Friday, May 25, 2012

The Rise of Value And The Fall of Everyone Else



In my younger days, and by younger, I mean a few years ago, I played a lot of video games. I loved Sonic, Mario, Earthworm Jim, and any number of other titles (did I just date myself?). Lately, I've been playing increasingly fewer games. Controllers lie dormant. Some of my systems aren't even plugged in. I'm simply not interested. My reasons are numerous, but one thing that exacerbates the issue more so than any other factor, and the point that I want to discuss in this article, is that the various game companies are completely oblivious to the idea of value.

As I write, I am staring at my Xbox 360. It sits across the room. It's my second one, because as happened with every 360 that was purchased on launch day, my first one died. The 360 could be one of the coolest things ever made, dominating the technological zeitgeist for even the most casual users of gadgets. It could have been the iPad of the living room. Instead, Microsoft kneecapped it. The poor Xbox never once came anywhere close to fulfilling its potential. It could have been a computer. It could have been a media player. It could have been a media server. It could have been the true center of the living room. Instead, it's the mildly successful also-ran of the video game world. It's insanely popular with "core" gamers and no one else.1

The reason why my Xbox invades my thoughts is that Microsoft and Verizon recently announced the ability to watch a small package of Verizon FiOS channels via the Xbox. Then, Microsoft announced "partnerships" with Comcast, HBO, and Major League Baseball, allowing users to stream video through their Xbox. According to the press releases -and as we all know, press releases are always measured and completely free of hyperbole- these agreements give you the freedom to watch whatever you want, however you want.

Only, they don't.2 In a technology world moving by leaps and bounds every year, what needed to be announced was something truly amazing and innovative. This is not that. As a response to the rapidly-shifting market, this isn't a measure. It's not a half-measure. It's not a quarter-measure. This thing isn't even a tablespoon.

All of these announcements "announce" either something that no one cares about, or is something that people have been able to do on their computers for years. You need memberships for the media and Microsoft's proprietary Xbox Live service and your internet access. Truly, Microsoft may as well have announced the ability to play Playstation games on the Xbox, but only if you already have a Playstation.

Microsoft made another Xbox-related announcement about a month later, where they affirmed that no new Xbox will be announced or even much discussed in the following 18 months. They are resolutely confident in the ability of the Xbox as a platform to continue on for the next two years. Most people responded with a wide-eyed stare, of course, since video game sales were, at that moment, declining,  and in many cases, doing so precipitously.

In fact, as I write this, video game sales have plunged for the fourth month in a row. Nintendo is going to post its first annual loss ever. Microsoft's only division that saw a decrease in business is its entertainment division, which essentially is the Xbox and nothing more. And Sony is against the ropes in ways it has never been, having posted a $5.6 billion annual loss.

This is not because there hasn't been a new system released in some time, even though many game developers like Ubisoft seem to think that. It's not for a lack of good software, seeing as the quality of games is increasing.3 Indeed, it's not because the game companies aren't being good game companies. In most ways, they are doing exactly what they've been doing for over thirty years. And that's the problem.

Instead of evolving with technological development, the game companies continue to beat the same drum. And since times they are'a changin', as they always do, it eventually comes to the point where the only way to grow profit is not to change drums, but to force people to dance differently.

Thus, we see the video game companies continually try to trap customers in such a way as to maximize money from them. While this seems like good business sense, it is actually the opposite. It is the mission that destroys a company. The real end of good business sense is a focus on what else the company can do for the customer. Business saavy comes from figuring out how to make money in this process.

That is a much harder prospect. Because the ideal situation for a video game system is giving the customers everything for free. The greatest business genius in the world could figure out how to make money from that. Currently, every game system except for Nintendo sells the system for a loss and makes up the profit on games. In essence, they were giving away something in hopes of earning it back. This worked fine right up to the Xbox, which never earned a profit for Microsoft.

What's even more absurd is that the game companies are, in essence, fighting the very same business model that they are using now. Their original model gave away the system, and now they argue that they can't just give things away. Wait. What?

It's as though, instead of realizing that the market was shifting, the response of the entrenched companies was to double down on what they knew. And like so many companies that enacted the same strategy, it's killing them. Truly, the sickness that courses through the veins of these corporate corpora will ultimately be fatal if left untreated.

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The last time that I started my Xbox360 to actually play a game was over a year ago, when I played Halo: Reach for the last time. Before that, the last time that I played was to reach about the 75% point in the RPG Blue Dragon, before stopping and never finishing. I have never, not once, used my Xbox for any other media purpose. I have never used Xbox Live Arcade. I have never downloaded trailers. I have never played a multiplayer game online. For me, the Xbox is used exactly like my Nintendo was back in the 80's. I put a game in and press start.

As game systems have tried to become platforms, this simplicity is lost, and that's not necessarily a bad thing. But since the transition from game system to platform has been so incompetent, we have the ridiculous situation of everyone I know owning a game system, but not playing any games. Now, for example, everyone I know who streams Netflix to their television does so with a Wii: a service about which Nintendo could not care less. Do you think that Nintendo would pay some attention to this, now that they are losing money? You might. And you'd be wrong.

The two opposing philosophies of business and design clash on the Xbox in ways that are unmatched anywhere else in the technology world. Microsoft gives us trailers, movies, and TV shows... all of which are available freely on the web. So, of course, Microsoft doesn't give us access to that. Noooo. That would be much too easy. Microsoft would rather restrict your access to freely available stuff. Of course, then they have to answer the question of why anyone would watch media on their Xbox that they could watch on their computer? Aside from saying "yeah, but it's on your TV... ooooooh," Microsoft hasn't really provided an answer.

So as a platform, the Xbox sucks compared to a computer. Hell, it sucks compared to an Android tablet plugged into a TV. But that's fine, right? I mean, the Xbox is primarily about having fun with games. So as long as it gets that right, it's good. And arguably, the Xbox is getting a lot correct in this regard, but only for a particular demographic. They are the ones who are buying 4,765,897,492 copies of Call of Duty on launch day. I am not a member of that demographic.

