Sleeping Dogs, Tomb Raider and Hitman Absolution may have earned critical acclaim, but that’s all they earned for Square Enix.

Square Enix’s Yosuke Matsuda has some strong words for disc-based HD games sales, in the 2013 Report to Shareholders. He knows that Sleeping Dogs, Tomb Raider and Hitman Absolution were all good games; the critics said as much when they released, but from a financial perspective none of them hit sales targets or made anything like the return Square Enix hoped for. Matsuda believes this isn’t just a temporary blip but evidence of an industry-wide problem with the HD games business model. Overheads are just too high with disc-based sales, and increased competition has meant that the big publishers are spending too much cash over too little a share of the marketplace.

The problem isn’t just competition, it’s the whole disc-based cycle. A publisher will spend years, and millions, developing a title with no prospect of a return until launch – a process that only gets longer as gaming options and devices get more sophisticated – and at the end of it all, it has to deal with a retail network that’s becoming more selective about the games it takes on board. Shelf space is at a premium in a crowded marketplace. Aggressive marketing, buy-back and rebate policies, as well as price protection guarantees, all help get those boxes on the shelves, but they also cut deep into the margins made on each box. None of this is news to Matsuda; when the fiscal results for 2013 were published there were very clear indications that operating income losses – a 99% drop over the previous year – had eaten up any hope of a Digital Entertainment profit. There’s a reason why publishers set seemingly unrealistic sales targets, and this is it: in a marketplace where unreasonable costs are incurred, unreasonable targets are the only hope of making cash back.

Matsuda has some thoughts on how to solve the problem. Free to Play has deeply impressed him. “The F2P model is flexible in that earnings are adjustable according to players’ demand without any restriction on distribution of game products,” says he; a F2P model means Square doesn’t have to wait for disc sales to make cash. However the much bigger shift, as he sees it, is that there are so many more ways of enjoying games. You don’t have to play on disc any more; HD games are available via all kinds of other media, including the cloud and microconsoles. Why rely on a disc-based business model, if the customers can get the same game without the box?

If Square Enix is to survive, it needs a new skill set. “The environment supporting high-end games is definitely expanding,” Matsuda concludes, “and this fact convinces me of the advent of a new age when we can fully demonstrate all the game development capabilities we have accumulated to date.”

Source: Square Enix 2013 Report

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