For a sense of how fast the video games industry is changing, look no further than Supercell, the three-year-old Finnish development studio that was this week valued at $3bn.
Like its peers King and Rovio, makers of Candy Crush Saga and Angry Birds respectively, Supercell is at the forefront of a new breed of games developers that have grown at an astonishing pace by producing “freemium” games for mobiles and tablets.
Titles such as Supercell’s Clash of Clans, which attracts 10m users every day on Apple’s iPhone and iPad, can be downloaded and played for free – money is made by charging for extra in-game features.
These games are also attracting increasing attention from investors, thanks to the potential for huge profit margins. Supercell, which has about 100 employees, brought in $106m of operating profit and $179m of revenues in the first quarter.
The question, however, is whether these profits are sustainable. So far, most of the app sensations created since the iPhone launched in 2007 have been one-hit wonders – even if, like Angry Birds, their developers have managed to sustain that hit through sequels and branding partnerships such as Star Wars.
“Audiences for these types of games have proven to be extremely promiscuous,” says Ed Barton, video games expert at Strategy Analytics. “But perhaps Supercell has bottled lightning.”
The games industry is haunted by the memory of what happened to Zynga, whose market capitalisation has fallen by almost three-quarters from a peak of more than $10bn after it floated in 2012 to a valuation below Supercell’s.
Zynga, once the most successful game developer on Facebook, was hit hard when the social network changed the way apps were allowed to use the service. Making matters worse, Zynga has also struggled to replicate the success it found with “social gaming” on mobile devices.
By contrast, King, the London-based developer that is preparing for a multibillion-dollar initial public offering in the US, has managed to make that move from social to mobile. Mobile gaming is the hottest part of the market, thanks to rapidly growing consumer adoption of smartphones and tablets. But even here, fierce competition from thousands of games developers means longevity is a challenge.
“Nobody has really been able to build a sustainable games business” on mobile, says Supercell’s chief executive, Ilkka Paananen. “That happens to be our core mission. We really want to build a company that is built to last for decades.”
Where Zynga and others have gone wrong is focusing on short-term returns that please investors at the end of the quarter, he says. “There’s been too much pressure on the financial side by squeezing too much out of your users and shady marketing techniques. We don’t want to have any pressures like that.”
By selling a majority 51 per cent stake to SoftBank for $1.5bn, Supercell hopes to avoid that fate, leaving to King the tricky task of sweet-talking Wall Street investors. Shares in SoftBank rose more than 2 per cent in Japan on Wednesday morning, after the deal was announced, while GungHo, another games company in which it has invested, leapt 20 per cent as investors became excited about the potential of the partnership.
The performance of Japan’s online games makers has varied amid concerns over sustainable profit growth. DeNA saw pre-tax profits rise by almost a third on revenue up almost 40 per cent for the year to March, while Nexon, a pioneer of the freemium business model, reported a sales increase of nearly a quarter year on year but a slight dip in net income in 2012. Gree saw net profit fall 53 per cent in the year to June.
“We are extremely profitable as a company but the extreme irony is you get to this by prioritising engagement and retention” of players, not profits, Mr Paananen says. Supercell’s returns are all the more astonishing given it has just two games available – until last week – and only for iPhones and iPads. Part of the logic for going two-player with SoftBank is its expertise in Asia, where mobile devices running Google’s Android are much more popular than Apple handsets.
Given the difficulty of producing new hit games, Mr Paananen says he is focused on increasing the value of the company’s existing franchises, Clash of Clans and Hay Day, for mobile devices.
Mr Paananen says his goal is to create games “that people will play not for weeks, for months but actually for years”.
“We believe you can’t be the number one company on any platform without being able to focus on that platform,” he says. “Very deep in our DNA is to do as few things as you can, then do it as well as you can . . . We believe that mobile will be the dominant platform of gaming for the foreseeable future.”
Supercell says it wants to be like Nintendo: a games company that has for 30 years put lovable characters and fun gameplay ahead of cinematic graphics and such like.
By contrast, local rival Rovio says it wants to create the “Looney Tunes of the mobile generation” with an Angry Birds movie in the pipeline. Rovio’s follow-up to Angry Birds, Amazing Alex, failed to generate enough sales to live up to its name, but the Finnish company has managed to build a big business from licensing its colourful birds and pigs to companies such as Hasbro for use on toys.
Winning a power-up from SoftBank will help Supercell prevent marauding clans from disrupting its business in the same way it did to its rivals, according to one early investor.
“The global nature of the deal will create a competitive advantage out of global scale,” says Kristian Segerstrale, a former Electronic Arts executive and partner at Initial Capital. Production values and rising marketing costs will push up the budgets required to create a hit game, he adds, making it harder for new entrants.
However, many people in the industry warn that mobile game development is still a sector in great flux.
Even the way that these games make money is being questioned. In the UK last month, a regulatory investigation into free video games found numerous cases of “unfair commercial practices” in the way that some developers charge money for virtual goods.
“We’re still in a period of instability and there’s a lot of consolidation yet to come,” says Steve Bailey, games analyst at IHS. “You have so much attention and resources being poured into the assumption of success on mobile that there’s a lot of companies that have to stumble and fall.”
Additional reporting by Jennifer Thompson in Tokyo
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