So you think you are going to write the next Doom and get rich? You've got this killer idea for an awesome game that millions of people cant wait to play?

Well I cant say anything about your idea but in terms of finances, getting rich is, ahh, shall we say unlikely. The video game business is profitable but the odds are stacked against the little guy with a big idea.

AAA-game development involves several types of companies. Most people dream about being a game developer, ie making a game, but the real power lies with the publishers and the retailers.

Publishers put up the money to make games. They take the financial risk and they reap the reward. Retailers are the way customers get games and they expect to be compensated handsomely for shelf-space.

So before you quit your day job, lets take a look at some numbers.

the power of bad assumptions

People who want to make games generally love games not finance. Consequently, a lot of them assume a straight-line return model. If I sell 1M, games I get $60 x 1M... In other word, they assume that they get the money when a game sells.

With that assumption, this is what their returns would be - fabulous wealth!!

Revenue split

Sadly, the fabulous wealth conclusion is forgetting about the other people in line. The first thing to consider is the revenue split. If a game sells for $60, who gets that money?

As you can see from the revenue split table, the answer is retailers and publishers. Console makers get a $5 pop from EVERY game sold for their system but a developer gets less than 10% of each game sold. And it gets more complicated.

OK, you say. You are happy to share the wealth but why so much?

Well, retailers get paid because you cannot sell any games without them. They own the customer.

Publishers get paid for two reasons. First, they put up the money. Second, developers dont own a suit or have the faintest idea how to get a contract with a retailer; publishers can do both.

OK, you say. You are happy to share (all) the wealth but how many games do you have to sell to get rich? That depends on the contract.

the magic of pre-paid royalties

As I mentioned, publishers are the glue that keeps the game business moving along. Publishers invest the money to make games. Developers are basically contractors who are paid to make a game. Developers sign a contract with a publisher whereby they get money to make the game (ie salary) and agree to pay that money back from their royalties.

For instance, if the game costs $5M to make, the publisher gives the devs $5M. They spend it to make the game and agree on a royalty rate, such as 20%. For every game that sells, 20% of the publishers split (not the sale price) goes to the dev. Once that amount is MORE than the $5M the publisher loaned the dev in the first place, the dev gets a royalty.

This process is called a "pre-paid royalty" model. If the game doesn't sell, the devs got paid to the do work and move on to a new game. If the game sells a ton, everyone gets rich, right?

developers - better keep the 1984 Honda

Let's look at the developer's view in two scenarios. In scenario 1, the game cost $5M and scenario 2, $10M. In both cases, the game cost exactly what the publisher advanced, the publisher gets 40% of the $60 retail price and the developer royalty rate is 20%.

This chart shows the developer's profits (ie royalties) given various number of units sold. Compare this with the first chart on gross revenue.

It turns out that the game has to sell over 1M units before the developers get anything for the $5M game. If this is a $10M game, they have to sell over 2M units! At 20% of 40% of $60, it takes a lot of units to pay off that initial "advance."

How many games sell over 1M units? Wikipedia knows the answer is not many. This is why very few developers ever get rich. Most games never pay a developer any more than the salary they got to make the game.

For a real contrast, lets look at the publishers returns for the same two games.

publishers - what color Lexus did you want?

Using the same simplistic model but adding $1M of additional marketing/advertising costs to the $5M game and $2M to the $10M game, we get a very different payout model.

Publishers lose money until they sell 250,000 copies of the $5M game or 500,000 copies of the $10M game. Like the developers, the more a game costs the harder it is to pay it back. But unlike the devs, the returns are sweet indeed!

By the time developers see a dime in royalties, say 1.25M units, the publisher has pulled in $23M in profit! That's a 380% return on investment.

Granted, this model is simplistic but the point is clear: the real money in game development is found with the publishers. This matches the business school principle that the rewards go to the party who risks capital, but it doesn't match the dreams many of us harbor about being rewarded for creativity and hard work.

Online publishing

Armed with this financial knowledge, think about online distribution or publishing. By removing the retailer and their monopoly on shelf-space, online distribution completely changes the revenue models we have discussed. Suddenly the 40% retailer cut is up for grabs. Either the publisher gets more or you can lower the price. The important thing is that the revenue split is fundamentally different which is what makes it so exciting.