DEC. 22, 2012 • DFC Intelligence was founded in 1994 with a stated goal to provide strategic data research that would better enable companies to understand the growing video game industry and the emergence of what people back then were calling by such quaintly antiquated terms as Multimedia and Information Super Highway. The philosophy driving DFC then, as now, was distinguishing between what was real, what was hype, and from that point building a trustworthy roadmap of how new and established markets were likely to emerge, grow and change established consumer behavior.

Unfortunately, not every research firm in our business chooses methodologies that adequately distinguish from reality and hype. One of the specific issues that has come up consistently over the years is the basic lack of understanding of market segments and overall market size. In many cases, consumer surveys have been performed as a way to size the market before critical aspects about that market are even well understood. Simply put, DFC believes that consumer surveys should never be used to size a large, diverse market like the video game industry. Asking consumers how much they spend on something can give directional indications but it should never be extrapolated to market size.

Consumer surveys should actually only be done when a company has a fairly sophisticated view of the market and wants to understand or back up key assumptions. They always need to be closely checked against other data sources. In the game industry, talking to consumers is best done on a product level.

For companies looking to understand an industry like video games, DFC Intelligence always urges getting a high level segmentation in order to better understand what points should be subject for more detailed research. A high level segmentation can usually be done fairly quickly at a relatively low cost and it is a great way to figure out where you want to spend money or target going forward. In many cases an initial segmentation of an industry can be almost all qualitative based on industry knowledge.

There is simply no one source of information that can provide a complete overview of the complex worldwide market for the video game industry. In covering these complex areas there is no one secret “methodology.” DFC’s approach involves looking at a wide variety of different data. This is called a “triangulation approach.” The types of data used vary based on what information is trying to be obtained. However, even to obtain a large scale macro worldwide picture of something as basic as “how big is the global game industry?” it is important to rely on a variety of sources to triangulate market size.

To better understand DFC’s methodology approach it is necessary to present an overview of some of the various data sources DFC often uses and their strengths and weaknesses.

Most research firms use only one, or possibly two of the above methods. However, all of the methods have major issues when aggregating even a single market such as the U.S. or even understanding an individual platform like the Xbox 360. These issues are magnified substantially when it comes to estimating multiple markets and multiple platforms on a worldwide basis.

DFC Intelligence’s triangulation approach uses multiple methods to triangulate and extrapolate overall market size, product performance and directional trends. Of course, with this approach it is necessary in many cases to do an apples-to-oranges comparison across different research methodologies and different tracking mechanisms and different markets. Every research project requires a different solution based on the goal of the project and the availability of information. However, by 1) having an understanding of the limitations of each different approach; 2) using as many different data sources as possible and 3) being upfront about the limitations of ANY market sizing research, it is possible to spot inconsistencies among reported data and come up with a reasonable market estimates

To better understand DFC’s methodology approach it is necessary to present an overview of some of the various data sources DFC often uses and their strengths and weaknesses.

Distributor reported information: Historically, this is the most commonly used source of both extrapolating market size and understanding individual product performance. This is where a research firm samples sales at a panel of distributors and extrapolates market size by estimating what percentage of the market that panel represents.

• Strengths: This can be a very accurate approach for contained markets with a limited product base controlled by a relatively small number of distributors.

• Weaknesses: When you have a large number of distributors and channels, multiple markets and many different types of products this approach starts to breakdown. This is the case in the PC market, portable market and with digital distribution in general.

• Key Use: Always use as a triangulation point if available. But never rely on solely.

Manufacturer reported information: This would involve a combination of publicly reported information and confidential self-reported information.

• Strengths: This can be used to extrapolate across a number of markets if you have enough companies reporting

• Weaknesses: Highly subject to misreporting and misinterpretation. Need multiple providers and need the ability to cross check with other data collection methods.

• Key Use: Always use as a triangulation point if available. But never rely on solely.

Consumer surveys: This is asking consumers about their behavior.

• Strengths: spotting broad consumer trends and overall product perception. Can also get some solid insights into cross media preferences and demographics.

• Weaknesses: Highly subject to misreporting and misinterpretation. By itself it is almost useless in trying to extrapolate overall market size or product performance. Very expensive for what it delivers.

• Key Use: Use with caution. Best for when a firm understanding of a market has been obtained and you want to gain better understanding of a very specific issue on consumer attitudes and preferences. Never use surveys to extrapolate market size or product performance.

Monitoring consumer usage: This method involves tracking how consumers use a product without having to rely on self-reporting from the consumer.

• Strengths: Not subject to misreporting if done properly. Can be used to size market with appropriately representative panel.

• Weaknesses: Expensive, potentially intrusive and hard to do. Doesn’t necessarily tell you about actual spending behavior.

• Key Use: If available can be a key source for analysis and also as a triangulation point if available. However, it will usually be limited to a very specific product, platform or consumer type.

