Flight 0.7%
Arcade 0.5% 100% 0.5%
Others 2.3%
Total 100.0% 37.8%
Source: ESA, ThinkEquity LLC
Exhibit 31: Addressable Market Size Estimation Of In-Game Advertising For Online Games
2008
2011E
Best Worst Base
Three-Year CAGR in Online Gamers 10% 0% 5%
Online Gamers (million) 67 90 67 78
Internet Users (million) 248 295 273 284
Online Gamers (% of Internet Users) 27% 30% 25% 27%
Hours game play/week/player 7.0 8.0 6.0 7.0
Hours game play year (million hours) 24,504 37,273 21,003 28,366
Percent Of Ad-Friendly Titles 100% 100% 100% 100%
Ad-Friendly Game Play (million hours) 24,504 37,273 21,003 28,366
Ads Served Per Hour of Game Play 20 20 20 20
Total Ads Served 490,072 745,470 420,062 567,320
CPM $1 $5 $1 $2
Market Potential for in-game
Advertising ($ million) $490 $3,727 $420 $1,135
Source: ThinkEquity LLC estimates
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Who Will Succeed: Characteristics Of Winners In Games As A Service
“In a traditional gaming business, once the disc is pressed and shipped to the retail, more or less the show is over. In the
free-to-play model, once we launch a game the show starts.”
Heiko Hubertz, CEO, Big Point
“This is a new kind of gaming business, and it's not build and publish; it's build and serve and then have recursive loops
around tweaking and serving. It's an always-on business…where you have to have people watching your leading
indicating metrics all the time…you're constantly turning dials.”
Mark Pincus, Founder & CEO Zynga
“When selling games in a retail environment, prominent placement and recognizable brands are important sales drivers.
On social networks, things are different. On social networks, you almost never look for games in a retail or catalogue like
environment; you stumble on them because your friends play them. In fact, there's today not a single game franchise in
the Facebook games top-10.”
Kristian Segerstråle, Founder & CEO, Playfish
“The skills that it takes to make a successful, console game…are very different from the skills that it takes to make a
successful online game. EA excels in having big teams, big marketing budgets, big brands and not necessarily adapting
quickly to changing market conditions, to building a platform, which are what you're going to do online.”
Jim Greer, Founder & CEO Kongregate
Focus On Understating Consumer Behavior
Similar to the differences between the SaaS model and the traditional on-premise Software model (the on-premise model
centers around closing the deals, while the SaaS model is about maintaining the customer base by proving the value of
software every day), the online gaming model is about retaining the user base by delivering a continuously pleasant and
engaging game-play experience. Similar to Web 2.0 businesses, online gaming companies have to continuously collect
customer feedback (implicit and explicit—through various analytical software as well as through In-game non-player
characters), understand and analyze customer behavior, and regularly update the game based on this understanding of
consumer behavior.
Managing Piracy Versus Managing Communities; Aggressive Marketing Campaigns Versus Viral Marketing
Managing online games is about successfully managing communities, in our view. Vendors, who offer the platform for
developing and fostering community bonds can have strong community that is self sustaining, one that can invite their
friends and spread word of mouth. While in the traditional packaged game business, the vendors have to worry about
curbing piracy to grow, the online business is more about nurturing communities. While in the traditional packaged game
business, vendors have to create aggressive marketing campaigns to create buzz around their games, online games are
more about spreading messages by more-sustainable (and practically free) word-of-mouth marketing. Not only do we
believe that the successful companies will use these customer evangelists to spread the word, but they will also use them
for supporting players and handholding new players.
Distribution Is About Viral Nature
Success of the online game is usually proportional to the virality of the games, with the elements of the social interaction
in the game. As we mentioned before, for online gaming, virality drives adoption as opposed to the large distribution
networks. In this marketplace, IPs become less important—success of a game may not necessarily translate into success
of a series of games; players are far less forgiving and expectations are always moving up, people’s
recommendations/number of people playing become more important than the title of legacy of the IP.
Monetization Through Alternative Models
A successful company will typically use all the ammunition on hand to monetize its games. A vast majority of the players
will most likely not pay for the game directly, but these players are equally important as the paying users. We believe that
successful companies want to keep their communities healthy (even those that are not paying users) and will use
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May 4, 2009
Industry Report
advertising to monetize this population. Only a small percentage (5-15%) of the players will be willing to pay for
subscription fees/virtual goods. We believe successful companies will adopt advertising combined with other forms of
monetization to optimize value creation by each player.
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Take A Break: Time To Play Scramble
Unscramble the names of my favorite top 25 video games of all time (in no particular order).
AMIRO
EOKMOPN
EJBEEWELD
ISSM
OORTM KMAATBL
PFEE ERNO DSED
OLAH
NANSYFATAI LF
BAIAE RNG
ATHRNTTEAO D FGU
DNLEF NAMD
FGOGERR
TERSIT
OBSEOBG NP
YALTONCC M
FRAWRATC
NEED LFGHTELAOE Z D
THI RGAOUER
WNW OSCKWDEMA
OL T AFCYDLU
ARMRB ETIOD
AEENGIL
E ENTDILREVSI
AJMBOEN SD
HF LOMNADR EOO
Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
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May 4, 2009
Industry Report
Take A Break: Time To Play Word Search
Find the names of all of the companies featured in the CEO interviews section.
g o o n a e t u d m i i n b x i e
y o i i e d m g l e i d u d x a l
k k m e t a b o l i g n v n i t r
t n i g a i k a c r c l i l t m v
a a f d g x a l a h o w v c v t h
i m a e e i j b b d i f o e l r i
d g i g r o e a h o m m x i n i o
l i a k g r l n i u a e e a e o p
f j l w n l e n i b r u t d i n y
e t a l o c o h c l a t i g i d u
r n p s k r o w t e n o w t k a n
r i r m a a l l h f v o h b i o e
y o e c x g e d t u m i a l c c a
g p f d b l n r w s n e l i b o g
a g f e p l a y f i s h r n a m r
m i o d t p e t z o d n f i o g f
e b l t r a d i a n c e s i e n g
Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
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May 4, 2009
Industry Report
Interviews With The Leading Private Gaming Companies
The images on the following pages are courtesy of the respective companies' Websites.
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Online Gaming: An Interview With The Founder And CEO Of
Acclaim
Company: Acclaim
Founder and the CEO: Howard Marks
THINK SUMMARY
We had a chance to interview Howard Marks, the founder and CEO of Acclaim, a developer and publisher of free-
to-play online games largely focused on the audience in the western hemisphere. We believe that a shifting user
preference toward the social and connected experience will likely drive the popularity of free-to-play and multi-
player gaming, especially with the younger generation, which does not view gaming as a solo experience limited
to consoles. The company is not seeing any impact of the slowing economy, which may reflect the resiliency of
online and free-to-play gaming, and also, the apparent nascent stage of the opportunity.
KEY POINTS
• Acclaim is a developer and publisher of online games, with over 10 million registered users, mostly from
the United States and Europe. The company offers its games as free-to-play and monetizes through
virtual goods sales and in-game ads.
• Given the broad demographic of the gaming audience and the shifting user preference from traditional
media to online games, Marks expects in-game advertising to emerge as a sizeable market opportunity.
• While the older players in Western countries, who grew up playing console games, may find free-to-play,
PC, and multi-player gaming a different experience, the younger generation, which grew up on the
Internet and is used to the connected social experience, such as Facebook, Twitter, etc., is much more
comfortable with the multi-player gaming, free-to-play, and virtual goods model, driving the popularity of
free-to-play multi-player online games, in our view.
• We view favorably the frictionless and scalable model of online gaming that relies on acquiring players
through viral or word-of-mouth marketing, which we believe strengthens community bonds among players
and ultimately helps to promote the longevity of the games.
• According to Marks, the company seems to be benefiting from the slowing economy, which may
represent the resiliency of online and free-to-play gaming and the apparent nascent stage of the
opportunity.
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Atul Bagga, ThinkEquity LLC (AB): Can you explain Acclaim to investors?
Howard Marks, Founder and CEO, Acclaim (HM): In 2005, we purchased Acclaim assets with the goal to restart it
as an online game company based on a free-to-play model. Currently, we have close to 10 million
registered players. We have a few types of games; we have hardcore massively multiplayer online game
targeted toward young males, and we have browser-based games that are targeted toward a broader
demographic. We are also developing our own browser-based game using Flash. And the first one is
being released, called Rockfree. We have another one called Prize Potato, which is on Facebook right
now, and a couple more games, one is called “Kogamu” and the other is called Acclaim Poker.
AB: What is your business model?
HM: All our games are free-to-play and we plan to monetize them through selling virtual goods and ads.
AB: What is the current revenue split from various streams and where do you see that trending over the next
couple of years?
HM: Advertising model is dependent on economic conditions. Longer term, I think that there'll be some
significant opportunities to get brands to target our consumers because brands will have a hard time
finding their audience on TV, radio, or prints, given the declining popularity of traditional media amongst
the younger generation.
AB: Who is your primary target audience?
HM: It depends on the game. Just like a TV network targets a broad audience through a variety of shows, we
target a different audience through a variety of games. The download MMO games are hardcore,
certainly 90% men, usually teenage boys and young adults. The browser-based games target different
demographics. We have games just for girls. We have games like Rockfree, which will be probably 50-50
boys and girls, teenagers, and young adults. Currently, about 75% of our revenue comes from the
hardcore market, but we expect that to change with new games that we are launching now.
AB: Can you talk about the geographies that you target?
HM: We are 65% U.S. Half of the remainder is Europe; the other half is the rest of the world.
AB: What is the typical ARPU on your games?
HM: It depends on the game; the monthly ARPU for hardcore games is generally $25 to $45, and for the
browser games, is $10 to $15.
AB: How big could this market be for Acclaim?
HM: Well, it's pretty simple to calculate. Look at the size of the videogame market and then look at the size of
the TV market. What's interesting with online games is that we cover both. We're more of an online media
company. To understand our potential, look at the value of Google! Now, where do people spend most of
the time online? Is it on searching for things or is it entertaining themselves? If it's entertaining, then our
industry is worth more than what Google is worth. So we think the potential is pretty big.
AB: What are the secular drivers for online games, and free-to-play, ad supported, and virtual goods models?
HM: A big size portion of the ad market is going to go towards us because the consumer is changing their
habits. As they change their habits over time, like they did with the record industry, that's where you
capture the value. So we're already seeing a transfer of value from the traditional media, like TV to
games. With video games, it was hard to capture user behavior post the game sale; with online games, it
is very easy to capture and that will drive the advertising sale on games.
As for the virtual items model, it is about changing consumer preferences. A lot of old gamers, who grew
up playing console games, may not be comfortable with this model, but the younger generation is very
comfortable with it. We have already seen the changing consumer preferences transform businesses like
Facebook and Twitter. We have already seen success of the model in Asia, where online games has
become a quite significant industry compared to TV and music.