I want to put a video game into a system, turn the system on, and play. On the Xbox 360, you cannot do this. You have to sign in. You have to update. You have to have ads streamed to your system. This set-up sucks. If I had more abilities with my system, as I mentioned, this wouldn't be necessarily bad. I might put up with it if I could easily play any video file from my computer on my Xbox, browse the real internet and watch Hulu and Youtube, install my own software, or otherwise have a system that isn't tailored and restricted in such a way as to try to milk me for as much money as possible. As is apparent from the demographics of the system, only the hard-core gamers care enough to let Microsoft do that.

The Wii provided at least part of what I wanted. It was a game machine. I put games in and I played. Nothing else. The Wii had a few fun things to play around with -weather, news, Netflix, etc.- but it was primarily a game machine. I appreciated that. But as I have been hitherto saying, that is no longer enough. Nintendo still limits what can be put on the system. They still deny the threat of cell phones and tablets. They still say that a business model of cheap games could never work.

Much like Microsoft, Nintendo's sales have been in free-fall. As I write this, Nintendo has just announced its first annual loss ever. Sales of the Wii missed targets by 25%, the same for the 3DS, and nearly 50% for the DS. And yet, instead of realizing that a sea change has happened, instead of recognizing the complete paradigm shift that is taking place, the president of Nintendo reaffirmed that no changes to strategy are necessary.

I've wasted more time in Angry Birds than I care to admit.
Nintendo's myopia is only further confirmed by their quixotic quest to stamp out system modding and piracy. It reveals a company that is just as clueless as Microsoft, but their DNA allowed them to stumble into the best model, one where games are paramount and easy to use. Now, the games that Nintendo so treasures are moving to different platforms, ones that are more liberated, cheaper, and easier to use: to wit, computers, cell phones, and tablets.

For example, for the most part, I've moved over to free games online at places like Armor Games and Kongregate precisely because I can simply press a button, play, and then leave when I want to. Most of these games are no where near the epic experiences that Nintendo and their ilk provides, but obviously, at least for me, the value of that extended experience is not enough to get money from my pocket and place my butt on the couch.

I am just an anecdote. But all three major video game companies hitting the skids is not.

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At the root of these myriad companies' problems is the same thing: value. As the world advances, where value originates changes. Entertainment once came from traveling minstrels, then centralized theaters, then movies, then home media. In turn, home media companies had to compete with computers and video games. And now everyone must compete with the internet, pocket computers, and even new forms of book distribution. There are more competitors for consumer attention and dollars than ever before, and with a middle-class that is earning less than they have in over two decades, if you fail to deliver value, your customers will leave.

The very heart of value is enabling. A company creates more value by enabling more things. A company reduces value by charging more for the same thing or charging the same for less. Value comes from providing something new, be it completely new or simply a new price. Growth comes from value. Life comes from growth. Life provides the ability to continue providing new things to customers. If you are not growing your value proposition, you are shrinking. If you are shrinking, you are dying. If you are dying, YOU ARE DYING. This is the nature of business.

Cell phone manufacturers are an excellent example of this phenomenon. One only has to look at the list of once-great brands that have since either fallen by the wayside or been completely eliminated. Motorola was once the absolutely dominant American brand. They went from a major player, earning billions, with double-digit market share in 2005, to irrelevancy and bankruptcy in 2008. Nokia went from the #1 cell phone company on Earth, to fighting for its very life in only three years.

Chart provided by Asymco
The dramatic fall in the cell phone industry is only one place where this happens. Any industry where the quality of the product fluctuates so wildly can experience similar upheavals. By quality, I don't mean manufacturing quality, I mean quality in the sense that the product is suffused with a set of particular qualities that affect buying decisions. Qualities such as cost, desirability, color, brand, speed, etc.

You see similar wild drop-offs in any industry where the desired qualities change so quickly. In cell phones, which have evolved into pocket computers, it is because technology on that scale is evolving at an incredible rate. People always want the best screen, the most memory, the newest material, and so on.

But as I said, this isn't unique. Fashion, entertainment, interior design, and even baby names all see similarly rapid rises and falls. All that's required is a change in sentiment and boom, the entrenched players fail. And with the internet, changes in sentiment can be near-instantaneous.

Defending one's business from this is recognizing where value comes from and charging hard at it. There are many fashion brands that have been permanent fixtures on the Saks Fifth Avenue shelves. They do this because they reinvent their style every year. They chase the next big value shift. Only when a company rests on its laurels, does the market have a chance to grow around it.

There are two ways to provide value: the superstar model and the appliance model. The former is manifested in a fashion company. They are always trying to find the next new thing. They understand the basics of what they provide, but are always attempting to break the mold. Of every company in the technology market, the best one that I think exemplifies that is Google. Just look at all of the weird crap with which Google has experimented.

The latter model, appliance, means that a company knows what their product is being used for and simply provide more and better of the same. They are always on a quest to lower costs or provide a better experience. To use the example of the cell phone industry, Apple was the superstar with the iPhone. Other companies could have competed against that by making their phones with better screens, more memory, better audio quality, better materials, etc. It's still a phone, just better in every way than the previous model.

The appliance model, and the potential longevity it provides, is best manifested in the automotive industry. With every iteration, they build something that's fundamentally the same, but better: more power, better materials, lower cost, nicer stereo, etc.

While the superstar model gets all of the attention, I think that both models are of equal value. Both will, when executed properly, generate a great reputation and allow your company to continue. The superstar can easily rest on its groundbreaking efforts and simply make better versions. Apple is doing this with the iPhone. Likewise, an appliance company can leverage its reputation to attempt a new product type. The best companies frequently cycle in and out of both models.