Industry insider surveys: This method involves talking to key people that work inside the industry and have a deep understanding of key subjects.

• Strengths: A core method that is an absolute necessity to obtain a true understanding of what is really going on.

• Weaknesses: Completely qualitative. Time consuming, hard to assess what is true versus hype and involves talking to many hard to reach people.

• Key Use: A necessity. Networking and detailed interviews with many industry insiders beyond what is published or delivered at an industry conference is a necessity for in-depth understanding. However, it needs to be combined with other data collection methods.

Most research firms use only one, or possibly two of the above methods.  However, all of the methods have major issues when aggregating even a single market such as the U.S. or even understanding an individual platform like the Xbox 360.  These issues are magnified substantially when it comes to estimating multiple markets and multiple platforms on a worldwide basis.

DFC Intelligence’s triangulation approach uses multiple methods to triangulate and extrapolate overall market size, product performance and directional trends.  Of course, with this approach it is necessary in many cases to do an apples-to-oranges comparison across different research methodologies and different tracking mechanisms and different markets.  Every research project requires a different solution based on the goal of the project and the availability of information.  However, by 1) having an understanding of the limitations of each different approach; 2) using as many different data sources as possible and 3) being upfront about the limitations of ANY market sizing research, it is possible to spot inconsistencies among reported data and come up with a reasonable market estimation that can consistently track market growth and trends over time.

Yet data sources alone are not the end all to our research. The key assumptions research firms bring with them to their data sourcing is also critical. There were several key assumptions built into DFC’s belief system that informed our triangulation approach from the start. These subjective beliefs can often be as critical as raw data because they often determine how the data collection process is organized.

Among core early DFC assumptions, first, and foremost, was the core foundation that consumers really like games and are willing to pay more for them than many other forms of entertainment. Back in 1994, the market was dominated by 16-bit video game cartridges that sold for $50 to $75, about the same MSRP as today’s top games. However, while many retro gamers will take issue, the games of 1994 generally provided much less multi-faceted entertainment value than the games of today. Nevertheless, most everyone under the age of 20 were flocking to these games.

The main issue of concern was that, by and large, adults did not play video games in significant numbers. This led many outside observers to relegate video games to the status of toys, and conclude that the segment was close to reaching the saturation point among its youthful consumer base. In other words, analysis of the video game industry followed the traditional analysis of the toy industry. It was DFC’s belief that the video game industry would emerge more along the lines of the music and movie industries and be far larger than just toys for kids.

DFC’s second major assumption was that as game consumers aged they would continue to play games. This was an extremely important distinction because it meant that instead of losing consumers every year the game industry would just grow older and larger over time. This same phenomenon occurred with the music industry in the 1980s. In the early years, rock and roll music had appealed mainly to an under-25 demographic. The launch of music CDs saw a large number of adults going out and replacing their music collection. As a result, the music industry tripled in size in a few short years during the late 1980s. The music industry has had its struggles, but bands like the Beatles and Rolling Stones continue to have success with marketing their catalogs across multiple platforms to a truly multi-generational audience.

It is now obvious that on both core points, DFC was right about the game industry. Revenue from video games has exploded and it is clear that the demographics of gamers have aged along with its initial consumers. Consumers love video games and they have become a core part of not only the U.S. entertainment culture but also have had success on a staggering global level.

The third assumption was that games would come down in price with a wide range of pricing options. The thinking was patterned after the high tech industry where evolving and expanding technology led to cheaper hardware, as well as new software delivery mechanisms that led to cheaper content. Our view was that online networks and broadband penetration would both lower the price of manufacturing and increase distribution options. In the 16-bit days, prices were over $50 because cartridges stored game code on then expensive memory chips that cost $15 to $30 to manufacture, and which had to factor in the major cut the brick and mortar retail/distribution infrastructure took from each sale. DFC thought that the low cost of CDs and the ability to deliver products digitally would greatly expand the market as prices came down.

On this point, DFC was off by quite a few years. With the launch of CD-based games prices did come down to the $40 range for a period of time. However, manufacturers realized how much consumers love and are willing to pay for top games and they eventually pushed the price up to $50, $60 and even more for certain products. Meanwhile, the emergence of a broadband online network was far slower in coming than most anticipated. Even in 2010 online distribution and storage of a large game is simply not cost or time effective for most consumers in the U.S.

Another area that DFC had forecasted would help bring down game prices was the potential to have consumer spending subsidized by advertising. Most major entertainment forms are able to attract advertisers when they reach a critical mass of users that spend a large portion of time interfacing with the products. Revenue generated from advertisers helps lower the end cost to consumers. Of course, television and consumer magazines are two great historical examples of allowing high-end products to be delivered at a very low cost to the end-user.

