Square Enix recently released its earnings reports for the 2022 fiscal year. It doesn’t bode well for AAA studios. Could next year be the year of the indie developer, or will Microsoft eat everyone’s cake? Keep reading – there’s a lot to unpack here.
Financial Statements
If you’re one of those people who want to dig into the dirty details, Square’s financial reports can be found here.
Let’s start with key quotes from the ‘Message to Our Shareholders’ doc (pages 7-8).
“Achieving major growth in the game industry is difficult now for companies that compete primarily in the Japanese market, given its graying demographics. As such, it is critical for our business that we produce hit titles that speak to the global market…”
“The investment required to develop game titles is an order of magnitude greater than in the past. In other words, the Japanese market is no longer sufficient for achieving a level of earnings that enables us to recoup our development investment and generate a profit. We, therefore, need to approach our development efforts based on the assumption that we have to succeed in the global market.”
“Another change is how easily accessible information on games has become for our customers…”
“We have identified AI, the cloud, and blockchain as focus investment areas under our Medium-Term Earnings Targets and Business Strategy.”
What do Square’s financial statements mean for the game industry?
Square Enix has been known to cater to the Japanese market. That’s not a secret. This is also why Square partners with Sony more than it probably should. Square’s financials are starting to show the impact of those decisions.
The details are in the numbers. Like all tech businesses now of days, it looks like Square’s earnings were propped up by the cloud. In this case, specifically, Final Fantasy 14. The 2022 fiscal year would have been worse if it weren’t for that MMO.
Looking at the quotes above, Square’s CEO puts a lot of the blame on the rising cost of game development. Lots of AAA game studio budgets easily rival or surpass blockbuster movie titles. With an aging Japanese population, there isn’t enough revenue to support AAA game development while focusing on a single market.
Square also has a history of bringing games to Sony before other platforms. This has evidently been a revenue bottleneck for Square.
All fingers point to a more diverse ecosystem being the future for everyone. In the future, based on the latest statements by Square’s CEO, we can more than likely expect that Square will be targeting the global market more broadly.
Does exclusivity hurt game developers?
This likely means that we won’t see limited availability releases as we saw with the Final Fantasy 7 Remake.
The Final Fantasy 7 Remake made its debut splash on the PlayStation 4 with a later release to PC via an exclusive deal with Epic Games. To date, it still has not been released on the Xbox.
Square is leaving money on the table, and they know it. It’s likely gamers won’t see an expedited release of the Final Fantasy 7 Remake franchise to all platforms anytime soon. Square already has sweetheart deals they are contractually obligated to meet, even if Square seems to regret those decisions.
It’s estimated that Square spent roughly $200 million on the Final Fantasy 7 Remake. Though it’s unclear whether that number includes the operational costs for FF7 after release (Eg. Support, marketing, maintenance, etc.) As of May 2022, Square topped 10-million-unit sales for it. I’m sure that number has only grown in the past five months.
If we give Square the benefit of the doubt, that’s roughly $600 million in sales (if all 10 million copies were purchased at MSRP. But remember, Final Fantasy 7 was offered as a free title with Sony’s monthly round-up of games in the PlayStation Plus service months back. It’s been on sale a lot too, and both Sony and Epic take a chunk of each FF7 purchase for themselves. That number is likely far lower.
How big of a return Square made on the Final Fantasy 7 remake is debatable. However, that rough napkin math only emphasizes the statements made in Square’s earnings report. If Square released Final Fantasy 7 on all platforms on day 1, how much more revenue could they have had?
Microsoft et al. Enters the Chat
We can’t look at Square’s earnings report in a vacuum. I assure you that other game studios and tech companies are not.
Earnings reports tell us a lot about where industries are going. If Square is saying that they need to expand globally, then there’s a good chance other businesses need to as well.
Game studios must look at those exclusivity deals and debate if they are worth it. To be clear, I’m only referring to big-budget game franchises. When you start entering indie territory with teams of five people or less, exclusivity deals and backdoor negotiations are very much a viable business strategy. Their budgets are much smaller.
The gaming landscape is shifting dramatically, however. Players like Microsoft and Sony are gobbling up big studios. Microsoft is making a financial play with Xbox Game Pass despite not meeting targets in their earnings calls.
Microsoft recently purchased Bethesda Software, amping up their Game Pass library. They also have deals pending approval to purchase Activision as well. That Activision deal has stalled temporarily as Sony claims the Microsoft Activision acquisition would be anti-competitive, citing Call of Duty as a reason why.