As regards the video game industry, Nintendo brilliantly took both routes. They created a superstar new product while also focusing very much on the core experience of game play. Microsoft and Sony, with their explosive and flashy new systems, appeared to be shooting for superstar status, but actually took the appliance approach. Their game systems didn't try anything new. They had the same controllers. The same setup. The same games. The same ever-ageing demographic.

Theoretically, this shouldn't have been bad. As I said, both approaches can succeed if the companies maintain a perspective on value. But instead of doing that, both companies significantly reduced value by charging extremely high amounts for their systems, increasing the average price of new games, locking out third-party accessories, and doing little to appeal to those who were not "core" gamers, willing to pay for the newest blow-people-away game.4

Sony lost its view on value the most, Microsoft second, and Nintendo least. Not surprisingly, those line up exactly with the total success of the systems.5

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A middleman’s business is to make himself a necessary evil.
– Neuromancer by William Gibson

The loss of focus on value is greatest in the industries that were most predicated on middlemen. The music business failed so quickly because it was constructed around record companies that existed because it was, at the time, hard for artists to directly connect with fans. Now, instead of focusing on the value that they could still be providing, the record labels are obsessed with trying to force the world back into an old business model that only worked to begin with because of technological limitations.

The video game business is in a bit of a nether region. They offer games, which don't have value, but everything surrounding the games is very expensive. As such, companies can attach those games to other products and services without much real innovation. Xbox Live is a good example of this. While Microsoft has done little with Xbox Live aside from gaming, it is at least better than Sony and Nintendo, both of whom are ignorning the online revolution and are instead waging a massive, fruitless quest to stamp out system modification (oh, and there this whole deal). At least Microsoft realizes to some tiny degree that the market is changing and that what you sell must change as well.

But instead of focusing on that, instead of focusing on making the hardware and service as excellent as possible, we have Microsoft's strategy, which is to try to become the Apple of video games. In this plan, they have a massive, vertically-integrated ecosystem from which they can squeeze money from things that don't actually have value. Microsoft, just as Apple did, is trying to turn itself into a middleman.

This can be immensely profitable if done correctly, as Apple showed, and the various media companies showed in decades past, but it is necessarily bad for the consumer. It keeps prices high. It reduces competition. And importantly, it reduces the motivation for the company that rules the roost to make any advances or changes that can affect its position.6

In its pathetic and desperate attempts to be Apple, Microsoft has forgotten what wins. Openness wins. That's why Windows dominated Apple. That's why AOL died. That's why I think that the iPhone will eventually fall to Android. That is why the Xbox, Wii U, and Playstation will all inevitably fall into obscurity. Because instead of trying to increase value every year; instead of trying to grow, advance, develop, change, and push the market forward; instead of doing anything, they simply do what they do. Year in, and year out. It's no wonder that other forms of entertainment and interaction are growing at the expense of video games.7

Truly, the video game world is in a precarious position. All that someone has to do is make an attractive device that bucks the market, and everyone knows this and wants it. That is why so many people jumped on the recent news story that Steam and Apple may be considering a joint game system. Because Apple's goal would obviously be to do what the Xbox should have done, but never did. I don't see that being made right now, but as the technology world has shown time and again, the next big thing is always just around the corner.

For example, Canon's 5D Mark II, released over three years ago, redefined low-end video capture. Near-cinema-level video was accessible for a tiny budget. It turned video production on its head. The world went crazy. Instead of pushing things forward, Canon stagnated for three years, then finally released a new camera, the 5D Mark III, with no video upgrade at all, for over $1,000 more than the original camera. It was because they wanted to sell the good cameras to Hollywood for a massive profit and didn't want to undercut their new baby.

But just as the world felt the cold death of technological stagnation setting in, the next big thing turned the corner.

Blackmagic, a small media company that dealt primarily with video capture and post-production hardware, released their Cinema Camera. It costs $3,000 and absolutely blows away everything from every other company on Earth. The only way that a customer can buy a better camera, or even find a comparable camera, is to spend $20,000 or more at another company. And a price-to-price comparison isn't one, with no other company even coming close at the $3,000 price point. This camera is a seismic shift. EOS HD even went so far as to say that "the fall of the big guys" has begun.

If you ever, EVER artificially restrict the value that you could be offering to your customers, you open your company up to competitors who will drop a product on the market that does what you refused to do, and by the time you have managed to get a product out of your pipeline, you're out of business. Want evidence? Just ask Nokia and Sony Ericsson how it worked for them.

When a company tries to become a middleman and restrict access and behavior, they become a gatekeeper. They have value only as long as they are the only gate through which to pass. No company should ever want to be a gatekeeper! That guarantees, literally guarantees, that the company will go out of business in the future. It means that a company only has value as long as its competitors stay down.

We, again, see the legacy media companies doing this. They try to pass laws. They try to make their own media outlets like the perennial failure Hulu. They try to recreate their own mini-monopolies as some last-ditch effort to avoid irrelevance. Microsoft does not want to be this. The entire video game industry does not want to be this. But instead of adapting, they are putting their fingers in their ears and going la-la-la all the way to bankruptcy court.

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In their myopic quest to build and control mini-monopolies, companies forget that success in the past was not achieved because someone was actively trying to build a monopoly. Well, sometimes they were. I'm pretty sure that Rockefeller was actively trying to build a monopoly. But even then, he did not start off thinking "Mua hahahaha! Soon I shall control it all!"

All of the Captains of Industry grew their wealth by expanding value and creating better products. They connected railway lines, manufactured better steel, built a car for the masses, and expanded the use of petroleum. Their companies turned toxic after becoming monopolies, but they did not get there by acting like one, nor did they succeed by trying to initially circumvent free-market concepts.

Music companies did not become rich middlemen because they were actively trying to be. They became that way because the technology required a middleman. They simply filled the gap. Someone had to record the music, press the records, distribute them hither and yon, pay for advertising, and all other related tasks. They were actually providing a great deal of value in their position as middlemen, and as such, they became enablers. By enabling, they increased value, even though the side-effect of this was an iron grip on the process.