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GaaS Whitepaper 2009

  • 1. Please see analyst certification (Reg. AC) and other important disclosures on pages 210-211 of this report. Think Entertainment: Gaming The Emergence Of Games As A Service THINK SUMMARY: Over the long term, we believe that gaming will emerge as a true multi-channel Games As A Service, where players will be able to play games on multiple channels with the game experience optimized for each of the channels and profile information seamlessly carried across the platforms. In the meantime, we expect strong growth in online gaming, social gaming, mobile gaming, and alternative business models. A large population of Internet users and the efficiencies of the digital channel will drive growth in online gaming, in our opinion. We think that social gaming will be another growth area, driven by the large reach and viral nature of the social networks. Similarly, we believe that the ubiquity of mobile devices and the emerging devices and platforms will put mobile gaming on a strong growth trajectory. With strong growth in the number of gamers, gaming is fast becoming an attractive alternative media for advertisers, in our view. We are also optimistic about the virtual goods model, which we believe could get a boost from the Generation Y's comfort level with Internet and virtual worlds. KEY POINTS: • Long term, we believe that gaming will emerge as a true multi-channel Games As A Service, where players will be able to play games on multiple channels (PC, gaming consoles, and mobile), with the game experience optimized for each of the channels and profile information seamlessly carried across the platforms. • Given the advancement in technologies, today's PCs are robust gaming machines, comparable to the dedicated gaming consoles. Also, we believe the large population of Internet users (15-20x that of the gaming console base) plus inherent advantages of online distribution make the Internet an attractive gaming platform. • We believe that the social networking sites not only create a platform for viral distribution of games, but even more importantly, fundamentally transform the gaming experience into more of a social experience for players to spend time with their real-life friends, which we believe broadens the scope of gaming to include non-gamers and presents an attractive billion-dollar-plus market opportunity. • Similarly, we are optimistic about the mobile gaming space. We believe that the large penetration (2-3x that of Internet users and 30-40x the console installed base) and the ubiquity of mobile devices positions mobile phones as attractive gaming devices. We think that recent advancements in technology (iPhone and Google Android) and emerging platforms for mobile applications (AppStore) should overcome historical constraints and be catalysts for mobile gaming. • We believe that a broadening demography of games, coupled with a strong growth in the usage level of games, positions gaming as an attractive alternative media for advertisers that are grappling with the reducing effectiveness of traditional media. We think that advertising could emerge as a multi-billion dollar opportunity for gaming. • We believe that Generation Y's comfort level with Internet and virtual worlds could drive spending on virtual goods. • We think the key success factors in the new world of gaming will be: a) a focus on understanding consumer behavior (versus on AAA titles in the older model), b) building communities (versus building IPs), c) managing virality (versus large marketing campaigns), and d) monetization through alternative models (versus price discounting). Reason for Report: Industry Update Atul Bagga 415-249-6362, abagga@thinkequity.com May 4, 2009 Industry Report
  • 2. Page 2 May 4, 2009 Industry Report The Emergence Of Game As A Service Source: Getty Images Atul Bagga 415-249-6362 abagga@thinkequity.com GAME ON are you ready to play?
  • 3. Page 3 May 4, 2009 Industry Report Table Of Contents Section 1: The Emergence Of Games As A Service Emergence Of Games As A Service ..........................................................................................................................5 The Digital Revolution.................................................................................................................................................7 Competitive Landscape Of Games As A Service.................................................................................................... 10 Take A Break: Time To Play Crossword Challenge ................................................................................................ 12 Online Games.......................................................................................................................................................... 13 Demand Drivers For Online Games ........................................................................................................................ 14 Emergence Of Social Gaming: Convergence Between Gaming And Social Media................................................ 18 Drivers For Social Gaming....................................................................................................................................... 19 Market Size Estimation For Social Gaming ............................................................................................................. 21 Mobile Games Coming Of Age................................................................................................................................ 23 Drivers For Mobile Gaming...................................................................................................................................... 24 Potential Market Size—Mobile Gaming................................................................................................................... 27 Weapons Of Price Discrimination: Free-To-Play, Pay-For-Items Model................................................................. 28 Drivers For Free-To-Play Model .............................................................................................................................. 30 Market Size Estimation Of Virtual Goods In Games................................................................................................ 34 In-Game Advertising ................................................................................................................................................ 35 Demand Drivers For In-Game Advertising .............................................................................................................. 39 Market Size Estimation Of In-Game Advertising ..................................................................................................... 41 Who Will Succeed: Characteristics Of Winners In Games As A Service ................................................................ 43 Take A Break: Time To Play Scramble.................................................................................................................... 45 Take A Break: Time To Play Word Search.............................................................................................................. 46
  • 4. Page 4 May 4, 2009 Industry Report Section 2: Interviews With The Leading Private Gaming Companies Online Gaming: An Interview With The Founder And CEO Of Acclaim .................................................................. 48 Online Gaming: An Interview With The CEO Of Bigpoint........................................................................................ 52 Mobile Gaming: An Interview With The CEO Of Digital Chocolate ......................................................................... 56 In-Game Advertising: An Interview With The CEO Of Double Fusion..................................................................... 59 China Online Gaming: An Interview With The COO Of Ferry Game....................................................................... 63 Online Gaming: An Interview With The CEO Of Gaia Online.................................................................................. 67 Online Gaming: An Interview With The CEO Of K2 Network .................................................................................. 71 Online Gaming: An Interview With The CEO Of Kongregate .................................................................................. 75 Online Gaming: An Interview With The Co-Founder Of Metaboli............................................................................ 80 Online Gaming: An Interview With The Founder And CEO Of Miniclip.com........................................................... 84 In-Game Advertising: An Interview With The CEO Of Mochi Media ....................................................................... 89 Virtual Currency: An Interview With The Founder And CEO Of Offerpal ................................................................ 94 Social Gaming: An Interview With The CEO Of Playfish......................................................................................... 98 Online Gaming: An Interview With The CEO Of Turbine....................................................................................... 102 Gaming Suppliers: Interview With The CEO Of Vivox........................................................................................... 106 Social Gaming: Interview With The CEO Of Zynga............................................................................................... 110 Section 3: Private Company Profiles
  • 5. Page 5 May 4, 2009 Industry Report Emergence Of Games As A Service “In the last five years, an Omni Media market has emerged in which everyone has become a gamer to some degree. They are playing simple, convenient, and social games on a wide variety of new platforms including mobile phones, the Web, smartphones, social networks, and online console networks like Xbox LIVE.” Trip Hawkins, Founder & CEO, Digital Chocolate Recently someone posted a question on LinkedIn—“How did you do job search pre-Internet days?” It should have been a simple question to answer for most people of my generation who were born in the late ‘60s and early ‘70s, who, unlike today’s generation, didn’t grow up on the Internet and who started careers before the world was connected like it is today. But for some reason, I had difficulty even remembering how we searched for jobs without emails, job boards, alumni Websites, LinkedIn, and Twitter. Then it dawned upon me how much we take the Internet for granted and truly how much it has transformed our lives. It is difficult to even imagine life without Internet. How would people communicate in a world without emails? How would a research analyst like myself perform due diligence in a world without Google? How would we have any chance to find our old school friends in a world without Facebook? The Internet has changed our lives by revolutionizing many industries, including music, video, software, telecommunication, newspaper and publishing, project management and entertainment. Until about five years ago, CDs were the dominant format for music delivery—almost 100% of music was delivered in CDs. Fast forward five years, to the iTunes, Amazon Music, Wal-Mart world. CDs, as a delivery format for music, has shrunk to 30%, and digital music has become the dominant medium of delivery (see Exhibit 1). Exhibit 1: Evolution Of The Music Industry 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1997 1999 2001 2003 2005 2007 Mobile Digital CDs Cassettes Source: Recording Industry Association of America Similarly, the Internet has changed the way we watch videos—from DVDs to iTunes, to YouTube; from TV to Hulu, Joost, and TV.com. But it has not always been a revolution. For some industries, it has been a process of slow evolution. For such transformation to materialize, there has to be some real tangible benefits for consumers, for vendors, or for the other stakeholders. We believe these tangible benefits are the mandatory, but not the sufficient condition to make this change happen. And that’s why in some cases, we have often seen a long process of evolution that involved multiple iterations of business models and innovation in technologies. Take software for example. Software as a Service (SaaS) had to undergo many iterations (client-server model, ASP model, hosted model) before it came into being as multi-tenant, browser-based Software as a Service, as we know it today.
  • 6. Page 6 May 4, 2009 Industry Report Even if we have the right business model and the technology, it may take time and a catalyst to create sufficient momentum that would spur wide adoption. Again, take the example of software. Even though the SaaS model has been in existence for almost 10 years, until approximately five years ago, it was considered a fad; until a couple of years ago, it was considered acceptable only for small businesses; and now it is well accepted by small, medium, and large businesses alike and we expect it to grow more than twice as fast as the overall software industry and to become a significant portion of enterprise software by 2012. Exhibit 2: SaaS Versus Packaged Software Growth 0 500 1000 1500 2000 2500 3000 2002 2003 2004 2005 2006 2007 2008 RevenueIndex SaaS On-premise Source: FactSet and ThinkEquity LLC
  • 7. Page 7 May 4, 2009 Industry Report The Digital Revolution From To Music has Changed Home Video is Changing TV has Changed News Media has Changed Phone has Changed Communication has Changed , Software is Changing Source: Company Websites
  • 8. Page 8 May 4, 2009 Industry Report The Internet changed all of these industries because of a few common themes: reduced cost of ownership, increased convenience, and freedom from proprietary technologies. Consumers benefited by the ease of use, the ease of the buying process, a lower upfront investment, the ability to buy in small sizes, and the ability to buy without making a long-term commitment. Vendors benefited by streamlined supply chain, low friction sales model, satisfied users who become evangelist of products, viral marketing, reduced costs for development and support. We believe that the same reasons will transform the gaming industry from packaged software to Games as a Service business. We are at the dawn of multi- channel-game-as-a-service. What Is Multi-Channel Games As A Service? We believe that today’s Internet generation is looking to stay connected with their friends at all times. With increasingly capabilities and functionalities of the smartphones, users are connecting with their friends on their mobile devices while on the move (think Twitter, Facebook Mobile, Google Latitude) and via computer while at work, school, or home. According to Research In Motion (the maker of the BlackBerry), the MySpace BlackBerry application had 400,000 downloads within one week of launch in October 2008 and Facebook BlackBerry application downloads surpassed the one million mark within five months of launch in April 2008. Gaming will be no different, in our opinion. We believe just like people want to stay connected with their friends on social networks, players want to stay connected with their friends on virtual worlds/game environments too. With the next- generation of gaming phones, we expect to see convergence between social gaming, mobile gaming, and online gaming. We believe this convergence makes sense not only for core gamers who may want to track their guild activities, but even for the casual gamers who may want to use the same avatar (a representation of the gamer in the game environment) on all platforms to make progress within game levels and to share achievements irrespective of the platform. The next-gen multi-channel games will let players enjoy the game at any channel of his or her choice and give the player the ability to change the channel, but still pick up the game from where he or she left off. For example, “Jane” can play a game on her console at home, and when she leaves for work, she can continue to play the same game on her mobile device. While at work, she can check the stats, send a message to one of her guild friends, or even play the game on her work computer without the need for a separate download and while using the same avatar that she used in her console or mobile device. Not only will she be able to play the game on all channels, but the game play will be modified in all three instances to make the best of available hardware and to maximize the gaming experience based on the players’ device preference at that time.