Microsoft has readily stated that it would not make Call of Duty, or other Activision games, Game Pass exclusives. Tech journalists, such as Paul Thurrott, have supported Microsoft, stating that it doesn’t make financial sense to make Activision games Game Pass exclusives, too.
Square’s most recent financial report seems to offer in-direct evidence supporting Microsoft’s claims.
In the coming years, we’re more likely to see big-budget games not be platform exclusive, excluding Nintendo. Nintendo’s business model depends on its exclusive IP rights. They are the anomaly here.
Game Studios Face Rough Futures
Square is also blaming the internet for its drop in revenue. Square’s CEO specifically called out how easy it is today to access information for games. There’s a lot of grey area here, however.
I didn’t find specific claims as to why access to information was a detriment for Square in its report. There are two possible theories I can think of off the top of my head:
• Game reviews hurt sales. While gamers have always had access to game reviews via classic publications like Game Informer, social communication has ramped up significantly over the past decade. This goes beyond social media like Twitter or Twitch but enters platforms where fandom can truly geek out at the most intricate levels, like Reddit. Such discussions could impact sales by convincing people not to buy games or wait for discounts.
• Gamers don’t spend as much time in games as they used to because of online guides and discussions. Games with social aspects, like Minecraft or Fortnite, do well with engagement, while most gamers may play through non-social games like the Final Fantasy 7 Remake once. It’s too easy to watch a playthrough on Twitch or find a guide to walk players through games. Otherwise, these single-player games aren’t creating the mindshare they once did. They are more akin to disposable media, like a B-rated movie.
The last interesting tidbit is how Square called out AI, the cloud, and the blockchain as future revenue drivers. We could write pages of content just for that statement alone, but here’s a dirty version of how I see it.
Is Cloud Gaming The Future?
Cloud gaming is a thing, and it’s only growing. Companies are still working out the gritty details of what a cloud gaming future will look like, and they have a lot of work to do. However, cloud gaming opens the doors of possibilities that console and PC gaming don’t. There’s a lot of innovation waiting in the cloud.
Square may be focusing on the cloud to broaden its user base. It’s far more cost-effective for potential new customers to enter the cloud gaming ecosystem compared to expensive consoles or PCs. Phil Spencer recently stated that cloud gaming is not an if/or thing, either, only supporting this position. Cloud gaming is part of the future and will live alongside high-powered local gaming machines.
No, It’s Not About Crypto…
(image credit: Investopedia.com)
What’s more worrying is Square’s focus on the blockchain. They’ve already created a blockchain division. Other game studios have started experimenting with block-chain based purchases like DLCs, skins, and loot boxes, too.
In its simplest form, blockchain technology is nothing more than a distributed ledger. If you passed out copies of your checkbook to friends and family, and their copies of it automatically updated each time you pay a bill, that’s blockchain technology in the crudest example. Blockchain tech is often confused with cryptocurrency, but in reality, the blockchain and crypto are two different things.
Where does this fit into gaming? That’s hard to determine. Blockchain technology could enable a second-hand market for DLCs and in-game add-ons like skins and weapons. Except companies like Square could benefit from second-hand sales for digital in-game content. That’s one growth vertical.
Another possibility is gambling. One of the few places that blockchain tech makes a lot of sense is in the online adult gaming world. Square can enter similar markets almost overnight.
Blockchain faces an uphill battle in the game industry, however. As we’ve already witnessed for Bitcoin and Ethereum, blockchain ledgers can grow to the point of absurdity. Transactions on the Bitcoin and Ethereum ledgers can take days to complete. Both ledgers are huge, too. If you thought the digital download for Call of Duty is large, try looking at the BTC ledger…
Gamers are already fighting against things like NFTs and loot boxes in games. The EU market is regulating such activities, with other countries soon to follow.
So, where does blockchain fit into the gaming ecosystem that digital platforms like Steam or Game Pass don’t already cover? I’m not sure myself, but if you have any good arguments or examples, please leave them in the comments for me.
SkyNet…
Finally, there’s the AI portion of Square’s message. AI paints an exciting picture for me. We’ve seen huge boons in machine learning thanks to companies like Google, AWS, and Open AI. Stable Diffusion is an excellent example of where we are heading. Likewise, Whisper may have destroyed the transcription industry overnight.
Game developers have been using neural networks in games for years. Machine learning is a great way to create more realistic NPCs and bots. What if AI could interface with games in other ways, however?
Years back, an AR game was released where players needed to dig through loads of ‘found footage’ to piece together puzzles and solve the story. Imagine if a game like that was AI-driven and individual experiences could be tailored to different gamers on the fly. What would that look like?
