The economist Joseph Schumpeter used the term “creative destruction” to describe how innovation creates new markets while bringing ruin to old ones. In San Francisco earlier this year, we got a glimpse of how this concept might play out in the games industry.

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OnLive, a service that promises to deliver the most sophisticated games to consumers without requiring consoles or high-end PCs, trumpeted its Schumpeterian challenge to Sony, Microsoft and other hardware manufacturers at GDC. The idea is that OnLive will transform the tubes of the internet into controller and video connections. Games will run on OnLive servers, and the internet will carry players’ commands in and real-time video out – streaming games, in other words. Though OnLive’s debut prompted skepticism, it’s success could effectively render most current gaming hardware obsolete.

Not long at all after OnLive’s appearance at GDC, two other businesses stepped forward to offer their own solutions for streaming games: Gaikai and Otoy. Their near simultaneous debut alongside OnLive could signal a historic wave about to hit the games industry. If streaming becomes the dominant model for game distribution, then we’ll see disc-based gaming overturned at its crest, at the very moment when it threatens to submerge all other entertainment media. To get a sense of what this change could mean, The Escapist spoke with David Perry of Gaikai, Jules Urbach of Otoy and David Helgason, CEO of Unity, a software company that specializes in development tools for making streaming games.

The streaming revolution will effect big changes on three principal groups: game makers, hardware manufacturers and players. We’ll take each group in turn.

Developer’s New World

OnLive makes its service clear. You pay them a fee and either download their plug-in or hook up their “MicroConsole” to your TV. Then, you go online, browse their game catalog, choose a game and play it.

Gaikai and Otoy haven’t said quite how their models will work, but they’ll amount to something similar. “I’m trying to make the videogame industry’s games more convenient than Flash,” says Perry. “That’s all.”

Streaming technology seems to help developers by eliminating both the console middle-man and PC system requirements, which dramatically shrink their potential customer base. But it also poses challenges: It could place more computing power in the hands of developers than they know how to leverage, and it could enable a tempting but tricky new business model.

First, power. Jules Urbach is the CEO of both Otoy and LightStage, the company behind a new video capture technology that produces ultra-realistic computer graphics. Urbach thinks moving games from consoles to servers will result in never-before-seen levels of graphical realism.

He argues the hardware arms-race we see among gaming platforms today will always result in a compromise between quality and price. A console manufacturer must always develop an affordable platform to gain the largest possible installation base. “Can it ever compete with what you’re going to get on the highest-end device? Probably not,” says Urbach. “And even if it does, there’s something beyond that.” The Cloud.

“The Cloud” basically means “a hell of a lot of interconnected servers.” Streaming services don’t just place Cloud Power in the hands of end-users, but in developers’ hands, too. “You could potentially scale the quality of the games as high as you want on the server side, and that’s something no developer has ever had,” says Urbach.

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It may also be something no developer wants to have, given the kind of effort it will require to take advantage of that power. And it’s not clear what kind of visuals customers really want.

Aligning developers’ and players’ demands will take some doing. OnLive advertises traditional console games on its site, but if streaming obviates development for consoles, why would games remain the same? It’s likely that developers will turn to business models already in place to determine how they should approach making games for this new service.

No Free Lunch

This where the free-to-play model comes in. Free-to-play games draw numbers that dwarf those of top-selling disc-based games. KartRider, a free, Korean racing game, is more popular than World of Warcraft by millions. Operator Nexon makes money by charging players for upgrades to their karts. Taking advantage of staggeringly huge audiences requires certain niceties of development and pricing, however. “Whenever you deal with free-to-play, you obviously have to be very careful with the math,” says Perry.

No game is truly free. Somebody pays for bandwidth, to say nothing of development and maintenance costs. Fortunately, free-to-play enables a type of economic jujitsu. “Scaling up your audience dramatically, that’s step one,” Perry says. “Step two is coming up with a model where there’s no limit on what they can pay you.”

Eliminating an entry fee – the price of the game – makes it possible to charge customers infinitely. A price of $60 per disc guarantees a fixed revenue; no less, but also no more. Perry calls this the “moneywall” – it keeps players away from the game and establishes a limit on revenues.

Free-to-play lets players spend as much as they want on a game. While some players spend only a few bucks, others spend thousands. In order to satisfy that kind of demand, developers have to maintain special production schedules. “You launch the game with enough content to keep the people happy for now, and you iterate every six weeks,” says Perry. “If you talk to a really good social company, all the good ones are down to about a week.”

“The most impressive ones,” he says, “the state-of-the-art ones, are down to once a day.”

Game developers will have strong incentives to apply the free-to-play model to the new streaming services. At Unity, Helgason has seen some surprising successes. Unity’s development tools underlie streaming games, such as Cmune’s Play Paradise Paintball and downloadable games such as ZombievilleUSA for the iPhone. “Some of our customers are making a lot of money, and they’re just kids,” says Helgason, “And it’s nice to know their return on investment is hugely higher than most of the stuff that comes out of EA.”

