The DeanBeat: How should the game industry deal with the recession?

As the second quarter earnings results come in, it seems likely that the broader economy is swinging into a recession. The question remains how long it will last. And my question is: how should the game industry deal with this turn of events?

We’ve seen two quarters of negative growth in the U.S., fueled by factors such as inflation, high interest rates, the war in Ukraine, rising fuel prices, the supply chain snarl, China’s logistics problems, the return of COVID variants, whiplash in the stock market, and the cryptocurrency and NFT price crashes. That’s a crapload of things that are dragging things down, and gaming cannot defy gravity.

Within gaming, major games have been delayed because of the difficulty in making games via remote management, and Microsoft reported a decline in game revenue in Q2. It is starting to feel like a time when things aren’t in our control, even though game companies are always in control of whether their games are fun or not. But I don’t quite think it’s time to panic.

Pat Gelsinger, CEO of Intel, just cut his company’s estimates drastically yesterday as the chip giant missed its second-quarter earnings and revenue targets by billions of dollars. He thinks the PC industry will shrink 10% this year, and he believes Intel will see the bottom by the end of the third quarter. That’s a relatively short recession, but it’s enough for Intel to put hiring on hold.

Mark Zuckerberg, CEO of Meta, also noted the slowdown is happening as Meta missed its earnings and revenue targets as well. He has been willing to lose $2.8 billion a quarter in the Meta Reality Labs (metaverse and VR) division. But this week, Meta decided to raise prices on its VR headsets by $100, which will likely slow down the VR games industry in a pretty big way.

“Typically the industry uses (recessions) as a time to demonstrate responsibility to shareholders by cutting a few projects, closing a studio or laying people off,” said Caroline Stokes, a human resources expert and CEO of Forward. “2008 and 2009 were brutal as the mobile industry was shaken up considerably. My eyes are on the VR and NFT companies taking the hit and reforming.”

Deja vu

We can argue about the facts and the possible duration and which sectors are vulnerable within gaming, but the industry has been through this plenty of times before. In 2008, the game industry saw a year of growth even as the Great Recession happened amid the bursting of the housing bubble and an accompanying financial meltdown. And during the recovery from that recession, the industry began a transformation as Facebook and mobile games exploded.

We also faced this recession/gaming impact question during the height of the pandemic in 2020. In that environment, games benefited with a 30% boost in users and sizable growth in revenues and hours played. New users converted to play games so they could socialize with people they could no longer meet in person. Game companies got a historic shot in the arm as player engagement grew. Gaming distracted us from our problems, and it had a positive impact on our mental health. But the best-case predictions about how this would lead to a permanent renaissance did not materialize.

But it’s different in 2022. The game industry has more competition for a user’s time, as people have returned to travel and other in-person activities. This time, the game industry isn’t the only choice that people have for entertainment, and engagement is slipping. On top of that, Apple prioritized user privacy over targeted advertising, and mobile gaming is losing momentum.

Chris Heatherly, former head of games at NBC Universal, said in a message the outcome for each game company in the recession depends on sector dynamics.

“If you’re in mobile, I think we are going to see a lot of layoffs. The privacy [push by Apple] has changed the economic model of the business and with all the consolidation, the push is going to ring the cost out,” said Heatherly. “I don’t see the IPO market being healthy for 12 to 24 months, so that puts pressure on all these guys that did not IPO during the boom.”

While game VC funds are plentiful now, they may be more cautious about deploying capital and they will ask for more favorable terms and lower valuations.

“If you are in a startup and raised pre-bust and have runway, preserve it,” Heatherly said. “It’s going to be a while before you can raise on good terms. Even console seems like a tough place. All that consolidation by the first parties means they will rely on their own titles more so than the third parties. People will keep playing and buying games but probably rely on these subscriptions more than before. Less likely to spend $60 on a game they aren’t really anticipating. I think we’re in a for a tough couple of years, but I hope not.”

Recession proof?

Yet some optimism is there, based on the old saying that games are recession-proof.

“People play games in good times and in bad times (maybe even more in bad times). It’s escapism,” said Rahul Sood, an industry veteran and CEO of Irreverent Labs, a blockchain game company, in a message to GamesBeat. “Game developers should focus on making great games, unique experiences, and keep going.”

Mike Wilson, CEO of Deepwell and another industry veteran, concurred, “We traditionally sell a lot of games (in a recession). Home entertainment always does well when people slow down and stop doing more expensive things.”

Some also have an upbeat view in terms of the stage of life that companies are in during a recession. Jadu CEO Asad Malik said in an interview with GamesBeat, “We think that winter is actually a great time to build. Our hardcore audience is still here with us.”

Newzoo analyst Rhys Elliott said in a message that games have been recession resistant and platforms like the Wii thrived during the 2007 to 2009 downturn. Now, there are more than 3.2 billion gamers.

And by comparison, Elliott said, “In 2022, gaming offers more monetization methods, more ways to play, and is a bigger part of so many consumers’ lives. This means we expect gaming engagement and consumer spending to continue even if the economy takes a downturn.”

Newzoo estimates the game market will grow 2.1% to $196.8 billion this year, a bit slower than it expected earlier this year. But that revision of revenue numbers isn’t a disaster.

“Gaming’s continued strong growth trajectory—even in the face of stabilization following 2020’s boom—is a testament to the market’s power, innovation, and resilience. While 2022 will be a challenging year for
consumers economically and for console and PC in terms of growth, we are far more optimistic for the future,” Elliott said. “COVID-19-related delays mean we will see many of the hit games that were supposed to launch this year instead release in 2023 and 2024, which we believe will be some of gaming’s best years ever in terms of quality content that consumers love.”

Many startups, including game companies, may not be able to raise money like they did in the past couple of years. That does not bode well for anyone failing to execute on their plans. Those companies may not succeed in getting an additional round of funding.

