- The release of the new Xbox and PlayStation consoles follow years of change in the market.
- Microsoft, Sony and Nintendo are investing more heavily in software, subscriptions and content.
- Cloud gaming, Big Tech and consolidation are set to drive more change in the industry in future.
LONDON — We've come a long way from the arcades of the 80s.
Today, the way more than 700 million people play video games is on a dedicated console, with the console industry on track to generate $45 billion in revenue this year, according to market research firm Newzoo. And the way companies in the sector make money has changed rapidly over the years.
Now, with new consoles from Microsoft and Sony on sale, there's a clear push from both companies deeper into software and subscriptions — similar to the way Apple has placed a greater emphasis on services in recent years.
They're hoping to capitalize on rising demand for games as consumers around the world spend more time at home during the coronavirus pandemic. But a viral pandemic isn't the only thing that's changed the gaming industry recently.
According to Daniel Ahmad, analyst at Niko Partners, consoles are now a much more profitable business for firms like Microsoft, Sony and Nintendo than they were a decade or two ago.
"We're now moving to a point where hardware is profitable, software has always been profitable and network services are playing a much larger role in keeping people within the console gaming ecosystems," he told CNBC's "Beyond the Valley" podcast.
Digital distribution of games has allowed firms to rake in bigger profit margins than selling physical copies in stores, Ahmad said. Whereas publishers would traditionally make about $35 on a $60 game sold in-store, online downloads mean they can now make as much as $45 per game; this can increase to 95% for platform holders like Sony selling their first-party games digitally.
Sony and Nintendo have reported much higher digital download numbers this year. That trend looks likely to continue, with both Microsoft and Sony selling digital-only versions of their new consoles at lower prices.
So-called gaming ecosystems are set to become even more important over the next few years. Microsoft, for example, is betting heavily on building out its player base across a range of different devices, including its Xbox consoles, Windows PCs and smartphones.
The company released its xCloud gaming service commercially in September as part of its Xbox Game Pass subscription platform. Cloud gaming lets users play a game that's streamed to their device from a company's remote infrastructure. Such services are typically available through paid subscriptions, similar to Netflix but for games rather than TV shows and movies.
"We think of the console as something that is always going to be part of gaming, because what it does is it effectively gives someone the flagship experience," Sarah Bond, Microsoft's corporate vice president of gaming ecosystem, said in an interview for "Beyond the Valley."
"But the other thing we've seen — and there really has been a rise in this over the last 10 years — is people wanting to game across devices," she added. "So the console plays that role as part of an ecosystem where people can actually game anywhere."
Japanese rival Sony, meanwhile, is pitching the PS5 as an all-in-one system that gives players access to its exclusive games as well as its PlayStation Plus and PlayStation Now subscriptions services, which offer online gaming, some free titles and cloud gaming.
Analysts say the PS5's predecessor, the PlayStation 4, largely beat Microsoft's Xbox One console due to the number of exclusive games it sells. Sony's in-house studios have produced several popular franchises, such as God of War and The Last of Us.
Nintendo similarly takes advantage of its vast catalog of intellectual property, with series like Animal Crossing and Super Mario selling multi-million hits on its Switch console.
The company stands out as it's less concerned with Microsoft and Sony's next-gen console battle, choosing instead to ride a wave of continued demand for the Switch. However, it hasn't missed out on the rush toward subscriptions and services, using its paid Nintendo Switch Online feature to drive additional sales from software.
Now, other tech giants are stepping on gaming companies' turf. Google, Amazon and Facebook have all released their own cloud gaming services, looking to carve out a share of the $160 billion games market.
Niko Partners' Ahmad said there are two main strategies coming out of Big Tech: On the one hand, Google and Amazon are trying to compete with the likes of Steam and Epic Games as digital game distribution platforms themselves. On the other, Facebook is using game streaming as an advertising tool.
"How that works is, you're scrolling through your Facebook feed and you can instantly jump into and experience a game," he said. "If you like that experience, you can then click to play and play more on the device of your choice instantly. On console, you can do that through instant demos; being able to play a game instantly without having to download it."
For now, cloud gaming is mainly seeing adoption among console gamers who want to continue playing the titles they enjoy on other devices, Ahmad said. It's going to be an opportunity for tech companies of all stripes to take advantage of the growth in mobile gaming, which now accounts for almost half of the entire market, according to Newzoo.
Microsoft, a company valued at $1.6 trillion, sees cloud gaming and subscriptions as a chance to drive more users toward its content. The company recently bought Bethesda Softworks, the video game publisher behind hit franchises like The Elder Scrolls and Fallout, for $7.5 billion.
"Content is key to people driving our gaming subscription, and it's something that people look for," said Bond, who added that Bethesda's content would help "accelerate" growth of its Game Pass subscription service.
Ahmad thinks there could be more consolidation on the horizon: "The ability for games to generate huge amounts of revenue over the long term is going to be really important to a lot of these platform owners."