The current streaming model still presents a number of points where players run into walls: registration, downloading, installation and patching. Each of these factors discourages potential players. Plus, free-to-play games usually look terrible. Streaming services mean to solve all of these problems at once. Since all of the installation and updating takes place server-side, you’d never have to install another game. The last few impediments to streaming games would disappear, and content would attain the level of the highest quality disc-based games.

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“We’re still waiting for that one great game, but when it comes, you’re going to see all videogame investments swing to free-to-play,” says Perry.

Streaming services will present game-makers with challenges of plenitude. Console makers have to face challenges of scarcity.

Bye, Consoles

“It’s going to be very hard to convince players they have to keep buying a completely new console and that all of the games that they currently have are about to become redundant,” says Perry. Consoles are paragons of planned obsolescence. Do they deserve to be destroyed?

Think of all those guys down at the disc factory or all of the good folks who scrape off whatever it is that burns up in your 360 after a Red Ring of Death. The crashing of the console industry would have huge consequences – nothing on the order of the collapse of General Motors, but a similar shockwave will blast through the supply chain. You may never again hear a GameStop employee tell you that you should have pre-ordered a game released last week.

Let’s set aside our tears for consoles and focus on the big boys for the moment. Perry and Urbach think Sony and Microsoft may hang around. “I think the console manufacturers all have to stream at some point,” says Perry. “I think it’s a certainty.” What remains uncertain is how long they’ll resist this change and what form they’ll take when they give in.

OnLive’s MicroConsole provides a good example of where the Big Three may be headed. “There still is a piece of hardware at the end rendering this stuff that’s streaming from the server,” says Urbach. “You might see a PlayStation 4 that’s super cheap and is just a great way of streaming content.” The hardware could even take a form invisible to the average consumer. “You may see it reduced to a chip that goes into every possible device out there,” he says. “It’s what’s happened with music, and it’s happening with video and television. And you’re going to see it happen with games.”

“Just because CDs went away doesn’t mean that there’s no music players sold,” he says.

Manufacturers can take small comfort in the thought that they can still produce some manner of object for sale. But players are looking at a future of zero media, in which streaming dissolves their games into the ether.

Zero Media

Players have two fears to consider with streaming services: that their games will have no permanence, and that they will never be rid of them. “The concept of cloud gaming is that the game is out there somewhere,” says Perry, “Everything is out there in space.” While charming, this expression is also disturbing. Couldn’t you easily lose your game in the Cloud? And how do you sell back or buy a used wisp of Cloud?

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For Perry, consumers have already begun to answer these questions. He points to videos on YouTube, photos on Flickr and music on iTunes. “We’re becoming more trusting of the net,” he says. “I don’t think we really have to educate anyone into that.”

He thinks we’ve made peace with both the absence of material goods and the loss of their re-sale value. “How many of your mp3s have you sold off?” asks Perry. The fine-grained nature of digital purchases – you buy just the songs you want, not necessarily a whole analog record – offsets the loss of a secondary market.

On the other hand, Urbach points out that we can unload old digital goods. “You’ve got people putting their entire World of Warcraft accounts up on eBay,” he says. “There’s nothing saying you can’t put your entire server-side game collection up.”

But the fear is that there will be Terms of Service that will say exactly that, putting an end once and forever to the used game trade. “I think if you try to stop that, if you build that into the technology,” says Urbach, “all you’re doing is leaving yourself open for more flexible technology to knock you down.”

He also assuages the fear that the toppling of a particular streaming service will deny us access to our games. “While it’s nice to have that box and to own a disc, that doesn’t necessarily guarantee compatibility for the rest of your life,” says Urbach. “With server-side rendering, basically, anything that we put up on that system will work forever.”

Streams from a Cloud

There’s reason for skepticism about these services, but they have an air of inevitability. It seems clear that streaming will happen and that it has a very good chance of becoming the dominant distribution model for games. Arguably, it already is – it’s just that the games aren’t as immediately impressive as their disc-bound counterparts.

Should OnLive, Gaikai and Otoy succeed, offering lag-free play and high-quality games, then we’ll see the biggest shift in the videogame business since home consoles overtook arcades. For all that this represents a revolution in technology, Perry, Urbach and Helgason remain humble about their role.

“I would love to sort of brag that we’re changing the world,” says Helgason, “but the world is really changing anyhow.”

That’s the core message in all of their discussions: Yes, developers, manufacturers and players will change the way that they approach gaming, but only by shifting toward what other developers, other players and other manufacturers are already doing. For all its creativity and all its destruction, the movement toward streaming games is merely a part of a larger tectonic shift away from fixed media and into the digital ether.

Ray Huling is a freelance journalist living in Boston.

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