Electronics Arts Case Study
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The video game industry was in a constant state of change because of the rapid growth characterizing the gaming technology. As a result, companies which were in a position to develop games that were compatible with the latest gaming platform stood to gain a greater share of the market than their competitors. In this respect the three major companies which controlled the industry were Sony with its play-station platforms, Nintendo with its Wii platforms and Microsoft with its Xbox platforms. These three companies controlled the industry because game developers like Electronic Arts had to develop games which were compatible with these platforms. Otherwise the products would not sell in the market because the hardware market was divided between these three players. As a result, video game developers like Electronic Arts had to sign contracts with one of these gaming console manufacturers before they could start to develop games.
Two trends that particularly characterized the industry were the increasing tendency on the part of the consumers to play games on the Internet and the rising costs of developing video games. These two trends drove the business and the economic characteristics of the industry in the sense that the demand and supply situation involved in the industry was considerably affected by how the developers marketed their products and by how they formulated the strategies to minimize costs of production. Electronic Arts for example was developing games based on ideas that were generated in-house rather than on licensing rights the purchasing cost of which severely impaired the profit level. However Electronic Arts, one of the major players in the industry, was experiencing static revenues because the changing business and economic characteristics of the industry driven by the online phenomenon and by rising production costs were making it a difficult task for the company to develop competitive products. As a result, rapid technological growth, migration to online gaming and rising production costs were the three defining characteristics of the industry.
Of the five competitive forces, the bargaining power of suppliers is the strongest and the threat of the new entrants is the weakest. The threat of new entrants is weakest because given the prevailing structure of the industry, developing and publishing games required access to massive resources. For example, some of the recent games had Hollywood celebrities recording their voices for characters in the games. Companies contemplating entering the industry would also need to have special equipment and manpower in order to develop video footage to be included in the games. Additionally, most of the games never went beyond the conceptualization phase. As a result, companies had to invest millions in order to develop and publish games for the gaming consoles, PCs and the mobile devices. For this reason, the industry was currently going through a consolidation phase which enabled companies to pool their resources in order to develop competitive products. As a result, new entrants with limited resources would be operating at a disadvantage.
The suppliers in the industry were the three gaming console manufacturers: Nintendo, Sony and Microsoft. They had all the bargaining power in the industry because unless game developers like Electronic Arts developed games based on gaming console manufacturers’ specifications, there was no point in making the investment in game development. Nintendo, Sony and Microsoft were writing the rules of the game in the industry by setting a blinding pace of technological growth in the form of releasing upgraded versions of the gaming consoles periodically. Game developers had to have the resources to keep pace with this growth because if they released games that did not utilize the full potential of the latest technology in the gaming consoles, they had no chance against the intense level of competition that characterized the industry. Therefore the bargaining power of suppliers who were the three major gaming consoles manufacturers in this case was the most important source of influence in determining the profit potential of new entrants.
The most powerful driver of change in the industry was the rapid progress of technology as determined by Nintendo, Sony and Microsoft. New generations of gaming consoles had rapidly advancing technological features which current games had to fully utilize in order to generate appeal in the market. Immense technological sophistication was an enabling factor in this case in terms of allowing game developers to incorporate a wider range of content in their products. As a result, the industry was rapidly growing in terms of the range of games available. This was being driven by the advanced graphics manipulation capabilities of the latest generation of gaming consoles. However the growing richness of content characterizing currently released games was not the only factor that was driving industrial change. Probably a stronger contributor to industrial growth was the trend on the part of the gaming consoles to evolve to a state in which they could be used for a wider range of purposes other than game play. For example, the latest generation of gaming consoles had hard drives into which gamers could download games from the internet. As a result gaming devices were becoming multipurpose devices and this evolution of the gaming console was attracting new segments of the market.
An important aspect of industrial growth was the changing nature of the distribution structure. Traditionally, game developers were paying for shelf-space in retailer stores in order to sell their products. However, the recent explosion of broadband connectivity worldwide had allowed customers to download games from the Internet. As a result, it was no longer a profitable distribution strategy to pay for physical distribution. Not just internet connectivity had brought about this change in the industry. Wireless mobile devices had also given extra pace to the development of online distribution. As a result of these changes, the level of competition in the industry was changing in terms of competitors focusing their resources on products that were more targeted towards online compatibility.
EA was implementing the differentiation strategy in its efforts to build and maintain a competitive edge. This strategy was being implemented at EA not just in terms of developing mission-rich products but also in terms of publishing and distributing the products. For example, digital distribution was one of the most important directions in which the video game industry was moving. As a result, the management at EA had diversified into a distribution structure by means of which the games would be available for downloading online. In other words, the company was differentiating its distribution strategy. The company was also going for the full market coverage strategy in terms of making the products compatible with all the major technological platforms available. For example, it was releasing games that were compatible with the cellular phone technology.
Even though EA was mainly implementing the differentiation strategy, it was also practicing the cost minimization strategy in some aspects of its operations. For example, when it came to the question of choosing which games to develop, the company preferred to rely on ideas that were developed in-house. This was opposed to developing games based on ideas which required the purchasing of expensive licensing rights. One of the most important industry dynamics was the fast rising costs of developing games. This was exacerbated by the fact that when it came to developing games based on Hollywood movies and popular sports like the NFL, superstar endorsements gave the games the extra appeal which generated market demand. However the price of these endorsements was rising fast and one of the strategies that EA was following was to develop the games based entirely on resources available in-house so that reliance on capital-intensive outside resources could be scaled down. Therefore, EA was implementing a combination strategy according to which it practiced differentiation in distribution and cost minimization in product development. It was also implementing the full market coverage strategy internationally.
The combination strategy that EA was implementing was not leading to expected resulted as according to the financial data provided, revenue of the company had topped out. Whether in terms of geographic region or in terms of business segments, the revenue that the company was generating had leveled off. One of the strategies that EA was implementing was the cost minimization strategy. This was in the form of focusing game development in areas which avoided purchasing of licensing rights. However according to the income statement provided, the cost of developing products was either still rising or had remained the same over the last five years beginning with 2007. In fact, according to exhibit 6 in the case, the operating expenses of the company were growing. According to the financial performance data given in the exhibit, the company was experiencing rising costs in each of the different areas under operating expenses. The most damaging aspect of the operating costs comes from the research and development costs. As provided in the exhibit, it had skyrocketed in 2007 relative to what the costs had been in preceding years.
EA was migrating to the digital distribution structure in terms of distribution strategies. This should have reined in marketing and sales expenses. However as we can see from the exhibit, the costs in these areas were rising as well. Therefore, the strategy in this respect was not working as expected in terms of boosting the company’s financial performance by means of controlling costs. The distribution issue is one of the defining characteristics of the industry inasmuch as it determined competitive advantages enjoyed by game developers to a considerable extent. However in order to take advantage of lucrative shelf space in retailer stores, the game developers had to commit themselves to a considerable level of resource investments in order to engineer the best exposure for their products. However this mode of marketing video games was becoming outmoded as a result of the development of the digital distribution structure which eliminated the need for the considerable resources investments. EA had adopted this strategy to no justifiable results according to the rising marketing and sales expenses in exhibit 6.
The fact that EA’s combination strategy was not working in terms of boosting financial performance is best highlighted when gross profit and operating profit are compared. The level of gross profit had gone up in 2007 from what it was in 2006. However operating profit had taken a nosedive. This illustrates the poor job that EA was doing in controlling its costs.
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