  • 9. Page 9 May 4, 2009 Industry Report Exhibit 3: Emergence Of Games As A Service FreeFree--toto--PlayPlay Pay to PlayPay to Play: Upfront Purchase; Subscription Virtual Goods Ads Premium Content Subscription Others – App Install, Incentive Marketing PC Gaming Console Gaming Mobile Gaming Online GamingSocial Gaming Multi-Channel Games As A Service Source: ThinkEquity LLC
  • 10. Page 10 May 4, 2009 Industry Report Competitive Landscape Of Games As A Service Company Products Free to Play Pay to Play Virtual Goods Premium Sub Ads Others License Fee Subscription Online Gaming: MMO/Core Games Acclaim 2 Moons Activision Blizzard World Of Warcraft CCP Games Eve Online Cryptic Studios City of Heroes Electronic Arts Warhammer Online: Age of Reckoning Jagex Runescape K2 Network Knights Online NCSoft Lineage II Nexon Maple Story Perfect World Perfect World Online Sony Online Entertainment Everquest Square Enix Final Fantasy XI THQ Company of Heroes Turbine Lords of The Ring Online Online Gaming: Virtual Worlds Disney Club Penguin Gaia Online Gaia Online Linden Labs Second Life Sulake Habbo Continued…
  • 11. Page 11 May 4, 2009 Industry Report Company Products Free to Play Pay to Play Online Gaming: Casual Games AOL AOL Games BigFish Games Bigfishgames.com Disney Go Disney Electronic Arts Pogo.com iWin Hotel iWin Kongregate Kongregate.com Microsoft MSN Games Miniclip Miniclip.com Playfirst DinerDash PopCap Bejeweled Viacom AddictingGames.com Yahoo! Yahoo! Games Mobile Gaming Cellufun Digital Chocolate Electronic Arts Gameloft Glu Mobile Hands On Mobile NgMoco Playfish Playfirst Oberon Zynga Social Gaming Digital Chocolate Tower Bloxx Electronic Arts Scrabble Playfish Pet Society Playdom Mobsters Serious Business Friends For Sale SGN Fluff Friends Zynga Texas Hold'Em Source: ThinkEquity LLC
  • 12. Page 12 May 4, 2009 Industry Report Take A Break: Time To Play Crossword Challenge Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
  • 13. Page 13 May 4, 2009 Industry Report Online Games Online games have been in existence almost since the beginning of the Internet. Historically, online games could only be played on PCs, but that changed with the launch of PS2 and Xbox, which allowed online play. And now, the next- generation consoles come with enhanced online capabilities that allow players to find and connect with their friends online such as Xbox Arcade, PlayStation Network, and Wii Virtual. Online games include a gambit of genres and categories, from causal games to hardcore Massive Multiplayer Online (MMO) and everything in between. Casual games are games that are easy to play, require less commitment, and last smaller sessions like puzzle games, time management games, racing games, arcade games, casual action games, card games, and word games. The biggest driver for casual games has been the increased number of connected devices. While core games largely remained confined to the bedrooms of core gamers who owned one or another console, casual games broadened the scope to include just about everyone. Although a large percentage of the PC users and mobile phone users may not identify themselves as gamers, various studies suggest that most of these users often indulge in some form of game play on their PCs and/or phone (mostly casual games). Casual games open up the target market to about one billion Internet users, and about four billion mobile subscribers—numbers that dwarf the target market for core games, limited to about 100 million console owners. Massively Multi-player Online games are played between thousands of players and are generally targeted toward core gamers. MMOs can range from role-playing-games (MMORPG), first-person-shooter games (MMOFPS), real-time strategy games (MMORTS), sports games, and racing games. MMOs became immensely popular amongst the Asian gamers because of the affordability, and in some cases, government regulations on availability of consoles. Another big catalyst for the MMO games happened in early 2000, when some of the Asian companies started to experiment with the free-to-play model to revive interest in some of the old catalog games. The idea of free-to-play games is that players can play the game for free and pay smaller amounts to customize their avatar or to buy virtual weapons, maps, more levels, or new cars that enhance their game play. The free-to-play model gave a new lease to some of the old and dying games, and has now emerged as the dominant model for MMO in Asia, in our opinion. Exhibit 4: Broad Categories And Target Audience Of Online Games CORE GAMESCORE GAMES ADVANCED CASUALADVANCED CASUAL GAMESGAMES CASUAL GAMESCASUAL GAMES AdventureAdventure ArcadeArcade WordWord CardCard SimulationSimulation SportsSports PuzzlePuzzle MusicMusic Time Mgmt Time Mgmt ActionAction MMORPGMMORPG StrategyStrategy BoardBoard RacingRacing ShootingShooting Martial Arts Martial Arts Fantasy/ Action Fantasy/ Action Teens/Young MaleTeens/Young Male Kids/Kids/TweenTween FemalesFemales Source: ThinkEquity LLC
  • 14. Page 14 May 4, 2009 Industry Report Demand Drivers For Online Games Online Gaming Opens Up Much Broader Market: Ubiquity Of PCs And Internet Personal Computers are everywhere—home, work, during the commute on public transit, on vacations, on business trips, on airplanes, and at airports. In contrast, consoles are mostly available at homes. The total population of PCs has already surpassed the one billion mark and is expected to reach two billion by 2014, according to Gartner. The Internet has even deeper penetration with more than 1.5 billion users worldwide and is expected grow at 15-18% over the next three years (according to Internet World Stats). On the other hand, the worldwide console population is estimated at about 100 million (260 million for the current and previous generations combined). Even within the U.S., the number of Internet users (at about 250 million) far exceeds the number of the gaming consoles installed base of 48 million. PC gaming not only opens up a bigger market, but it also expands the usage beyond the home. Players are not limited to playing the games only within their living rooms, but now, the players can have the same gaming experience during breaks at work or in a hotel room while traveling. Exhibit 5: Internet Users Far Outnumber The Gaming Console Users - 200 400 600 800 1,000 1,200 1,400 1,600 million 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Consoles Installed Base (Two Most Recent Generations) Internet Users Source: NPD, www.Internetworldstats.com With recent advancements, we believe technology is not a barrier anymore. Not only are PCs everywhere, but today’s PCs are powerful gaming machines. Historically, there has been a large gap between PC hardware and console hardware and, therefore, for a high-quality, 3D gaming experience, someone has to have a dedicated gaming console system. The line between the PCs and the gaming consoles have blurred with the recent advancements and democratization of specialty hardware, in our opinion. Today’s PCs are powerful machines capable of playing high-definition 3D rendering, removing the need for a dedicated game console. In addition, increased adoption of online gaming and falling hardware prices have helped accelerate the pace of innovation in PC gaming peripheral technology—like a motion sensor controller (similar to that of a Wii remote), which makes the digital experience more real and interactive. Exhibit 6: Development In PC Peripheral Bringing PC Gaming Closer To Console Gaming: CyWee Z Controller for PC Games—in the straight position (for tennis, golf games), in the gun position (for shooter game), and in the wheel position (for racing or aviation games) Source: CyWee
  • 15. Page 15 May 4, 2009 Industry Report In addition, the increasing speed and ubiquity of broadband makes it easy to transfer high-resolution graphics over pipes, enabling gamers to have an immersive 3D experience without noticeable lags. The new technology is now enabling gamers to have immersive 3D experience even within browsers, i.e., without the need for a client download, which should further reduce friction for online games. Exhibit 7: Sample Of The Immersive 3D Experience With Online Gaming Source: Company Websites (clockwise from top left): World of Warcraft by Blizzard, Warhammer Online: Age of Reckoning by Electronic Arts, Gaia Online, and Vivaty Scenes for Facebook by Vivaty Reduced Cost Of Ownership For Consumers If you are like most gamers, you will want to play at least 20-30 different games per year, you will want to own all the major consoles, and you will need to buy a new generation console every three to four years to play these games in their full glories. That works out to an annual spend of about $2,000-2,500 per user on gaming, which might be out of budget for many gamers. Even more importantly, although the marginal entertainment value of every next game for a user is arguably lower than that of the previous game that he/she owned, the marginal cost remains the same. And, as a result, most gamers end up buying about four to five titles (about $250-300) per year. Since Game as Service enables players to pay as they go, a player doesn’t have to buy all 30 games (that she wants to play) at $60 a piece. Rather, the user can play all the games only as much as he/she wants to play and pays only for as much as he/she plays. Game companies should benefit as many players, for who a marginal $60 investment for the 10 th game didn’t make sense, will now be willing to open their wallets for not only the 10 th best game but also for 11 th , 12 th , and all the games that they would not have bought.
  • 16. Page 16 May 4, 2009 Industry Report Avoid Buyer’s Remorse “For the premium [subscription] offer, they [subscribers] play ten different games a month; for the basic offer, they try or play four to five games a month. … They try them, and concentrate on those they really like, which is the interest of this service. Our customers don't have the stress to choose one game among the others in the shelves, which is a bet, because every gamer has made several times the wrong choice. A game is very personal; the packaging does not tell you what is really inside the box, and the game reviews, and friends' recommendations, only limit the risk to make the wrong choice.” Thibaut de Robien, Cofounder of Metaboli And then there is always the case of buyer’s remorse, players getting stuck after buying a game because the game was not really their type. The problem is exacerbated for kids games, as these players arguably have a lower attention span. Exhibit 8: Buyer’s Remorse: “Those WERE the droids I was looking for…” Source: www.pbase.com/joony/image; www.flickr.com/photos/24973901@N04/2762458387/ With Games as a Service, players are paying only for their playtime and, therefore, avoid buyer’s remorse. Not only that, Games as a Service enables the vendors to offer “Try and Buy”—the idea is to offer a free trial for a limited time, and if the player likes the game, she can either buy unlimited play or enroll in some other form of game subscription. By offering a free trial, the vendor can cast a wider net and players who otherwise may not have bought the game, may now try the game and eventually convert to become paying customers. Furthermore, since the players have already tried the game before making a monetary commitment, the buyers’ remorse is limited, resulting in fewer returns and fewer customer service calls. Improved Efficiency With Digital Distribution “There's a shift and a disruption going on in the games industry that had for so long relied on producing very expensive, high budget games, and when these big budget games fail, developers go out of business. The times are changing. Now solo game developer and hobbyists can develop a game in their spare time and find an audience through sites like Miniclip and they don't have to get involved in this very complex, hierarchy of distributors and publishers.” Robert Small, Founder & CEO, Miniclip.com In the traditional packaged game distribution channel, since the shelf space is limited, the retailers are willing to assign the premium shelf space only to the super-hyped, highly anticipated, AAA games. As a result, most of the smaller or second tier titles are either left out for non-premium shelf space where they have limited visibility from walk-in customers, or even worse, these titles may not get any distribution deals. This creates a Catch-22 situation for smaller titles—since they don’t have the fire power of an AAA title, they cannot get the premium shelf to get players attention, and since they don’t have the players’ attention, they have even less chance to succeed. Not only that, larger gaming companies mostly focus on AAA titles that may appeal to broader mass markets, ignoring the needs for smaller niche markets, which creates inefficiency in the market.