No matter the value that is created, no matter the extent of a company's enabling, this is fundamentally a closed system, whether the companies involved actually wanted it that way or not. A creator could not get in without going past the gatekeepers and the gatekeepers had fundamental concerns. For example, record companies had a finite amount of resources that were available to invest in the best music, so if a musician's music didn't past muster, he or she never gained access. That there may have been a small market that wanted his or her music was immaterial. The record companies had to focus on profits.

But as time went on, the fundamental limitations weren't enough. The companies tried to force artificial limitations on the market, such as when they tried to ban tape recorders in the 1970's and VCR's in the early 1980's.8 They didn't know it at the time, but that was the beginning of the end, not Napster. Instead of growing value, they became resistant to growth. They became toxic. And they have been toxic ever since. And as technological development grows faster, the speed with which these companies fail has increased to the point where a multi-billion-dollar company can fail in only a few years.

But I digress. This is about modern companies doing modern things. In Microsoft's quest to create an Apple-like model in the video game world, how Apple did it is happily forgotten.

The iPhone did not become the dominant smartphone because of Apple's work, it became that way because of the army of developers working on its semi-open platform. Apple tried the whole Microsoft tack early on, when they didn't offer developers an API. Instead, they said that apps could be developed within the browser, because remember, this was practically a desktop. That bit of mind-numbing stupidity is often forgotten as people lay endless praise at the feet of Apple, because Apple did something truly worthy of that praise: they realized their mistake.

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In 2008, almost a year after the iPhone had been out and coinciding with the release of the iPhone 3G, Apple opened the phone's API and launched the now omnipresent App Store. This completely contradicted the statements made by Steve Jobs during the launch of the original iPhone, where he argued that no one needed an API since they could easily make applications within the phone's Internet browser. This was an awful idea and everyone knew it. After months of market pressure, Apple announced in October 2007, three months after the launch of the original iPhone, that they realized the error of their ways and would be opening the phone.

They didn't open it all the way, though. They restrict the apps that can be in the App Store, and this is frequently done to just squelch competition. They prevent people from doing what they want with their phones and tried to criminalize the act of jailbreaking the phone. Think about that. They tried to criminalize a person doing something with their property. Apple officially went toxic.

To see the inherent strife in this approach, look at the endless struggle with the so-called jailbreakers. The percentage of iPhone's that are jailbroken in secondary markets like China approaches or passes 50%. The percentage in the US is nearly 12%. For such a technical and esoteric thing to do, those numbers are astonishing, especially when you consider that Apple is actively trying to prevent this.

What's important to note is that those numbers are likely not because people want free apps. Most apps cost so little as to make the danger of getting them through non-official channels not worth it. The average price for an App Store application was only $1.47.9 When an app costs $0.99, as many do, it's pointless to pirate. No, those numbers are so high because people, once they become acclimated to a device and a system, yearn for fewer restrictions. Even the name itself, jailbreaking, implies freedom from shackles.

The App Store wasn't created specifically to lock people to the iPhone. Truly, as mentioned, Apple's early model for app development, which would have used various internet markup languages, would have been completely open. Anyone, anywhere, could have made an "app." The locked App Store was created because Apple needed to create a seamless, secure experience that allowed people to press a button and get an app. Nothing like that existed. The App Store's creation increased value, enough so that the iPhone has independently created an entirely new market.

Remember that market share chart? Well, it only tells half of the story. This chart is in raw dollars.

Chart provided by Asymco
That massive slab of blue that represents the stratospheric profit of Apple is a testament to the success that can be had when a company enables in a truly novel, innovative way. Apple turned cell phones from phones with a few computer-like features, to fully-capable pocket computers that just so happen to make phone calls as well. The App Store birthed a revolution.

As the market evolves, though, the value that was inherent in the App Store's locked model is evaporating. The channels through which people with cellphones can get new apps are expanding every day. Soon, the Apple App Store will either have to open up, increase services provided, or face a decreasing value proposition. And if Apple continues with its oppressive activity in the App Store as a solution to the problem, they court oblivion.

Why did I just go on this enormous tangent? Because the success of the iPhone is a case study in the profit that can be had from going the extra mile to deliver truly innovative value and the ease with which entrenched players can be utterly destroyed. And since the inception of the App Store, it has similarly been a case study of the conflict that can easily arise from a company losing focus on what is actually valuable. The strife within Apple mirrors the industry on the whole. The risk for Apple, as it is for every company, is if their products suddenly stop offering enough value to offset the toxic behavior, their fall will be fast and brutal.

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Everything that a company does must be done with an eye toward enabling and increasing value. Prices must go down, services must go up, and if possible, whatever the customer wants needs to be delivered. It is the very definition of free market growth. What the game companies are doing is trying to directly contradict free market economics with the creation of mini-monopolies.

But since these mini-monopolies aren't true monopolies, they are affected by outside systems and variables. And this is a good thing. These outside variables, unaffected by the monopolistic forces within the video game system, follow free-market principles. They are enabling forces that are positive for the consumer. So, instead of reducing value in the system to which they are tangentially associated, they actually increase value.

If you want to compete with used games, lower the cost of the game.
A convenient example, the used game market. It is good. It is enabling. It is of extreme value, especially to the hard core gamers that are the heart of the multi-billion-dollar industry. The ability to resell a game increases the game's value. If I know that I can resell something, I'm more willing to spend a lot on it. To see this in action, one need only look to one of the primary industries on the planet, the automotive industry.

The true cost of a car, as measured by Consumer ReportsAutocarAutomobile, and nearly every auto publication in the world, includes the expected resale of the car. It's one of the reasons why Honda and Toyota so frequently top "best deal" lists, even though they were more expensive than their competitors' models. So to compete, companies like GM and Kia had to lower their prices to close the gap.

