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Video Games Under The Gun, as Big Changes Loom

As the video game industry gathers at E3 to look forward to the holiday season and what it hopes are more prosperous times, storm clouds are gathering on the horizon that have the potential to radically change gaming in the months and years to come.

The substantial growth of video games as a financial and pop culture force has put gaming on a number of new radars — both competitive and political. And interested parties are moving in from all sides.

The most prominent example, of course, is Apple. The iPhone and iPad have opened up new avenues for independent game makers, who are regularly outselling established publishers such as Electronic Arts and Take Two Interactive Software on the platforms. The hardware itself, meanwhile, has overshadowed Sony’s PSP handheld device and has proven a viable threat to Nintendo’s dominance of the portable gaming category.

“The iPhone, the iPad and the App store ecosystem represent a massive threat to the traditional game industry, in that they’re quickly monopolizing the bite-sized, cost affordable, accessible and on-demand gaming experiences,” says Scott Steinberg, head of the video game consulting firm TechSavvy and founder of Game Industry TV. “Even hardcore gamers are beginning to exhibit casual gaming habits. They’re looking for gaming on the go.”

Apple basically stumbled into the gaming world, succeeding despite itself, which has actually hampered the company’s impact on traditional gaming companies.

“There’s so much content available for the iPad and iPhone,” says Eric Handler, managing director of media, entertainment and video games research for MKM Partners. “Apple doesn’t do a good job of segmenting out the high quality stuff. They don’t do as good a job promoting titles as a Sony or Nintendo.”

That could be changing, though. Apple recently hired a respected game journalist to spearhead its gaming efforts in the App Store — and draw attention to the best titles.

E3 Electronic Entertainment Expo - A CNBC Special Report
E3 Electronic Entertainment Expo - A CNBC Special Report

Social gaming platforms are less of a threat to the core gamer, but continue to lure away casual players — which have traditionally been the chief buyers of consoles and titles in the later half of a game machine’s lifespan. Microsoft and Sony are hoping to lure them back with motion control sensors later this year, but neither Kinect (formerly known as Project Natal) nor Move offers the jump in/jump out flexibility of “FarmVille” or “Mafia Wars”.

Competing platforms are just the start. For years, state and local governments have squared off with game makers over the sale of violent games to minors. The ones that passed ordinances, though, have always seen them overturned by courts. But in its fall term, the U.S. Supreme Court will review a California law prohibiting the sale or rental of violent video games to minors.

A lower body had ruled the bill unconstitutional, but the Court surprised many by electing to review the case. It’s a decision that could have far reaching implications.

While the video game industry has its own ratings system (which has been widely praised), minors still are frequently able to purchase M-rated games (the equivalent to R-rated movies). If California’s law is deemed constitutional, other states may emulate the legislation – and that could result in a substantial hit to publisher revenues.

M-rated titles do not make up the majority of games on the market, but they tend to be the industry’s biggest hits, including Activison’s “Modern Warfare 2” and Take Two’s “Grand Theft Auto IV”.

Gaming industry insiders believe the Court will back the industry. It might — but it’s worth noting that many of those same insiders expected the court to deny California’s appeal, letting the reversal stand — which might not have ended the debate over regulation, but would have muted it considerably.

“This does promise to be a momentous decision,” says Steinberg. “Could this turn the tables? Undoubtedly — if it passes.”

Ironically, one of the gaming industry’s biggest threats is itself. Development costs for top-tier games continue to increase, cutting into publisher margins. A few disappointing titles can dramatically impact earnings. (EA is perhaps the best example of this, as the company’s turnaround has gone on much longer than anyone expected.)

While the next generation of video game systems isn’t expected for another 3-4 years, those new machines will only boost costs further when they do hit the market. And with consumers beginning to show resistance to the $60 retail point — especially with low-cost apps and free social games available — that’s problematic.

If next generation systems do arrive in 2013 or 2014, development work will likely begin on launch titles within the next 12 to 18 months — with production costs that could be as high as $100 million per title. And that’s a gamble many publishers can’t afford to lose.

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