Many adults find the games kids play in more than 40% of North America’s basements incomprehensible and noisy.
But those kids, in fact, are fueling the development of a major new industry.

The video-game industry likes to compare U.S. sales of games, which stood at US$7.3 billion at the end of 2003 (sales in Canada totalled about $810 million), to the $9.5-billion in ticket sales the movie industry
reaped in 2003. (All amounts are in U.S. dollars.) Both industries are growing, but the
video-game sector took only seven years to shoot up 143% to its 2003 mark from $3 billion in 1996. In the same period, the movie industry added just 58%, with box-office sales growing to $9.5 billion from $6 billion.

But comparisons between the two industries are misleading. Total U.S. sales in the video game industry, including consoles, stand at $10.2 billion. Total movie revenues are considerably higher once rentals are added in, as San Diego-based DFC Intelligence analyst David Cole points out: “Video rentals alone were higher than ticket sales in 2003 and reached $14.2 billion. And you have to add to that DVD sales and lots of royalty rights.”

Still, chances are the gaming industry will one day overtake movies if this key consumer trend endures. A 2003 survey by the Entertainment Software Industry finds that 34% of men between ages 18 and 34 choose to play a video game in their leisure time, while only 14% prefer going to the movies.

Despite that, the video game industry’s hot growth days are behind it. It took only five years, from 1996 to 2003, for software sales to double. In 2002 and 2003, the compound annual growth rate slowed to 11%.

Still, those numbers shine when compared with the whole technology scene, says Voicu Valentir, senior analyst at National Bank of Canada in Montreal. “One hundred dollars invested in the Nasdaq 100 in January 2000 would have delivered only $42 at the end of February 2005. The same $100 injected in Activision Inc. [a leading video game company], would have delivered $472; in Electronic Arts [Inc.], $315; in Take-Two Interactive [Software Inc.], $295; in THQ [Inc.], $198,” Valentir says.

Currently, the industry has plateaued.
“Console sales have somewhat flattened out, but you would expect that at this point in the cycle,” says Stephen Kahn, senior vice-president of world equities at TAL Global Management Inc. in Toronto. The last generation of video consoles, which came out at the end of the ’90s, such as PlayStation and the Xbox, are showing their age and gamers are waiting for the next generation, which should start coming out in 2006 and 2007. “The time to take positions is now,” Kahn says.

Until recently, price wars were another factor keeping a lid on growth and profits. Major players, such as Take-Two Interactive, pushed down prices in the important category of sports games.

But those pressures have since abated, says Ian Ainsworth, senior vice president of Mackenzie Financial Corp. and portfolio manager of Universal Emerging Technology Fund. Ainsworth and other analysts say the gaming industry still has long-term growth potential.

That growth stands on three underlying trends, says Ainsworth. First, technology advances constantly improve games’ graphic attractiveness, performance level and interactivity potential. So there’s a lot of room for innovation.

Second, popularity of online games is building as new channels of distribution develop along with new micro-payment schemes. According to DFC Intelligence, the online gaming segment will show the strongest increase. Cole thinks revenue will jump to $9.8 billion in 2009, from $1.9 billion in 2003.

“[One key advantage of online gaming] is that it will protect companies from piracy on the part of countries in which copyrights are not as respected,” Ainsworth says. As for micro-payments and online subscriptions, they will ensure more stable revenue streams.

The popularity of online gaming can only expand with the spread of high-speed Internet connections. Asia shows the greatest potential. Although the number of homes with such connections at the end of 2003 stood at 25.5 million in the U.S. and 19.5 million in Europe, Asia was leading the way with 36.1 million connections, notes DFC Intelligence.

Ainsworth points to another trend: globalization. The rise of Asia will force companies to design games with a planetary perspective. It is noteworthy that Electronic Arts, the world’s largest game maker, has recently opened a development
centre in China.