If you want to compete with used games, lower the cost of the game. This lowers the value gained from trading it in, meaning that more people will opt to keep their games instead of sell them, thus reducing inventory in the used market. It also lowers the future value from selling the game, causing more people to buy the game new.

This isn't hard. This is basic economics. But apparently, the video game industry is filled with people that just barely passed 7th grade.

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As with the music and movie industry, a major problem that, while easily solved by a chimpanzee that has taken Econ 101, has positively befuddled the video game industry, is the inherent valuelessness of software. One of the key aspects of modern economic thought is the principle of diminishing return. This is sometimes called a law, but I think that is inaccurate. There are no laws in human behavior. One aspect of diminishing return is that the cost of a good will eventually fall to the marginal cost of producing one more copy of that good.

So for example, a company is producing bicycles, if they produce more, they will sell more. But eventually, it will produce so many that those who would buy at the original price are used up, thus necessitating a price drop. Lather, rince, repeat, until eventually, the price has fallen to the price of manufacturing. This is an element of the much-feared race to the bottom.

Obviously there are limitations to this, as is the nature of economics. This theory assumes perfect systems, which we of course do not have, and it also assumes that the product in question does not change. Luckily, there are many ways that a company can "buck" the concept, such as good branding, design, or distribution. But in general, this rule always affects a market. It can't be stopped because the number one, number one, determinant of whether someone will buy a product or not is price. As such, prices will tend to trend downward.

So let's take that rule and apply it to games and any such digital information. After the information is out there, what is the cost of making one more copy?

Zero.

Or so close to zero as to make no difference. As such, basic economics states that the cost of games, music, movies, truly anything that can be broken into ones and zeroes, should be free. Not because data want to be free, or any other such techno-utopianist nonsense. They should be free because they cost nothing to replicate. And in a system that bases value on scarcity, a good that isn't scarce isn't worth anything.

Value comes from other elements. And regardless of the various old-guard companies protestations to the opposite, there are many places to derive value in this brave new world. And if the old guard wants to ignore these possibilities, other companies will simply step up to the plate. And as I've repeated throughout this, as the speed of technological development increases, the speed with which a company can fail also increases.

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When a company has been fighting behavior for a significant amount of time with no headway, they are stupid to continue.
Growth happens. Regardless of what the incumbent companies want. The best that they can hope to achieve is to slow that growth. We see this with large, legacy companies using their influence to try to maneuver government to pass laws against progress. The media industry is forcing through dozens of bad laws every year in their positively quixotic quest to stop advancement. They get copyright extended, make technology illegal, and spend millions in taxpayer dollars to block websites like The Pirate Bay that simply crop up in another form the very next day. They positively wreak havoc.

So not only does growth happen, trying to stop it harms everyone.

The market says what it wants. If users are doing something that a company doesn't want, they aren't wrong for doing it. The company is wrong for not wanting it. The market is always right, regardless what the company believes. This is obviously not a hard-and-fast maxim, since holding that perspective can be just as myopic as resolutely rejecting it. But when a company has been fighting behavior for a significant amount of time with no headway, they are stupid to continue. The righteousness of the act is immaterial.

At the risk of becoming political, I look to the Drug War. Each year, we increase spending, increase incarceration rates, increase incursions into other countries. Each year, drug use stays the same and drugs become easier to get. As we learned above, this makes perfect sense. When you fight something and drive it out of legitimate channels, you increase its value. If you increase its value, ever more producers will step in willing to provide.

As an economic entity, a company needs to embrace what it fights. By embracing it, it controls it. It controls the revenue channels. It controls the price. It controls the customers. By fighting it, the company abdicates control. And do I even need to say how dumb that is?

Games, music, movies, they are all fundamentally the same thing. They are 1's and 0's. That means that copying the information is cheap and easy. Legacy companies cannot seem to accept this. They fight it. They have lost control of the brave new, digital frontier. The stupidity of this decision beggars the imagination, because they could have used their money and strength to gain a significant foothold in this new gaming world.

Instead, we have companies like Doublefine showing the big boys how it's done. They raised over $3 million on the service Kickstarter for a classic-style adventure game like King's Quest, and that isn't surprising. Some, like at Kotaku, the video game website, have tried to argue that this is only applicable to dead genres. That's, of course, wrong.

Compare that to the Kickstarter project of Christian Allen. This is a guy who has worked on some big, recent shooters, and who wants to make an "old school tactical shooter". He has made...$48,000 at time of posting. He can call it "old school" all he wants, but the words "tactical shooter" sound like the kind of game that gets released every few months on a current generation console, which in turn - and regardless of the kind of game he has in mind or its chances of success - reduces the effectiveness of his campaign. 
It's sad, and can be brutal, but that's how Kickstarter is going to work, at least for video games that need any sizeable amount of money (as in, anything more than an indie game that only needs $10-$20,000). Despite what it actually is - and what it's pitched as makes it sound cool - Allen's game sounds like something we're getting already from publishers. 
His other problem is that, while he's got some great games to his credit, the name "Christian Allen" isn't one consumers are familiar with. Since the service relies on people putting money down with almost nothing but a pitch and a name to go on, they're going to go with what they know. And what they know is the people they already know and the games they grew up on.

This only makes sense if we assume that indie guys are the only ones Kickstarting games. There is no reason whatsoever for that to be the case. Instead, what this large amount of money reveals is precisely where value can shift, and that the money of the current system can be found elsewhere.

The Kotaku article does make a good point, though: with everyone trying to get their voice heard, the din becomes so overwhelming that buyers don't know where to put their money. The solution lies in the very companies that swear up and down that without the current, dead system, they would cease to exist: the publishers.

The publisher becomes the name. The publisher becomes the filter. Kickstarter doesn't even need to come into the equation. Ideas are pitched, and a publisher puts its weight and reputation behind it. That provides the filter for the ideas that the public wants and gives indie developers with good ideas the opportunity to get their work heard above the din.

