Why VR and AR Games Won't Be Profitable Soon

The excitement over virtual reality (VR) and augmented reality (AR) games has been reaching high hype levels lately, but if you're expecting to make a profit you'll need to have patience and deep pockets. There are several reasons for this, and some strategic ways around the problem. First, though, why is there so much excitement about VR and AR?

Much of the enthusiasm is infectiously transmitted through those who have experienced it directly and have a following. When John Carmack gets so excited by something he leaves his company and goes to work for a startup, that means something to a lot of people. As demos spread for Oculus and other platforms, and videos began to be distributed, we saw more well-known people in the industry get excited. Science fiction thrills that were imagined long ago are on the verge of becoming available... at least in a crude form.

Where there's enthusiasm among leaders, money follows. We are now seeing billions of dollars being invested in startups like Oculus and Magic Leap, and companies like Sony, Microsoft, and HTC/Valve are investing heavily. Dozens if not hundreds of developers are working on VR and AR titles. Some of the hardware will be arriving soon -- Samsung's $99 Gear VR, created in connection with Oculus, is slated to ship before the end of the year. (It's basically a holder for the latest Samsung smartphones, but is said to work quite well.)

So there's plenty of money being spent, lots of developers working on titles, and hardware that's going to arrive soon. Shouldn't profits follow quickly? No, and there and some good reasons why.

First, the hardware's going to be relatively expensive at first... and it's hard to say how long it will be before the cost drops. The Oculus Rift is, according to founder Palmer Luckey, going to be more than $350 -- not counting the fact that you'll need a very powerful PC to drive it. (The short version is if you didn't buy your PC at the high end of the power scale in the last couple of years, you'll need to spend about a thousand dollars on new PC hardware.) Sony's PlayStation VR will likely be in the $400 to $500 range from hints they've dropped, not counting the PlayStation 4 you'll need to have. Microsoft HoloLens... we have no idea, but the development kits are going for $3,000 each. HTC/Valve's Vive is probably going to be well over $500, not counting the beefy PC you'll need to drive it. Magic Leap's hardware is a complete unknown, but don't expect all that investment ($542 million so far, with a rumored $1 billion round being readied) to go into a low-priced consumer item.

Price is critical for mass market sales numbers, unless the value proposition is so obvious people are happy to spend high prices. Apple can sell 50 million new smartphones in a quarter at prices north of $500, but that's because people already know all the uses they have for the device, and they feel that's worth it. For VR and AR gear, we still don't really know what complete applications will be like -- and what they'll be charging for them. The value proposition is unknown, which means the initial sales will be to deep-pocketed enthusiasts. There are perhaps a few million of those, but that's not enough to generate massive profits for software.

Which brings us to the virtual elephant dancing on your palm -- software. There's plenty of great demos being shown, but hardly any complete experiences. No killer app has emerged, though Minecraft has some potential given its power on other platforms. How long until we see a killer app? Unknown. It could be months... or years... or maybe never. These are difficult things to create -- every designer I've spoken to working on VR and AR tells me the same thing: "You have to rethink every aspect of the design." And then you have to create some things, and try them out, and until they're in the market where people can buy them, we don't really know if ten people or ten million will love them.

The business model (or models) for VR software is also unknown. Should we expect a ten-minute experience for $10? For $50? Nothing I've seen so far looks free-to-play with virtual goods on VR, and I wouldn't expect that model right away. Experiences may have to be brief because of motion sickness concerns, at least the more intense experiences -- and the more intense experiences are what you're likely to pay more for. This all makes trying to predict how much money you can make from your VR game, and when you can make it, a complete fantasy not anchored by any facts. This must make things fun for venture capitalists trying to evaluate investment in VR developers.

One investment banker I talked to said he doesn't expect profits from VR for three to five years. That sounds about right to me. Why, then, is money rushing in now? Because many of these people feel that AR and VR has the potential to be the next big market -- perhaps exceeding the mobile mrket in size. Placing your bets now, and going through the learning curve early, will position you better for success when the field becomes profitable.

So what's a small developer to do? Find a sugar daddy -- an investor with deep pockets and plenty of patience. A major publisher who's looking to make a mark in VR, or a venture capitalists with a long view, or perhaps one of the makers of VR hardware that wants to have software to take advantage of the hardware. If you don't have one of these connections, the best way to get there is to do something dazzling with one of the VR development kits already available. Find something interesting that's not already being done, or solve a problem that's been identified, Whatever you do, be different.

