Phil Spencer is right: AAA games are in big trouble

All is not well in AAA games.

In the past, those outside of the industry assumed this to be true based on dipping sales, poor working conditions, and a cratering of creativity — as publishers like EA, Activision, and Ubisoft have stopped taking risks, and have spent more time and money on their diminishing pools of hit franchises.

But today, thanks to this week’s Xbox leak, we can see how the turmoil appears from the inside. Tucked away in industry business conversations, the head of a major console platform has explained the challenges ahead — and what led to this debacle.

While sifting through the most interesting bits of the leak, Kotaku senior reporter Ethan Gach spotted an email from the head of Xbox, Phil Spencer. In just 650 words, Spencer summarizes how the shift to digital storefronts caught major game publishers flat-footed — and says that those publishers have continued to fail to adapt.

In an industry known for its secrecy, Spencer has been comparably open about how the sausage is made. By C-suite standards, of course. But even still, this note is refreshingly clear, vulnerable, and insightful. As other game journalists have noted, it’s rare to get such a helpful look behind the curtain.

Here’s an excerpt of the email in question from within the Xbox leaks:

In terms of subscriptions and the impact on larger publishers I realized that I haven’t really done a good job sharing our view on the disruption AAA publishers potentially see and how their role in the industry will likely change with the growth in subscription platforms like Xbox Game Pass. .

We should start with the question of why game publishers exist in the first place. And like many other forms of media the idea of a game publisher was created from an access “moat”; like movie studios locking up theater distribution, album companies locking up radio play, game publisher’s scale in physical retail game sales allowed them to secure retail shelf space, in-store promotion and margin structure beyond what any individual studio could dictate when games were primary sold in retail stores. If you were a studio, you needed a AAA publisher to reach a customer at an Egghead software.

This constriction in the access from creator to consumer stayed in place for years and in that time AAA game publishers increased their control. The creation of digital storefronts like Steam, Xbox Store and PlayStation Store eventually democratization access for creators breaking physical retail’s lock on game distribution. AAA publishers were slow to react to this disruption. The AAA publishers did not find a way to leverage the moat that physical retail created in the digital realm in a way that had them continue their dominance of the game marketplace. They have not found a way to effectively cross promote, they have not found a way to build publisher brands that drive consumer affinity (the way Disney has in video), they did note create a social platform that would allow them reach beyond their aggregate IP MAU. Without a lock on physical distribution the role of the AAA publisher has changed and become less important in today’s gaming industry.

Over the past 5-7 years, the AAA publishers have tried to use production scale as their new moat. Very few companies can afford to spend the $200M an Activision or Take 2 spend to put a title like Call of Duty or Red Dead Redemption on the shelf. These AAA publishers have, mostly, used this production scale to keep their top franchises in the top selling games each year. The issue these publishers have run into is these same production scale/cost approach hurts their ability to create new IP. The hurdle rate on new IP at these high production levels have led to risk aversion by big publishers on new IP. You’ve seen a rise of AAA publishers using rented IP to try to offset the risk (Star Wars with EA, Spiderman with Sony, Avatar with Ubisoft etc). This same dynamic has obviously played out in Hollywood as well with Netflix creating more new IP than any of the movie studios.

Specifically, the AAA game publishers, starting from a position of strength driven from physical retail have failed to create any real platform effect for themselves. They effectively continue to build their scale through aggregated per game P&Ls hoping to maximize each new release of their existing IP.

In the new world where a AAA publisher don’t have real distribution leverage with consumers, they don’t have production efficiencies and their new IP hit rate is not disproportionately higher than the industry average we see that the top franchises today were mostly not created by AAA game publishers. Games like Fortnite, Roblox, Minecraft, Candy Crush, Clash Royale, DOTA2 etc. where all created by independent studios with full access to distribution. Overall this, imo, is a good thing for the industry but does put AAA publishers, in a precarious spot moving forward. AAA publishers are milking their top franchises but struggling to refill their portfolio of hit franchises, most AAA publishers are riding the success of franchises created 10+ years ago.

For the mega-publishers, the prognosis is grim — which explains why Activision would want to make room for itself under Xbox’s umbrella. But there’s a silver lining around the thunderclouds. In Spencer’s own words, most of the great and beloved games of this era have been “created by independent studios with full access to distribution.”

It’s worth noting that Spencer’s email is from March 2020. A lot has changed since then. (Undoubtedly, Xbox leadership now wishes it had partnered with one independent studio in particular.) But what’s chilling about the message is how timely it feels in 2023. Spencer saw the storm coming; now it’s here.