The last two years have been an extraordinary time for the video games industry. The global pandemic has turbo-charged interest in gaming among traditional users and newcomers alike while accelerating pre-existing trends.
The 'pandemic profits' enjoyed by the sector as lockdowns shook-up other forms of socialising and entertainment are well known (see our previous horizon scanner: "Achievement Unlocked - investment and M&A in the games industry"). According to leading market analyst NewZoo, the global industry generated estimated revenues of $177.8 billion in 2020, up +23.1% YOY and equating to the highest growth since records began.
Maintaining that stratospheric momentum was bound to prove challenging. As lockdowns have lifted throughout 2021 and other forms of socialising and entertainment have begun to return, the negative effects of the pandemic are now being felt. Games studios navigating remote working have announced delays for new releases, and ongoing constraints in the global supply chain – particularly for semiconductors – have constrained supply of new hardware (especially in PC and console). For the first time this millennium, a small -1.1% YOY decline in global revenues to $175.8 billion is now estimated for 2021.
These challenges were, however, felt primarily in PC and console, with mobile continuing to be as dominant as ever. Mobile games are forecasted to generate $90.7 billion in 2021, up +4.4% YOY and finally accounting for more than half of the global market. 2.8 billion of the world’s 3.0 billion gamers by end of 2021 will play on mobile devices (compared to 1.4 billion on PC and 0.9 billion on console).
But if 2021 was when the industry caught its breath after 2020's breakneck growth, 2022 and beyond promise a return to form for a sector whose fundamental prospects remain strong. The true benefit of the pandemic is less likely to be an adrenaline shot to revenues and user numbers (though this was certainly welcome) and more likely the acceleration of pre-existing trends.
Outdated stigmas around video games are quickly dissolving and a wider appreciation of the valuable role they play in our world, both economic and social, is taking hold. Major phenomena such as Fortnite, Roblox, and Minecraft are emerging as platforms in their own right, their virtual worlds existing as extensions of our own and providing opportunities for social interaction, the creation and sharing of user content, digital commerce, and individual empowerment not easily replicated in other media. There has been much recent commentary (backed by significant investment activity) that these online virtual worlds represent the embryonic stages of the "metaverse", a focus that will certainly survive the pandemic.
As will wider trends in the industry. NewZoo forecasts a swift and healthy recovery for the global market into 2022, with a CAGR in the period 2019–2024 of 8.7% to reach over $218 billion in 2024. New entrants will continue to join the market, spurring competition with existing majors and bringing innovation in both technology and business models. Advances in cloud gaming and the success of subscription services, combined with the dominance of mobile and the increasing prevalence of cross-platform play will continue to drive down barriers to new player acquisition and increase revenues.
Many of the biggest industry majors have already launched or announced plans to launch cloud gaming services (including Amazon, Google, Microsoft and Tencent). Workarounds to run services within browsers such as Safari on iOS (and thereby avoid the app-store-within-app-store issues Epic Games has encountered with Apple and Google) have seen Microsoft successfully launch Xbox Game Pass and Xbox Cloud on both iOS and Android devices. Between Xbox, PC and mobile, it is now truly possible to pay Xbox games anywhere at any time, regardless of your available hardware. Global cloud gaming revenues for 2021 are expected to exceed $1 billion for the first time. The recent announcement by Netflix that it is entering the market via its acquisition of Night School Studios will soon see games included directly within the streaming service at no extra cost, in a bid by the entertainment giant to compete with video games in the 'attention economy'.
This doesn't mean 2022 will be plain sailing for the industry. Regulatory headwinds, blowing from both East and West, linger on the horizon. A greater focus on the perceived harms posed by video games continues to follow the industry's growing profile and the evolution of major game franchises as new social platforms. The impact of game mechanics such as loot boxes and microtransactions is a focus of concern, with recent studies linking their use to problem gambling. Some countries have already classified loot boxes as gambling and the position remains under review in others (including the UK).
These issues are compounded by concerns around potential gaming addiction, particularly among younger and vulnerable people. The risk of regulatory interventions having a significantly adverse effect on the industry is increasing. Recent developments in China for example – limiting the number of hours minors can play online to three per week and during set times on the weekend only – have already impacted the share prices of major publishers.
Regulatory authorities will not be the only source of pressure. Employment practices and culture within the industry are increasingly under scrutiny, particularly in light of wider societal movements (such as #MeToo). Key concerns are likely to focus on the widespread use of ‘crunch', calls for worker unionisation, and continuing revelations around toxic working cultures and sexual harassment. Recent events affecting Activision Blizzard for example – which have seen mass staff walkouts and other major industry players publicly reconsider their ongoing partnerships with that publisher following allegations of widespread sexual harassment – demonstrate a growing pressure from within the industry to address these issues.
An expanding metaverse?
The notion of the "metaverse" is not new, being first posited in science fiction back in the 1990s. And despite recent fanfare around the term, it is widely acknowledged that a true realisation of the metaverse (also known as "Web 3.0") is likely to be years if not decades away. So why at this moment is there so much excitement around the idea? And how is it relevant to the video games industry?
There is no agreed definition of the metaverse and much misunderstanding around the concept. It is commonly (mis)described as virtual reality or a user-generated virtual world, but this characterisation tends to miss the wood for the trees. While virtual reality technology and the existence of a persistent 3D virtual environment are features of and gateways to the metaverse, they are not the metaverse any more than Google or the iPhone are the modern mobile internet.
