On the Shelves

On the Shelves

Different outlets might sell the same game at different prices for reasons of strategy: for example, some retailers will choose to sell a high-profile game at a discount for a short time to draw customers. However, publishers will also change their suggested retail prices with time, lowering them when demand decreases ([Larame03]). What happens to developer royalties at that time?

If the royalty rate has been set as a fixed percentage of the publisher's sale price, for example 20%, the royalty amount decreases proportionally with the price. One consequence of this fact is that, if the game has not yet earned back its advance at the time of a price drop, the developer might have to wait until unit sales reach much higher levels than expected before he receives a check.

The other royalty model, in which the developer receives a fixed dollar amount per copy of the game sold no matter what the publisher's sale price might be, would therefore seem more attractive. Unfortunately, this model has a serious flaw of its own: as the publisher's price drops , the fixed royalty accounts for an ever-increasing share of the publisher's revenue, until it becomes economically preferable for the publisher to stop marketing the game even if there is still a demand for it.

From the developer's point of view, the optimal agreement ought to generate royalty income as soon as possible and keep the game on the shelves as long as possible. One way to build this strategy into a contractual clause would be to:

• Set a ceiling to the unit sales that can be used to recoup the advance. For example, an advance of $1,800,000 at a royalty rate of $9 per unit corresponds to 200,000 units sold at full price. The contract might therefore specify that the developer is entitled to receive royalties as soon as unit sales reach 250,000 copies, even if the advance has not yet been recouped due to price cuts.

• Set an escalating royalty percentage once the advance has been earned back. For example, the royalty on the first 100,000 units might be 20% of the publisher's price, the rate on the next 100,000 might be 25%, and so on. This way, the developer shares in the success of a hit, but since the royalty remains bound to the publisher's price as a reasonable percentage, there will never be any incentive for the publisher to drop the game as long as demand stays strong, since both parties earn money on each unit sold. After all, by the time the higher royalty rate comes into effect, the game is already profitable for both parties.

When Do Royalty Checks Arrive?

Finally, most publishers pay royalties on a quarterly basis, and only on copies that retailers have paid them for (because they have been sold to consumers). This means that it takes some time for money to flow back into developers' pockets: if a game reaches the target sales numbers required to generate royalties on October 21, the fact will be reflected on the publisher's fourth-quarter report, which might only be completed in February—and accounting might not print the developer's check until March.

Case Study 1.3.2: Royalties versus Guarantees

Sarbakan, a developer of online games based in Quebec City, is most notorious for its mystery serial Arcane and its action series SteppenWolf , both published by Warner Bros. Online. Sarbakan's business model relies on a balance between original intellectual property (whether sold outright , work-for-hire style, or licensed to distributors according to non-exclusive agreements) and service deals.

"We want to maintain a 50–50 split between creating our own projects and providing our services to other intellectual property owners ," says Richard Vallerand, Sarbakan's vice president for creative affairs and production. "These are very different businesses, but they complement each other very well."

In SteppenWolf 's case, Sarbakan sold all rights to the property to Warner Bros. The publisher provided a budget sufficient to insure profitability, and Sarbakan retained a share of future earnings tied to the property. "This way, we gained access to Warner's tremendous marketing machine. This allowed us to gain more players faster than we could have on our own. And since they own the rights, our partners will be more interested in migrating the property toward other media; television, for example. Obviously, they are in a much better position to do so than we are."

By selling the rights to SteppenWolf to Warner Bros., Sarbakan accepted a smaller share of the property's revenue. However, with the power of the conglomerate behind SteppenWolf , this small share might actually amount to more, in the long run, than what Sarbakan might have been able to generate on its own.

"Plus, Warner has allowed us to retain a great deal of creative control over the characters and storylines. This is not the case when we work on someone else's intellectual property: when we do so, the decision process always involves a lot of back and forth."

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