ROLAND BERGER STRATEGY CONSULTANTS CONTENT. Fresh thinking for decision makers

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1 ROLAND BERGER STRATEGY CONSULTANTS CONTENT Fresh thinking for decision makers Casual games are for everyone and everywhere But popularity doesn t always equal success How to get from customers to cash remains the crucial question SEPTEMBER 2012

2 KEY SUCCESS FACTORS FOR GAME DEVELOPERS 10 Developing games for early technology trends/platforms 9 Increasing 8 Continuous monetization improvement of launched games 6 Mass 5 Aggressive 7 Expanding media PR coverage distribution channels cross promotion between games to keep the user base with the developer 4 Releasing only high quality games with professional design and fault proof engines 3 Concept testing with customers in early development stages 2 Fresh ideas as games unique selling point 1 Management attention to key performance indicators

3 CONTENT Casual Gaming MORE THAN FUN AND GAMES: CASUAL GAMING GROWS UP You ve seen them on the train or perhaps even while waiting for a meeting to start. Maybe you or your children are among them. They are building cities, solving puzzles and playing poker when they have breaks throughout their day. Casual gamers. They play games that are quick to learn and only spend about 15 minutes on each playing session, which enables them to reach the next level or even finish the game. Because they do not involve the complexity of traditional video games, millions of people around the world are playing these casual games at home or on mobile devices as they are on the move. About a quarter of the world s population play casual, social or mobile games. In the United States, 145 million people or almost 50% of the population are casual gamers. Unlike traditional video games, casual gaming appeals to more women than men sources show that anywhere from 55% to 75% of casual gamers are women. Plus players tend to be slightly older than the traditional gaming set. Despite their popularity, social and gaming markets are not mature and casual gaming companies are struggling to generate consistent profits from their successes. Just because millions of users are playing their games, doesn t mean they are making money. In addition the market is becoming increasingly crowded, games are becoming ever more sophisticated and distribution channels are fighting for their share of profits. Yet even in the midst of a challenging business environment, Roland Berger sees opportunities for success in the casual gaming industry. Because casual games reach a mass-market audience, they have potential to generate profits. POPULARITY DOESN T EQUAL SUCCESS Casual games have no doubt been well received by the public. US company Zynga, one of the largest casual game developers in the world with highly popular titles on Facebook, generated USD 1.14 billion in More than 55 million users play its recently launched game "The Ville" each month, where the main aim is to build the home of your dreams and decorate it. Rovio, a mobile game developer from Finland, created the highly popular Angry Birds, which has been downloaded more than 1 billion times since its launch in December That growth is not expected to slow down anytime soon. Analysts estimate that the global online and mobile video market will show an increase of almost 60% by 2016 reaching USD 46 billion from USD 29 billion in MILLIONS OF PEOPLE ARE ATTRACTED TO CASUAL GAMING Number of casual gamers in the US In the nascent Central European market and well developed Asian market the mobile and online gaming market is set to skyrocket. In Central Europe growth should average 15% a year from USD 1.2 billion in 2012 to USD 1.9 billion in Asia will see growth of 14% a year from USD 18 billion in 2012 to 29.9 billion in In Latin America, market growth is still strong averaging 12% a year until 2016, while in Western Europe growth should average 10% a year. Even the saturated North American market is expected to grow 8% a year during that time.

4 ROLAND BERGER STRATEGY CONSULTANTS COUNTRIES IN EUROPE ARE GROWING UP TOO Mobile and online gaming market growth, , in USD 464 m 784 m Germany Source: PwC GROWTH RATES FOR DEVICES PROVIDE THE FOUNDATIONS FOR FUTURE GROWTH OF CASUAL GAMES Global number of smartphones (with ios or Android operating systems) and tablets 13 m m 876 m m France >200% per year >280% per year 552 m 786 m Spain m Italy 18 m 573 m 878 m Tempted by wide known successes such as Zynga or Rovio and the promising market outlook, an ever-growing number of entrepreneurs are attempting to hit the jackpot. Until now casual gaming companies have treated game development much like the lottery, relying on the fickle tastes of customers to make or break them. Success has been highly dependent on customer reception, title promotion and interesting and catchy ideas. Before creating Angry Birds, Rovio, for example, released around 50 games that did not catch on. As casual gaming marketing matures and larger companies enter the market, this arms race of game development is becoming increasingly expensive and fierce. Casual gamers are becoming more and more demanding in terms of game quality and variety. Even minor flaws in the game can easily deter users from playing it. Customers require ever more ingenuity and can quickly become bored with existing games. Advanced technology and skilled programmers to develop these new games require large upfront investments. Even promoting games through traditional means is becoming more difficult. With more titles flooding the market, the costs of reaching target users are high and the effects of word of mouth low. In addition existing players are dominating these channel making it challenging for new entrants to get noticed. Zynga, for example, spends USD 100 million per year on advertising on Facebook. The cost of creating a competitive Facebook social game has now increased from USD 50,000 to 100,000 in 2009 to USD 500,000 to 1.5 million. New entrants are also at the mercy of distribution channels, which have strong bargaining power and can change the rules at their whim. For example, Facebook previously allowed game developers to freely promote their products, sending other users information about friends results. But in 2010 Facebook began requiring developers to ask for member permission before posting on their wall, forcing developers to increase marketing spending. Another example is the Apple App Store, where featuring a game on the front page significantly boosts sales of a title, but the selection depends on a decision made by Apple. With success stories like Rovio the market potential of casual gaming seems seductive, but the reality is far harsher. These kinds of success stories are increasingly becoming a rarity. As the market becomes more crowded, developers will struggle to get noticed. Winners will be few and most will simply be pushed out. Even big, well established players on the market, such as Zynga, with a significant audience are subject to the whims of a rapidly changing gaming market and shifting consumer needs. Zynga's shares have heavily underperformed on the stock exchange since its IPO at the end of 2011, mainly due to financial results that fell short of investors' expectations. Zynga also miscalculated the market, proving how hard it can be to predict consumer tastes, when it acquired rival OMGPOP for USD 180 million in March The deal proved an expensive mistake for Zynga. OMGPOP s product "Draw Something", which shot past all established games in early 2012 has soon started losing popularity among players Source: Gartner 2011 The example of Zynga shows that players on the casual gaming market cannot rest on their laurels and they need to quickly convert their business model from art into science to stay one step ahead. Their key priorities must be to professionalize development and operations, apply consistent and robust approaches to KPI monitoring and invest in consumer under-