  • 17. Page 17 May 4, 2009 Industry Report Digital distribution by definition breaks the barrier of limited shelf space, which makes the distribution to the niche markets financially viable. With digital distribution, vendors can publish titles focused on the smallest of the niche; and use guerrilla marketing or viral marketing to reach the desired segment efficiently. Digital distribution may also help expand margin for vendors—as vendors save on the cost of medium, packaging, and slotting expenses. Exhibit 9: Digital Distribution Enables Reaching Out Long Tail Rhapsody Wal-Mart Amazon.com Barnes & Noble Netflix Blockbuster Source: “The Long Tail” by Chris Anderson Viral Growth “We don't really spend any money on marketing….Our growth is from friends recommending games, friends challenging each other to games, so it's word of mouth and virality.” Jim Greer, Founder & CEO, Kongregate “We acquire all our customers through word of mouth. We’ve never done any marketing in the history of the company. Even within our game, there are very few places that you will see us advertising membership. …In many respects, it is one of the world’s best kept secrets.” Mark Gerhard, CEO, Jagex Viral marketing refers to users promoting an application to other users without getting directly paid for the same. Online gaming vendors utilize viral marketing to expand reach and create buzz. With online games, players challenge their friends by emailing links or by embedding links on their profile pages, and help vendors reach new audiences without spending any money on customer acquisition. A number of online gaming vendors like miniclip.com, Jagex, Big Point, and Kongregate have been able to build significant audience without reportedly spending any money on digital marketing. Ability To Respond To Changing Consumer Demands “It [online gaming] is more similar to a Web 2.0 business model than a pure video gaming business. The traditional video gaming business companies are in a retail business where you ship games and then it's a one-off sale until there is a next expansion or sequel. … We have a large number of experienced, dedicated, full-time employees whose job is to interact with our gamers and generate revenues. We get gamers' feedback, their needs and wants and desires, and we funnel that information directly toward our developer and then we update the game on a regular basis.” Joshua Hong, CEO, K2 Networks Gaming is largely a hit-driven business, and predicting a hit or miss before a game launch is not an accurate science—it is more of a guessing game. In the traditional video gaming business model, after a game is launched, there is a little that the gaming vendors can do to fix issues with the game or make changes based on the users’ response. The traditional gaming vendors rely a lot on focus group studies and consumer behavior studies conducted during the product development stages and before the game launch. Unlike traditional gaming vendors, online gaming vendors have the ability to make regular updates to their games based on the players’ behavior/demands. Sophisticated gaming companies spend considerable resources in gathering and analyzing implicit and explicit consumer feedback to update their games, which reduces the risk profile of the business. 735,000 Songs 2.3 mil Books 25,000 DVDs 39,000 Songs 130,000 Books 3000 DVDs
  • 18. Page 18 May 4, 2009 Industry Report Emergence Of Social Gaming: Convergence Between Gaming And Social Media “What makes social gaming particularly interesting…not only the viral distribution of games, but also the ability to create game play where the game knows who your real world friends are and let you play with them…the emotional drive to play is not to kill time or escape but rather to socialize, communicate and express, much like why we play board games, ball games or card games in real life.” Kristian Segerstråle, CEO, Playfish “For the first time ever, we're letting them [users] engage in games with their real friends in their real social networks. Gaming is a fundamentally social experience, not a single-player experience, and not a technology experience. We are bringing gaming back to its roots.” Mark Pincus, CEO, Zynga We define social gaming as games that are played on a social network or virtual worlds between friends. Social networks could be existing networks (e.g., Facebook, MySpace) or networks designed especially for gamers (e.g., Arcadia). Social games bring a fundamental shift in the video games—away from a single player shooting aliens or killing monsters to a fun activity where one is playing with one’s real life friends in a virtual environment. Social gaming enables players to play against their real life friends and provides a place to hang out in a gaming environment thus taking the games back to its roots of fun activity. We believe social networks have been the hottest trend in 21 st century, exhibiting the fastest growth of any media. According to industry sources, more than two-thirds of online users have participated in a social network over the past year, and this number is expected to rise. The trend is not limited to the young users anymore, and people ages 35-54 years have shown the highest growth of any demographics. Exhibit 10: Time To Reach 150 Million Users/Units 89 38 14 7 5 0 10 20 30 40 50 60 70 80 90 Years Telephone Television Cellphone iPod Facebook Time to Reach 150 Million Users/Units Source: Portio Research, CNN Money Games are one of the most widely used and fastest-growing categories of applications on social networks. Most of the social games are based on a free-to-play model and monetize users through premium subscription, in-game ads, virtual item sale, incentive marketing, and application installations. We do not expect the vast majority of the users to directly pay for the games, and believe gaming companies will be monetized through in-game ads, while a small percentage of the players (10-15%) will convert to paying users either through subscribing to premium content or regular buyers of virtual goods.
  • 19. Page 19 May 4, 2009 Industry Report Drivers For Social Gaming Large Underpenetrated Market Today’s generation is connected on social networks. According to comScore, more than two-thirds of Internet users are also on social networks, and the number is still growing. The popularity of the social networking sites is not just limited to the Y generation, more and more people 35 years of age and older are also joining these social networks. The latest statistics regarding Facebook users show that the number of users in the 35-54 years of age population has increased 10x versus 88% growth for the 18-34 years of age group since October 2007. Not only are more people joining these social networks, but they are also spending more time on these social networks. According to Hitwise, the average user is now spending approximately 27 minutes/day, up 71% Y/Y. We believe the reach and the demographic of the users on these sites make the social networks fertile ground for the game vendors to acquire users, build awareness, and create buzz through viral marketing. We believe that the penetration of games on social networks remains less than 10% and suggests significant room to grow. Exhibit 11: Comparison Of Internet And Social Networking Growth 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 900,000 2007 2008 Internet Users Social Netowrking Users Consoles Installed Base Source: NPD, Internetworldstats.com Viral Marketing “Over 95% of our growth is viral. In fact, when we launched our first title a year ago, we started by inviting 100 of our own friends and we've grown from there to over 60 million registered players across our games organically.” Kristian Segerstrale, CEO, Playfish The other day, I got a message on Facebook, “Pamela (real name substituted with a similar sounding name) thinks that you would cheat on your wife. See what else Pamela is saying about you.” I knew very well that it was a bait to lure me to add another time waster application, but it was coming from Pamela, my old school friend, and I just couldn’t resist finding out what she was saying about me (and seriously, I had no idea that Pamela could have said such things about me for the promise of some measly virtual goods). Funny part was that the application was fun and I ended up saying some nasty things about my other friends, and I am sure that, just like me, my friends must have received the notification (such as Atul thinks you are a liar. See what else Atul is saying about you); and probably they must be checking out this application and saying nasty things for their friends and so on. All of these people checking out the application and evangelizing the application without a single penny out of the company’s pocket, now that is the power of viral marketing. A person can see viral marketing in action if he/she plays Playfish’s Who has the Biggest Brain on Facebook. After the player completes the game, it will ask the player to send his/her brain-weight score to friends who have never played Who has the Biggest Brain, inviting them to play and compare their brain-weights with that of the player (user acquisition) and send a tout to friends who have already played this game (repeat players); and, of course, as one can imagine, the friends the player touts will most likely beat the player’s score and tout the player and others back.
  • 20. Page 20 May 4, 2009 Industry Report Viral marketing refers to users promoting an application to other users without getting directly paid for their efforts. For online gaming vendors, social networks offer an inexpensive way of marketing their games to new users and improve stickiness through viral distribution. We believe that social networking sites level the playing field for small developers to compete with large companies like Electronic Arts (recall the success of Scrabulous, developed by two brothers in remote corners in India, which became a rage on Facebook through viral marketing). Exhibit 12: Example Of Viral Distribution Source: Playfish’s Who has the Biggest Brain on Facebook; Playfish’s Who has the Biggest Brain invites you to send a tout (Who is your Daddy Now!) to your friends on Facebook, whose score you have beaten. For social networking sites, games provide an easier way to monetize their users, in our view. Despite significant size, strong community, and solid ecommerce platforms, most social networks have struggled with monetizing their users. With ARPU hovering in the range of $0.10-0.25/month for most of the social networks versus as high as $150/month for some of the online games, social networks do look under-monetized. Most social networks rely largely on banner and text ads for user monetization, but, given low conversion rates (less than one-tenth of a percent), display ad rates for most social networks hover at about $0.10-0.25 cost per thousand (CPM) versus as high as $35 for video ads and $8 for display ads for in-game advertising. We believe online games provide a natural way for the social networks to monetize users through in-game advertising and more importantly through virtual goods sales. Games can also help social networking sites strengthen community bonding among their users. We believe that not only will games help social networking sites monetize their users, but they will also help to increase the stickiness of these social networking sites. Games are known to bring communities closer, to encourage user interaction and active participation (e.g., more than two million user-generated content on Spore, and more user- generated content on Halo than YouTube videos produced in a month), which is the lifeblood for social networking sites.
  • 21. Page 21 May 4, 2009 Industry Report Market Size Estimation For Social Gaming Exhibit 13: Addressable Market Size Estimation For Social Networking 2008 2011E Best Worst Base Population (million) 337 368 368 368 Internet Penetration 74% 80% 74% 77% Internet Users (million) 248 295 273 284 Social Network Penetration 53% 80% 60% 70% Social Network Users (million) 131 236 164 198 Gamers on Social Network 25% 50% 25% 40% Gamers on Social Network (million) 33 118 41 79 Paid Users (Virtual Goods, Premium Subs) 2% 10% 2% 5% Paid Users (million) 1 12 1 4 ARPU - Paid Users ($/month) $2 $10 $2 $5 Market Opportunity - Paid Users ($ million) $16 $1,414 $20 $238 Ad Supported Users 98% 90% 98% 95% Ad Supported Users (million) 32 106 40 75 Hours Game Play/Week 5 5 5 5 Ads Served/Hour Game Play 20 20 20 20 Total Ads Served (billion) 167 551 208 392 CPM $0.30 $5.00 $0.50 $2.00 Ad Revenue Opportunity ($ million) $51 $2,757 $104 $784 Effective ARPU ($/month) $0.17 $2.95 $0.25 $1.07 Addressable Market Opportunity ($ million) $66 $4,172 $124 $1,023 Source: ThinkEquity LLC estimates
  • 22. Page 22 May 4, 2009 Industry Report 16 Of The Top 50 Applications On Facebook Are Games Rank Game Developer Monthly Active Users (in thousands) Reviews 7 Texas Hold’Em Poker Play Texas Hold'Em with your fb friends. Get free chips every day that you play. Zynga 12,330 5,047 8 Pet Society In the world of Pet Society you and your pet can have a great time! You can play games, decorate your house, and even bring gifts for your friends when you visit them. Play now and share the fun with everyone! Playfish 10,567 70,431 9 Mafia Wars Start a Mafia Family with your friends, do Crime Jobs for cash, buy Powerful Weapons, and Fight!!! Zynga 9,494 9,394 18 YoVille YoVille is a world where you can buy new clothes for your player, purchase items for your apartment, go to work, and meet new friends. Join YoVille today for free! Zynga 5,347 3,496 25 Geo Challenge Geo Challenge takes you on a tour around the world as you put your geography knowledge to the test! Playfish 4,051 494 28 Word Challenge Word Challenge is the addictive new word game featuring vivid animations, 40,000+ words, 20 vocabulary types, a bonus game mode and weekly, monthly, and all-time top scores. Playfish 3,531 1,846 29 Who Has The Biggest Brain? Think you are smart? Play this highly addictive brain training game to prove it! Ever wondered Who Has The Biggest Brain amongst your friends? Play and invite your friends to find out! Playfish 3,517 2,300 31 MindJolt Games Play over 500 games. At MindJolt Games you can play any of the Arcade, Puzzle, Strategy, and Sports games we offer for free. MindJolt 3,220 388 33 Bowling Buddies Go bowling with your friends! Featuring stylish 3D graphics, easy controls, tons of achievements, customized characters and challenges against your friends. Playfish 3,685 2,125 36 Street Racing Pimp your rides, start a crew with your friends, and race! "It don't matter if you win by an inch or a mile. Winning's winning." - The Fast & The Furious Zynga 2,690 5,300 39 Vampire Wars Drink the blood of the innocent and tear your enemies limb from limb in Vampires! Zynga 2,641 7,054 42 Kidnap! is an international game of Nap or be Nap’d! Pick your favorite city in the world and cram all your Friends inside! Time is running out. With Nappers popping up across the globe, it’s literally you against the world! Context Optional 2,494 598 44 Friends For Sale! Buy and sell your friends as pets! You can make your pets poke, send gifts, or just show off for you. Make money as a shrewd pets investor or as a hot commodity! Serious Business 2,151 2,801 45 Mob Wars Join the Mafia, and start your own mob. Band together with your friends to become the most powerful force in the elite criminal underworld of Facebook. Mob Wars 2087 18,174 46 Poker Palace Play for FREE in the best poker game on Facebook! Fun & Easy! Trevor Smith 1,917 362 48 Minigolf Party Get your golf on and join the fun with Minigolf Party! This crazy collection of courses takes you on the minigolf ride of your life. Playfish 1,866 553 Source: Facebook as on 04/21/09
  • 23. Page 23 May 4, 2009 Industry Report Mobile Games Coming Of Age We define mobile games as the games played on mobile phones, and smart phones (not including games played on the handheld consoles like the PSP or the Nintendo DS). Games started making their appearance on the cell phone almost from the time commercial cell phones were launched. The first mobile game was Snake (launched in 1999) that came pre- installed in Nokia phones and has been reportedly played more than a billion times. Exhibit 14: Evolution In Mobile Phones Source: Company Websites (from left to right): Motorola DynaTac launched in 1983; Screenshot of “Snake,” the first mobile game launched in 1999; iPhone (launched in 2007); and Electronic Arts games on T-Mobile G1 aka gPhone launched in 2008 With improving hardware, increasing ubiquity of broadband on mobile devices, and increasing affordability, we believe mobile gaming is quickly coming to the mainstream in the United States. The audience for mobile games is not just limited to core gamers, but has expanded to include professionals looking for easy stress busters between meetings or while traveling, and teenagers who are now increasingly mobile. Mobile games (such as Snake) can come pre-installed with phones, or can be bought through mobile operators’ e-stores or, more commonly, now from third-party stores (e.g., Apple AppStore). Players can play these games by themselves or they can play against their friends.
