Selecting a Project

Even the largest publishing house only has the wherewithal to market a tiny fraction of the games submitted to it. Therefore, the process through which publishers select the projects they will invest their precious resources in is extremely crucial.

Publishers evaluate projects with a "profits and losses statement" like the one presented in Case Study 1.4.1; let us examine the factors that influence this calculation.

Case Study 1.4.1: Estimating a Project's Profitability

Here are examples of profits and losses spreadsheets for a mid-range PC game and a franchise console title.

PC Game

	Early Adopter	Peak	Budget	Total
Gross unit price	$40	$30	$15
Expected units	0	80,000	40,000	120,000
Gross revenue	$0	$2,400,000	$600,000	$3,000,000
Cost of goods	$0	$120,000	$60,000
Advance/R&D	$1,500,000
Marketing	$200,000	6.7% of sales
Direct (total) expenses	$1,880,000
Breakeven	62,667
Profitability ratio	1.6

Franchise Console Game

	Early Adopter	Peak	Budget	Total
Gross unit price	$40	$30	$10
Expected units	350,000	500,000	150,000	1,000,000
Gross revenue	$14,000,000	$15,000,000	$1,500,000	$30,500,000
Cost of goods	$2,450,000	$3,500,000	$600,000
Advance/R&D	$3,500,000
Marketing	$2,500,000	8.2% of sales
Direct (total) expenses	$12,550,000
Breakeven	313,750
Profitability ratio	2.4

Let's define the line items in this spreadsheet:

• Gross unit price: The price at which the publisher sells to retailers. This is usually 50 to 70% of the retail price paid by consumers.

• Expected units: Target sales numbers.

• Gross revenue: Gross unit price multiplied by expected number of units sold.

• Cost of goods: The cost of printing game media, manuals, packaging, and shipping and handling. For console games, this includes the unit royalty paid to the platform owner; for example, $3 to $8 depending on the retail price and the platform.

• Advance/R&D: The non-refundable sums paid to a third-party developer, or the money invested in developing the game internally.

• Marketing: The sums devoted to advertising the game in print, online, and on TV, plus in-store marketing and promotion. For most projects, this is roughly 8 to 10% of gross revenue, but some publishers will invest much more.

• Direct expenses: Advance/R&D plus marketing.

• Breakeven: Number of units that must be sold to cover the game's direct expenses.

• Profitability ratio: Gross revenue divided by total direct expenses.

Note that indirect costs, including trade show expenses and publisher staff salaries, are not accounted for in the profitability ratio calculation. Neither are profit margins. The actual ratio that the project must generate to justify investment depends on publisher overhead and profit objectives; for a small publisher with limited staff, a ratio of 1.5 might be sufficient, while giant companies traded on the stock market might need a ratio of 3.0 or more.

The Two Risks

Sadly, game development studios are inherently unstable. For every company that achieves long-term success, many close their doors after releasing only one or two games, and even more never manage to ship a single title. Furthermore, the game market is highly hit-driven; according to numbers quoted by [Laram e00], only 3% of PC games and 15% of console games sell more than 100,000 units in any given year—and 100,000 copies is rarely enough to make a high-budget release profitable. For a publisher investing time and money in a project, these facts translate into a pair of major risk factors:

• The risk of cancellation: That the project will never yield a product, because it will be cancelled along the way.

• The risk of commercial failure: That the finished product won't find success in the marketplace.

The publisher's decision process must balance these risks against the product's inherent appeal, to determine whether its potential payoff warrants the investment.

Reducing the Risk of Cancellation

Most game project cancellations derive from excessive delays and/or poor quality. Thus, well-established teams with proven track records of success stand the best chance of securing publishing deals. When Sid Meier created Firaxis, the press reported contract signings involving the new company within weeks.

For the typical startup, the situation is more complicated. Some publishers will demand to see a 25 to 75% complete version of the game as a proof of the developers' credibility before they invest. Others will sign a contract based on a fully functional demo, but for a modest advance only. In both cases, the new team will have to find alternative sources of funding (debt, capital, or sweat equity) for part of the development process.

Reducing the Risk of Commercial Failure

With thousands of games released every year, and room for but a fraction of those on retailers' shelves, publishers will favor projects with built-in target audiences. For example:

• A sequel to a current best-seller. If Zombie Rodent Disco Kings sold 3 million copies, retailers and consumers will clamor for Zombie Rodent Disco Kings II.

• A game that fits the general parameters of a popular genre. It is easy to assess the potential sales figures for a war game, a shooter, or a golf simulator.

• A game based on a popular license. When deciding between two games to buy, the typical consumer will tend to choose the one featuring Star Trek or Sesame Street characters.

While these "franchise games" by no means guarantee success, they are perceived as more likely to make an impact in the retail market than their wholly original or off-beat competitors.

Making the Decision

A variety of strategies are available to publishers seeking further risk reduction:

• Cross-collateralization: This is an accounting process that ties together the earnings of several games (or of the same game on multiple platforms) so that the profits made by one have to recoup the losses of the others before royalties are paid to the developer.

• Budget games: If a game can turn a profit on sales of 5,000 units, the risk is minimal.

• Hedging the bets: Larger publishers might play the odds by acquiring the rights to many high-profile games and hoping that one of them will turn into such a hit that it will more than make up for any losses on the others.

• Affiliate label status: Some small and mid-sized publishers will delegate the massive sales and distribution effort to a larger company to reduce their costs. Strategy First, a PC game publisher profiled in Case Study 1.4.4, is an affiliate of Infogrames.

However, the most important factor in the decision remains the individual game's odds of making it to market and being successful there.