One final thought: Gaming may not even turn out to be the biggest market segment for VR and AR devices. Certainly vertical markets will have more money to spend on expensive hardware early on. Yet much of what game developers come up can be used in non-gaming applications as well, perhaps to great effect. Keep your mind open to other possibilities for VR and AR, and make sure you've got plenty of funding lined up. You're going to need it.

Activision Gets Very Serious About eSports

While you can't necessarily trust press releases about how serious a company is about something, you can always gauge seriousness by the amount of money a company spends. By that yardstick, Activision Blizzard is getting very serious indeed about eSports, with two executive hires that have to have pretty good price tags attached -- plus the company has set up an entire new division devoted to eSports. If you were wondering how important Activision Blizzard considers eSports to be, the answer is -- pretty damn important.

The leader of the company's new eSports division is someone with a solid-gold sports media resume: Former CEO of ESPN and the NFL Network Steve Bornstein will serve as the division's Chairman. "Bornstein is largely responsible for the ESPN that we know today, having overseen the launch of some of the network's key franchises, including SportsCenter, ESPN the Magazine, the X Games and the annual ESPY Awards," noted Mashable's article on the announcement. "He later served as president of ABC, then president and CEO of NFL Network, which he helped to launch."

Adding to that experience will be the division's new senior vice president, Mike Sepso, who most recently was a co-founder and president of Major League Gaming. He's been involved in eSports since the beginning, pretty much.

Another thing worthy of note is that Activision Blizzard has tripled the prize pool for Call of Duty's eSports series, the Call of Duty World League, to $3 million. The company is also hiring a number of positions for its eSports division, and no wonder -- Heroes of the Storm is heating up, Hearthstone is a major hit, and Overwatch will be coming soon. Yes, StarCraft II is fading, but there's plenty of eSports action for the company to look forward to.

Like every other publisher, Activision Blizzard is seeing the enormous growth in eSports and the vast dedication of eSports fans -- and the major amounts of money they can spend on free-to-play games that happen to be eSports.

It does make you wonder when Electronic Arts is going to have an entry into eSports. Their MOBA attempt, Dawngate, was cancelled after it just didn't seem to catch fire among early beta testers. The MOBA space is awfully damn crowded, now, though, so finding a way in won't be easy.

Activision Blizzard's used its IP very successfully with Hearthstone and Heroes of the Storm both drawing on the beloved characters for the past twenty years or so. Sure, they're good games, too, but they got off to a much faster start because fans know and love the characters already. Overwatch will be interesting to keep an eye on because the IP is entirely new -- how fast will fans get into this new universe?

Now the question becomes just what the new eSports division intends to to do. Support their eSports with more structure (like leagues), build out true professional sports league structures with farm teams and such? Start paying professionals a salary like Riot does? Invest heavily in video production, as Riot has been doing? How exactly will Activision Blizzard capitalize on eSports enthusiasm to boost revenues and profits, and what sort of capital will they need to spend to accomplish that?

All interesting questions, and we're going to have to watch as answers emerge. 

What to Expect from Nintendo's NX

A new report in the Wall Street Journal  provides some information about Nintendo's upcoming NX console, citing "people familiar with the development plans." Nintedo is apparently starting to distribute developer kits, a sure sign that the actual release of a console is not all that far away -- possibly as early as summer 2016. In a perhaps not-coincidental move, Nintendo has opened up applications for a new Nintendo Developer program, which is aiming to streamline the process of making games for Nintendo platforms.

According to the WSJ report, the NX will combine both a mobile platform and a home console -- you'll be able to detach a portable unit and play away from home. Supposedly, according to those unnamed people, Nintendo will be putting "industry-leading" chips in the NX console, a distinct change from the power of the Wii U and the 3DS, both far behind the latest generation of consoles and (for that matter) mobile devices.

This news has, as you might expect, caused excitement among Nintendo fans. It certainly makes sense for Nintendo to aim for a new console in 2016, as there's really no hope for the Wii U at this point to start selling in large numbers. The only thing that might even cause that would be a major price drop, at which point Nintendo would be selling it at a loss. And without a large library of software to sell for it, and minimal third-party support, it doesn't seem likely that Nintendo would make enough from software sales to cover the losses on a reduced-price Wii U.

The NX may also replace the 3DS line, which is also underperforming -- again, with no real prospect of a significant boost in sales, as mobile phones become better game-playing devices every day. All that's missing on mobile phones is Nintendo IP -- which we'll be getting later this year, courtesy of Nintendo's partnership with DeNA. In the face of that, expecting people to buy 3DS units would not be wise.

