27. November 2023
Play – 1 von 2 Insights
At the beginning of 2023, we explored the state of the industry focusing on key trends for the year ahead. We looked at the exceptional levels of growth and investment seen through the pandemic years of 2020-2021. This capped a period of exponential growth for the sector prior to a small slowdown in 2022 (-4.3% YOY) which saw the industry suffer its first year without growth in over 20 years.
Throughout 2023 the industry has continued to grapple with varied headwinds, ranging from geopolitical uncertainties and worsening macro conditions (in particular, higher inflation and rising interest rates), a post-pandemic correction in demand, changes in mobile privacy frameworks and significantly increased regulatory interventions. However, vast opportunities continue to underline the strength and bright future of the industry, including innovations in technology and business models which are driving growth (e.g. subscription services, live-service games, transmedia) and emerging technologies like cloud gaming and AI. Today we look at what actually happened in 2023 before once again being so bold as to offer a few predictions for the games industry in 2024.
It's been an interesting year for the industry. Growth returned, with the sector expected to grow by +2.6% year-on-year (YOY), generating global revenues of around USD 188 billion, according NewZoo. That might seem sluggish compared with high double-digit growth during the pandemic, but it reflects a return to a more sustainable pre-pandemic pace. Such a prompt return to growth should also be seen as an achievement against the continued challenges the industry faces. Near and long-term projections remain strong, with NewZoo forecasting global revenues of USD 212 billion by 2026 and Konvoy even more bullish at USD 288 billion by 2028 with a CAGR of +8.84% during the period. Player numbers are also expected to keep growing, reaching USD 3.8 billion in 2026.
The slower pace of growth and a risk-off mentality for strategic investors (who are responsible for over 90% of M&A deals) has had an impact on fundraising and M&A activity this year. The first half of 2023 saw a significant decline in private investments (including venture capital), with the value of transactions down -81% and deal volume down -24% against H1 2022, according to InvestGame. This decline must, however, be set in context, with the 2020-2022 period seeing unprecedented levels of investment into the sector (as much as 3-4 times the level from 2019).
The shift this year, while no doubt a result of a more challenging macro environment for the technology sector generally, again represents a normalisation of the gaming sector back to pre-pandemic levels. Early-stage investment continues to be active (with smaller cheques into innovative businesses offering better risk-weighted returns), while growth and late-stage investments have cooled. A closed IPO window and significant disconnects in valuation expectations (particularly for those who raised at high valuations during the boom years) have reduced the appeal of later-stage investments. All of this, however, is a trend seen across technology investment generally and is not specific to gaming.
A notable exception to this trend, of course, has been investments into AI and this was also true in gaming. Inworld AI raised USD 50m this year and also announced a partnership with Microsoft – it is focused on building generative AI tools for game design and production (more on this below).
The M&A scene has also been interesting. Activity levels in the first half of the year were significantly down compared to the same period in 2022 – by as much as 50%. Again, this needs to be seen in the wider context of technology M&A where volumes have dropped to the lowest level since 2020. Strategic investors (especially Big Tech) have been risk-off in the face of economic uncertainty. Both they and financial investors are sitting on large cash piles but are deploying these more sparingly, and when doing so are encountering increased regulatory scrutiny. The second half of 2023 has, however, seen some of the biggest strategic investors return to close significant deals in gaming. The most spectacular was Microsoft's acquisition of Activision-Blizzard, which completed in Q4 following a protracted regulatory battle (more on this below). Tencent, Playtika, Sony, Sega and Savvy have also all been active.
Despite continuing economic uncertainty, financial and regulatory challenges, and downward pressure on valuations, many analysts remain positive about the future for gaming investment. The sector remains highly competitive and is seeing a lot of innovation. Big Tech majors increasingly predominate and are making acquisitions as part of long-term strategic plans. Early and growth stage companies will need to raise fresh capital or consider M&A exits – with downward pressure on valuations across tech generally, many bargains will be found. And with early signs of improvement in macro drivers (e.g. inflation starting to fall), there are growing expectations of a tentative return to deal-making next year.
