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A Middle Class Struggle

This article on the challenges that mid-sized, publicly owned companies like THQ face was originally featured in Game Informer issue 228. 

“Think about what we have coming in front of us. Homefront. The next Red Faction. The Warhammer 40K MMO. Saints Row 3. People can say what they want, but we’ve got a pipeline that I think [EA, Activision, and Take-Two Interactive] would be envious of…”

THQ CEO Brian Farrell was pretty confident when he spoke those words to IGN in early 2010. Unfortunately, only one of those games – Saints Row: The Third (above) – was a success, and two years later the title is arguably one of the only positives the company ­can ­claim.

Coming into this year, THQ had high hopes for a number of its initiatives. Homefront was looking to compete in the already crowded FPS market, the uDraw tablet was seen as a way to target its kids’ audience in a way that was different from the traditional movie-based licenses the company was even then trying to get away from, and both Red Faction: Armageddon and MX vs. ATV Reflex were being counted on to provide a solid backbone as previously successful franchises. Unfortunately, none of these brought the results the company was looking for. Although the company did have stalwart performers in its WWE and UFC games, with so many other projects underperforming, the company’s third quarter losses was three times what they were in 2010. This was underscored most notably by the uDraw failure, which accounted for $100 million in lost revenue.

In the ugly aftermath of such a disappointing year, the company dropped its uDraw tablet line entirely, implemented organizational changes that will result in the loss of 240 people across the company at large, and faces ­possible ­delisting from the NASDAQ because its stock has traded for under $1 for 30 days. Is THQ’s situation just a product of its own doing, or does it speak to a larger issue in game publishing and development that makes it hard for mid-sized companies like THQ to thrive?

Stuck In The Middle

THQ certainly deserves the bulk of the blame for its collapse, but there is a backdrop to the company’s mess that highlights larger systemic problems for mid-sized publishers who are struggling to keep up with bigger competitors like Electronic Arts and Activision-Blizzard.

THQ is a publicly traded company on the NASDAQ, and as such, the pressure to give shareholders a good stock price can affect the company. Billy Pidgeon, senior analyst at M2 Research, says that bigger companies like EA tend to under-promise and over-deliver to their shareholders, while mid-sized companies like THQ tend to do the opposite because shareholders expect it to grow and become the next EA. Being publically traded can also put too much emphasis on the relative short term, which is at odds with the two- to three-year development cycle for triple-A games and the five- to seven-year one for consoles.

“There are risks, also, to being a mega-publisher,” Pidgeon admits, “but it is a tough place to be a mid-range publisher because the pressure and the focus is to move up and become a larger publisher and even a mega-publisher if possible. For a mid-sized studio, it’s very risky. Backing specific ­platforms and filling specific category holes can cost you big time. You really have to manage your portfolio and assets very carefully and not overreach.” Pidgeon points out that downsizing can be impossible as well because of the painful cuts in personnel and assets that are ­often ­necessary.

Despite the shedding of organizational jobs (as opposed to the development talent at the studios), THQ has signaled that it still intends to move up rather than move down. The company declined to be interviewed for this article, but CEO Brian Farrell has publically stated that THQ expects to compete in the core gamer market with original IP such as Homefront (now in the hands of Crytek), titles from the newly created THQ Montreal studio headed by Patrice Désilets (Prince of Persia, Assassin’s Creed), the Insane collaboration with director Guillermo del Toro, the Saints Row franchise, and more.

Core gamers certainly hope that THQ can execute this strategy, but unfortunately having a slate of potentially attractive games is only one piece of the puzzle. Colin Sebastian, senior research analyst at Baird Research, argues that hunting for a few hits is a losing proposition in this day and age.

“I think scale is very important in this industry,” he says. “You [have to] have something that distinguishes you, your games, your platform, and you have a cost structure that matches that like Epic or Valve. As opposed to the old, traditional portfolio approach to publishing where you have this overhead of sales, marketing, distribution, and developers, and are going to put out 10 games and hope that two or three of those are good enough to pay for everything else. That’s an outmoded business model in video games.” Larger companies may be able to mask their problems through the sheer size of their gaming libraries, but there is little margin for error in most ­companies’ ­catalogs.

Sebastian says that the shrinking video game market adds extra pressure to the search for hits. “The whole console market is consolidating to a small number of really large franchises,” he says. “It makes it tough for second-tier publishers that have only small- and mid-sized console titles, and that’s where THQ finds itself.”

Looking at the NPD sales numbers for 2011, it’s hard to argue that there may be fewer consumer dollars to go around as this console generation winds down. Software sales in 2011 were down three percent from the previous year, ­hardware sales for the year decreased, and sales figures for the industry overall in January 2012 signified the 28th month of decline since March 2009, according to industry ­website ­Gamasutra.

Then you must consider the age-old specter of rising development costs and the fact that you have to spend money to make money. “The break-even point for a large-scale console game has gone up,” Sebastian says. “It used to be you could make money selling four- or five-hundred thousand copies of a PS2 game, and now you have to sell at least a million units of an Xbox 360 game to break even.” This raises the question of whether titles like Darksiders II or Tomonobu Itagaki’s Devil’s Third – two relatively unknown titles to mainstream gamers that would demand aggressive marketing budgets to raise awareness – even have a shot at achieving ­mainstream ­success.

Meanwhile, Pidgeon notes that this is one area where THQ in particular could exhaust itself trying to chase its own tail. Investment fuels growth, but growth has to occur to raise the capital for investment. Pidgeon says that if THQ’s employee layoffs ever reach the studio level and developer talent has to be cut, this could affect the games that are supposed to make the company profit. Investment back in the company isn’t always easy, but it’s necessary. “THQ has to do two things to survive now: Increase revenues and increase profits, and that can be hard to do,” he says. “You have to invest to become profitable, and then you have to build and maintain that for a while, and then you can start to bring in the high profit margins, but it does require some investment.”

Continue for analysis on THQ's possible future.

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