Gamemakers Get Down with Downloading

Online access to new games is becoming a key strategy.
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Digital distribution is looking more like the next big thing for video-game makers.

Nintendo

(NTDOY)

has added at least eight more games for the Wii Virtual Consoles, its online-game download service, in a move thatsignals the growing importance of digital distribution for the gaming industry.

The new Wii titles include games like

Duck Hunt

,

Pilot Wings

,

Kirby's Adventure

, and

Punch Out

.

Other gaming-console makers, like

Sony

(SNE) - Get Report

and

Microsoft

(MSFT) - Get Report

have also latched on to the trend. Sony has said that it will haveabout 40 titles available for download for its upcoming PS3 platform,while Microsoft has always emphasized the importance of the onlinecommunity to its Xbox strategy.

For video-game companies, the trend translates into greater margins,lowered marketing costs, and less reliance on an expensive retaildistribution model with traditional consoles.

"This affects game companies twofold," says John McPeake, ananalyst with Prudential Equity Group. "It changes how much revenuethey can get from each game and the additional profit from sellingvalue-adds like characters or weapons."

Already, game publishers like

Activision

(ATVI) - Get Report

are seeing therewards. In its latest second quarter, Activision said it more than doubled revenue from commercially viable downloadable game content. Activision CEO Bobby Kotick has called it a "long-term growth driver."

Including both PC and console games, the worldwide online-gamemarket is expected to grow from $3.4 billion in 2005 to more than $13billion in 2011, according to DFC Intelligence, a research firmfocused on the video-game industry. That market forecasts both digitaldistribution, advertising and online sales of value-added items togamers.

Digital distribution of games for consoles in particular is being driven by the rise in the number of households that have broadband,higher PC penetration and more connected console systems. Andincreasingly, North America will challenge current market leader Asiaas the leading region for online games, says David Cole, an analystwith DFC Intelligence.

The upcoming console systems from Nintendo and Sony have a major focuson online connectivity. Microsoft started the big push with its XboxLive online-game service and is now central to its Xbox strategy.

On Tuesday, Microsoft said it will extend its Xbox 360 online-distribution channel to offer video downloads.

For console makers, an online-distribution channel offers thepossibility of much higher margins. "There's no cut to the retailerand no big marketing spend apart from what companies are already doingto promote their games," says Brendan McCabe, an analyst with CIBC World Markets.

An online-distribution channel also offers gaming companies theopportunity to make incremental sales like new characters or moreweapons in case of action games to draw in users after their initialpurchase.

Still, a change toward a full-on digital distribution model is years away, says McCabe. "A lot of factors have to go into this so I don't think this is a case of, wow,overnight margins are going to go through the roof," he said. "But inabout five years or so we are likely to see this shift."

Most consoles now don't have the capacity to support digitally downloading "heavyweight titles." The Xbox 360's hard drive, for instance, holds just 20gigabytes of data, while an average game can run into 10 to 11 gigabytes.Gamers typically have a collection of titles. Meanwhile, newer titlesare also much heavier, and a single game can be up to 60 gigabytes.

"It

traditional game purchases is still going to be a dominant retail model for a long time," says Cole. "Online distribution can work better for older games that are smaller in size."

DFC Intelligence expects multi-player online games like

VivendiUniversal

's

World of Warcraft

to do better when it comes toonline distribution compared to other game genres like sports, racingand action.