As we explored in our sector analysis earlier this year, there are growing concerns among some that the industry is undergoing a transformation. With their extensive acquisition and investment activity in recent years, large cash reserves and market-leading positions in adjacent technology sectors, the Big Tech majors have moved into gaming. Amazon, Apple, Google, Meta, Microsoft, Netflix, Nvidia, Tencent and Sony, to name a few, make up a significant amount of global revenues with the top five gaming companies by revenue in 2023 coming from this group.
Regulators have grown increasingly concerned about the power of Big Tech in the economy generally. Many regulators also harbour regrets about the perception they were more permissive with antitrust oversight when those companies were building their original businesses. The deep experience of tech giants in building massive online, diversified businesses together with even deeper reservoirs of capital allow them to make the biggest bets in gaming which inevitably attracts regulatory scrutiny, particularly around merger control, antitrust laws, online safety and data privacy.
Perhaps the most notable example this year was Microsoft's acquisition of Activision-Blizzard and its two-year regulatory battle with the UK Competition and Markets Authority (CMA) and the US Federal Trade Commission (FTC). We analysed the deal and what it showed about the regulation of gaming M&A in partnership with InvestGame earlier this year. A key area of focus was cloud gaming, seen by some as capable of revolutionising the industry as it did with music, TV and film (on which, see further below). Microsoft's already strong position in cloud infrastructure and its success with its Game Pass subscription service raised concerns that adding exclusivity for the Activision IP portfolio could give it a commanding position and reduce competition in cloud gaming before it has properly got off the ground. The deal was eventually allowed by the CMA after significant and unprecedented concessions aimed at cloud gaming. It is still being challenged by the FTC. The key takeaway: regulators are increasingly willing to flex their muscles in gaming and technology deals and, given the wider background, that is unlikely to change soon.
We are also seeing increased use of antitrust laws in private litigation, both between industry players as they jostle for strategic advantage, and from consumers. The ongoing legal battles between Epic, Apple and Google over the latter's 30% distribution fees associated with their respective app stores are a prime example. Sony has also faced class action lawsuits in the UK for alleged abuse of dominance in connection with its digital store.
Amidst the outrage felt across the industry earlier this year when Unity announced its controversial new fee structure for developers using its Unity engine, some of the loudest outcries were that the policy was anticompetitive. Many claimed this was an abuse of dominance by Unity of its leading position in game engines to favour its newly acquired ad analytics business, Grow Solutions, at the expense of rival, AppLovin (a leading provider of ad analytics to mobile developers). There are reports developers were being offered 100% rebates on the proposed fees if they used Unity ad analytics. Over 70% of mobile games are built on the Unity engine. There has been no news of legal action by private parties or regulators. However, the massive public backlash did cause Unity to significantly rework the fee changes. Its share price fell nearly 40% and the CEO has stepped down. There are rumours AppLovin may even try again to acquire Unity. Events may therefore overtake this one, but the whole saga underlines growing regulatory concerns around anticompetitive structures and practices in the industry.
The CMA has also launched market investigations into whether Apple and Google dominate mobile web browsers in a way which harms competition, and into whether Apple restricts cloud gaming on its app store. This has recently stalled following a challenge by Apple in the Competition Appeal Tribunal, but the CMA is appealing to the Court of Appeal. A new Digital Markets, Competition and Consumers Bill is now before the UK Parliament which, if passed, will grant the CMA new powers to address competition concerns.
Regulatory scrutiny is not, however, restricted to competition concerns. The UK's newly introduced Online Safety Act (OSA) regulates illegal and harmful online user-generated content, with a focus on content that is harmful to children on services likely to be accessed by them. While the OSA regime is likely to take a few years to become fully operational, Ofcom's extensive fining powers (up to GBP 18m or 10% of annual global revenue, whichever is higher) will ensure it has teeth. Many in-scope service providers will also have to comply with the EU's Digital Services Act which covers similar ground. Both pieces of legislation are likely to have a significant impact on the games industry. You can find out more about the OSA here and the DSA here.
Subscription models face a new challenge with the current Digital Markets, Competition and Consumer Bill (read more here) that is currently making its way through the House of Lords. The Bill proposes a significant overhaul of how subscription-based models work. Games providers will need to start adjusting their practices in readiness for when the DMCC Bill comes into force (likely in mid-2024). The culmination of these changes could drive a shift towards more ad-supported games or a slow-down in subscription revenue as we discuss here.
