Playing for Keeps – Part 3: Outlook for the UK

MATURITY
Although its leading studios still rank well on the world stage, the UK has without doubt lost ground to emerging markets in recent years. Games made in Canada’s studios generated more revenues than the UK’s in 2006, with Canadian games taking an estimated 13.2 per cent of western games retail revenues, compared to the UK’s 12.4 per cent.

In terms of development expenditure, the UK is much further ahead, due to dollar-sterling exchange rates, the higher cost of development resource and the larger number of development staff in many more development companies in UK studios. So, despite spending 75 per cent more on production, UK games grossed less than Canadian games world-wide in 2006. Canada’s studio sales lead is not yet large, and the two territories will jockey for third position for several years yet. However, more fundamental issues threaten increased instability.

INNOVATION
The UK has historically generated strong IP, some of which (SingStar, Goldeneye, RollerCoaster Tycoon, Elite and Grand Theft Auto) have created or defined genres. The UK industry’s strongest period of originating groundbreaking new IP came when game production budgets could be self-financed from a developer’s own cash resources, when the break-even points for the developer were within reach and publishers were less aggressive about owning new IP. In general, these conditions no longer exist.

Although still a premier location for innovative game development, much of the investment in successful new IP is being made by global publishers based partly in the UK, and the pace of original IP deriving from UK-owned companies appears to be slowing.

SLOWING PACE OF IP CREATION
This lack of ground-breaking new IP is not due to a deficit in creativity. It has more to do with structural and cyclical drivers around how games production is financed, such as dramatic hikes in console development costs driving up break-even points for publishers (even higher for developers), risk-aversion amongst publishers as they invest in titles and technology for new consoles, the inability of independent developers to access external finance, and commercial models delivering little if any royalty flow to independents.

Few UK studios can afford to self-fund a new IP on a current generation console, which forces studios to target lower cost platforms with lower potential returns, to undertake shorter term work-for-hire projects to maintain their understanding of new console platforms and invest heavily and continuously in updating their games production technology. GIC identifies this as the IP poverty trap, one characterised by limited access to finance, either private or public.

ACCESS TO FINANCE
The private sector provides little succour to companies seeking funds for IP production. Finance companies got burned by games companies during the dotcom boom years and many remain sceptical about games and in particular traditional games development, which is perceived as high risk and low reward.

The current boom in online games and community investment has largely bypassed the UK due to an almost complete dearth of UK-based online games or community companies. Most of the available funding comes from trade sources, deriving from direct publisher to independent developer deals or subsequent to acquisitions of independent developers. The UK has been a primary target for acquisitions by global publishers looking for experience and IP. Such acquisitions are an entirely natural part of the ecosystem of the industry, inherently creating short-term value for UK entrepreneurs and often precipitating substantial injections of capital by the parent company to finance their new acquisition’s expansion. Historically, IP creation has derived from both publisher and independent studios, but the balance is becoming skewed.

Increasingly, major games development territories such as Canada, France and, surprisingly, the US are characterised by federal or regional governmental support, in the form of tax breaks, IP funds and investment incentives tailored specifically to games companies’ needs. Here the UK falls far behind its competitors, with low games-specific funding which cannot address the fundamental problem of poor access to finance. What support is available (such as R&D tax credits) is appreciated by the industry but, returning around 5 per cent of a games’ development expenditure, has limited impact on development expenditure, especially compared to games tax breaks of 20 per cent to nearly 40 per cent in competitor territories. Regional European-funded activities by various games clusters and RDAs vary widely. Some provide IP funds but the availability and scale of such funds does not always correspond to the location or needs of games companies.

GROWTH POTENTIAL
After a fall between 2000 and 2004, development expenditure has been growing as have the numbers of staff in the industry. Numbers of independent developers have not recovered substantially, but the extinction event was Darwinian in outcome, leaving better-run, more financially stable and effective developers better able to service their publisher partners and theoretically better positioned to develop new IP. At this juncture in the current cycle, publisher studios are growing fast and the independent sector is buoyant. Recruitment needs are still undersupplied, in part due to concerns about the quality of games graduates, resulting in only 30 per cent of games graduates finding work. The fight for talent is fierce and leaves many small developers struggling to expand.

COMPETITIVE OUTLOOK
The landscape has changed over the last five years to an uneven and globalised playing field in which UK companies compete at a distinct disadvantage. With poor access to finance, the UK is the highest cost market for development in the west, and its games industry currently appears to have little prospect of games-specific tax or investment incentive support from central government. Government will be engaging with industry during two seminars on October 24th to discuss how the UK games industry can continue to effectively compete globally.

Despite global pressure and concerted campaigns to tempt UK studios to relocate to subsidised markets like Québéc, the UK games development market is not under imminent threat of collapse. It is currently buoyant and growing, driven by publishers growing their studio headcount substantially and seeking experienced, technically proficient 3rd party studios to satisfy the demand created by the apex of the current cycle expected over the next one to two years.

The UK will remain the largest and highest-skilled games talent pool in Europe, and its studios will continue to be targets for acquisition by global publishers keen to acquire ready-formed, innovative and technically expert teams. However, as development costs grow and development experience in lower cost markets rises to meet that of more mature markets, international companies will find it harder to justify locating or growing in the UK.

The medium term threat to UK development is stasis or possibly mild contraction in the face of strong competition from developing markets, Canada in particular. The longer-term threat is more serious, triggered by the IP poverty trap. Despite the advent of new distribution channels like casual games download services on consoles, poor access to finance, outdated commercial models and rising production costs are creating a bottleneck for new IP that will continue to struggle to get to market. This risks damaging the UK’s one unique selling proposition which can counteract the cost argument – its creativity.