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In this week’s article, we will be discussing Microsoft’s game streaming strategy and the reason behind its US$ 7.5 billion Bethesda acquisition.

Microsoft has been on a tear in recent years. It has pivoted from focusing on the declining Windows and PC-centric ecosystem and has recovered from completely missing the shift to mobile. It did so by being a cloud company first, under the guidance of Satya Nadella. For more background on this transition, read here.

The upcoming game streaming war

Last week, Microsoft announced that it’s buying one of the most successful game publishers in the world, ZeniMax, which owns Bethesda (publisher of The Elder Scrolls, Doom, Fallout and many others) for US$ 7.5 billion in cash. This is the largest gaming acquisition in Microsoft history (note: even after the acquisition, the company is still very cash rich. It has about US $136.5 billion in cash and a trailing 12-month cash flow of US $45.2 billion).

The size of the acquisition emphasized the strategic importance of this move and of gaming for Microsoft’s business. 

Gaming is big business

The gaming industry is projected to generate US $159 billion in 2020, increasing to US $200 billion in 2023. See Figure 1 for the breakdown of consumer spend vs. platform.

Figure 1: Consumer gaming spend by platform. US $77.2 billion is mobile, US $36.9 billion is PC, and US $45.2 billion is console. Data is from here

Some of the top earning games are the free-to-play online games: for example, in 2018, Fortnite raked in US $2.4 billion (that’s almost the same as Avengers Endgame’s box-office haul). Still, the crown of highest grossing games is held by Grand Theft Auto (GTA), which have sold more than 150 million units (translating to more than US $7 billion in revenue from games sold) and continues to print cash through GTA Online’s microtransactions.  

So far, the trend seems to indicate that this growth is only just beginning. On average, the global consumer plays about 6 hours of games per week. Younger consumers have a higher preference to play games than watch TV/movies (Figure 2 below).  

Figure 2: Consumers younger than 45 years old prefer to play video games than watch/stream TV and movies

This means, from the perspective of how a consumer spends his/her time and share of the wallet, gaming is in direct competition with traditional media (Movies and TV).

As Reed Hastings (CEO of Netflix) once said“We compete with (and lose to) Fortnite more than HBO”.

So, if we take the perspective of gaming as a substitute for media (TV/Movies), then you can see that the natural evolution of gaming is to become a streaming-first global product (just as TV and movies have become). And in order for this to happen, a strong robust cloud infrastructure is needed. 

Cloud Gaming is a new market for cloud computing providers

TV/Movie streaming services have made the leap to the cloud. To deliver its global services, Netflix leverages Amazon’s web services. Meanwhile, for its streaming service, Disney leverages Microsoft’s Azure solutions.

In contrast, gaming has largely been run locally on the device (whether it’s mobile phones, PC or console). The migration to the cloud has not happened yet, due to a combination of various technical challenges. 

For the cloud sector, gaming is still largely an untapped use case. But this is beginning to change; all of the large cloud providers have announced their subscription gaming initiatives:

  • Google launched Stadia
  • Amazon announced Luna+
  • Compared to these other two, Microsoft’s gaming efforts are more mature. Microsoft has more than 15 million subscribers of the Xbox Game Pass (which comes in various tiers ranging from US $10 to US $15 per month).

The Xbox announcement

Before the Bethesda acquisition announcement, both Sony and Xbox announced the pricing of their next generation consoles. The announcements highlight the different strategies that the two companies are undertaking.

Sony is placing its hardware as a gaming console first – a similar strategy that won the company the previous generation console war, where PS4 outsold the Xbox 2 to 1. In contrast, Microsoft announced multi-tiered pricing, where you can purchase the console upfront or pay monthly and bundle with the Game Pass subscription:

  • Series S Xbox will cost upfront US $299 or bundle with the highest tier Game Pass for US $25 per month, which translates to a discount of US $59.
  • Series X Xbox will cost upfront US $499 or bundle with the highest tier Game Pass for US$35 per month, which translates to a discount of US $19.

From the pricing above, you can see that Microsoft is incentivizing users to subscribe to its premium gaming service, and part of this premium gaming service is cloud gaming (called xCloud) that allows you to play anywhere on any device

What does the Bethesda acquisition mean? 

Increase recurring revenue

Well, it is likely that Micfrosoft will continue to sell Bethesda’s games to other console makers/platforms. This means, gamers can still have the option to pay US $60-70 per game on other platforms. While, for Microsoft’s game subscribers, gamers just pay the monthly subscription fee, which makes the monthly fee more appealing.

Increase cloud usage

But the bigger goal for Microsoft is likely how cloud gaming can drive adoption of its cloud infrastructure. Afterall, the cloud business generated more than US $13.4 billion in the last quarter and is the fastest growing business for the company (about 4X larger than the gaming business). 

Microsoft’s endgame is to have all the different game publishers build their own gaming subscription service – powered by Azure (see Figure 3 below).

Figure 3: Microsoft’s Azure powered cloud gaming powering various game subscription services

This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.

Our team members at Vested may own investments in some of the aforementioned companies. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. Note that past performance is not indicative of future returns. Investing in the stock market carries risk; the value of your investment can go up, or down, returning less than your original investment. Tax laws are subject to change and may vary depending on your circumstances.

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