The public release of ChatGPT by OpenAI at the backend of 2022 immediately sparked widespread expectations for how AI may fundamentally change the global economy. Many see recent AI advancements as a tipping point, similar to the arrival of broadband internet and mass adoption in the early 2000s or Apple's launch of the iPhone in 2007.
AI has been used in gaming since its beginnings and the earliest arcade games. Throughout game history it has underpinned the automation of non-playable characters (NPCs) and enemy opponents, the enhancement of graphics and visual effects, and the personalisation of gameplay. Recent advances such as ChatGPT, however, have been in the field of generative AI. This encompasses AI algorithms trained on vast data sets to spot patterns and use neural networks to generate ostensibly original content (image, text and audio) in response to natural language prompts.
In the field of game development, this is expected to have a profound impact. AI tools are rapidly entering the market which allow developers to automate content creation and reduce development time. No-code software tools, powered by generative AI, simplify the development process by eliminating the need for complex coding, enabling developers to focus more on creativity and innovation. Rapid and de novo generation of art and design assets, and voice content, is also possible with minimal or no input from human artists or actors. This raises a plethora of legal and ethical considerations around copyright infringement and mass job losses. The impact of AI in entertainment was at the heart of the writers' and actors' strike in Hollywood this year.
Generative AI is also expected to drive substantial innovation and benefits for game design and user experience. Greater personalisation of gameplay with significantly streamlined and more intuitive user-generated content is expected to drive endless possibilities for gamers to create their own tailored experiences. Using procedural content generation, AI might analyse the behaviour of players to tailor a game and even to make it unique to each player. Through textual prompts, players may be able to create characters, items, levels, and other game assets on the fly. This is all likely to become central to the idea of an immersive gaming experience.
And this is just a snapshot of how generative AI will impact gaming. It also offers a near irresistible value proposition for developers when set against the soaring costs and timelines for game development. Triple A games now regularly take 5-7 years to develop and demand budgets in the range of hundreds of millions of dollars. The risk associated with such investment if a game is ultimately unsuccessful can be ruinous. Adoption of some form of generative AI in the game development process is expected to be near universal.
Having said that, the response to generative AI has not been wholly positive. There are growing concerns of mass job losses and a diminishing role for human creativity. International legal frameworks also remain in their infancy, creating significant legal risks. There are concerns the foundation of generative AI is inherently infringing of copyright (based on the idea that value is being derived through the use of generative AI algorithms which have been trained on vast data sets comprising intellectual property owned by other parties who have not been consulted or compensated). This argument forms the basis of ongoing Getty Image lawsuits against Stability AI. There are also issues around IP ownership in any works which are created using AI. Who owns the copyright in such work – the human who asks the AI to design a new lead character for a game (perhaps in the style of a rotund Italian plumber wearing red and blue overalls), the holder of the licence to use the AI, the owner of the AI itself, or someone else perhaps (answers on a postcard please)? This is an important question when the value of your business is based on IP.
Many jurisdictions are now considering how their legal frameworks need to be updated to account for generative AI. However, it is likely to be some time before legal certainty is achieved and we are looking at a fragmented legal framework for the foreseeable future. We explored issues around AI in gaming with our Interface series earlier this year where we also looked in particular at the concerns around copyright infringement.
Generative AI is not the only innovation disrupting the games industry. We described the key features and differences between cloud gaming and games subscription services in our sector analysis earlier this year. We also explored how key market players are striving to carve-out significant positions in both sub-sectors – Microsoft, Apple, Google, Netflix, Nvidia, Samsung and Sony are all materially active here. One central theme to developments in this space is the rising costs of gaming (both hardware and software) with cloud and game subscriptions being offered to improve access. Another theme is the ongoing war among all consumer-facing technology and entertainment services (TV, film, music, gaming, and social media) for the attention of its users.
At around USD 3-4 billion in 2023 (in an industry worth USD 188 billion) cloud gaming is currently small but growing fast, with the most bullish estimates anticipating a 47% CAGR and total revenues of USD 85 billion by 2028. There is expectation that it could have a profound effect on the industry, potentially reshaping it as dramatically as cloud streaming did for music, TV and film. The costs of gaming – both hardware and software – have been rising considerably in recent years. This is a significant factor in the growth of cloud gaming, particularly where this is bundled with a game subscription service like Microsoft's Game Pass. Technology limitations around latency are also being lessened – though these are unlikely ever to be completely overcome – with the continued expansion of 5G networks.
