Monetary Aspects of Development Contracts

Before we look at the retail market itself, let's examine the contracts that developers sign with publishers; specifically, the clauses that specify how (and when) the developers get paid. For the purposes of this discussion, the enormous variability of development contracts will be reduced to two broad categories: cost-based deals and royalty-based partnerships.

Cost + Margin Deals

This model, commonplace in subcontracting but also becoming more prevalent in the context of full development deals, minimizes risk for the developer, but at the cost of lower potential profits. In short, cost and margin deals involve four steps:

1. Call for proposals. The publisher asks the developer for a proposal based on broad parameters; for example, a racing game featuring the publisher's licensed property, for console X, to be delivered in the third quarter of 2004.

2. Evaluation. The developer evaluates the cost of making the game.

3. Negotiation. The parties agree on an acceptable profit margin for the developer. Sometimes this is done explicitly: the developer discloses their cost evaluation and the price is set at 20 or 40% above this figure. More often, the publisher asks several teams for competing bids, and the developers include their own (secret) profit margins in their proposals.

4. Development. If the developer is able to deliver the product for less than the expected cost, they pocket the difference. Conversely, if costs run out of control, their profits diminish. In extreme cases, the developer might end up completing the project at a loss; while publishers will occasionally agree to pay more than expected rather than seeing a high-payoff game be cancelled, they will only do so if they are convinced that it is the only way to save the game—and they won't forget the incident.

For developers, cost-based contracts might be attractive because risk is confined to the developer's own operations: accurate evaluations and smooth projects guarantee profitability, no matter what happens in the marketplace. However, if the game turns out to be a hit, the developer might regret trading away a share of royalties in exchange for safety.

Advance + Royalty Deals

The royalty model, borrowed from book publishing, is the traditional framework in the game business. It involves three major steps:

1. Advance. The publisher agrees to pay the developer a fixed amount, which might or might not cover development costs, before the game is published.

2. Earning back the advance (or "recouping"). The advance is tied to the game's initial sales. For example, if an advance of $500,000 is paid based on $10 per copy, the developer will receive no additional money until the game has sold over 50,000 units. (If the game never reaches this sales target, the developer will never see another dollar, but at least they get to keep the advance. Deals that require reimbursement of un-recouped advances are all but unheard of, and should be avoided at all costs.)

3. Royalties. Once the game's sales have earned back the advance, the developer receives additional money for each copy of the game sold. This amount might be defined in dollars (e.g., $5 per copy) or as a percentage of the publisher's gross sale price, which can vary a great deal during the game's life cycle.

For developers, the royalty model might involve greater risk if the advances do not cover the cost of production. However, if the game becomes a best seller, the developer stands to earn much more money than in a cost-based arrangement.