The Big Merger

April 28, 2003

Interactive entertainment has become one of the world's most popular pastimes, pulling in $25 billion worldwide in 2002 - $11.6 billion in the U.S. alone*. This surge in popularity, accompanied by an expanding customer demographic, is widely credited to Hollywood's influence on the industry. As software competition increases, Hollywood and the gaming industry are becoming more enmeshed, and it is likely that video games will emerge as the most lucrative form of entertainment in the future.

The merger of the entertainment and gaming industries began when some PC titles, in the pre-console era, were developed using the motion picture model viz. more complexity in characters that could be representations of the players ("avatars"), a narrative thread that went beyond the original premise, and (increasingly) sophisticated graphics. As video games began to resemble Hollywood movies, the relationship between movie studios and game publishers grew stronger. The two industries now actively work together, licensing properties and negotiating deals to develop titles based on traditional Hollywood content, frequently creating games based on popular entertainment titles, personalities and animated characters.

Despite growing cooperation between the industries, however, the production of movie-licensed games has become an increasingly elaborate process. In some instances, license negotiations begin three years before a movie's release in order to release the game at the same time. Sometimes, a game is released a few weeks before a film, in order to help promote it. Because movie and game products share the same content and are used to promote each other, games must be as sophisticated and high quality as the movies they're based on. Consequently, video games have become as complex (and as costly) to create as major motion pictures, requiring highly skilled teams of pre-production, production and post-production personnel. This has spurred an employment crossover between Hollywood production and video game production, particularly in the past few years. Many of the large gaming companies, such as Activision and THQ, are now based in Southern California, and just this past year Electronic Arts, the world's largest gaming publisher, opened EA Los Angeles, hiring an initial staff of 300 with the intention of tapping into the entertainment industry's large talent pool of digital artists and experts in special effects, audio production, and script writing (formerly, the company known as Dreamworks Interactive was acquired by EA and production moved to Vancouver, Canada). The major Hollywood studios have also spun out gaming subsidiaries, such as Virgin Interactive, Disney Interactive, and Universal Interactive.

As a growing percentage of game titles are based on Hollywood properties, and created using the Hollywood film model, the success or failure of titles based on shared content raises basic questions for both industries. Is a game's marketability based solely on the value of the Hollywood property, or on the quality of the game itself and the way it was marketed. Because gaming companies make licensing offers for a select crop of A-list properties with global recognition - Harry Potter, James Bond, Spider-Man, etc. - bidding wars have driven up licensing fees. Licensed products do typically sell in proportion to the popularity of the underlying license. However, that does not mean success in one area guarantees success in the other. The essential factors that make a Hollywood property a successful video game have only started being defined after a series of high stakes wins and losses.

"The point is a good or a hit movie doesn't ensure a successful video game," says Wedbush Morgan gaming industry analyst Michael Pacter. "I don't think the studios understand this at all and the publishers understand it only partly. I think that a video about a boy with magic powers would have done okay without the Harry Potter movie, but the value of Harry Potter to Electronic Arts was probably more in the brand recognition and the safety factor. So it's a really interesting dynamic."

Pacter points out how Disney Pixar licensed three yet-to-be-released films, Finding Nemo, The Cars, and The Incredibles to THQ for a rumored $250 million guaranteed. This led THQ to eventually absorb a hefty impairment charge in December, clearly indicating that the company was not expecting to sell enough units to cover the costs of the licensing.

"If you spend $250 million on a particular set of games or licenses, then you need to do at least $250 million in revenues. And only two games in history have ever done $250 million in revenue. I think eventually the bidding is going to level out to probably a more realistic level, so that we're back to Spiderman, where Sony Pictures/Marvel only got $10 million. But that's the right way to go for the future success of the industry.

by Wendy Hall, Larta Staff Writer
additional reporting by Ketaki Sood, Larta Research Economist

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*Source: Wedbush Morgan