Since the days of the Atari 2600, the video game industry has stuck to the same formula: Consumers buy console hardware, then purchase each game separately – at prices ranging from $20 in the 1970s to $60 today.
But the changing nature of the industry has made some question that model. Increasingly, players are balking at the high price of titles, opening the door for the mobile market to grow. That sort of defection isn't especially surprising with casual players (who have always tended to chase bargains) -- but with core players beginning to rethink their buying habits, the industry is being forced to evolve.
Free-to-play games are increasingly moving out of the shadows. And San Francisco-based Kixeye is one of the companies in the gaming sector leading the way. It's showing its industry how to focus on gamers other than just the casual crowd.
As the maker of both Facebook and standalone free-to-play titles, Kixeye courts the same audience that buys "Call of Duty" and "World of Warcraft."
It makes core games for core players. It just happens to offer them for free, making its revenue on micro-transactions – small purchases from a small segment of the overall audience.
It's making a lot of money in the process. Revenues in 2012 were above $100 million – and CEO Will Harbin says he expects to double or triple that figure this year. Average revenue per daily active user, he added, was 20 times higher than Zynga (reported them to be 5.1 cents per day in the fourth quarter of 2012). Analysts note that Kixeye has been profitable and cash flow positive since 2011.
"I've always been a passionate gamer and wanted to do something in gaming -- and I saw this as an opportunity to do that," Harbin said. "Nobody was making these sorts of games."
It was a risk at the time, but the company's model is one that has analysts watching closely.
"What Kixeye did was look around the [free-to-play] market, take the best of it and apply it to their customer," said Billy Pidgeon, senior analyst for Inside Network. "Kixeye puts out a game that hardcore gamers – people who really consider themselves gamers – want to play, even though it's on Facebook or a web platform or mobile.You're giving people a game of quality."
(Read more: The Future of Garbage Is … No Garbage)
Other publishers could be taking note as well. More and more companies are beginning to test free-to-play web and social gaming offerings for core players. Ubisoft last year launched a free-to-play Facebook version of its "Ghost Recon" franchise. (The experiment lasted less than a year, though.)
And Blake Jorgensen, CFO of Electronic Arts announced this week at a Morgan Stanley Technology Media & Telecom Conference that the company is looking to incorporate micro-transactions into all its upcoming titles – both free to play and those bought at traditional retail stores.
"We're building into all of our games the ability to pay for things along the way," he said. "Consumers are enjoying and embracing that way of the business."
Kixeye isn't alone in the free-to-play core gaming market. Riot Games' "League of Legends" boasts 32 million active players each month. And Wargaming.net's "World of Tanks" has 50 million registered users in 200 countries, who make an average of 3.5 million item purchases each day.
What makes Kixeye unique, though, is its tight focus. It has grown to its position on the strength of just a handful of titles – and it makes it easy for players to move between the worlds.
"Kixeye's games are … differentiated from its competition insofar as they are 'zero sum,' meaning that players can take items from one another, providing an incentive for many to gain stature and power in order to be better positioned competitively," noted Wedbush analyst Michael Pachter.
Harbin said another key to success has been making games that are enjoyable whether customers are making those transactions or not.
"In a very well-optimized ecosystem environment, only 10 percent of your users are going to pay, so you need that other 90 percent to be engaged," he said. "You're creating a user-generated [massively multiplayer online game]. Everybody has a role. People who play for nine months… and don't spend a dime still contribute value to the game."
(Read more: The Little Company That Conquered Conglomerates)
While there have been whispers of a possible IPO for Kixeye, Harbin shrugs those off. He doesn't believe there's a market window for a public offering at this time, he said. And since the company has raised about $22 million in venture funding in addition to its profits from its games ,there's no need to raise the money. Any serious thought of an IPO is at least a year or two out, he said.
The focus now is on expansion – launching games in new genres, like the shooter and role-playing worlds. At the same time, bigger publishers, who have traditionally held a lock on the core gaming audience, are moving more into the free-to-play space, something everyone in the category is watching closely.
"I can see our space is getting a little bit crowded," said Wargaming CEO Victor Kislyi. "However, this is leading to the fact that lots of game are trying to copy [each other]. … At the end of the day, there will be leaders who will think strategically, who will change the direction in free to play. You have to invest. You have to risk. You have to be strong. There are pretty much only two options. You're either following the crowd, copycatting successful formulas again or you want to become one of the leaders."
As for Harbin, he said he's not too worried about the EAs and other traditional publishers taking a bite out of Kixeye's user base.
"These guys are too slow," he said. "They're leaving themselves exposed for someone to come in and steal their thunder.They're their own worst enemy."