Video Game Dollars: 'Steam' Feels the Heat

When privately held Valve Software launched its Steam digital distribution platform in 2004, basically selling computer games over the Internet, it was an enormous bet for the company.

Expensive and untested, the service was something new in the gaming world and served a dual function.

Half-Life 2
Source: Valve Software
Half-Life 2

On one level, it was a way for the developer to boost its margins, letting it avoid retail stocking fees and publisher royalties. At its heart, though, it was a piracy protection move, requiring users to authenticate copies of its highly anticipated game “Half Life 2 .”

Things quickly evolved. Steam today hosts and sells over 1,100 titles (from virtually every major game publisher in the industry) and has over 25 million active user accounts. Competitors estimate the company holds a commanding 70 percent share of the PC digital distribution market. And starting this week, Steam made its debut on Apple computers.

Computer Congester?

The service is not without its detractors. Early users (and a handful of modern ones) complained that Steam slowed their system down and was difficult to uninstall. Marcin Iwi?ski, founder of a competing (and much smaller) digital distribution service, has recently been particularly brutal in his comments on the service, likening it to malware.

Valve disputes that label, saying it constantly monitors the system and tries to tackle problems from its users quickly.

Half-Life 2
Source: Valve Software
Half-Life 2

“We have tried to be completely transparent in giving folks control over Steam and trying to let them know what we’re doing,” says Doug Lombardi, vice president of marketing at Valve. “It’s one of [company founder Gabe Newell’s] pet peeves to have a software application that is, in any way, obnoxious or intrusive on a user’s machine. That’s something we take to heart.”

Analysts note that while the complaints are sporadic, it’s important for Valve to stay on top of them.

“The reason they’ve been wildly successful so far is they offer positive incentives for people to authenticate online,” says Billy Pidgeon, senior analyst at M2 Research. “If people are seeing performance hits with their system, they’re getting into dangerous territory.”

Valve doesn’t release sales numbers for Steam, but recently reported unit sales increased by more than 205 percent in 2009. And even though the PC market is often given second-class citizenship by game publishers, that’s enough money to start raising eyebrows—and that means more competition is on the way.

Who Would Compete?

Electronic Arts , Activision and Microsoft are all taking different approaches to digital distribution, but could all chip away at Steam’s market share.

EA is taking the most aggressive approach. The company is investing heavily in its EA Store and other digital platforms. Digital revenues at EA were up 33 percent in the just-completed fiscal 2010, hitting $570 million. Management expects that number to grow to $750 million in fiscal 2011. (The figure includes income from advertising and subscriptions as well as the store.)

EA, though, is a direct competitor to other publishers, which would likely prevent them from aligning with the company. Valve, on the other hand, has succeeded in wooing companies like Ubisoft and Take Two Interactive Software to Steam because it is less of a direct competitor (and likely offers a lower fee than brick and mortar retailers).

Microsoft, whose Xbox Live service is considered a leader in the console digital distribution field, has so far been unable to transfer that success to the PC world.

Half-Life 2
Source: Valve Software
Half-Life 2

Activision, meanwhile, has chosen to focus on in-game microtransactions in titles made by Blizzard Entertainment. That model, so far, has been tremendously successful. Last month, the company began selling a virtual horse in “World of Warcraft .”

Within eight hours, the queue to buy one was 80,000 players long and eventually topped 140,000. Activision is estimated to have made $3.5 million in one day on sales of the $25 item.

Beyond traditional companies, there are new competitors entering the digital distribution space. OnLive will use cloud computing to let players purchase games. (In other words, games will run on remote computers as you play them and be streamed via the internet to your screen. This means people will be able to play any game at its maximum visual settings, regardless of how powerful their system is.) Trion Worlds will offer a similar service, but will focus on original games, rather than republishing other companies’ titles.

“There are a lot of people fighting over that online game sector,” says Pidgeon. “I see online services of all sorts proliferating wildly over the next 10 years.”

Lombardi acknowledges that the field is getting more crowded, but says Valve is remaining focused on its product, rather than worrying about other companies.

“We think about what we want both as customers and developers, then keep executing,” he says. “This market is big enough for more than one player. There are enough PC devices out there that there’s going to be people who play multiple games on multiple services.”

Not everyone agrees. While the number of players in the PC digital space grows, some analysts question the logic of the investments.

“As long as there are going to be PC games, Steam will do fine,” says Michael Pachter, managing director of equity research for Wedbush Securities. “But Steam’s never going to be on Xbox 360 or the PlayStation. I just don’t think [the PC] is a big growth industry.”