But is the NX, as a dual home/portable console with "industry-leading" chips really a good prospect for Nintendo? I think there are some major hurdles for Nintendo to overcome here, as their strategic maneuvering room is getting smaller on all sides.

Look back in the early days of consoles, and you'll see relatively low-cost devices that were optimized for graphics and sound, producing much better quality graphics, animation and sound than most personal computers could. These consoles were also very easy to operate -- you just plugged in a cartridge and turned on the power, and in moments you could start playing. This was the era that saw Nintendo dominate the game industry, with the lion's share of the game revenues in 1990 going to Nintendo, or to publishers making Nintendo games.

Zooming ahead to today, the picture is very different. The two leading consoles (the PS4 and Xbox One) are essentially PCs with about mid-range graphics these days. Playing a new game is no longer "easy"; you have to install it, and probably some patches, a process that can take hours in some cases. Also, now being online is crucial to successful games, both because of multiplayer modes and because it means you can share your playing with an ever-growing audience of people who enjoy watching games being played. PC games are generating amazing amounts of revenue, particularly free-to-play games like League of Legends. And mobile games are now raking in more revenue than console games, reaching an enormous and diverse audience that spans the globe.

Where does Nintendo fit into this? There are a few major problems for Nintendo in this world. First, Nintendo has traditionally been very poor at anything having to do with online connectivity or social media. Perhaps the partnership with DeNA will help, but the company is more than a decade behind Sony and Microsoft when it comes to offering online services. Can they catch up with the NX? Somewhat, perhaps, but getting to parity with the competition would be a miracle.

Second is third-party support. At this point, Nintendo has lost all of the major third-party publishers (EA, Activision, Ubisoft, TakeTwo) -- and even their mainstay Japanese publishers like Sega and Konami and Capcom are dialing way back on any kind of console development. Will a new Nintendo console get back some of these lost publishers? It's going to be very difficult. They all have great places to investment development resources, and working with a new platform (with perhaps a major learning curve) is expensive in resource that can be profitably applied elsewhere. Nintendo will have to be incredibly persuasive, or spend heavily from its cash supply, to convince them otherwise. It will be hard to convince third parties that a new Nintendo console will be a huge success, after the debacle of the Wii U (the worst-selling console in Nintendo's history by far).

Finally, there's the issue of power. Nintendo has kept away from trying to match the power levels of recent Sony and Microsoft consoles, preferring to focus on gameplay and interesting (and inexpensive) hardware features that offer the possibility of different gameplay. This succeeded brilliantly with the Wii; its lack of power allowed it to be much less expensive than its rivals, and the motion control wand was easy to understand and use, leading to a much broader audience. The Wii U added a lot of cost with the gamepad, but without adding much horsepower -- enough to generate HD graphics, but it was basically equivalent to an Xbox 360 or a PS3 in graphics punch. Yet it wasn't much cheaper than a PS4 or an Xbox One, which both have far superior graphics.

These days good quality graphics chips, powerful CPUs and high-quality screens are all around us. But you can't create your own chips and expect to be price-performance competitive with mobile chips that are being produced in the hundreds of millions. Or PC chips that are produced in the tens of millions to hundreds of millions. Nintendo can certainly have industry-leading graphics if it wants to -- but then the hardware is going to be expensive, at least as costly as the PS4/Xbox One or more so, if Nintendo wants to at least break even on the hardware (and they like to make at least a small profit on the hardware). Or, Nintendo can choose to be less expensive than the console competition -- but then the hardware will once again be less powerful. Add in to this the rumored fact that the NX will have a portable component, which means (at a minimum) a device with a screen that will add substantially to the cost -- or it will be a noticeably poorer screen than what you already have on your mobile phone.

Nintendo will have to choose whether to be a console industry leader in graphics, which means it will be the highest-price console, or to come in equal to or less than other consoles, which means it won't have the room to be much better than them in the graphics department. This also comes at a time when more and more people are playing games on phones and tablets and PCs, with a vast array of very compelling free-to-play titles to choose from. And don't forget the Apple TV, which at $149 offers a very powerful, easy-to-use gaming device that will have all the marketing muscle of iOS and Apple behind it.

What will Nintendo do with the NX? It will be very interesting to see what choices the company makes, but it's not easy to see a winning strategy in the current marketplace.