This also gives a great tool to publishers, since they can know precisely what game players want before they pony up any development cash! They can put ideas up there, attach a price, and see what sells. These are valuable data! It's game sales and market research all wrapped up in one. This amazing value is being ignored by the big players in the industry.

Publishers would then be of enormous value to a small developer. The publisher "knows the ropes" as it were, and can tell the developer how many copies a particular game is likely to sell, how much the copies will sell for, and how much they would likely get in pre-sales. Some developers will eventually get big enough to bypass this system and go directly to the audience, but most will not, and there will always be an endless supply of small developers waiting in line to get their ideas heard.

Even before Doublefine, this business model could have been foreseen simply by the rise of Gamestop. Look at the average presales of games on the Xbox or Playstation 3. The numbers are enormous. Assuming a production budget of $20 million (the current average),10 they would need to presell less than one million copies to pay for the game before development even began. And considering big games like Battlefield 3, which pre-sold three million games, and then sold over 10 million copies in its first week, these numbers are achievable.11

This process is one of many ways to monetize data. Because remember, once data are created, they are infinite, but before they are created, they are very finite indeed. The creation of data has value. Data themselves do not. Yes, I could copy a game, but only if it has already been created. If I want the game to be created, though, I need to pony up. I need to become part of the creation process.

This is great. This is the business model that would have never been possible before the Internet. It allows consumers to become part of the process, as opposed to just, well, consumers. They are given the ability to literally vote with their wallets for what games get made. It helps to alleviate the risks associated with taking on a massive game development project, which as was mentioned earlier, are getting ridiculously high.

This opens up the industry in ways that were once only fantasy.

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As I mentioned, the opposing drives to both embrace and shun the new world are most strongly manifested in Microsoft, the Xbox specifically. They are software and hardware; old and new; conservative and progressive. Just as with the totality of Microsoft, there are very few things out there that, even after being beached on the market for over half a decade, are still as overflowing with potential as the Xbox is. All that Microsoft has to do is, ahem, completely overhaul their business model.

This sounds a lot harder than it is. What is currently being done need change only a bit. Programs will still be made, MSN will still operate, and Windows will still release a new version that only becomes acceptable after the first service pack. All that changes is the way that these products get wrapped and sold.

If I was the product lead for Xbox, I would make bold changes. My mission would be to destroy the competition by taking all of the steps that they were unwilling to take. I would accept all of the windmills against which they continue to tilt and learn how to make money from them. The fact that Microsoft isn't jumping on this just blows my mind. Nintendo and Sony are more vulnerable now than at any point in the last twenty years. Microsoft could become the name in home entertainment.

I would immediately drop the price of all new games to $30, last year's games would be $20, and older games would be $10. As I mentioned, the price of the product is the #1 determinant of whether someone will buy something or not. There are massive numbers of people out there who simply will not buy at current prices. Change that.

Lower the price of a good and increase sales. Steam saw this happen. Author after author has discovered that by reducing the cost of their books, their sales numbers can increase not by double digits, or triple digits, but by quadruple digits. 5000% increase in sales? Sure. It's happened.

This would reduce used game sales, reduce piracy, and increase the number of games sold. More games means more fans, more fans means more revenue channels, and more revenue channels means more chances to sell ancillary goods and services. Microsoft should also be keenly interested in the resulting increase in sales of the system (especially now, with sales dropping). As time goes on, the number of cheap games available also rises. This increases the value of the system, and causes more people to buy it, even when its price stays the same. And this is precisely the growth curve that we saw.12

I would immediately stop the mandate from above that Xbox needs to toe the Microsoft party line. Xbox needs to open up as much as possible. You will never have some massive, beautifully integrated system where you can happily milk users of money, be it on their laptop, desktop, tablet, cell phone, or television. And the more that you try to achieve that ridiculous goal, the more that you will push people away.

I would open up development of the Xbox 360 and foster a hacker community around it. Instead of banning users who modify their systems, I would include them. They are the hardest of the hard-core, the most dedicated. Even if their primary goal is piracy, all that reveals is that they care so much about games as to undertake a risky endeavor that could destroy their machine. They are the biggest fans and instead of being embraced, they are treated like criminals. Obvious to anyone with half a brain, this is counter-productive and just plain stupid. It is rumored that Bill Gates once held up a modified Xbox at a Microsoft board meeting and asked "How can we engage these people?" Apparently, that question never left the board room.

Well Bill, I'll tell you how you engage them. It's not hard. Simply stop pushing them away. Create a hacker equivalent of Xbox Live. I recommend calling it Xbox Undead (geeks love zombies... for some reason). Users can freely connect whatever the hell they want to the network. Encourage development of the network by the network. It becomes a massive, open-source gaming environment, managed by Microsoft, and powered by Xbox. Just imagine the possibilities.

When games cost $60... I have a large incentive to simply derive entertainment elsewhere.
Microsoft needs to develop the community around the Xbox as interactive, not merely consumptive. Host annual hacker/development conferences. Call them X-Con, or something like that. Have contests where creators must rapid-prototype a game in 24 hours for a competition. Have shows for the coolest modification to a system. Sell booths for small-run accessories by minor companies that Microsoft helps fund.

What Microsoft is trying to do is generate support for the Xbox brand. Microsoft should explicitly say that the compact that is being made among them, the consumers, and the developers is that they will design and build a standardized system (the hardware, software, and services) and offer access for a price. And once access has been granted, people are free to do almost anything they want in order to drive progress and earn money. Everyone becomes involved in the growth, maintenance, and money-making potential of Xbox. Instead of just a soulless monolith of a company hawking a product, they will become the jovial leader of a common group.

