Over the past decade the videogame industry has grown into a global colossus worth more than $25…

Battling Piracy in the Videogame Industry

Over the past decade, the videogame industry has grown into a global colossus worth more than $25 billion a year in revenues. For the three biggest players in the industry, Sony with its PlayStation, Microsoft with Xbox, and Nintendo, this potentially represents a huge growth engine, but the engine is threatened by a rise in piracy, which cost the videogame industry an estimated $4 billion in 2005. The piracy problem is particularly serious in East Asia (except for Japan), where videogame consoles are routinely “chipped”—sold with modified chips, called mod chips, that override the console’s security system, allowing it to play illegally copied games and CDs. Importers or resellers, who charge a small markup for making the modification, illegally install the mod chips. In some areas, such as Hong Kong, it is almost impossible to find a console that hasn’t been modified. Because they allow users to play illegally copied games, consoles with mod chips offer a gaping gateway for software pirates, and they directly threaten the profitability of console and game makers. The big three in the industry all follow a razor and blades business model, where the console (razor) is sold at a loss, and profit is made on the sale of the game (razor blades). In the case of Microsoft’s Xbox, estimates suggest the company loses as much as $200 on each Xbox it sells. To make profits, Microsoft collects royalties on the sale of games developed under license, in addition to producing and selling some games itself. Games typically retail for about $50, and Microsoft must sell six to twelve games to each Xbox user to recoup the $200 loss on the initial sale and start making a profit. If those users are purchasing pirated games and playing them on “chipped” Xbox consoles, Microsoft collects nothing in royalties and may never reach the breakeven point. Sony and Nintendo face similar problems. In East Asia, some 70% of game software sold in the region may be pirated thanks to the popularity of “chipped” consoles and the low price of pirated games, which may sell for one-third the price of the legal game. Historically, all the big videogame companies tried to deal with the piracy problem in East Asia by ignoring the market. Sony launched its PlayStation II in East Asia two years after its Japanese launch, and Microsoft delayed its East Asian launch for a year after it launched elsewhere in the world. But this tactic is increasingly questionable in a region where there may soon be more gamers than in the United States. Industry estimates suggest that Asian gamers spent more on videogame software in 2005 than U.S. gamers did, much of it on lowpriced pirated games. Another tactic that both Sony and Microsoft are now using is to regularly alter the hardware specifications of its consoles, rendering the existing mod chips useless. But the companies have found this is just a temporary solution: within a few weeks, mod chips made to override the new specifications are available on the market. A third tactic is to push local authorities to legally enforce existing intellectual property rights law that in theory outlaws the mod chip practice. For example, Microsoft, Sony, and Nintendo joined forces to sue the Hong Kong company, Lik Sang, which sells mod chips through its website and is one of the world’s largest distributors of the chips. Some observers question the value of this tactic, however; they argue that if Lik Sang is shut down, many others in Hong Kong may be willing to take its place. What is needed, they argue, is concerted government action to stop the pirates, and so far East Asian governments have not been quick to act. A final way of dealing with piracy is to change the business model. All three main players in the industry are now starting to push online games, where customers pay a subscription fee to play online, as opposed to a onetime fee to purchase a game. This business model makes piracy much less of an issue and it may drive growth forward in places like China, where piracy is endemic. Indeed, current estimates suggest that there are already 29 million gamers in China, most of whom play pirated games, and that this figure will increase to 55 million by 2009. If a good percentage switch to online gaming, the revenues could be significant.

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