Michael Pachter, analyst at Wedbush Securities, said that recessions normally involve people being unemployed, and unemployed people tend to spend more time playing games. Therefore, in a normal recession, games are recession resistant.

“This time, even though we’ve seen GDP decline for two quarters in a row, [the Fed] refuses to call it a recession, since employment is at 50-year highs,” Pachter said in a message to GamesBeat. “We don’t have the same phenomenon we have had in past recessions with bored, unemployed people consuming cheap entertainment. It’s hard to say that games will thrive and hard to say that games won’t. Inflation fears are unprecedented (it’s been 40 years since the last time we had inflation), so perhaps people will spend less money on expensive entertainment (vacations) and more on cheap entertainment, but we can’t really know for sure.”

Blockchain games and the metaverse to the rescue?

Many developers and gamers feel that blockchain games are a wrong-headed detour, rather than an onramp for the wonderful future that lies ahead in the metaverse. But blockchain game companies are going strong. They accounted for $2.3 billion of $7 billion raised by private game companies in the first half, according to investment bank Drake Star Partners. These companies should be flush with cash.

For the companies that have half-baked plans to cash in on an overhyped craze, the end is near. The vaporous companies will no longer be able to fake their way to funding, and investors will be asking more about profits and revenue, rather than just numbers of users. Many people will see this as a positive, as the scam companies and weak ideas will be shaken out by the recession, and quality companies will remain.

But many triple-A game developers have moved into blockchain games and they’ve raised a lot of funding. For those that are far enough ahead in their plans, this is their opportunity to launch games that shake up the industry and give financial rewards to players. (The recession is a time when players may come to appreciate that model). But if the progress is slow and players pull back from experimental games, all bets are off.

Hiring will get easier

We have some consolations. Quality game companies always seem to get funding and gamers always gravitate to the best games, whatever the economy.

As costs fall during the recession, and the labor shortage loosens up, game companies may be able to hire talent more easily at lower costs. That’s why so many entrepreneurs say that recessions are the best times to operate a small company (once you have funding).

And so far, the game industry has slowed down but it hasn’t been hit as hard. Niantic and Unity have seen layoffs, and Ubisoft pulled the plug on four games in development, but mass layoffs haven’t yet swept through the entire industry. By contrast, other tech companies are laying off people. Layoffs.fyi says 420 companies have laid off 59,000 people so far in 2022. The game industry by comparison is lucky.

While the pace of acquisitions has slowed and game investments have moderated, blockchain game investments kept growing strong in the first and second quarters, according to Drake Star Partners.

“Fortunately, the game industry appears to continue to grow,” said Chris Hewish, president of Xsolla, in an interview. “While it’s not growing at the same pace that it has been over the past few years, we are seeing continued growth in the industry.”

So what should game developers do?

Still, it’s prudent for CEOs to think that funding sources could dry up for a couple of years and maybe growth won’t come back in a big way until 2023 or 2024. They should preserve their cash.

The people who don’t panic, like Mr. Potter or George Bailey in It’s a Wonderful Life, are the ones who survive and live on to consolidate the market.

“Big companies will probably slow hiring, focus on shorter-term gains (getting more out of existing games, putting a priority on games near release),” said Steve Peterson, CEO of StoryPhorce, in a message. “Smaller developers will have to be careful about their finances — big contracts can get yanked, and then the developer employees get hired away… it’s happened before and likely will again. Small developers should see players continue to spend, but perhaps more cautiously — be conservative on overall spending but try to expand your audience and keep them engaged.”

Of course, the predictions are going to get worse if the recession keeps on going. Now is a very good time to test the will of everybody involved in gaming. Will the platform owners do the right thing for their ecosystem and continue to invest in them? Well, Meta’s price increase isn’t a good one in that respect. Will developers keep faith and continue investing in their games and employees? Will VCs continue to believe in their companies and give them more money? Time will tell.

In my opinion, long-term thinking is what pays off. Sure, everybody should execute and focus on doing business right. But if you’re building a fun game, or a cool platform, or a thriving ecosystem, you should stay the course. A recession should turn you off from your dream of decentralization, or steer you off the course of an open metaverse.

More than 20 years ago, Microsoft endured ridicule and criticism as it lost billions moving into the game console business in the middle of a huge downturn. Back in 2001, Microsoft sold the Xbox at a loss so it could break into gaming and beat Sony and Nintendo. It lost around $125 on every console sold. It sold 24 million. Bill Gates also added more memory to the machine to make developers like Tim Sweeney happy.

Losses added up to $4 billion in the first generation. It seemed like a huge disaster. But Microsoft soldiered on. Now Microsoft’s gaming makes billions in a quarter. Microsoft also took a $1.1 billion write-off with the Xbox 360 to pay for the Red Rings of Death. Now, Xbox can make billions of dollars a quarter. That’s the way to steer your way through hard times. I chronicled this in a couple of books and long story on the Red Rings of Death in the past.

By comparison, Facebook/Meta has been losing close to $3 billion a quarter with its VR/metaverse division, Meta Reality Labs, as it pushes the Meta Quest 2 into the market. This is a huge ecosystem play, and it comes after spending $4 billion to acquired Oculus in 2014.

Meta is still spending like crazy, but it just raised prices on the Meta Quest 2 by $100 each amid the recession. The contrast with Microsoft is striking. The price increase is not the way to demonstrate to the ecosystem that you have the will to persevere.

Developers will notice, and they will conclude you don’t have the spine to go the distance, to finish what you started. It may save billions and make shareholders happy. But it is not the way to win an ecosystem war.

I’m happy to hear more about this subject, as the conversation here is just starting. And this will be one of the topics we explore at our next event, GamesBeat Summit Next 2022, in October.