  • 24. Page 24 May 4, 2009 Industry Report Drivers For Mobile Gaming Ubiquity Of Cell Phones Cell phones can be found almost everywhere, in our opinion. The number of cell phone subscribers in the United States has grown almost 10x to 262 million in 2008 from 28 million in 1995. Worldwide, the number of mobile subscribers has more than quadrupled over the last seven years to 4.1 billion in 2008 and is expected to reach 5.2 billion by 2011, according to Infonetics Research. The number of mobile users far exceeds the number of gaming consoles (about 100 million for the current-generation consoles, 260 million for the current- and previous-generation consoles combined) and the PC population (about 1 billion) or Internet users (about 1.5 billion) combined. Exhibit 15: The Number Of Mobile Subscribers Has More Than Quadrupled In The Last Seven Years - 500.0 1,000.0 1,500.0 2,000.0 2,500.0 3,000.0 3,500.0 4,000.0 4,500.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 MobileSubscribers(million) Source: International Telecommunication Union Not only do mobile subscribers outnumber the PC users and gaming console users, we believe mobile phones are almost everywhere. While someone cannot carry a console or a PC all the time, a person is almost always carrying a cell phone. Therefore, when boredom strikes, people are more likely to reach out to their cell phone for a quick game, which we believe makes the cell phone an attractive candidate as a game console. Hardware Reaching To Age “The iPhone is the archetype and the inflection point, but Apple alone cannot supply all the demand. Hence, we now have a clone industry making things like the Google Android and many manufacturers and all carriers and channels will get in on the act. It will take a few years to build industry capacity, but we are now officially in the go-go growth phase.” Trip Hawkins, CEO Digital Chocolate Not only are phones becoming ubiquitous, phones are also increasingly becoming more sophisticated. Some of the next- generation phones promise to deliver a gaming experience comparable to that of a gaming handheld device (like a Nintendo DS or a PSP) or even that of a gaming console. Exhibit 16: Potential Upcoming Mobile Phones Source: Company Websites (from left to Right): Nokia Concept Phone, Nokia n81, Anycall 5200, and Samsung SPH- B5200
  • 25. Page 25 May 4, 2009 Industry Report We believe that the inflection point in mobile gaming truly came with the launch of the iPhone. With its 3.5” color screen, multi-touch capability, robust processor, 3-D graphics capabilities, and accelerometer, the iPhone was the first mobile device capable of playing full-fledged games, such as Sim City 3 and Spores. And people have taken note of it, they are using iPhone as a gaming device and they have even ditched their gaming handheld device in favor of the iPhone. According to ComScore, 32.4% of iPhone users have downloaded a game, compared with a market average of 3.8%. The success of the iPhone has attracted a number of iPhone clones, and also some serious players that are positioning mobile devices as video game players. Increasing Affordability We believe that falling hardware prices plus an alternative revenue model for games make mobile gaming within reach of the masses. Especially in the emerging markets where the PC or console penetration is low, mobile devices offer a good gaming platform and with affordable revenue models (combination of premium subscription, ad supported, virtual goods), mobile gaming could be one of the cheapest sources of entertainment for a big population. The Asia/Pacific region is already the largest mobile gaming market, estimated at $2.3 billion and expected to reach $3.4 billion by 2011, according to Gartner. Increasing Broadband Speed On Mobile Devices With increasing wireless data speed on mobile devices, players can easily find and play against their online friends. Increasing broadband speed allows players to play online games with no lags within an immersive 3D environment. Exhibit 17: Broadband Speedometer Broadband Speedometer – Maximum Download Speeds Wireline 2.5 G Wireless 3G Wireless 4G Wireless Cable Modem 768kbps 30Mbps 56kbps 144kbps 144kbps 384kbps 2Mbps 3Mbps 3.6Mbps 2Mbps Dial-Up ADSL IXRTT GPRS EDGE EVDO UMTS / WCDMA HSDPAEVDO Rev. A WiMAX 20Mbps FiOS 30Mbps 3Mbps 1.5Mbps ADSL ADSL 15Mbps 5Mbps FiOS FiOS NottoScale Source: CTIA Website Lucrative Business Model For Wireless Operators And Platform Vendors In our view, gaming provides an attractive revenue stream for mobile operators in the form of accompanying sale of data plans and also revenue share with game developers. Although the revenue from gaming remains pretty small compared to the overall mobile business, it could start to look as an attractive way to grow a company’s ARPU as it struggles with falling prices and slowing growth. Not only is the opportunity lucrative for carriers, we believe that it makes a lot of sense for gaming vendors, as the incremental cost of porting existing games on a new platform is minimal and, therefore,
  • 26. Page 26 May 4, 2009 Industry Report incremental profit margins substantial. According to an article in The Wall Street Journal, Simon Jeffery, the U.S. president of Sega said he believes that [despite 30% revenue share with Apple] "games sold via the AppStore are the most profitable in terms of any of the formats.” Emerging Standardized Platforms For Gaming Historically, non-standardized phones, varied carriers specifications, and multiple operating systems meant that the mobile gaming companies had to port their games on a number of platforms and support hundreds, if not thousands, of SKUs, which involved significant upfront costs and maintenance costs and stifled innovation. With the emergence of the iPhone (although a proprietary platform, given the high reach of iPhone, it eliminates the need to support multiple platforms to achieve similar penetration), Google Android, and Nokia Ngage, the mobile gaming market, in our opinion, will concentrate to a few standardized platforms, which should make the job of maintaining and supporting versions of mobile games easier for the developers and encourage innovation. Easy To Use And Consumer-Friendly eStores For Games We believe that improving user experience for buying and installing of mobile games will drive adoption of mobile gaming. Historically, most people played only those games that came pre-installed with the mobile phone, given that the process of installing games on the phone has been pretty complex. Apple changed that with the launch of AppStore, which made the process of browsing, searching, downloading, and installing games very easy and user-friendly. The popularity of AppStore can be gauged by the fact that since it opened in July 2008, and there have already been over 500 million applications downloaded on 17 million iPhones, i.e., about 72 apps/year/iPhone versus 2.5 apps/non-iPhone smartphone owner (Source: MMteric 1/31/08 Survey of U.S. Mobile Owners).
  • 27. Page 27 May 4, 2009 Industry Report Potential Market Size—Mobile Gaming Mobiles games have come a long way since their humble beginning as a “Snake” in 1999. Gartner estimated the worldwide mobile games market at $4.3 billion in 2007, and expected it to grow at 22% over the next five years. In the U.S., mobile gaming was estimated at $717 million, with an estimated growth of 24%. The Asia/Pacific region is the largest mobile gaming market, with revenues estimated at $2.3 billion in 2008. We believe that the potential opportunity for mobile games could be more than $2 billion in the United States alone. Exhibit 18: Market Size Estimate For Mobile Gaming Number of Mobile Subscribers (million) 225 Penetration of Games 25% Potential Market (million Subscribers) 56.25 Average Spend/Day $0.10 Potential Market Size ($ million) $2,053.13 Source: ThinkEquity LLC estimates Our assumption of $0.10/day for mobile games is based on the average pay for other mobile services commonly available. Exhibit 19: Average Cost Of Mobile Value Add Services ($/day) $0.00 $0.05 $0.10 $0.15 $0.20 $0.25 $0.30 $0.35 SMS (200/month) Wikimobile MobiRadio Weather Channel Games Service (Our Assumption) Source: ATT Wireless
  • 28. Page 28 May 4, 2009 Industry Report Weapons Of Price Discrimination: Free-To-Play, Pay-For-Items Model Imagine yourself as a game publisher working on the latest and the greatest game. As a game marketer, you know that your audience is composed of roughly three core segments: • Core Gamers: These players will play your game five hours a day, seven days a week. They will be waiting in the line from early morning on the day of release to get their hands on the first copy of the game. • Ex-Core Gamers: These used to be core gamers, but now because of the work/family pressure, they don’t have the same time commitment for the games as they had before. Nonetheless, their love for the latest games is not lost, and they are willing to make-up their lack of time by spending extra on the games. • Price-Cautious Gamers/Students: These love to play games as much as core gamers, but don’t have enough money to buy all of the latest games. They will probably wait for someone to sell a used game or worse they will be downloading a “crack” copy of the games. In a traditional business model, a company can price its game at about $40-60 and capture a part of the first two segments, and if the game is successful, the company will come up with a sequel, charge full price, and offer the previous release at a deep discount in hopes of capturing the last segment. However, by charging a fixed price, it may be leaving money on the table as its top customers in the first and the second segment might be willing to pay much more than the list price of the game (and in many instances they are already paying to black marketers for the first copy of the game or to gold farmers to advance them in the game). What if there was a way to capture more value from the top two segments and also capture some value from the third segment, without antagonizing your core customers? In contrast to the traditional model where companies charge a fixed price to all of the prospects, the “free-to-play” (FTP) model allows customers to self select the segment they belong to and pay accordingly. In addition to offering price discrimination, the FTP model also enhances the community around the game (lure of free to play), increases longevity of the game, and helps increase the game’s stickiness. FTP games can be monetized either through ads (more on this in the next section) or through the sale of virtual goods. Virtual goods are digital goods that people will buy using real money in order to get additional functionality (e.g., virtual currency), more power to their avatars (e.g., better swords, more powerful weapons), to customize and improve their avatar’s look (e.g., cool sunglasses, designer jeans), or as a token of appreciation to other players (e.g., virtual flowers, birthday cake). The virtual goods model has been very successful and is the most-dominant model in Asia. We believe that with the increasing popularity of online gaming and with the Y Generation’s comfort level in expressing itself via the Internet, the virtual goods model is likely to take off in the U.S. and other Western countries too. Taking a cue from the success of the virtual model with companies like Sulake, Second Life, Facebook, Gaia Online, K2 Network, Nexon, Acclaim, and Aria, we believe that more online gaming companies will experiment with the virtual goods model in the West.
