Quantifying the Boom in Gaming and Esports
Key Insights
The global gaming market will surpass $159B in revenue in 2020, a 9.3% increase over 2019, with a roughly even split between mobile gaming and console/PC.
The gaming model shifted rapidly over the past few years, as many game developers such as Epic Games and Riot Games shifted the traditional one-time licensing model toward games that are free to play with a revenue model fueled by in-game purchases.
The esports industry received $1B in funding in 2019, and industry revenues may reach $4B by 2022.
As esports leagues restructured and legitimized, teams and their players realized quickly that they need a team to manage sponsorships, revenue sharing, and merchandise.
Market Overview
According to Newzoo, the global gaming market will surpass $159B in revenue in 2020, a 9.3% increase over 2019. Of this $159B, mobile gaming will generate $77.2B,while console/PC gaming generates the balance.[1] There are many public companies in the mobile and console/PC gaming space, most notably Tencent ($20.3B revenue in 2019), Apple ($10.8B), Sony ($13.5B), Microsoft ($9.27B), Google ($7.35B), Nintendo ($5.13B), Electronic Arts ($5.39B), and Activision Blizzard ($5.84B). Emerging private firms include Sea Limited ($1.14B) and Valve ($2B), the creator of the Steam app store.[2],[3],[4] With a near 40% stake in Fortnite creator Epic Games and full ownership in League of Legends creator Riot Games, Tencent is a proactive M&A leader in the industry.
The Shift in the Gaming Model
The gaming industry evolved significantly in recent years. Historically, most games sold for a $60 one-time licensing fee, a model with which public firms like Activision Blizzard and Electronic Arts stuck. Any free games that were on the market were pay-to-win, where the user would have to pay to unlock advantages in the game. Now, many game developers, most notably Epic Games, Riot Games, Tencent, and Valve, shifted from these $60 or pay-to-win games to free-to-play games with a “game-as-a-platform” model. One of the most popular examples of this successful shift in strategy is the popular battle royale game, Fortnite, created by Epic Games.[5]
In these “game-as-a-platform” games, like Fortnite, users do not need to pay anything to be competitive, but rather they pay for experiences or for cosmetic upgrades for their characters, weapons, or vehicles, items that have no impact on the success or failure on the users playing the game. From the developer’s perspective, these items cost little to create and release into the game, and they are free to reproduce. Therefore, this results in impressive margins for game developers, and essentially gives them “the ability to print money.”[6] Epic Games, the creator of Fortnite, netted $3B in profits on $5.6B in revenue in 2018, representing a 54% profit margin.[7],[8] Additionally, technical requirements to play “game-as-a-platform” games are much lower than before, making them as accessible as ever. For example, you can play Fortnite on your phone. These two factors contributed to significant growth in the player base, which resulted in more marketing for the game, more exposure for professionals, and more in-game purchases.[9]
The boom in in-game purchases led to the creation of internal economies within each game, in which users can buy and sell cosmetic upgrades from the game itself or from other users. Although they have no effect on the actual game, the value of the items can be quite significant depending on the item’s rarity. Game developers manipulated the value of many of these items by making them only available for a limited time, by making them exclusive to certain players, or by making them rarer for players to acquire. These strategies increased players’ desire to obtain items while they are available, boosting sales for game developers.[10] According to 2019 data from Statista, 87% of gamers make in-game purchases, and the average annual spend for each user on League of Legends and Fortnite was $92 and $82, respectively.[11] Furthermore, Electronic Arts’ popular FIFA Ultimate Team game mode (which is their hub for in-game purchases) now represents a greater revenue figure than sales from the game, FIFA, itself. According to Electronic Arts’ most recent 10-K, Ultimate Team net revenue was $716MM in the first half of FY2020, up 40% from 2019.[12]
Managing the E-Sports Boom
As previously mentioned, the significantly larger player base from this recent shift to free-to-play games allowed for more organic marketing and exposure for the games and the professionals who play them. Due to this, the e-sports industry received more attention from investors and sponsors than ever before. In 2019, investors pumped nearly $1B in funding into the esports industry, supplemented with 33 M&A deals totaling $475MM. While the $1B in funding represented a decrease from 2018 (primarily due to two unusually large deals closing in the Chinese market, $462MM in Series B funding for Huya and $632MM Series E funding for Douyu), it was a 33% increase from an estimated $750MM in funding in 2017.[13],[14] The 2019 funding statistics led to increased estimates of $4B in revenue by 2022 in the esports industry, according to Quantum Tech Partners, a gaming-focused advisory group.[15]
There are two primary models game developers and e-sports teams elected to pursue to legitimize the industry to its fans and sponsors. Valve stuck with the more antiquated model, with a somewhat hands-off approach. In this model, independent organizers host tournaments with amateur teams, where there are little to no restrictions on the number of teams allowed in these leagues or tournaments. Valve hosts a few major tournaments each year, but there are no league-wide sponsors, and there exists no revenue sharing. Individual sponsors for each team are essentially the only driver of revenue.[16]
Riot Games, creator of League of Legends, elected to pursue a different model, taking a much more active approach. Prior to 2018, this structure had region-focused tournaments which filtered into a world championship. The structure was also similar to how many European soccer leagues operate: a fixed number of teams in each league, where the bottom few teams are relegated to another league each year and the top few teams from lower leagues get promoted. This significantly discouraged investment into teams and the industry in general, as there existed a substantial amount of risk as to which teams would survive relegation each year. This uncertainty is what ultimately caused things to change. In 2018, this model shifted to a franchising structure, without any relegation system and competition primarily tied to each region. Riot Games established revenue sharing through securing league-wide sponsors. Without any relegation system, there is less risk from an investor’s perspective, as they can be certain of which teams will be in the top leagues and benefit from sponsorships and revenue sharing. Other esports leagues have since adopted this model.[17]
Post-2018, these franchises expanded with full management teams and branding through the sale of apparel and other merchandise. The next stage for the evolution of e-sports may be securing media rights, though this is still unclear. Gaming personalities can build personal brands beyond the game, become influencers, and unlock hundreds of thousands of dollars of earning potential.[18]
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Footnotes
[1] Size of the global gaming market
[3] Revenue excludes hardware sales
[4] https://newzoo.com/insights/rankings/top-25-companies-game-revenues/
[5] Invest Like the Best podcast EP.180, “Investing in Gaming”
[6] Invest Like the Best podcast EP.180, “Investing in Gaming”
[9] Invest Like the Best podcast EP.180, “Investing in Gaming”
[10] Invest Like the Best podcast EP.180, “Investing in Gaming”
[12] EA Ultimate Team revenue data
[15] Esports 2019 funding data
[16] Invest Like the Best podcast EP.180, “Investing in Gaming”
[17] Invest Like the Best podcast EP.180, “Investing in Gaming”
[18] Invest Like the Best podcast EP.180, “Investing in Gaming”