Microsoft continues to see significant success with its Game Pass subscription service (which now includes Xbox Cloud at no extra cost). Between Xbox, PC and mobile, it is now possible to play Game Pass anywhere at any time, regardless of your available hardware. Sony has responded with a much-publicised reworking of its own subscription service, combining a back catalogue of games (contemporary and classic) with its own cloud gaming service. Google, having officially shut down its ill-fated Stadia platform at the beginning of 2023, has pivoted away from a consumer facing role and is instead looking to leverage its strengths in cloud infrastructure with its B2B-focused Google Cloud for Games offering. The aim here is to help developers of live-service cloud-based games to connect players with the best servers, store critical game data at scale with extremely low latency and provide powerful analytics and AI support. This is an interesting play from Google and draws on its core strengths in cloud infrastructure. Meanwhile, Google continues to experiment with consumer facing game streaming alongside the expansion of YouTube as an all-in-one entertainment platform (with live streaming, VoD, music and games). It has recently launched its YouTube Playables product, which enables users to play games natively on the YouTube platform alongside regular videos.
Streaming giant, Netflix, has also been making moves in gaming, acquiring multiple studios, and releasing mobile gaming apps which are free to its subscribers. Recent additions to its gaming catalogue have added highly successful PC and console titles like Hades and Dead Cells – a potential paradigm shift for the service whose gaming catalogue until now has been mobile focused and not well-adapted to gaming on a TV. The company has also launched a limited beta test of its own TV-based cloud gaming platform in Canada and the UK which uses smart phones as the primary controller. It believes it can succeed where Google Stadia failed by positioning gaming as a significant value-add to its current TV subscription service rather than a wholesale replacement for dedicated games consoles. The streamer is clearly serious about its ambitions in gaming, and with less than 1% of its current 221 million subscribers engaged with gaming on Netflix, there is a huge opportunity for it to open a new front in the war for its users' attention.
Samsung has also entered the cloud gaming market via a strategic partnership with Xbox Cloud Gaming and Nvidia GeForce NOW to bring cloud gaming directly to its smart TVs. On the mobile side, it has also released the Samsung Game Launcher which allows users to play games over the cloud without requiring downloads. Whereas the approach to cloud gaming on PC and console has really been about solving the access question, Samsung's mobile approach is aimed at reducing user acquisition frictions at point of download, together with storage limitations. This is an interesting idea, especially in light of mobile's current sluggishness and user acquisition issues.
Overall, we are seeing a lot of innovation in cloud gaming and subscription services, and we firmly expect growth in both areas to continue into 2024. This will be a key battleground as industry players – from gaming incumbents like Microsoft to intrepid newcomers like Netflix – fight for position in a hyper-competitive sector and scramble to hold the attention of ever-distracted users.
The last two years have been interesting for the games industry. A sector used to long-term growth came to the end of two exceptional pandemic years before shrinking slightly for the first time in over two decades. Macro-economic challenges in the form of higher inflation and rising interest rates have hit the global economy, and the technology sector especially, over the last two years and the games industry has not been immune.
In 2022, changes in mobile privacy policies on iOS and Android also strongly hit the established business models of mobile gaming (the industry's biggest sub-sector), and the industry continued to grapple with this in 2023. Regulators across the world are also increasingly intervening as the industry has matured into the largest entertainment sector.
Despite all this, however, medium and long-term prospects for the industry remain incredibly strong. Growth has returned in 2023 – a real achievement in light of ongoing macro-economic challenges. Investment activity slowed in 2023 but is expected to return in 2024 at more sustainable pre-pandemic levels. The games industry continues to be a hotbed of technological and commercial innovation with significant developments being seen in AI, cloud gaming and subscription services which could revolutionise the industry. There are increased challenges facing the industry, for sure, but there are also vast opportunities for those bold and innovative enough to seize them.
27. November 2023
von mehreren Autoren
von mehreren Autoren
As we welcome the new year, Richard Faichney reflects on the year that was and looks ahead to what the next 12 months might hold for the video games sector, with a focus on corporate deal activity, key commercial trends and increasing legal challenges.
von Richard Faichney