  • 29. Page 29 May 4, 2009 Industry Report Exhibit 20: Examples Of Virtual Goods Source: Games Screenshots (clockwise from top left): Webkinz, Disney’s Club Penguin, Sulake’s Habbo, Puzzle Pirates, Zwinky, and Nexon’s Maple Story
  • 30. Page 30 May 4, 2009 Industry Report Drivers For Free-To-Play Model “…some of the old players will continue to play subscription-based MMO, or console games, but the younger audience is different, they start right from the free-to-play experience and once you get the taste of it, then there's no going back. Why would you want to pay $50, get a game that you don't even know whether you're going to like it?” Joshua Hong, CEO, K2 Networks Effective Way To Control Piracy And Build Community Although the lure of converting pirated copies into legal copies by effective anti-piracy measures may seem lucrative, a couple real-life examples suggest that the conversion rates remain insignificant (as low as 0.02%) with anti-piracy measures. On the other hand, anti-piracy measures generally cause inconvenience and, thus, user dissatisfaction for legitimate buyers, which risks the popularity of the games. For example, Electronics Arts’ “Spore” was one of the top ranked games, but was also a highly pirated game. As Electronic Arts put stringent anti-piracy controls into place, the number of illegal downloads was reduced, but so was the ranking. However, the free-to-play model enables vendors to build community and momentum without worrying about piracy. We believe the question that game vendors will have to answer is, are they willing to sacrifice community around the game and potentially jeopardize the popularity of the game to be able to sell an insignificant number of titles or can they find alternative ways to monetize users who wouldn’t want to pay hard cash for the game? We believe that vendors (especially the newcomers, without the legacy of owned IPs) will be willing to eschew the loss of upfront sale and embrace the alternative monetization models such as virtual goods. Virtual Goods Model Enables Price Discrimination Unlike fixed fee-based models (such as subscription or outright purchase), the virtual goods model allows the vendors to price discriminate the customers by letting players choose the value they assign to the game. By making the games free- to-play, vendors are able to attract a larger audience. Players with free time on their hands (like students, cost-cautious players) will spend time/effort to advance levels in the games, while players who need instant gratification of moving up the ladder (like ex-core gamers and core gamers) would rely on virtual goods. While we acknowledge that some of the players who would’ve spent $60 for the game may not spend the equivalent amount in the free-to-play model, we argue that the free-to-play model will encourage some otherwise non-paying players to spend on the game and some hardcore players to spend much more than what they would’ve spent with the fixed fee model. Exhibit 21: ARPU Distribution Curve Of ZT Online, A Free-To-Play Game By Giant Interactive (20) - 20 40 60 80 100 120 140 160 - 500 1,000 1,500 2,000 Users ('000) ARPu($/Month) Source: Company Reports and ThinkEquity LLC
  • 31. Page 31 May 4, 2009 Industry Report Perfect Price Discrimination: “Holy Grail” Of Producer’s Pricing Source: ThinkEquity LLC P1 P2 P1 P2 P3 P4 P5 P6 Shown on the left is a typical supply-demand curve in a normal functioning market. The demand curve is represented with the red line and the supply curve is represented with the blue line. Equilibrium occurs at a price point where marginal cost equals marginal revenue, i.e., where the demand and supply curve intersect. However, at the equilibrium price point, a number of customers benefit as they only have to pay the market clearing price, which is lower than their perceived value of the goods. The amount that these consumers (with low price elasticity) end up saving is called consumer surplus (represented by the red shaded region). Producers use a variety of price discrimination techniques to minimize consumer surplus and maximize producer surplus. Simply speaking, price discrimination suggests that producers can offer the identical goods or services at different prices. The simplest form of price discrimination is used by retailers in the form of discount coupons. With the simplest form of price discrimination, a demand curve is divided into two parts and a higher price (P1) is charged to the consumers with low price elasticity while a lower price (P2) is charged to consumers with high price elasticity. The “Holy Grail” for the producer is to achieve perfect price discrimination, i.e., charging every consumer the price that he or she is willing to pay, thus fully eliminating consumer surplus.
  • 32. Page 32 May 4, 2009 Industry Report Increase Longevity And Improve Games’ Stickiness Unlike a fixed fee game, where players are only putting in efforts to advance levels, in the virtual goods model-based games, players advance levels though efforts as well as through spending hard cash on virtual goods. And so, with every virtual goods purchase, players are increasing their investment in the game and thus increasing switching costs for themselves, increasing the longevity of the games. In addition, the free-to-play model attracts more users (lure of free) and the larger community itself becomes a draw for new players. This was evident in the example of Shanda, a Chinese gaming vendor that was able to grow revenue and increase useful life of its games by converting the business model from a subscription model to free-to-play model. Exhibit 22: Annual Revenue Contribution From Shanda’s Legend Of Mir 2 $0 $50 $100 $150 $200 $250 $300 2004 2005 2006 2007 2008 Year Revenue($million) Source: Company Reports (Shaded area represents the game was converted to free-to-play model) Emergence Of New Payment Channel Players under 18 years of age account for 25% of video games sales and likely account for a much-higher percentage of the online gamer population. Being underage, these players usually do not have access to the popular payment methods like credit cards or PayPal. In the past, gaming vendors struggled with the issue of accepting payment from the younger players. Gaia Online, which has a large percentage of users in this demographic, has full-time personnel who open envelopes to collect cash mailed by their players to purchase virtual goods. Nexon changed that with its Maple Story pre-paid cards. Pre-paid cards are popular in Asian countries. The idea of a pre- paid card is that the users pay in advance to buy prepaid cards and enter the code to their online account to get credit for the value of the pre-paid cards. Since the pre-paid cards are available at retail locations, younger players can use their allowance to easily buy the cards from the retailer and use the credit to play games. Increasing acceptance and popularity of the pre-paid cards could cause more vendors to experiment with the virtual goods model. Generation Y’s comfort level with virtual worlds will likely translate into increased popularity of the virtual goods model, in our opinion. “A lot of old gamers, who grew up playing console games, may not be comfortable with this model, but the younger generation is very comfortable with it. We have already seen the changing consumer preferences transform businesses like Facebook and Twitter.” Howard Marks, Founder & CEO, Acclaim While some may snicker at virtual goods, others, especially those from generation Y, who are comfortable at expressing themselves via social Internet sites such as Facebook and Twitter, seem to also like virtual goods (e-greetings, e-flower, e-pet) as a way to express themselves in a similar way others find it natural expressing themselves by wearing a certain brand of clothes or jewelry. Having grown accustomed to the connected experience of the social networking and virtual goods in social sites, these users find themselves at ease with virtual goods in games that can help them advance levels.
  • 33. Page 33 May 4, 2009 Industry Report We also have the precedence from the example of the Chinese and Korean gaming industries where a number of users (mostly first-time gamers who didn’t have any preconceived notion about a virtual goods model) readily embraced the virtual goods model, making it the most-dominant business model in those countries. We believe that the generation shift will accelerate popularity of the virtual goods model in the Western countries as well. Ability To Grow ARPU The virtual goods model, by definition, delimits ARPU. Unlike the subscription model or outright purchase model where users pay a fixed fee for one-time purchase or monthly (or hourly) subscription, users in virtual goods pay based on their engagement level with the game—the more they are engaged, the more they value the game, the higher their spending is likely to be. The virtual goods model gives vendors the ability to link customers’ perceived value with the price of the game. It’s no surprise then that smart companies can do a perfect segmentation of the market and optimize the price- demand curve of their product. Exhibit 23: Game Spend As A Percentage Of Per-Capita Income Games Spend as %of Per-Capita Income 0.00% 0.02% 0.04% 0.06% 0.08% 0.10% 0.12% 0.14% 0.16% 2003 2004 2005 2006 2007 China U.S. South Korea Source: ThinkEquity LLC Virtual Goods Model = Unpredictable Cash Flow? We don’t think so. A common misconception around the virtual goods model is that the revenue stream under the virtual goods model is unpredictable since the virtual goods purchases are largely driven by the whims of the players. Although we acknowledge that the rules of the game in this model change and the vendors have to be more proactive with updates and other reasons to encourage players to spend, we believe that gamers who are engaged with the game will continue to pay for the game as long as they see the right reason and value in spending. In fact, most of the Chinese gaming companies that work on the virtual goods model have seen their ARPU at a very consistent level after rising in the early stages. Exhibit 24: ARPU Of Chinese Gaming Companies (US$/Month) - 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 1Q06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 SNDA - Casual SNDA - MMO PWRD GA GIGM Source: Company Reports
  • 34. Page 34 May 4, 2009 Industry Report Market Size Estimation Of Virtual Goods In Games “Micro-transaction is essentially a form of pricing model and will have a meaningful share of the market in the U.S. because it provides more options to players.” Joshua Hong, CEO, K2 Network “The market [free-to-play, virtual goods based] is already a few hundred million dollars revenue per year...could easily be a billion dollar market.” Heiko Hubertz, CEO, Big Point “Virtual goods have only recently gone mainstream, and for every publisher that currently sells virtual goods, there are probably another five or six that are planning to do so soon. As consumers become more accustomed to virtual goods, and as the payment systems for acquiring those goods become more ubiquitous, the size of the market will expand exponentially.” Anu Shukla, Founder and CEO, Offerpal We estimate the total addressable opportunity for virtual goods model games to be in the $2 billion range in the U.S. Our estimate is based on the assumption of $14 ARPU per month per paying player, which we believe is reasonable considering most of the virtual-goods-model-based online gaming companies that we talked to reported ARPU of $10- 25/month/paying user. For our market size estimate, we are assuming 10% penetration (active paying users to the addressable gamers i.e., 15-45 years of age and an Internet User), which we believe seems reasonable compared to the 22% average for the Chinese gaming industry. Exhibit 25: Addressable Market Size Estimate For Games Based On The Virtual Goods Model China U.S. Total Population (million) 1330 337 Internet Users (%) 22% 73% Internet Users (million) 298 247 Population 15-45 Years Of Age (% of total) 41% 44% Addressable Population (Internet Users And 15-45 Years Of Age (million) 122.2 108.7 Paying Online Gamers (million) 27.1 10.9 Paying Online Gamers (%) 22% 10% ARPU/Month/Active Paying User $5 $14 Per Capita GDP $6,000 $47,000 ARPU/Per Capita GDP (basis points) 7.9 3.0 Market Potential for Virtual Goods ($ million) $1,540 $1,839 Source: IDC, InternetWorldStats, ThinkEquity LLC
  • 35. Page 35 May 4, 2009 Industry Report In-Game Advertising In-game advertising refers to advertisements that are made either within a game or used as a wrapper around games. We believe that with broadening scope and increasing ubiquity, games are emerging as a new media just like newspaper, TV, and Internet. While the effectiveness or the reach of the traditional media is declining—the conversion rates on Internet remain at very low levels, newspaper readership, and TV viewership continue to dwindle and TiVo complicating the ad delivery on TV-game play time has continued to increase. We believe the amount of time and energy that consumers spend playing games are too big to ignore from a marketer’s perspective. In-game advertising was traditionally limited because of non-availability of technology. Our view is that with the recent advancement in in-game advertising technology (ability to insert ads at any stage of game’s life-cycle, ability to serve ads dynamically) and ability to verify and measure effectiveness of in-game ads, the marketers will be more amenable to embrace the idea of in-game ads. Like Internet advertising, in-game advertising is measurable and accountable (unlike the effectiveness of advertising in traditional media, which is difficult to measure). We believe that sophisticated marketers are already taking notice of games as a media (see Exhibit 26 on President Obama’s presidential campaign ads in-games). Games give marketers a captive, targeted audience who most of the time is willing to watch ads in return of the value provided for free. Exhibit 26: President Obama’s Presidential Campaign Ads In Games Source: Screenshots from Electronic Arts’ Burnout Paradise and NBA Live In-Game Advertising For Consoles Games Consoles are emerging as media devices capable of playing not just games but also watching movies, downloading music, and surfing the Internet. Similarly, publishers are increasingly looking to monetize their games with ancillary revenue streams such as licensing for movies, character dolls, and increasingly in-game advertisements. Given measurability, accountability of in-game ads (as compared to TV), and a more highly targeted audience, and high brand recall (30% ad recall after six months for in-game ads versus typical 10% ad recall for traditional ad campaign per a study by Nielson), in-game ads for console games offer compelling value proposition to marketers, in our opinion. In-game advertising for the console game was popularized by Massive Incorporated (now part of Microsoft). The competitive landscape for in-game advertising is mostly limited to Massive, IGA Worldwide, and Double Fusion. While Massive is mostly focused on ads on the Xbox platform, IGA Worldwide and Double Fusion work with Sony Play Station Console games. • Static In-Game Advertising: The first generation of in-game ads, static in-game advertisements refer to advertisements that are hard-coded in the game environment. These ads can be in the form of product placement (e.g., Coca Cola vending machine in Splinter Cell), billboards (Sprite bill board in Splinter cell), or even as the part of the game play (Ax Deo Glowing Wall as an obstacle that players need to overcome in Splinter Cell). However, since static ads are hardcoded, they cannot be removed, altered, or tailored according to gamers
  • 36. Page 36 May 4, 2009 Industry Report demographics/preferences. Furthermore, these ads should be available even before the game is published (which makes it a difficult proposition—success of the game unknown). We believe most ads are now moving to second- generation dynamic in-game advertising. Exhibit 27: Example Of Static In-Game Advertising—Sprite In Ubisoft’s Splinter Cell Source: egamemarketing.com • Dynamic In-Game Advertising: Unlike static ads, dynamics ads can be delivered based on the players preference/demographics, and ads can be changed over time too. Game developers build “hooks” in the game environment (receptor of in-game ads) and no advertisement is hardcoded. Ads are delivered on these hooks via the Internet when the gaming device is connected to the Web. Dynamic ads also allow the publisher and marketers to track the ad performance metrics and make tweaks accordingly.