All of these ideas operate in accordance with basic economic understanding and theory. Making data and then trying to tie those data up via hardware or software restrictions is tilting against an economic windmill. Success is not had in fighting this and reducing value for people, it is had in shifting the money to another part of the equation that still has value. You don't use the hardware to tie up software, you use the hardware to enable software, thus people are forced to use your hardware/software combo because they want to.

Microsoft and game companies don't seem to get that the value that they offer is not the game, but the things around the game: the services. People buy through the iPhone's App Store because it is easy, safe, and streamlined. I could jailbreak my iPhone and get everything for free, but it is the polar opposite of easy, streamlined, and safe. That is the value. That is the reason to buy. And when apps cost less than $10 most of the time, I have little financial incentive to pirate when buying is affordable and easy.

When games cost $60, I have a large financial incentive to pirate. I have a large incentive to buy used. And most damning of all, I have a large incentive to simply derive entertainment elsewhere. The last one is the true risk for the video game industry - not pirates, not Gamestop. The real threat is that people will find what they want somewhere entirely different.

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If changes like these are not made, I see the video game world dying under the weight of its own bloat just as it did with the fall of Atari and before the rise of Nintendo.

Yes, the market will never completely die; it's far too advanced for that to happen. There will always be companies producing games, and there will always be gamers going to "cons" where they blow each other away in some game or another. What will go away is the vibrancy of the market. It will not disappear, mind you, it will simply go somewhere else: to cell phones, tablets, and computers. And in this exodus, storied names will die. The old market will whither to make way for the new. And while I do not think that it will be as bad as the great video game crash of 1983, it could be.

Because today, if a company does not have a pillar in the increasingly drab world of "core" gaming, they are left behind. Activision is predicated almost entirely on the strength of Call of Duty, which sells a bazillion copies with every iteration. Electronic Arts and Ubisoft are of similar foundations with franchises like MaddenBattlefield, and Assassin's Creed. They do not produce new games with new ideas and concepts. They produce the same product, iterated year over year, for the same audience.

The target market for these products, these core games, is of a character that they will accept annoyances in their interaction. They will deal with oppressive digital rights management (DRM). They will deal with a lack of vision. They will deal with high prices. They will deal with reduced value. They will deal with treatment illustrated by this horrifically candid interview with EA president John Riccitiello...

This is the strategy of a company that is working very hard to reduce value in their products, not grow with technological development. And while players of these games will deal with that, others will not.

Not surprisingly, other companies that do not have the game, but are still behaving like EA, are dying. They do not seem to know how to adapt, or are unwilling to out of arrogant intransigence. As such, we have stories like this.

Sega is losing money. One of the the companies! Sega and Nintendo defined the resurrection of video games in the 1980's. The Genesis, Saturn, and Dreamcast. For thirty years, Sega has been a part of the industry. And while Sonic has not seen a really good game in a long time, Sega has not been without its hits. This isn't just about bad business decisions on Sega's part. It's about value, and how Sega was not providing it. They could have leveraged their massive catalog and sold classic games for $0.99 each. They could have released a licensed emulator to play these old games. Instead, they released a mildly reworked collection of games and tried to charge $30 for it. They could have sold their racing games, which already earned their money back years ago, for cheap. They didn't. Recently, they hailed their fourteen-year-old game Virtual On: Oratorio Tangram, as though it was special that they were selling it for only $7.50 instead of $15.

Here's a shock: this didn't work.

There is this strange idea, illustrated by Riccitiello's interview (and manifested in other companies, as well13), that a company is providing sufficient value if people are paying the price that is asked. That is stupid. It's like saying that my house is fire-proof because it has never been on fire. It seems to stem from the inability to quantify value. Economics tries its best, thus the concept of money, especially fiat money, but value itself is abstract and detached from any measurement. Value is a relational concept. Something does not have 23 units of value. Something can only have higher or lower value than something else.

Video game companies do not sell games. They sell value in the form of entertainment.
That is why value growth is so god-damned critical. A company can never know how valuable its product is. All it knows is that this year's product is more valuable than last year's product. If the company always grows its value, it decreases the chance that a competitor can blow its products out of the proverbial water.

That fear is the beating heart of the free market. The fear that, at any time, a competitor can come and steal market share by providing higher value, keeps companies innovating. Sometimes, though, that threat isn't readily apparent. This can be because of arrogance, as with Nokia, or because the industry is a slow-moving industry. For example, I'm sure that many small grocers and markets thought that the value they provided was more than enough to sustain them. That was, of course, until Wal-Mart came to town.

The video game industry is facing its Wal-Mart today. And they are doing exactly what small grocers around the United States did: nothing.

---

Video game companies do not sell games. They sell value in the form of entertainment and entertainment can come in the form of nearly anything. I can be entertained by gardening, cars, exercise, or chronic onanism. Truly, there are few things in the world that are as highly competitive as the entertainment industry. Game companies must realize that their competition is not each other. Their competition is EVERYTHING that can entertain. If they don't keep pace, either with continuing development or reducing prices, they will be overwhelmed. That is precisely what happened in 1983.

A company does not sell things. No matter what they sell, their actual product is value. They must disconnect the concept of value from what they are actually selling. That value may come in the form of a product or a service, something durable or something consumable. But all companies are fundamentally selling the same thing. To succeed, they must maximize that value, because that's how they make their product better.

Likewise, when it is understood that, along with all the companies within a specific market, every company everywhere is selling value, it is an inescapable realization that everything in the world is, in fact, competition. If a company is selling laptops, they not only compete with other laptop manufacturers, they are competing with Nike, Starbucks, and Old Spice. Everyone has a limited amount of money, and the only way to guarantee a slice of that pie is to maximize value. A company must provide so much value that anyone who is even remotely interested in their product will take it. That's why free data are the best data; it completely eliminates any reason to not take it.

Let me say that again, the only way to compete is to maximize your value. If you reduce your value by trying to maximize profit or arbitrarily differentiate products, you are guaranteeing your eventual death. It may not be now. It may not even be next year. But it is a guarantee. You will be the record industry. You will be Motorola.