The concept is difficult to capture neatly for the same reasons it would have been impossible to define the modern mobile internet and its revolutionary impact on global society back in the 1990s. However, according to key proponents such as Tim Sweeney (Founder of Epic Games) and Matthew Ball (Essayist and VC investor), the concept typically describes a future iteration of the internet. An internet comprising persistent, massively-scaled and shared 3D virtual spaces linked to a virtually enhanced or augmented physical reality (being a fusion of both, while allowing users to experience it as either) where people can create and engage in shared experiences as participants in an economy with wider societal impact.
Another central feature is interoperability across all aspects of the internet and decentralisation of control (powered by distributed ledger technology, such as Blockchain and NFTs) as a response to the perceived limitations of the existing internet which has seen the accumulation of significant gatekeeper power in centralised entities (such as Apple, Google and Facebook). The ongoing legal battles between Epic Games and Apple/Google around the influence they exert via their respective app stores can be viewed in this context.
The metaverse, then, might be best understood as the next stage of the modern mobile internet, not supplanting it but building upon and iteratively transforming it. Consider the evolution from the internet established between the 1960s-1990s (or Web 1.0, comprised mainly of static read-only websites) to the current mobile internet (or Web 2.0, which involves greater user interaction and participation, and facilitated the rise of phenomena such as Wikipedia, Facebook and YouTube). The mobile internet did not emerge fully formed on the back of a single technological advance nor did it change the underlying architecture of the internet. However, we still recognise the internet today as fundamentally different. This is because mobile internet led to changes in how, where, when and why we access the internet, as well as the devices, technologies and companies we use, the products and services we buy, and prevailing business models.
Okay, but why is this relevant to the games industry in 2022? Well, the way certain aspects of video games are evolving (accelerated by COVID-19) is bringing together many markers of an embryonic proto-metaverse.
Gaming has been developing in recent years into an experience encompassing playing, viewing, socialising, creating user-generated content, and economic engagement far beyond the core experience of playing the underling game. Games like Fortnite, Roblox or Minecraft are increasingly described not as games-as-a-service but rather games-as-platforms. These platforms provide massive multiplayer cross-platform simulations offering competitive gameplay as well as sandbox environments in which to express one's creativity or simply socialise with friends around non-gaming experiences. Witness the music concerts by Ariana Grande and Travis Scott in Fortnite or by Lil Naz in Roblox, each attended by millions of people (albeit in thousands of separate instances limited to around 50 attendees each). Consider also the cross-pollination of IP within Fortnite with brands as diverse as Marvel, Sony, the NFL, and Balenciaga recognising the commercial value of being present within these worlds.
The technology powering these games-as-platforms is also a crucial component of any future metaverse. The core product of Epic Games, for example, is not Fortnite but rather its Unreal Engine. The company has been developing this for decades and it is now one of the world's most capable, diverse, and realistic simulation software, able to run sophisticated simulations of environments, physics, people, and events. As a result, the simulations in Unreal Engine now exceed most bespoke tools available in other fields. The US military uses Unreal Engine for its simulations, while Unity (the primary competitor to Unreal Engine) was used in the design of Hong Kong international airport to simulate people flows and events such as fires, storms, and delays.
"You guys aren't ready for that yet… but your kids are gonna love it"
Viewed from our current vantage point in 2021, so much of the metaverse still seems fantastical. The more we consider the possibilities inherent in visions of Web 3.0, the more we find our imaginations running wild. And as Marty McFly found in Back to the Future with his heavy metal rendition of a Chuck Berry classic, some ideas come just a little before their time. It is as difficult now to imagine the full possibilities and implications of Web 3.0 as it would have been in the 1990s to comprehend the full impact of Google and smartphones today. Nevertheless, many investors are starting to contemplate such a world, and its earliest expressions are being found in the video games industry.
In the near future, therefore, we expect ongoing interest and investment in the proto-metaverse. For the games industry, this will likely focus on technologies which enable and power the metaverse (such as cloud gaming, AR, VR, Nvidia Omniverse, blockchain and other distributed ledger technologies), and the cross-media, cross-platform brand and IP partnerships already seen in the likes of Fortnite and Roblox.
We also expect to see ongoing efforts by those vested in the realisation of the metaverse (eg Epic Games) to challenge the alleged control enjoyed by incumbents such as Apple and Google over the critical infrastructure of today's internet.
At the time of writing, the Californian court hearing the dispute between Epic Games and Apple has ruled that Apple cannot prevent in-app links to third party payment options and has issued an injunction for Apple to update its app store accordingly. However, the court also declined to find that Apple holds a monopoly over app distribution and said that the 30% cut on in-app payments taken by Apple is therefore not contrary to antitrust regulations. Epic Games was also found to be in breach of contract and ordered to pay to Apple 30% of the sales made under the alternative payment system it had introduced to the Fortnite iOS app. The decision is subject to appeal by both parties.
Looking to the future
As we move into 2022, the industry's prospects look promising. The pandemic windfalls have been banked and its ongoing challenges are being navigated. The near future will continue to see mobile dominate and accessibility increase with the rise of subscription business models and cloud gaming, all underlined by intense competition and investment. With games evolving beyond their core experiences and into social platforms in their own right, the industry will also continue to attract significant attention as a potential source of the proto-metaverse.