  • 37. Page 37 May 4, 2009 Industry Report Exhibit 28: Examples Of Dynamic In-Game Advertisements Source: Screen Shots from (clockwise from top left): Electronic Arts’ Madden NFL, NBA Live, Battlefield 2142, and Need for Speed Advertisers clinch deals with console manufacturers to publish ads on their platforms, clinch deals with game publishers to place ads in their upcoming titles by offering either upfront fixed fee or revenue share (with some minimum revenue guarantees), and sells the inventory to its clients (brand managers). In effect, ad networks have to manage the risk of game success. The typical CPM range is approximately $25 to $35, which likely will come down as more inventory becomes available. Since most of the console games are targeted toward core gamers, mostly males within the 18-34 years of age group, the scope of in-game advertising is primarily limited to brands that cater to this demographic. The scope of in-game advertisement on consoles is further limited because a number of games may not be appropriate for advertisement, i.e., marketers may not want to associate their brands with violent games, and, many times, ads may not make sense given the gaming environment such as a fantasy realm. In-Game Advertising For Online Games Online games are probably the easiest target for in-game advertising since these games, by definition, are all always online. Ads can be delivered within the game environment or as pre-rolls. In-game advertising for casual games is more akin to other advertising on other Internet properties rather than in-game advertising on consoles games. In-game ad networks typically work with game developers, ad enable their games, maintain inventory on a large number of ad- supported games, publish these games on third-party publishers (such as Yahoo! Games, Real Arcade, etc.), and serve
  • 38. Page 38 May 4, 2009 Industry Report ads on these games. Most ad networks are focused on causal games, given the extremely large number of small game developers in that space and strong demand from gamers for these games. Exhibit 29: Examples Of In-Game Advertisements In Online Games Source: Screenshots from (clockwise from top left): Miniclip.com, Kongregate, Second Life, and Gaia Online We believe that online games could be the bigger segment in in-game advertisement for the following reasons: - Much Bigger Player Base: Unlike console games that are sold for a fixed price, many online games are launched in a free-to-play model (supported by virtual goods, premium subscription, incentive marketing, and/or ads), which broadens the player base. - Casual gamers also come from broader demographics. In contrast with core gamers who tend to be largely 18-34 year old males, casual gamers encompass a wider demography that includes women, elderly, and younger players. - Captive And Engaged Audience That Values Free Content And Is Willing To Listen To The Message: Furthermore, casual gamers may be more receptive to watch ads as compared to core gamers. Core gamers who spend hundreds of dollars on consoles and another $50-60 on games may view an advertisement as an intrusion into their gaming environment versus casual gamers who may be more willing to watch ads. By nature, casual gamers are interactive and a playful audience that can be lured into game-advertisement and interesting ads (people watching Super Bowl ads after the game).
  • 39. Page 39 May 4, 2009 Industry Report Demand Drivers For In-Game Advertising Gaming Emerging As A New Media “Gaming is now becoming a major medium. Research by Nielsen has shown that there has been a 12 percent decrease in prime television viewership in the demographic of males aged 18 to 34 years vs. a 20 percent increase in the times spent playing video games for the same group. So the advertisers and their dollars have to follow where the consumers are going.” Justin Townsend, CEO IGA Worldwide Just like the Internet, television, and newspaper, gaming is emerging as a new medium. As the older media are increasingly becoming less effective (reduced readership of newspaper, reduced viewership of television complicated by the TiVo effect), advertisers are looking for new ways to reach their target audiences. With the increasing popularity of online gaming, gaming seems to be promising new media for advertisers to reach young users. The popularity of casual games has broadened the scope of gaming beyond just the young males to include females and older males and made games more ubiquitous. As ad buyers are becoming more familiar with the notion of gaming becoming a mainstream media, we believe in-game advertising growth will continue to accelerate. Technology Coming To An Age “To a large part, it's the availability of technology for dynamic in-game advertising which hasn't been available until now— this technology opened up the possibility for advertisers to once again reach the gaming audience effectively through standard media buys.” Jonathan Epstein, CEO, Double Fusion Strong ROI “We have a number of case studies that have shown positive results for the programs that our advertisers have done.” Jonathan Epstein, CEO, Double Fusion “The research proved that brand recall for ads in games eclipses that for traditional media, as high as 30 percent after six months vs. less than 10 percent for traditional ad campaigns.” Justin Townsend, CEO, IGA Worldwide “Our click rates are …much higher than what you would typically get in any kind of an Internet ad. And to some extent that's a function of the medium because if somebody's playing a game—they're more engaged, they're focusing on the window that the game is playing in, and they're more attentive. Whereas, if you're looking at content on a Web page, you've got ads around the top, bottom, and sides of the page but you're really focusing on the content in the middle.” George Garrick, CEO, Mochi Media “Our advertisers have had a lot of success on our site and a lot of those advertisers keep coming back and re-buying. We leverage our gaming community and the fact that our users are addicted to achievement.” Jim Greer, Founder & CEO, Kongregate Unlike traditional media, new media (such as Internet and games) lets the advertisers reach the target segment more effectively. Using behavior targeting, advertisers can personalize the message for each segments. Using A/B testing and multi-variate testing, advertisers can see the impact of the message on the fly and tweak and optimize the message. We believe that in-game advertising offers all the advantages of the online media plus offers more engaged users. While strong increase of online advertisement has led to “banner blindness” reducing the user engagement and therefore effectiveness of the banner ads; games offer engaged users. Unlike Internet users, gamers are pretty engaged since they want to advance to the next level, since they want to win and since they want to share their achievements with their friends.