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At the beginning, I said that the traditional video game industry's failure is inevitable. But just as the music industry's slow, painful death has provided the ash from which the phoenix of online music distribution can rise, so too will the classic system/publisher/developer model give way to something better. The profit possible from disrupting a massive industry is too great to let it simply sit, and few industries are as massive as the video game industry. It may be gradual, as we are seeing with the agonizingly slow death of the music industry. Or it may be rapid and sudden, like the fall of so many cell phone companies and the 1983 crash.

But as always, the world will go on. Just because people stopped buying video games in the mid 80's doesn't mean that they stopped buying entertainment. The money was still spent. People just stopped giving it to the game companies. It doesn't matter if your company is around or not. No one cares about you. Life always goes on with one company or another.

And that is the ultimate point: life goes on. The economy is like nature in that it doesn't care about specific constituents of the system; it cares about the system. Nature cares about life, and the economy cares about value. For the economy, value is life. It is the driving force. It is always there. It is the very stuff from which the system is built. If your company tries to fight this, it is doomed. No matter how good your company is, it is doomed.

Because as Jeff Goldbum's character in Jurassic Park said, life, uh, finds a way.

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1: The Kinect has introduced a large number of popular party games which has increased the system's popularity with the casual market. The X360 still pales in comparison to the Wii and mobile gaming, though, and lags the Wii in overall installed base by over 30 million systems.

2: The companies are trying their best to hide this fact, though. Comcast, for example, has announced data caps on their at-home internet service while simultaneously exempting all data that travels through their services in a ridiculous, value-destroying, and possibly illegal, scheme. http://arstechnica.com/tech-policy/2012/05/extra-lane-how-comcast-assures-that-xfinity-tv-on-xbox-360-works-well/

3: There is a disconnect between A+ titles as rated by reviewers and players, though. The players are getting tired of the same old game, over and over, and this is illustrated in the unprecedented rift between user reviews and critical reviews of Modern Warfare 3 on Metacritic. In this article from late 2011, A writer at IGN said that low user scores come from a vocal minority, and that he fully expected the user and critical scores to reach parity over time. Well, guess what never happened? That.

4: http://news.teamxbox.com/xbox/8962/Xbox-360-Only-Authorized-Third-Party-Accessories/
That link is shocking in its reveal of Microsoft as dumb, dumb, dumb. "Microsoft has made it very clear that it's all about profitability" The sheer magnitude of the wrongness of that perspective is why the Xbox 360 has never become the mega hit that it needed to be. Microsoft cared about squeezing money from people, instead of giving them a reason to buy.

5: "Success" needs to be explained. The Wii never did very well for third-party companies, so in that view, the system did worse than either the PS3 or the Xbox 360. But from the perspective of the company that made the system, only the Wii has made profit. Similarly, as far as consumer acceptance is concerned, the Wii devastated the other two systems. The Wii has sold 96 million systems (as of April 2012). The Xbox 360 has sold 66 million. And the PS3 has sold 63 million. In fairness to Microsoft, it has sold very few systems in Japan, while both other systems have done very good business there.

6: An excellent example is the studio system before World War II. Studios either directly owned or kowtowed theaters into accepting ridiculous deals. They would shovel out crap for years until ticket sales dropped, and only then would they release new ideas and new technology. Or for a more recent and more technological example, look at Intel in the 1990's. They milked every chipset for everything it was worth, even going so far as to drive IBM to develop PowerPC chips with Motorola and Apple to escape the monopoly.

7: As mentioned in the article, sales of video game related hardware and software is anemic, while tablets and cell phone sales are growing by literal leaps and bounds. Apple sets sales records with its iPhone and iPad every quarter (selling as many iPhones in one quarter as the three game systems combined sold in a year), and the top paid applications for both of those devices are games. It doesn't take much imagination to see the connection. Gamestop certainly does, seeing as they just expanded to selling tablets in 1,600 US locations.

8: In a case of near-hilarious irony, Sony was the company pushing for technological advancement against an intransigent Universal Studios. Then Sony went and bought some media companies, specifically Columbia Pictures, conveniently changed their tune, and it's been downhill ever since. Reaching the point today where, oh right, Sony lost nearly $6 billion. Oops. http://en.wikipedia.org/wiki/Sony_Corp._of_America_v._Universal_City_Studios,_Inc.

9: Those numbers are rising, though, and iPad apps average nearly $7. Prices like that will be unsustainable, and the value equation from jailbreaking increases with every price hike. Going much higher than $5 for an app is a bad idea when most apps never make a profit. And as the value of the locked App Store decreases over time, applications will need to maintain a low price to prevent large swaths of people from going to other channels.

Making matters even worse is the biased nature of app purchase demographics. Much like the video game world where "core" people constitute a great deal of purchases, so does a core group of customers constitute the majority of app purchases. Truly, over 70% of users buy almost nothing. The reason why app makers are earning money is because the pool of people is so damned huge. Raise prices, reduce the pool. That's bad.

10: http://www.develop-online.net/news/33625/Study-Average-dev-cost-as-high-as-28m

11: As I was writing this, the Kickstarter campaign for a cell-phone-compatible watch broke $10 million in funding, setting a new record only a month after the old record. http://www.techdirt.com/blog/casestudies/articles/20120514/00184818899/biggest-kickstarter-project-ever-surpasses-10-million-cuts-off-funding.shtml

12: Although, even the increasing value proposition isn't enough to counter the high price and gamer-oriented attitude of the system. From 2011-2012, it saw sales drop by nearly 50%. http://www.zdnet.com/blog/hardware/xbox-360-sales-down-by-almost-half/19902

13: Not surprisingly, all three of the companies mentioned in this part, EA, AT&T, and Verizon, were featured in The Consumerist's Worst Company In America list for 2012... and 2011, 2010, 2009, 2008... you get the picture.

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