Video games: rising costs a major challenge and AI may not be the answer, JPMorgan says

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The cost of developing the top-quality video games, known as AAA games, has surged tenfold over the past decade and a half but pricing and returns for the games industry has not kept up, JP Morgan has warned.

Increasing costs and lower returns for companies are a trend that the investment bank argues is structural rather than a mere byproduct of the pandemic.

In a detailed analysis, JP Morgan highlighted the significant challenges faced by the video game industry, particularly in Europe region, since the onset of Covid.

“Capex has doubled on average since 2019, while revenues generally lag far behind,” JPMorgan said in a note to clients.

Free cash flow has consistently underperformed analyst forecasts for each stock in their coverage every year since 2020, an underperformance that is only partly attributed to “feature inflation” – ie increasing complexity and scale of features in AAA games – as well as wage inflation, which together have absorbed over half of the incremental capital expenditure.

Pricing has been a tough nut to crack for the industry, with the analysts noting that “poor pricing power means costs can’t be passed on” and the standard AAA price has risen 17% since 2007 from $60 to $70. 

This situation is compounded by the fact that consumer expectations are set by so-called ‘AAAA’ titles from US peers, leading to even more severe ‘feature inflation’ where larger budgets are required to compete at the same price point.

JPMorgan also comments on the wage inflation and competition for talent, exacerbated during COVID as remote work infrastructure enabled US studios to hire abroad more easily, with development expenditure spent per developer is 30% higher on average than in 2019.

Looking ahead, the analysts are cautious, with the possible impact of artificial intelligence (AI) on the sector still unclear.

“A recovery in top-line demand could eventually help – but Avatar’s sales show this is yet to come.

“Ongoing restructuring may reduce costs, but doing so without damaging the pipeline will be difficult.”

The analysts said they have seen evidence AI is being rolled out and could benefit costs “but specifics remain scarce, as are the legal implications”, with AI being a key bone of contention and worry in Hollywood strikes last year.  

 

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Leah Sirama
Leah Sirama
Leah Sirama, a lifelong enthusiast of Artificial Intelligence, has been exploring technology and the digital realm since childhood. Known for his creative thinking, he's dedicated to improving AI experiences for all, making him a respected figure in the field. His passion, curiosity, and creativity drive advancements in the AI world.