  • 40. Page 40 May 4, 2009 Industry Report Measurability Of In-Game Ads “Other forms of display advertising, such as TV, print, and radio may have high reach but lower accountability and one cannot really determine the ROI on advertising in these means…[our advertising] is also very accountable because our software sits inside the games and we can measure and report back the effectiveness of the campaign to our advertising clients.” Justin Townsend, CEO, IGA Worldwide Not only are the ads on the games more effective but also measurable, unlike traditional media ads, which improves the value proposition of in-game ads to today’s sophisticated ad buyers who are looking to see a measurable ROI on their ad- spend. Improving Advertisers’ Sophistication Level With In-Game Advertising “I think for most advertisers, it's still considered a new media at this point. They're spending real budgets, but they probably are still looking at it as the new medium that they haven't fully figured out yet.” There's a lot of things that advertisers don't know yet, just because there hasn't been enough time to observe in enough different situations. So we're getting significant ad buys but we haven't had any million dollar ad buys yet.” George Garroick, CEO, Mochi Media “This industry has evolved at a rapid pace…As for the advertisers, we have come a long way in the past two years and I think the next three to five years, it's going to be a steep upward trend. In the early years, in-game advertising budgets were mainly from experimental budgets. Now it's coming from the digital budget itself, and in many cases we're seeing reallocation of budgets from outdoor advertising, print advertising, TV, and other traditional media that opens a big opportunity for us.” Justin Townsend, CEO, IGA Worldwide
  • 41. Page 41 May 4, 2009 Industry Report Market Size Estimation Of In-Game Advertising “Look at the size of the videogame market and then look at the size of the TV market. What's interesting with online games is that we cover both. We're more of an online media company. To understand our potential, look at the value of Google! Now, where do people spend most of the time online? Is it on searching for things or is it entertaining themselves? If it's entertaining, then our industry is worth more than what Google is worth.” Howard Marks, Founder & CEO, Acclaim We estimate the total addressable opportunity for console games advertisements to be in the $1 billion range. This estimate is based on our assumption that 40% of the consoles are connected to the Internet and that CPM will stabilize at about $10. We believe that the opportunity for ads on online games could be bigger than that for ads on console games. We have assumed a CPM rate of $2 for ads served on online games. Exhibit 30: Addressable Market Size Estimate For In-Game Advertising In Console Games 2008 2011E Best Worst Base Three-Year CAGR in Console Gamers 10% -2% 5% Console Gamers (million) 73 97 69 85 Hours Game Play/Week/Player 8.2 9.0 7.0 8.2 Hours Game Play Year (million hours) 31,161 45,522 25,037 36,073 Percent Of Ad-Friendly Titles* 38% 38% 38% 38% Ad-Friendly Game Play (million hours) 11,763 17,185 9,451 13,618 Consoles connected (%) 20% 50% 30% 40% Ad-Friendly Game Play on Connected Consoles (million hours) 2,353 8,592 2,835 5,447 Ads Served Per Hour of Game Play 20 20 20 20 Total Ads Served 47,054 171,846 56,708 108,941 CPM $10 $15 $5 $10 Market Potential for In-game Advertising ($ million) $471 $2,578 $284 $1,089 Source: NPD, ESA, and ThinkEquity LLC estimates
  • 42. Page 42 May 4, 2009 Industry Report * Ad Friendly Video Games By Units (%) Genre Units % Ad Friendly Ad Friendly Action 22.3% Family Entertainment 17.6% 50% 8.8% Sports Games 14.1% 100% 14.1% Shooter 12.1% 50% 6.1% Racing 8.3% 100% 8.3% Role Playing 7.6% Strategy 4.7% Fighting 4.5% Adventure 4.3% Children's Entertainment 1.0% Flight 0.7% Arcade 0.5% 100% 0.5% Others 2.3% Total 100.0% 37.8% Source: ESA, ThinkEquity LLC Exhibit 31: Addressable Market Size Estimation Of In-Game Advertising For Online Games 2008 2011E Best Worst Base Three-Year CAGR in Online Gamers 10% 0% 5% Online Gamers (million) 67 90 67 78 Internet Users (million) 248 295 273 284 Online Gamers (% of Internet Users) 27% 30% 25% 27% Hours game play/week/player 7.0 8.0 6.0 7.0 Hours game play year (million hours) 24,504 37,273 21,003 28,366 Percent Of Ad-Friendly Titles 100% 100% 100% 100% Ad-Friendly Game Play (million hours) 24,504 37,273 21,003 28,366 Ads Served Per Hour of Game Play 20 20 20 20 Total Ads Served 490,072 745,470 420,062 567,320 CPM $1 $5 $1 $2 Market Potential for in-game Advertising ($ million) $490 $3,727 $420 $1,135 Source: ThinkEquity LLC estimates
  • 43. Page 43 May 4, 2009 Industry Report Who Will Succeed: Characteristics Of Winners In Games As A Service “In a traditional gaming business, once the disc is pressed and shipped to the retail, more or less the show is over. In the free-to-play model, once we launch a game the show starts.” Heiko Hubertz, CEO, Big Point “This is a new kind of gaming business, and it's not build and publish; it's build and serve and then have recursive loops around tweaking and serving. It's an always-on business…where you have to have people watching your leading indicating metrics all the time…you're constantly turning dials.” Mark Pincus, Founder & CEO Zynga “When selling games in a retail environment, prominent placement and recognizable brands are important sales drivers. On social networks, things are different. On social networks, you almost never look for games in a retail or catalogue like environment; you stumble on them because your friends play them. In fact, there's today not a single game franchise in the Facebook games top-10.” Kristian Segerstråle, Founder & CEO, Playfish “The skills that it takes to make a successful, console game…are very different from the skills that it takes to make a successful online game. EA excels in having big teams, big marketing budgets, big brands and not necessarily adapting quickly to changing market conditions, to building a platform, which are what you're going to do online.” Jim Greer, Founder & CEO Kongregate Focus On Understating Consumer Behavior Similar to the differences between the SaaS model and the traditional on-premise Software model (the on-premise model centers around closing the deals, while the SaaS model is about maintaining the customer base by proving the value of software every day), the online gaming model is about retaining the user base by delivering a continuously pleasant and engaging game-play experience. Similar to Web 2.0 businesses, online gaming companies have to continuously collect customer feedback (implicit and explicit—through various analytical software as well as through In-game non-player characters), understand and analyze customer behavior, and regularly update the game based on this understanding of consumer behavior. Managing Piracy Versus Managing Communities; Aggressive Marketing Campaigns Versus Viral Marketing Managing online games is about successfully managing communities, in our view. Vendors, who offer the platform for developing and fostering community bonds can have strong community that is self sustaining, one that can invite their friends and spread word of mouth. While in the traditional packaged game business, the vendors have to worry about curbing piracy to grow, the online business is more about nurturing communities. While in the traditional packaged game business, vendors have to create aggressive marketing campaigns to create buzz around their games, online games are more about spreading messages by more-sustainable (and practically free) word-of-mouth marketing. Not only do we believe that the successful companies will use these customer evangelists to spread the word, but they will also use them for supporting players and handholding new players. Distribution Is About Viral Nature Success of the online game is usually proportional to the virality of the games, with the elements of the social interaction in the game. As we mentioned before, for online gaming, virality drives adoption as opposed to the large distribution networks. In this marketplace, IPs become less important—success of a game may not necessarily translate into success of a series of games; players are far less forgiving and expectations are always moving up, people’s recommendations/number of people playing become more important than the title of legacy of the IP. Monetization Through Alternative Models A successful company will typically use all the ammunition on hand to monetize its games. A vast majority of the players will most likely not pay for the game directly, but these players are equally important as the paying users. We believe that successful companies want to keep their communities healthy (even those that are not paying users) and will use
  • 44. Page 44 May 4, 2009 Industry Report advertising to monetize this population. Only a small percentage (5-15%) of the players will be willing to pay for subscription fees/virtual goods. We believe successful companies will adopt advertising combined with other forms of monetization to optimize value creation by each player.
  • 45. Page 45 May 4, 2009 Industry Report Take A Break: Time To Play Scramble Unscramble the names of my favorite top 25 video games of all time (in no particular order). AMIRO EOKMOPN EJBEEWELD ISSM OORTM KMAATBL PFEE ERNO DSED OLAH NANSYFATAI LF BAIAE RNG ATHRNTTEAO D FGU DNLEF NAMD FGOGERR TERSIT OBSEOBG NP YALTONCC M FRAWRATC NEED LFGHTELAOE Z D THI RGAOUER WNW OSCKWDEMA OL T AFCYDLU ARMRB ETIOD AEENGIL E ENTDILREVSI AJMBOEN SD HF LOMNADR EOO Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
  • 46. Page 46 May 4, 2009 Industry Report Take A Break: Time To Play Word Search Find the names of all of the companies featured in the CEO interviews section. g o o n a e t u d m i i n b x i e y o i i e d m g l e i d u d x a l k k m e t a b o l i g n v n i t r t n i g a i k a c r c l i l t m v a a f d g x a l a h o w v c v t h i m a e e i j b b d i f o e l r i d g i g r o e a h o m m x i n i o l i a k g r l n i u a e e a e o p f j l w n l e n i b r u t d i n y e t a l o c o h c l a t i g i d u r n p s k r o w t e n o w t k a n r i r m a a l l h f v o h b i o e y o e c x g e d t u m i a l c c a g p f d b l n r w s n e l i b o g a g f e p l a y f i s h r n a m r m i o d t p e t z o d n f i o g f e b l t r a d i a n c e s i e n g Source: ThinkEquity LLC (For solution, please email abagga@thinkequity.com).
  • 47. Page 47 May 4, 2009 Industry Report Interviews With The Leading Private Gaming Companies The images on the following pages are courtesy of the respective companies' Websites.
  • 48. Page 48 May 4, 2009 Industry Report Online Gaming: An Interview With The Founder And CEO Of Acclaim Company: Acclaim Founder and the CEO: Howard Marks THINK SUMMARY We had a chance to interview Howard Marks, the founder and CEO of Acclaim, a developer and publisher of free- to-play online games largely focused on the audience in the western hemisphere. We believe that a shifting user preference toward the social and connected experience will likely drive the popularity of free-to-play and multi- player gaming, especially with the younger generation, which does not view gaming as a solo experience limited to consoles. The company is not seeing any impact of the slowing economy, which may reflect the resiliency of online and free-to-play gaming, and also, the apparent nascent stage of the opportunity. KEY POINTS • Acclaim is a developer and publisher of online games, with over 10 million registered users, mostly from the United States and Europe. The company offers its games as free-to-play and monetizes through virtual goods sales and in-game ads. • Given the broad demographic of the gaming audience and the shifting user preference from traditional media to online games, Marks expects in-game advertising to emerge as a sizeable market opportunity. • While the older players in Western countries, who grew up playing console games, may find free-to-play, PC, and multi-player gaming a different experience, the younger generation, which grew up on the Internet and is used to the connected social experience, such as Facebook, Twitter, etc., is much more comfortable with the multi-player gaming, free-to-play, and virtual goods model, driving the popularity of free-to-play multi-player online games, in our view. • We view favorably the frictionless and scalable model of online gaming that relies on acquiring players through viral or word-of-mouth marketing, which we believe strengthens community bonds among players and ultimately helps to promote the longevity of the games. • According to Marks, the company seems to be benefiting from the slowing economy, which may represent the resiliency of online and free-to-play gaming and the apparent nascent stage of the opportunity.
  • 49. Page 49 May 4, 2009 Industry Report Atul Bagga, ThinkEquity LLC (AB): Can you explain Acclaim to investors? Howard Marks, Founder and CEO, Acclaim (HM): In 2005, we purchased Acclaim assets with the goal to restart it as an online game company based on a free-to-play model. Currently, we have close to 10 million registered players. We have a few types of games; we have hardcore massively multiplayer online game targeted toward young males, and we have browser-based games that are targeted toward a broader demographic. We are also developing our own browser-based game using Flash. And the first one is being released, called Rockfree. We have another one called Prize Potato, which is on Facebook right now, and a couple more games, one is called “Kogamu” and the other is called Acclaim Poker. AB: What is your business model? HM: All our games are free-to-play and we plan to monetize them through selling virtual goods and ads. AB: What is the current revenue split from various streams and where do you see that trending over the next couple of years? HM: Advertising model is dependent on economic conditions. Longer term, I think that there'll be some significant opportunities to get brands to target our consumers because brands will have a hard time finding their audience on TV, radio, or prints, given the declining popularity of traditional media amongst the younger generation. AB: Who is your primary target audience? HM: It depends on the game. Just like a TV network targets a broad audience through a variety of shows, we target a different audience through a variety of games. The download MMO games are hardcore, certainly 90% men, usually teenage boys and young adults. The browser-based games target different demographics. We have games just for girls. We have games like Rockfree, which will be probably 50-50 boys and girls, teenagers, and young adults. Currently, about 75% of our revenue comes from the hardcore market, but we expect that to change with new games that we are launching now. AB: Can you talk about the geographies that you target? HM: We are 65% U.S. Half of the remainder is Europe; the other half is the rest of the world. AB: What is the typical ARPU on your games? HM: It depends on the game; the monthly ARPU for hardcore games is generally $25 to $45, and for the browser games, is $10 to $15. AB: How big could this market be for Acclaim? HM: Well, it's pretty simple to calculate. Look at the size of the videogame market and then look at the size of the TV market. What's interesting with online games is that we cover both. We're more of an online media company. To understand our potential, look at the value of Google! Now, where do people spend most of the time online? Is it on searching for things or is it entertaining themselves? If it's entertaining, then our industry is worth more than what Google is worth. So we think the potential is pretty big. AB: What are the secular drivers for online games, and free-to-play, ad supported, and virtual goods models? HM: A big size portion of the ad market is going to go towards us because the consumer is changing their habits. As they change their habits over time, like they did with the record industry, that's where you capture the value. So we're already seeing a transfer of value from the traditional media, like TV to games. With video games, it was hard to capture user behavior post the game sale; with online games, it is very easy to capture and that will drive the advertising sale on games. As for the virtual items model, it is about changing consumer preferences. A lot of old gamers, who grew up playing console games, may not be comfortable with this model, but the younger generation is very comfortable with it. We have already seen the changing consumer preferences transform businesses like Facebook and Twitter. We have already seen success of the model in Asia, where online games has become a quite significant industry compared to TV and music.