5 CONTENT Casual Gaming standing. With these priorities in place, gaming companies will be able to exploit opportunities in casual entertainment anticipating trends before they become a victim to them. REACHING CUSTOMERS Industry shifts don t mean that companies should give up on casual gaming. Instead they would be wise to consider their own position along the casual gaming value chain, moving from killer products towards an analytical view that emphasizes KPI monitoring and analytics-based decision-making. To start they should understand all aspects of the casual games value chain. The casual games value chain was traditionally divided into six main parts: Developers - responsible for game preparation, including concept generation, graphics and game engine creation, testing, game optimization and maintenance after launch Publishers - taking care of the whole process of game distribution, usually for a certain share in revenues generated by the product Portals - game destination websites. They can be either proprietary portals of game developers or portals with games from a variety of developers Aggregators - intermediaries between developers, publishers and portals Middleware companies - enabling the process of game development, distribution and monetization Players - the end consumers Since casual games can be played through streaming to web browser or downloading and installing on a device such as PC or mobile phone, game developers are able to directly access their target audience by creating proprietary game portals. Zynga, with more than 90% of revenue generated through Facebook, has created its own portal to decrease its dependency on the social network the move was prudent especially in the face of changing Facebook policy which makes it harder for users to find games on the Web site and as a result has had negative effect on Zynga's games performance. Also game publishers are starting to cover a larger part of the value chain, mainly through acquiring game developers. New distribution models also hand more power to game developers as opposed to publishers, who control access with traditional boxed games. With the Internet, developers have the ability to reach end users directly. Because they do not have to share revenue with external partners, they are able to take a bigger piece of the cake. However, they also bear the responsibility for marketing activities aimed at attracting new users. Game portals allow developers direct access to gamers through web portals, which aggregate titles from different developers. For example SpilGames manages more than 45 gaming sites in 18 different countries, giving users access to a wide variety of games. Or developers can publish games on subpages of generalist portals. One example is Yahoo, which has a section dedicated to games (games.yahoo.com), offering access to more than 1,650 titles from different developers. The website creates even more loyalty among its user base, while giving game developers easy access to the traffic on the portal. The responsibility for promotion and traffic generation lies with the portal, but it is rewarded with, for instance, a certain share of the revenue generated by the games. ONLINE AND MOBILE GAME DISTRI- BUTION CHANNELS HAVE DIFFERENT REVENUE SPLIT SCHEMES Typical share of revenue 0% 5-50% 20-50% 30-80% 50-70% 60% Own website Social network General portal Mobile App Store Distributor Source: Roland Berger Independent website

