JUNE 20, 2008 • The PC game market is dead. Again. At least that’s what’s often been reported. If there has been a steep decline over the past few years, many people now are beginning to realize that this “decline” is actually just referring to sales of traditional boxed PC games at retail.  The reality of the market is quite different.

On a worldwide basis the PC game market has steadily increased year-over-year.  DFC Intelligence forecasts that the when online sources of revenue are included the PC game market reached $11.3 billion in 2007.  From a pure revenue standpoint, this makes the PC the number one platform for games.  The Nintendo DS was a distant second with about $5 billion in software revenue in 2007.

Ironically, many of the traditional game publishers started giving up on the PC game market just as it was about to takeoff.  Back in the 1990s, the PC was seen as the platform of the future.  Many analysts predicted that the growth of home PCs would soon make game console systems obsolete.  At the time, DFC Intelligence was seen as contrarian for arguing that console sales would eclipse PC game sales for the foreseeable future.  In the 1990s, retail stores were chock full with thousands of PC game titles in all conceivable genres.

This all started to change around the year 2000, right around the dawn of the 21^st century (which technically began 1/1/2001).  After years of steady growth in the U.S. reports from the NPD Group showed that for the year 2000 PC game revenue was flat at about $1.55 billion. More ominously in the fourth quarter of 2000, revenue for PC games was down 8% over the fourth quarter 1999.  This was the beginning in a long, steady decline for reported PC game sales at retail revenue.  By 2007, the NPD Group was reporting retail PC game sales in the U.S. at barely over $900 million.  Retail shelf space for PC games is a fraction of what it was in the late 1990s.

In reality, the truth has been that with the dawn of the new millennium, the PC game market has shown that the old way of thinking about the game business is rapidly becoming obsolete.  The NPD Group projects market size by tracking a sample of major retail chains in the U.S. This is the traditional brick and mortar buy a box at retail, twentieth century business.  However, the PC game market has led the way at breaking out of the twentieth century paradigm and exploding on a true digital basis that allows consumers to purchase and use products without ever visiting a retail store.  Retail sales remain an important component, but companies that focus only on that single business model are missing the bulk of the growth story.

First and foremost, even at retail, the PC game market has become a market for truly massive hits.  Looking just at the NPD numbers from the 1990s compared with today can highlight some of this story.  As mentioned, retail sales for PC games were reported as flat in 2000 versus 1999.  Over it was a different story for the top titles.  In 1999, titles in the NPD Group top 10 sold an average of less than 500,000 units in the U.S.  The top title, Rollercoaster Tycoon sold about 700,000 units.  Compare this with 2000 where NPD reported five PC games sold over 800,000 units and the top title, The Sims, sold 1.8 million.  The year 2000 started the retail decline, but it was also the year that top PC games broke out to have sales that could match hit games for console systems.

More importantly, 2000 was the year that it became clear that U.S. retail was not the wave of the future in PC games.  Of course, The Sims became the best selling PC game ever, but it also indicated a form of PC game play.  At the time of its release, DFC Intelligence wrote that “we feel The Sims is a compelling concept that will only improve over time.  The Sims has the potential to be one of the greatest game franchises of all-time.”  We argued that the unique nature of open-ended games where a player does not “win or lose” had a huge amount of appeal.  We also discussed the idea of being able to go online and buy individual items for the Sim universe and also eventually going online to communicate with other players’ Sims.

As a product, The Sims Online virtual world hasn’t yet worked out.  However, a clear driver of The Sims franchise has been the add-ons and the ability to trade with an entire community of Sims users.  The concept of a game being more about a virtual world/social network really achieved its first major success with The Sims.

The Sims exploded the success level for a PC game by expanding the definition of what it means to be a game and appealing to a much broader audience. Many consumers that would be traditionally defined as “PC gamers” scratched their heads in disbelief at the success of this “non-game” game. However, The Sims was (and still is) a very traditional boxed retail product. However, it was around 2000 that it became apparent that the PC game market was becoming about much more than retail sales.

Two products that did appeal very much to what traditionally would be considered a “PC gamer” were the massively multiplayer online games (MMOG) Ultima Online (UO) from Electronic Arts and EverQuest (EQ) from Sony Online Entertainment. These were games sold at retail but to play them required an online subscription and a monthly subscription fee of $10 for Ultima and $13 for EverQuest. The retail sales numbers for Ultima and EverQuest were nothing spectacular and implied limited impact.  However, for 2000, Electronic Arts was reporting over $20 million in subscription revenue in its SEC filing.  This was from a product released way back in 1997 that was currently all but non-existent on the retail sales charts. EverQuest was having significantly higher retail sales and it had a higher subscription fee. Like Ultima Online, clearly the bulk of EverQuest revenue was not being reported in the retail sales figures.

Another company that started making waves on the radar in 2000 was Pogo.com.  Pogo.com was originally funded by leading VC firm Kleiner, Perkins, Caufield & Byers in the mid-1990s as a service for hard-core PC gamers called the Total Entertainment Network (TEN).  In late 1999, TEN did a total about face and renamed itself Pogo.com with a focus on free casual, advertising supported online games. At the start of 2000, Pogo.com was claiming 5 million users. A year later, in early 2001, Pogo.com was acquired by Electronic Arts for $42 million. At the time, Pogo.com had grown to 17 million users and was the most popular game site on the Internet. Today, Pogo.com quietly generates close to $100 million in annual revenue for Electronic Arts

The year 2000 was when DFC Intelligence first started tracking the Korean market. In 1999, Blizzard Entertainment launched their hit real-time strategy game Starcraft in South Korea. In meeting with Blizzard in 2000 we were surprised to learn that sales of Starcraft in South Korea had surpassed U.S. sales (it had been a hit in the U.S.). It was this news that led us to an awareness of such companies as NCsoft and their smash hit Lineage.

Since the turn of the century, online games have exploded and subscription and digital distribution business models are now the norm.  In 2007, China was the fastest growing market and leading China online game provider Shanda passed the $300 million revenue mark.  Of course, the console systems still generate more revenue and have more big hit products than the PC.  This is a trend that is expected to continue for the foreseeable future.  However, as a gaming platform the PC is more exciting than ever and has several key advantages:

1) Big Hit Potential: The Sims, Blizzard games, Lineage, Half-Life, Age of Conan…top PC games can generate revenue equal or greater than the top console games.

2) Lifespan: EverQuest still generates revenue for Sony Online Entertainment.  NCsoft’s Lineage still generates over $100 million a year for NCsoft and its successor, Lineage II generates more.  These are games that are around 10 years old.

3) Low distribution costs: Pogo.com built up millions of users with  handful of employees and never shipping a box to retail. Today casual game providers like Real Networks are generating over $100 million in annual revenue with no retail presence.  Even when casual PC games received full retail distribution in the 1990s, $100 million in revenue was unheard from a PC game publisher in those categories.

4) Pioneering business models: Advertising, digital distribution, subscriptions are all huge growth areas. The PC is where all these models are being tested.

5) International appeal: Multi-billion game markets like China and Korea are predominantly PC-based. In many emerging markets the PC is a significantly less expensive and more utilitarian platform than game consoles which tend to appeal more to the very upper echelon of society.

DFC Intelligence forecasts that by 2013 worldwide PC game revenue will have reached over $19 billion.  This will still be smaller than the console software market, but it will represent all kinds of opportunities for emerging companies.