Game Development and Market Failures
YOU get a market failure, and YOU get a market failure . . .
OPINION
Unrestrained investment in a monopolistically competitive market results in failures for both investors and game developers.
WHAT'S GOING ON
Game developers want an economy where game production, consumption, and our employment are stable. People with good ideas would get funding, spend some time making a game, and then the gaming public would have an opportunity to pass judgment. Jobs would be stable and game companies wouldn't close without lots of warning, if ever. Life would be great for everyone.
Anyone watching the game industry today knows that things are #$%^. A long string of layoffs and studio closures, contracting overall revenue, and a market saturated with games (OK, that part is not so bad). If I tried to make a list of all the bad things that would be the whole article — other folks have done this already, so see links at the end.
As a scientist and engineer, I always ask, "Why? How does this work? Is this the best way? Does it have to work this way?"
Looking below the surface indicates that layoffs and studio closures are just symptoms of the true illness. If we want a hope of making things better, then we need a diagnosis.
Let's diagnose the game development economy by building a model of how it works.
Note: if you want a really detailed review of all the things that have been happening, read through Andrew Ball's expansive tome. He seems to have access to way more raw data than I do.
DIAGNOSIS THROUGH MODELS
The forces driving behaviors in the game industry are complex. I'll be mixing and matching terms and concepts from macro and micro economics to describe things in a structured way, but in a way that is also simplified.
The utility of models is not that they are correct — arguably, none are — but that they help us understand. A good model contains the right type of simplicity to clarify something, to help us to reason about something complex. You may not find all the nuances you care about, but those nuances should not affect our conclusions.
MONOPOLISTIC COMPETITION
The core of our model begins with a framework called monopolistic competition. If you research the concept you'll find a longer list than the one below as well a list of industries that fit into the category.
Yes, the game industry functions a lot like the restaurant industry, at least in terms of economics!
This list includes what I see as major drivers for the games industry. Some of the others aspects of monopolistic competition may be at play, but applying an economic framework is not always a one-to-one match. YMMV.
Let’s go.
🎲 Companies produce similar but not identical products where competition is based mostly on subtle product differentiation.
Check. There are many game genres, and most gamers will float between more than one genre. Differences can be very subtle within a genre but those differences can matter to gamers.
🎲 There are many producers and many consumers in the market, and no business has total control over the market.
Check again. Walled gardens like those of Sony, Microsoft, or Nintendo have some control over portions of the gamer population, but their sway is not wide or exclusive. Stickiness within a garden also seems to be decreasing in strength as cross-platform F2P games become more widespread.
🎲 Companies operate assuming their actions will not affect other companies' actions.
🎲 Decisions of one company do not affect the behavior of other companies.
This is not 100% true, but does have a lot of impact. No one wants to release on the same day as certain major games, like World of Warcraft or Fortnite, but decisions to create new games are not based on what another company is planning. Often that is because studio plans are effectively secret until later stages of development.
🎲 There are few barriers to entry or exit.
The two primary barriers are (a) money, and (b) forming a team. When interest rates are low, people borrow with abandon, and when wealth inequality is high, money goes looking for good ROI investments.
As for creating a team, there are always developers waiting to get in on creating a new game. One person can create a game with tool suites that are free to use for development. Game scope is only limited by the available person time and skill of the collective team.
The barrier to exit is an interesting issue. In essence, it states that there are no strong forces, no friction, preventing a studio from being shut down. Legal requirements vary from place to place, but those certainly don’t seem to slow or stop closures and layoffs.
🎲 The principal goal is to maximize profits.
Bingo card complete. This is the driving principle of shareholder capitalism and seems to be the case for most (although maybe not all) investors and publishers even if it is NOT how most game developers are motivated.
GAME ECONOMY MODEL
Let's go over how these things apply to our model of the game industry. This list doesn't include all possible factors, like regional or platform demographic differences, but it should be complete enough to guide our thinking.
INVESTMENT DRIVERS
Let’s start with these monopolistic competition features driving creation of studios.
🚧 Investors perceive little or no barrier to entry to create a new game.
💰 The principal goal is to maximize profits when the game is sold.
🙈 Decisions of one game investor do not affect the behavior of other investors.
⏱️ New studios can be formed in a matter of months.
These rules apply to investors and publishers, and even individuals who want to make a solo game. Under these conditions it is easy to see why a lucrative game market attracts a glut of new studios.
Critically, a lot of investors, even ones with no game development experience, can see the size of the pie and are certain that it’s easy to grab a big slice.
FEEDBACK TIMING
These mechanics are observations of how our industry works. The timing properties interact with the investment drivers in a feedback loop that we care about.
📅 After funding, a typical game requires 1-5 years to go from pre-production to delivery.
🏃 Investors will pull funding from a studio or live game upon observing an unanticipated probability of loss.
😱 Investor fear of lost revenue continues until they observe studios starting to be profitable again. Consider this a refractory period, or hysteresis if you prefer that term.
Engineers and mathematicians know that a dynamic system where the response speed is mismatched to feedback delay will result in unwanted behavior: oscillations, or a general failure to follow ideal or even predictable behavior.