Not long ago, I investigated making a ‘choose your own adventure’ style text-based chat game using AI to respond to player input. This type of game is easily doable today.
We’ve barely scratched the surface of how the game industry can leverage machine learning to bring us new experiences. It’s an excellent time for Square to capitalize on ML and introduce innovative new IPs. I’m sure companies like Microsoft are already experimenting in this area, too.
What can we expect in the future?
Unless Square can turn itself around, Square Enix may become the new HTC of the gaming world in the next five years. Time will tell, but Square Enix has some smart people working there, so I’m cheering for them. That doesn’t negate that Square is traversing a similar path to HTC’s in the smartphone world.
The biggest question is whether those sweetheart deals Square is contractually obligated to fulfill will do more harm than good before Square can pivot.
Square’s financial report shouldn’t be taken lightly. I can assure you that other AAA game studios are looking at their financial report and anticipating what their futures may look like. Square is a big name in the game industry. Other studios are going to look to them for guidance. At the very least, we’ll likely see fewer exclusivity deals going forward.
The bigger question is how blockchain tech, AI, and the cloud will fit into the gaming industry’s strategy.
Small Fish In A Big Pond
Square Enix is by no means an innovator in any of those departments. Many game studios and tech companies started investigating how AI, blockchain tech, and the cloud fit into the gaming industry years ago. Square’s 2022 financial report seems more like an admission than a revelation.
But because Square Enix is a large, legacy game business, game studios will understandably use Square’s statements as an affirmation to continue down those roads. Organizations like Microsoft and Epic are already better positioned to capitalize on those technologies.
Microsoft is making tons of strides in the AI market and is luring gaming studios to Azure with lucrative deals. Of course, Azure services are only one revenue vertical for Microsoft. Microsoft competes directly in the gaming industry through its Xbox brand, and its business model is so diverse that Microsoft can continue to purchase game studios (Eg. Bethesda and Activision) to strengthen Xbox Game Pass (driving more revenue growth via subscriptions in the same vein as Office 365 in the enterprise world).
On the other hand, Epic offers one of the most popular game engines on the market. It’s so popular that even Microsoft is thinking about transitioning to it. Unreal Engine 5 has tons of new features that make creating extremely engaging in-game worlds easy to create. Likewise, Epic uses the Unreal Engine for their in-house games, too. Epic has a good reason to keep innovating with Unreal Engine.
Too Good To Be Turring Approved
Advances in AI have come a long way. Dall-e2 amazed the world with how easily it can create images from text prompts. Its thunder was quickly stolen by Stable Diffusion – a competing free and open-source product like Dall-e2. Shortly after Stable Diffusion was released, OpenAI introduced Whisper – an AI-powered transcription library that’s arguably far better than what Google, Microsoft, and AWS offer.
There’s a lot of money in the gaming market. Given how fast AI has progressed, it won’t be long before companies like Open AI and Stability AI create machine learning models explicitly used for video games. You can bet your bottom dollar that Epic will almost immediately integrate AI into the Unreal Engine in a way that makes it as easy to use machine learning in games as it did with geometry-based mesh shaders and ray-traced lighting.
The gaming industry has never been better positioned to integrate machine learning models into video games. The GeForce Lovelace architecture and the upcoming AMD RDNA3 GPUs can easily chew through machine learning algorithms. Likewise, modern SoCs like Google’s Tensor chips and Apple’s M1 and M2 processors also have built-in machine learning cores. AI could potentially come to mobile games as well. Pathfinding algorithms in game engines are about to become extremely robust.
It’s Moist Up There
Regarding cloud gaming, Microsoft is already there, and Google will be licensing out Stadia tech soon. I wouldn’t be surprised if Google wrapped Stadia’s technologies into a GCP product within the next year, opening cloud gaming to even the smallest indie studios. AWS is hot on the heels of both companies as well. Amazon is a silent player in the game industry that is far too often underestimated. Like Microsoft, AWS is already competitive in cloud gaming, hosting, and AI.
It should be noted that cloud companies like Microsoft, AWS, and Google have been investigating blockchain products for some time. It’s telling that none of the big-name players have done much with the blockchain, though. If major cloud providers haven’t been able to leverage blockchain as a popular and reputable commodity product, I’m not sure how Square Enix can compete in that space.
Join The Red Tab Club
If the gaming industry is the modern-day equivalent of the gold rush, Square Enix has positioned itself to be the lonely miner scraping for gold. At the same time, organizations like Microsoft and Epic are the new Levi. Whether you interpret Square’s financial report as a revelation or an admission to upcoming industry changes, the writing is on the wall.
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