JULY 23, 2007 • In recent years there has been a great deal of buzz over the “casual games business.” To an outside observer of the game industry it may seem as if there has suddenly been discovered a wide swath of consumers with different playing habits. In fact what is referred to as casual games have always been a large portion of the game industry. What is often defined as the casual game industry in today’s market is simply describing new ways to generate revenue from product genres like side-scrolling action games that can no longer gain retail distribution and are often given away free online.

The term casual games can be confusing because it is used in so many ways. It can be used to describe a type of consumer, a type of game or a business model. In recent years, the most popular use has been to describe many of the PC game products that are available online, often for free. The casual game industry refers to efforts to try and charge consumers for playing these games and/or collect revenue from advertising sponsors.

DFC Intelligence is not a big fan of the term casual game. We feel it is a misnomer often applied to products that have struggled to find a viable business model. What are described as “casual games” are usually products that have a long established history in the video games. There is nothing particularly new or revolutionary about these products. These are the type of games that have sold very well in the past and are expected to do so for the foreseeable future. The big revolution has actually been on interface design and this has been led by Nintendo Co. Ltd., with new input devices especially targeted for the mainstream consumers, such as its touch screen DS, the Wiimote controller and the upcoming Wii Balance Board.

In our latest Online Game Market forecasts we breakout figures for casual game revenue generation via online digital distribution, advertising revenue and subscription revenue. However, this only tells part of the casual game story. The biggest source of revenue is actually revenue generated at retail. Unfortunately, the business model for many companies in what is now called the casual game industry does not have a solid retail component. Thus when we talk about estimates for online casual game revenue we are only talking about a fraction of the potential business to be earned by game genres that are often classified as casual games.

As the table shows, when we look at casual games as a genre we actually include products from several diverse categories, each with its own separate appeal.  In the traditional video game market, consumers for years have shown a strong willingness to pay for “casual games.”  In addition, they will often pay full retail sticker price.  The game industry was founded on titles like Pong, Space Invaders, Pac-Man and Tetris (a key driver of Nintendo’s portable game business).  With console game systems versions of products like Pac-Man continue to haunt the best seller lists even in today’s market.

When looking at casual games from a genre perspective we divide products into several very different categories including puzzle games, action games and character-based games which are often licensed from other media.  We would also note that many games from other genres are what many would consider “casual games.”  This would include simulation product like Nintendogs and strategy products like Brain Training and traditional board and card games.  Often kids and educational products like Nickelodeon and MyNoggin are included as casual games.  However, DFC Intelligence feels these products are different enough to deserve their own children’s category in our online game forecasts (any products designed to appeal to an under 8 demographic).  Then there are all the Virtual World products that some would consider casual games.  DFC Intelligence only includes those virtual worlds that have one of the game genres listed in the table as a casual game.  An example would be Neopets where one of the big attractions is all the free casual mini-games the user can play.

The main thing to note about games in this category is that they have relatively simple controls compared with the more intense action-oriented games that have had the greatest success on the console systems.  Usually they can be played in fairly short sessions, which make them good for gaming on the go.  However, the main feature is that they usually require the user to push only one or two buttons versus complex games that can routinely have up to eight or more control buttons.

Another key item to note is the difference in the definition of casual games in Asia versus North America andEurope.  In Asian markets like Korea and China the tendency is to describe a casual game as anything that is NOT a massively multiplayer online game (MMOG).  In other words this expansive definition would include genres such as racing, sports, fighting and so on as casual games.  In DFC Intelligence forecasts we do our best to separate out these genres from what we define as casual games.  When presenting our numbers for the casual game market we use the Western definition.

In short, to bow to popular terminology DFC Intelligence releases forecast for the “casual game market.”  However, it is important to understand how are forecasts are limited in scope.  The focus on our forecasts is not so much on the game genre as on the business model.  We are looking at games that are using online business models to generate revenue.  We are not including the billions of dollars that is already being spent at retail.

The online casual game business model is basically one where you aggregate a whole bunch of low cost content to attract eyeballs which will in turn attract advertisers and allow you to sell products and services to the user base.  Under this model a casual game can potentially be defined as any low cost product that has the potential to attract a lot of users.

For many years large portals have found that casual games can be “sticky” content. In other words, consumers hang around for a long time to play casual games and hopefully watch ads.  Advertising in casual games that are offered online for free has been around since before the turn of the century.  However, this has not necessarily helped the game developers and publishers because generally they don’t share in the advertising revenue pie.  Furthermore, for the more intense user of casual games the advertising has become so intrusive that an increasing number are willing to pay to turn-off the advertising.  This has resulted in the growth of casual game subscription services whose main appeal is no advertising.  It has also meant the growth in consumers purchasing a game online and having it downloaded via what we call digital distribution.  Game developers can get excited about the growth of digital distribution because, unlike advertising, developers have the potential to share in the revenue stream.

In other words, casual game digital distribution represents an emerging sales channel.  The main thing to note is that most casual game digital distribution is not to play the game online.  It is basically like purchasing a product at retail, except the transaction is done entirely online.  Once the game is downloaded the product can be played offline.  Most casual games are single player experiences.  In fact, we would argue that a game that can be played multiplayer online is almost by definition not a “casual experience.”  Playing others online is not for the faint of heart.

The online digital distribution of casual games is really a reaction to the massive decline in shelf space for PC games.  Most products that rely primarily on digital distribution are doing so because they can not get retail shelf space.  Around 1999 the retail shelves were filled with casual PC games.  This space started to collapse around 2000 as retailers increasingly focused on console and portable games.  It was exacerbated by the growth in online penetration where many low cost games were now offered for free.  Casual game developers were locked out of a revenue stream and basically forced to do work for hire.

The digital distribution model is a way for casual game developers to see some upside revenue from developing a hit product.  Of course, the big success will clearly be taking a franchise beyond digital distribution and delivering it not only at retail, but releasing versions for console ad portable systems.

For an investor looking to get into the casual game space one of the first questions to a prospective company should probably be what is your strategy for portable and console game systems.  Games for PC and mobile phones may be low-hanging fruit, but the big money is in the dedicated platforms.  A solid casual game IP needs widespread distribution across all platforms.  Ideally this would include multiple business models for distribution such as digital distribution for purchase across as many services as possible, retail if feasible, bundled in with advertising and subscription services and so on.

It is also important to distinguish between each party’s role in the food chain from developer, IP owner, publisher, distributor, aggregator and retailer.  The outlook and strategy for execution will be vastly different depending on where a company is in the food chain.  Right now too many people are focused on just the narrow area of casual games for the PC.  Yes, DFC Intelligence forecasts this to be a strong growth area.  Between 2006 and 2012, we expect worldwide revenue from just online distribution of casual games on the PC to nearly triple to over $1.2 billion.  Of course, this does not even include the additional revenue that can be earned from subscription services and advertising revenue.  When these figures are included worldwide online revenue from casual games is expected to reach nearly $2.3 billion by 2012.  However, most developers will not share in the advertising and subscription revenue and the real jackpot will be going to retail and the portable and console systems.