6 ROLAND BERGER STRATEGY CONSULTANTS REVENUE GIVE AWAYS Average revenue share for distribution partners in App stores 30% The rapid growth of social networks has created another powerful distribution opportunity for developers. By August 2012 Facebook reached 955 million active users worldwide, up from 100 million in Facebook succeeded in almost tripling revenue from games in 2011, reaching nearly USD 560 million, with the most popular titles reaching tens of millions of users. Facebook is expected to maintain its dominance in the social network distribution channel as it continues to expand into new markets. However, as many smaller regional or national social networks offer a less competitive environment due to their more limited game offerings, developers are starting to pay attention to these partners. The mobile channel has been gaining in importance in recent years. This channel is attractive for casual gamers, since it enables them to play anywhere, anytime. Games are distributed mainly in pay-per-download schemes. App stores, such as the Apple App Store, play the most important role in this segment. However, due to revenue sharing models, developers have to give away part of the revenue generated from user fees for downloads, which is usually 30%. FROM CUSTOMERS TO CASH In casual gaming players don t always translate to profit. When releasing games companies must carefully consider how they will charge for games and what additional revenue they can generate. Every pay model has positives and negatives, but the decision depends on the game itself and strategy of the company. The most common example, is the freemium model, where players get initial access to a game for free and purchase game play extensions, advanced functionalities or virtual goods for a certain fee. Free games are of course the easiest way to get a wide variety of users, but in reality few actually opt to spend real money. Because a tiny fraction of users spend a lot of money on the game, companies should pay particular attention to this group. To keep the light users who are likely to stop playing after a period, companies that employ this model should also regularly launch new games. Because this model requires a large number of users to pay off, it works best for online games such as those in game portals or on social networks. When a game is free of charge and it has a low learning curve, the number of players can quickly increase. With social networks results can be displayed to a user community, increasing rivalries and urging players to spend more time. That, in turn, motivates users to achieve better results, which translates directly into them buying game enhancements and additional features. Zynga successfully applied this model to games like CityVille, which were published on Facebook for free. Users in this case did opt to pay for the wide variety of additional features. At the other end of the spectrum are gaming companies that charge for games upfront, as is often the case for mobile games. Rovio, for example, used this model for its most successful title, Angry Birds. While this model shuts out light gamers not willing to pay the upfront price and sacrifices additional revenues that heavy gamers would potentially pay above the initial fee, it allows companies to capture money right off the bat. Companies can also charge gamers a periodic subscription fee. This model works best for web portals such as BigFish Games, which offers a wide variety of casual games covering both pay-per-download and free-to-play games. For a monthly subscription fee, users receive, for instance, free games, discounts on game purchases and early access to new releases.

7 CONTENT Casual Gaming Companies can also choose to combine the two models, using the paymium model, which offers a game for an upfront or periodic fee and, at the same time, enables gamers to purchase extensions, advanced functionalities or virtual goods for a fee during the game. Games with a strong brand can afford to use this strategy, because players are more willing to pay the initial fee and purchase features when they recognize and trust the name. Otherwise developers will need exceptional marketing to encourage users to pay multiple times. While in this model the developers maximize revenue from every user, it also requires that they invest in building their brand and in creating game marketing. In addition to charging users, gaming companies can also generate revenue through partnerships and advertising. Developers can get fees from partners in exchange for access to the user base. Players are offered free games in exchange for participating in various partner offers, including surveys, account sign-ups or loyalty program points. Or game companies can explore both regular banner ads and in-game advertising. For example, the fast-food chain McDonald s teamed up with Zynga to promote its brand in one of the company s most popular games, FarmVille. In this game, users manage their own virtual farms by planting and growing crops and raising livestock. As part of the cooperation with Zynga, McDonald s placed a branded farm within the game. However, developers often overestimate the impact in-game advertising, which has a limited ability to generate revenue in the casual games segment. And because in game advertising can even deter users from playing, developers have been reluctant to rely too heavily on it to generate revenue. LETTING USERS PAY WHAT THEY WANT CAPTURES THE MOST GAMERS Typical example of revenue split of freemium gamers % 9% 0.9% 0.1% play for free low spenders high spenders top spenders CASUAL GAMING COMPANIES CAN NO LONGER AFFORD TO LEAVE GAME DEVELOPMENT TO CHANCE The market is becoming more professional, shifting from an entrepreneurial game development model, where titles are produced by small startups with limited business experience, to professional companies that do not create games based on simple gut feeling, but make decisions along the entire development process based on comprehensive analyses of players' needs, behaviors and customer feedback. Companies such as Zynga are paying close attention to testing games in the early stages of their development in order to introduce well-thought-out games to the mass market. They are increasing their research and development spending, focusing on a few titles to make each one a major hit. Validating game characteristics with target users helps companies avoid unnecessary costs by allowing them to withdraw at an early stage from projects that are unlikely to prove successful. This new approach requires established corporate operations and a higher level of professionalism. Gaming companies will have to restructure their businesses to reflect new industry realities, employing standardized recruiting, emphasizing testing and investing in development. But through more professional operations, which incorporate careful analysis of distribution and revenue models, gaming companies are more likely to hit the jackpot. prove successful. This new approach requires established corporate operations and a higher level of professionalism. Gaming companies will have to restructure their businesses to reflect new industry realities, employing more professional recruiting for new employees, emphasizing testing and investing in development. But through more professional operations, which incorporate careful analysis of distribution and revenue models, gaming companies are more likely to hit the jackpot. Source: Roland Berger IF YOU HAVE ANY QUESTIONS, PLEASE FEEL FREE TO CONTACT US: Alexander Mogg, Partner alexander.mogg@rolandberger.com Maciej Korzeniowski, Partner maciej.korzeniowski@rolandberger.com Philipp Leutiger, Principal philipp.leutiger@rolandberger.com Agnieszka Babicz, Senior Consultant agnieszka.babicz@rolandberger.com think:act CONTENT Editors: Dr. Martin C. Wittig, Charles-Edouard Bouée Overall responsibility: Dr. Torsten Oltmanns Project management: Dr. Katherine Nölling Design: Roland Berger Media Design Roland Berger Strategy Consultants GmbH Am Sandtorkai Hamburg news@rolandberger.com

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