RESOURCE LIMITS
Investors need gamers to spend time, money, or both on their games. Gamers love to game, and will spend both freely, although there can be fluctuations caused by life events and by the appearance of unique or special games. But all gamers have resource limits.
💸 Gamers have a money budget.
⌛ Gamers have a time budget.
I call out money and time distinctly because participation in a free-to-play (F2P) game is critical to the happiness of gamers who pay real world money (RWM) in that game. They need other gamers to play with.
Time and money budgets will differ across demographics and platforms (console, PC, mobile). But regardless of the target demographics and platforms for your game, there is effectively a cap to both of these.
SPENDING BEHAVIORS
Let’s use more economic terms to describe how gamers exercise choice. These are not specifically characteristics of monopolistic competition, but they are critical elements to capture in our model.
🔃 Gamers have a high elasticity of demand for entertainment, meaning they can choose to spend variably, even nothing, depending on life events and preferences
🔀 Games have a high elasticity of substitution, meaning there are many games with roughly equal entertainment value, and gamers can and do switch without a lot of provocation.
👊 Gamer time and money are both rival to investors, meaning that time and/or money spent on one game (investor) is no longer available to be spent on another game (investor).
⏭️ Gamer time and money is non-excludable to investors, meaning that games (investors) cannot significantly limit gamers from switching freely to other games (investors).
When one game becomes boring (bad or no endgame), or a patch introduces some friction (crashes, bugs), or a reduction of perceived value (desirable cosmetics are severely paywalled), gamers simply switch to a different game with equivalent entertainment value.
For any economists who read this, think of each of these conditions as equivalent to a change in pricing. The product is entertainment, and the price is whatever a gamer needs to do to experience it. Increasing friction increases price.
MARKET CONSEQUENCES
A monopolistically competitive market can reach a steady state condition. In our case, there would be just the right amount of equally desirable games available. In that steady state, each investor would only break even, meaning none would make a profit. The incentive for additional investors to enter the RTS arena under those conditions would be very low, but gamers would be very happy.
Game development is clearly not in a steady state. Let's use an example to illustrate how our model can produce the oscillations we see.
🤑 It is possible for many investors to believe they can make a profit.
🥳 Investors with sufficient resources can enter the market at any time.
🤿 When the industry is looking profitable, a an increased number of investors dive in.
📅 Each new studio spends some months recruiting developers and then 1-5 years building a game.
🥧 The fixed pie of gamer time and money is allocated (roughly uniformly, possibly with a few exceptions) across all available games.
🌊 Visible studio success entices more investors, so we get a surge of studios employing developers, and later a surge of games.
💸 When the number of available games increases, each game accrues less gamer time and money, on average.
🏃🌪️ We progress to a state where a large number of studios can't generate enough return for an investor to break even, triggering a wealth-protection reflex. They shut down active games with low returns, and shut down studios that have not even shipped. Developers get laid off and the developer job market tanks.
⏳😱 Investors wait for game profits to look enticing again before going back to step one.
🔁 Rinse, repeat.
CONCLUSION
The game industry is experiencing a busted economy signaling a market failure for both investors and game developers. Let’s go over this.
You will find that academically focused definitions of market failure refer to 'efficiency'. When you dig deep you can encounter the phrase 'Pareto optimality' or 'Pareto efficiency', an abstract mathematical formulation that ignores actual human behaviors and needs.
That abstract term distances us from real world consequences and begs the question of what we should really be optimizing. Here is an alternative definition from study.com (an educational site) that is in plainer language. I think it captures the right tone.
"A market failure is a situation when . . . demand and supply are not equal. Complete market failures occur when no products are supplied at all. Partial market failure can happen when products are supplied in the wrong quantity or price."
The market for games has failed investors because games (investors) are in oversupply (wrong quantity) and returns are well below expectations (wrong price).
The market for game developer jobs has also failed. The availability of jobs is declining (wrong quantity), as is the compensation for jobs (wrong price). In the worst cases, compensation can be insufficient to cover frequent moves, sometimes across continents (wrong price).
Technically, the game industry is in partial market failure. But any game developer who has been negatively affected will be offended by the 'partial' qualifier as they experience the havoc wrought on their lives.
RESOURCES
89 Days Into 2024 And 8,800+ Video Game Layoffs Have Been Announced, Kotaku, February 2024
A Wikipedia entry: 2023–2024 video game industry layoffs
The Tremendous Yet Troubled State of Gaming in 2024, by Matthew Ball.
Monopolistic Competition: Definition, How it Works, Pros and Cons, Investopedia.
A Wikipedia entry that is more dense: Monopolistic competition.
Elasticity of Substitution, Inomics.com
Wikipedia article: Elasticity of substitution
What Is a Rival Good vs. a Non-Rival Good, With Examples, Investopedia.
Wikipedia article: Excludability
Price Elasticity of Demand: Meaning, Types, and Factors That Impact It, Investopedia.
YouTube video - Elasticity of Demand- Micro Topic 2.3
Study.com source for definition of market failure
Martijn van Zwieten presentation - Survive to ‘25 (and beyond)