Posted By Pramath | On 29th, Oct. 2021
Microsoft’s strategy in the video games market has started to come together and gain form over the last few years. Where once it was unclear what their place in the video game market was – were they just there to play second fiddle to PlayStation, or did they have an actual vision for the industry and medium that they were willing to commit to? – under Phil Spencer’s leadership, the brand has been revitalized, with Xbox doubling down on the strengths that made the brand so popular in the first place, which just so happen to be synergetic with the strengths and broader corporate strategy and direction of Microsoft as a whole as well.
No longer is Xbox just “PlayStation, but with Halo“. There is a very distinct vision and direction for the brand that has given it its own identity. Xbox under Phil Spencer and Satya Nadella has doubled down on it being more than a platform – an ecosystem – one that lives anywhere and everywhere, and allows people to play games on their own terms, at their own convenience, backed by top notch services and infrastructure, and without needing to make expensive piecemeal commitments. Almost every single move Xbox has made over the last half decade or so – backward compatibility, Game Pass, xCloud, One S and One X, Series S, Play Anywhere, you name it – has been towards this end.
Because for Xbox, as we have discussed before, success isn’t counted like it is for Nintendo and PlayStation anymore. They’re not trying to sell the most consoles or copies of games. I mean of course, if they do that, that’s great, and they won’t mind it – but they rather want to create a sustainable ecosystem of engaged users bringing in recurring revenue on an ongoing basis for years to come. For Microsoft, it’s all about that – and the centrepiece of this strategy has been Game Pass, which they have been pushing to an extraordinary degree over the last few years. From bundling it in with new console purchases, frequent $1 promotions, payment plans for the console that include Game Pass commitments, extremely high profile marketing and branding pushes, and, of course, day one releases for every Xbox first party game going forward, as well as some pretty high profile indie and AAA third party releases. Within just a few years, Xbox has received its killer app – and that killer app is Game Pass, which has been memed to death as “the greatest value in gaming” (admittedly not without reason).
But here’s the thing with having a subscription service such as this one – it’s really expensive to operate and maintain. It took Netflix and Spotify years until they started breaking even (not making a profit, just breaking even), and until then they were operating under millions of dollars of losses. The reason for this is obviously abundantly clear – you have to license and/or produce a staggering amount of content for your service, but you can’t directly monetize any of it. The income you are getting is only a fixed amount from your subscriber base, and especially in early years, your subscribers are likely to all be highly engaged ones, meaning they are actually consuming more content than you are getting income from them. Over time, this isn’t as much of a problem – once you get to a critical subscriber mass, you have tens of millions of users (or hundreds of millions, in the case of Spotify and Netflix), the bulk of which are actually engaging very little with the content on the service – paying more per month than they are consuming the content, in fact. Those people are the ones who end up not only subsidizing the more engaged users who consume content on the service relentlessly, but also comprise the profits that the service finally starts bringing in. This is why it takes subscription services so long to turn profits – because they have to reach, and then exceed, a certain critical mass of users to be able to do so, but doing so requires spending an absurd amount of money upfront to make the service appealing enough to want to subscribe to to begin with. You’re spending not only on ongoing operational and maintenance costs, but also to keep the content you do have, as well as to license and produce more content to continue to keep the service appealing.
It’s a massive investment – an investment of literally hundreds of millions of dollars over years with no actual guarantee of payoff, because just take a minute to think about how many media subscription services there are, and then think about how many are profitable. The only ones that we know for sure are profitable are Netflix and Spotify (and as mentioned, those took forever to get there) – other high profile services such as Disney+, Apple TV+, Amazon Prime, Apple Music? Those are still being fronted by literal multi-billion dollar corporations (trillion dollars, in the case of Amazon and Apple) in hopes that they eventually turn a profit.
This is also why the demands that Sony or Nintendo follow in Microsoft’s footsteps with a Game Pass like model are so uninformed. Yes, ideally, we would just have to pay $10 a month and we would have access to God of War or Breath of the Wild level games from Nintendo on day one without any further investment, but those companies are far smaller than Microsoft, which is a trillion dollar conglomerate that has a lot of other parts of the company able to subsidize a burgeoning expensive subscription service. For Sony and Nintendo, each new game is an investment unto itself that has to make sense on its own merits – not just as an addition to a broader subscription service that brings in recurring revenue at some point in the future. That’s actually why their hesitant toes in the water with their subscription services so far have largely been confined to older content – PS Now doesn’t really get new games day one, it gets older stuff, and was originally pitched as a service to access legacy PS3 content in the first place. Nintendo Switch Online’s primary appeal is the ability to access legacy NES, SNES, and N64 content. This means they don’t have to spend as much money producing content – the content is already produced. They still have to license it, sure, but even licensing costs for older content are far lower than newer contemporary stuff. If and when these services start to generate more revenue via a subscriber base attracted by access to legacy content, they can start spending on more contemporary content. We’ve already started to see PS Now include newer games over the last few years, in fact.
