The evolution of video game business models

The enterprise software market has been going through a product-to-service transformation for a number of years. One clear representation of this is the boom in open source and software as a service, both of which are built on a different value curve in relation to typical enterprise licensing.

The community and enterprise versioning strategy common in open-source companies is similar to free-to-play and premium versions of games, though games tend to have alternative paths to monetization--typically advertising.

The game market is at the beginning of an evolutionary path--moving from purely packaged games played on consoles to browser-based free-to-play and hybrid-hosted scenarios.

The crux of the change is in how games are monetized when there is no direct license revenue; ads, subscriptions, and virtual goods all have a place in the new ecosystem, but thus far, no one method has proven to be best.

I wrote previously about social-game company Playfish, when it launched a premium in-game ad campaign with Procter & Gamble and Herbal Essences via the Geo Challenge Facebook game in the United Kingdom. Playfish also introduced in-game advertising with Google and in-game transactions via Facebook earlier in 2008.

I asked Playfish Chief Operating Officer Sebastien de Halleux how a company developing casual games ever makes real money. As it turns out, several companies are already generating real dollars. The Playfish founders came out of Glu Mobile (in Europe), which apparently generates about $100 million in annual transactional revenue.

According to Sebastien, the challenge is less about revenue generation and more about distribution. Video games have a perceived value in the end users' mind. The trick is to become the facilitator of transaction-based monetization.

Playfish has five games, with 40 million users playing approximately 30 minutes per day. That engagement is worth a lot in the consumer advertising world, but most advertisers haven't caught up online yet. They spend the majority of their ad dollars on text ads and TV spots but haven't yet figured out how best to take advantage of user engagement as part of a social fabric.

Virtual worlds and good solutions are generally meaningful for end users, but the exclusivity of the content is what drives advertisers to pay to own the engagement cycle.

One challenge is that it's very hard to predict revenue due to the hit-driven gaming environment (not Web page hits, but hits, like big winners). Games, like movies or books, have a few hits, and you need to be able to build the hits and manage the portfolio to kill lesser titles.

Playfish started experimenting with user-generated-content (UGC) in its Pet Society game over the holidays. Users were able to create their own Christmas cards based on their avatars on Facebook, and hundreds of thousands of users participated.

Another interesting factoid related to UGC is that the audience for the Playfish games has changed a bit. It used to be females ages 35 to 45, and the new user base is closer to ages 18 to 34, primarily because of Facebook.

Sebastien alluded to Twitter integration sooner or later, something that I think makes a lot of sense because Twitter is a perfect utility to let your friends know that you just did something socially, even when they are not sitting next to you.

Don't forget that you can follow me on Twitter @daveofdoom.