DFC was also off in thinking that advertising would help lower game prices. In short, DFC’s belief that consumers love games was so accurate it meant traditional economic principles that should have meant a downward trend in pricing did not occur. Consumers were willing to pay a premium for games, or at least the right game. Revenue wise, top game product launches are the biggest the entertainment industry has ever seen.

Instead of saying that the core assumptions made in 1994 are wrong, DFC Intelligence likes to believes that its assumptions were actually on target, it was just more a question of “when, not if.” Unfortunately the “when” is always a huge unknown. In other words: ”When will broadband and digital storage costs allow for seamless download and storage of game products with a large client?” “When will pricing of games truly reflect their true entertainment value?” “When will advertisers find a way to effectively reach the massive amount of consumer leisure time being sunk into games?”

These strategic issues are all areas of core concern for DFC. In terms of the last issue, on advertisers effectively working with the game industry, DFC Intelligence is launching some major initiatives: 1) DFC is doing some detailed segmentations of the game industry to provide better clarity for all parties involved, and 2) DFC is planning to deliver some new research specifically on how consumer products and service companies can effectively use games as part of their marketing mix.

The thinking behind DFC’s initiatives is that there is a lack of common understanding about how the game industry works, the different types of platforms, consumer demographics and the various types of games. This is true not only for outsiders looking at the game business. There is also the lack of a common taxonomy within the game industry. Game industry professionals tend to think in terms of a specific game type, distribution method or platform. In other words, a developer of games for the iPhone often has a different vocabulary from a marketing manager of a major console franchise. An executive focused on action shooting gamers often has no understanding of the ways companies are reaching consumers on Facebook. Even PC game developers often speak a foreign language to console game developers. In short, the game industry has enough trouble communicating within itself, so outsiders from other industries are likely to get very confused.

Some major issues are: 1) consumer behavior is constantly evolving; 2) there is increasing overlap among consumers owning multiple game platforms and having more diversity of taste in game play and 3) distribution methods are very different based on product type, geography and demographic. Due to the lack of understanding of the consumer digital entertainment sector, many companies have shied away from the space, or even worse tried to enter the game market only to fail miserably. DFC Intelligence’s goal is to provide a strategic understanding of the various segments in the game industry and from that point examine how these segments interact. This requires a wide range of approaches using various different methodologies. At the heart, of this approach, the initial first step is to segment the market and come up with a common taxonomy for what is being covered. Many observers forget this first step.

It is only after the initial segmentation can the data collection process starts. It should be noted that every topic or issue covered will require a different data collection method. As an example we use the qualitative segmentation of potential game platforms. Of course, it should be noted that this is just an example of an initial roadmap that would be used for further research. Obviously filling in the numbers and details is a much larger project.

The initial segmentation on the previous page is a very initial start with no focus on actual numbers. The focus on this type of initial qualitative segmentation is key because without this analysis quantitative numbers can be very misleading. For example, both historic sales numbers and current usage data would show that the Sony PlayStation 2 is a very popular system among U.S. households. However, a simple qualitative analysis would indicate that the PlayStation 2 is an older system with a focus on a pre-existing library of products. It may look like a good opportunity, but for a company not already familiar with working with Sony it is probably not a good place to start.

This sample segmentation is intended to be an example of a starting point designed to raise more questions than it answers. Obviously from this point hard data needs to be collected and this is really a guide to start determining what questions need to be answered. In doing analysis DFC Intelligence would definitely look in more detail at the following questions:

• What are the actual unit sales trends both historically and the outlook going forward? • What are the major competing systems and what new products look to be competing in the near future? • What are application sales by type? • What is the range of application revenue? How does that range vary by type of application? • What is the cross platform ownership? • Where and how is marketing targeted for the system and specific applications? • What is the actual business model and royalty structure? • Who are the leading distributors? • Which companies provide applications for the platform? •What are the accessories available for the platform and how do they impact application sales? • What further segmentations need to be done for each individual platform?

Of course, this is a segmentation being done for only one country, the U.S. When analysis is done on an international basis it requires doing it for at least the top 20 countries worldwide. Obviously this gets extremely complicated and is why it has been so hard for companies to break into the game industry on a large scale.

Nevertheless, it is becoming essential for all companies in the business of delivering products and services to consumers to have at least a basic understanding of the game business. Video games as a core leisure time activity are taking up a growing share of not only consumer entertainment dollars but also consumer leisure time. This is leisure time that potentially could be used as a way for many companies to deliver marketing messages to consumers.

Furthermore, game platforms have the potential to also deliver many applications beyond just games. This could include applications that are more educational or information-based as opposed to pure entertainment. Already game systems are becoming a great fitness tool with products like the Nintendo Wii Fit and Microsoft Kinect.

DFC Intelligence initiatives are designed to get consumer products and services companies communicating on a more detailed level with all parties getting a better understanding of the common goals. This type of communication has been lacking and it is clear it has been an overall lose/lose situation with a great deal of money left on the table. DFC intends to do its part to start changing the status quo.