But the core point I’ve been driving at is presumably clear at this point – subscription services need to hit a critical mass to be profitable. Which brings us back to Game Pass.
Earlier this week, Axios reported that Microsoft had missed its subscriber targets for Game Pass by 11%; subscriber growth over last year was 37% rather than the 48% Microsoft had projected. Now, the optics of Microsoft not managing to hit targets for what has become their overwhelming focus in the video game space over the last few years aside, at first glance, this doesn’t seem too bad: they still saw growth (of 37%!) after all, and obviously you would expect growth margins to fall as the base they work from increase. But there are a few factors here that complicate the picture a fair bit.
The most important thing to consider here is that this missed target was in a period where entertainment media consumption went up across the board – COVID-19 induced lockdowns and quarantines across the board had people turning to indoor media entertainment for escape, and video game hardware and software sales rose tremendously in this period. Subscription services like Netflix saw insane growth. Individual projects, whether sold a la carte, or offered on services, such as The Queen’s Gambit or Animal Crossing New Horizons, saw huge success.
Then there is the fact that over the last year and a half, Microsoft has kicked up marketing efforts for Game Pass, made several high profile deals for day one launches on the service (such as Back 4 Blood or Outriders), procured an incredible amount of meaningful third party content (such as all the Yakuza or Kingdom Hearts games), offered multiple $1 promotions, bundled it with Xbox All Access, launched xCloud to the public, and of course, gotten a fresh chance for a crack at the console market with a new generation console launch. So amidst all of this, for Game Pass to miss its targets is a little… troubling.
As I’ve already mentioned, subscriber numbers are paramount to a subscription service’s long term health, which is where the concern for Game Pass now comes from. Until now, we’ve been acting under the assumption that Game Pass, even if not sustainable right now, will eventually get there. But the question is – what if it doesn’t? Microsoft has bet the farm on this service. Its entire gaming strategy is centred around Game Pass. What happens if Game Pass ends up joining the growing number of subscription services that simply never made it past the break even threshold? Remember, that’s not even a judgment of Game Pass’ offerings in and of itself, it’s an amazing service, but most subscription services never break even. What if Game Pass is one of them? How long can we expect Microsoft, the company that went ahead and purchased over a dozen gaming companies (including one of the most celebrated third party publishers) to ensure a steady stream of content on Game Pass, to continue taking a hit? At some point something would have to give, if that happens.
For now, it’s too early to sound the alarm bells. Game Pass still grew by over a third last year, after all, and growth is growth. Missed targets can also presumably be attributed to the fact that major Xbox exclusives like Halo Infinite were delayed (though with that game’s multiplayer component being free to play, it’s unclear if it will actually drive subscriptions to a huge degree), as well as there simply not being enough Xbox consoles available on the market, given the severe production shortages Series X and Series S have suffered. Microsoft, as a whole company, pivoted to subscriptions across the board a while back – Office, for example, is primarily offered as a subscription offering now – so it presumably knows the logistics and time needed to get a subscription service to be successful, and will probably not really take this as a signal to ditch Game Pass and video games and divest itself, because it would be hilarious premature to do that this early.
For now, Microsoft is committed for the long haul. The only thing is, it has to remain committed for a while, we’re not talking years, we are literally talking a decade plus window here. That’s how long it took services like Spotify and Netflix to break even – and those services had a significantly bigger subscriber base to work with, because they work on literally any and every device with a processor in it. Game Pass, or any gaming service, does not – so it might be even longer.
Is Game Pass sustainable? Not right now, by definition. Subscription services fronting millions of dollars of initial costs to get to break even point are obviously not sustainable until they get to said break even point, that’s exactly why they need the backing of massive corporations to subsidize them. So no, Game Pass, as it is right now, is not sustainable. Eventually, it might be. We just have to hope Microsoft has enough patience to get to that point.
Note: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, GamingBolt as an organization.
Platforms:PS5, Xbox Series X, PS4, Xbox One, PC, Nintendo Switch
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