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The casual games market is booming, generating over $2.25 billion in yearly revenue despite virtually no brick-and-mortar representation or advertising and marketing costs. But is this market rewarding for investors? For VCs interested in this space, here’s rundown of how it works.

A casual game is defined as a stand-alone entertainment software title that is digitally distributed by one or many “portals,” or independently owned Internet retail sites. Casual games typically operate under a try-before-you-buy business model –- the downloads allow players to play for a set period of time (usually 60 minutes) before shutting down. If the player wishes to continue playing, they must pay the retail price, which they can do electronically from inside the program, instantly unlocking the game for unlimited play. The average rate of purchase to play is lower than 1 percent, and games that convert higher than 2 percent are considered “hits.” The largest market for these games is women ages 30-60, a significant departure from the standard computer games market.

Development costs

The development cost of a casual game typically hovers somewhere around $100,000. That money goes into paying developers, including artists, programmers, game designers, project managers and audio engineers, as well as the developer’s overhead. This investment usually pays for between eight and 12 months of work. Of course, there are ways to reduce costs. In recent years, many developers have outsourced art and coding to companies overseas, in places like Eastern Europe, India or China. But such a move needs to be carefully managed, as many outsourced games are shipped with little quality control, often sporting poor or confusing English.

The primary profit center for casual games is online retail. Games in the genre retail for $19.99, minus retailer discounts and incentives. Since conversion rates for a casual game usually linger below 1 percent, the only profitable games are hits – mid-level successes rarely recoup their development costs. Causal games are not a high-margin business. Because the market involves so many middlemen, the final slice of the pie that makes it to developers is usually quite small.

Investing

Investment in casual game development can come in two forms: as a publisher or as a development partner. Each carries its own risks and rewards. Typically most VC investment in the casual games industry goes to the publisher, and most of the major publishers (including PlayFirst, Big Fish and iWin) were founded with VC money. Publishers then contract with individual developers to create games, paying them an up-front amount as well as a percentage of sales. Once the game is completed, publishers then distribute the game to portals and handle receivables from those portals. Most of the major publishers also maintain portals of their own, retailing both titles they publish as well as other games.

VC money does not, of course, guarantee a hit game. PlayFirst is the best example of using venture capital to successful ends, commissioning Gamelab (where I currently work) to develop their first set of titles, including the very successful Diner Dash. But another Playfirst-commission title we developed, Subway Scramble, didn’t do nearly as well.

Recently, a few studios have worked with VCs on the development side and then self-published the resultant games. This method eliminates the publisher’s revenue share, meaning more of the total income goes to the developer. Studios that have followed this method are typically more established in the marketplace, with at least one successful title under their belts. However, the lion’s share of the game’s sale price still goes to the portals and distributors, and recoupment can be slow.

Revenue streams

Developers and publishers depend on the revenue from hit games to subsidize their output, and there is still no dependable method to predict which games will be hits. With an average of one new game getting released every weekday, the market is already becoming saturated. Because development time is relatively short, a successful game will see its mechanics and theme copied and cloned within six months to a year of being released. So while the development cost of a casual game is low compared to a standard PC or console title, the chance of a single title turning a profit is also reduced.

Secondary revenue streams from casual games include advertiser-supported, “free-to-play” versions, which are generating a higher revenue-per-download rate than purchased games, as well as boxed
physical retail copies (usually handled through another third-party distributor) and ports of the game to other devices, including mobile phones and portable gaming consoles. Because casual games are
typically small in file size, with simple input mechanics, they make this transition more easily than complex PC games.

Investing in the casual games market is much like investing in any content market – dependent on a large number of unpredictable forces. There are proven marketing and content models that are exploitable, but the saturation of the market with products slavishly following those models steadily reduces their effectiveness. For a VC, the best bet is to work with an established developer with a strong, marketable idea and keep costs low. Anything else is way too risky for a market this crowded and volatile.

Written by K. Thor Jensen, who’s worked in the games industry for nearly 10 years and is currently an associate producer for Gamelab.

Image credits: playfirst.com, bigfishgames.com, and iwin.com.

Now that Thanksgiving is over, it’s time to start speculating about what will be hot and what will be not in 2008. After all, 2007 was not the Year of the Widget, despite what Newsweek predicted. If anything, it was the Year of Facebook, as the social networking site won a $240 million investment from Microsoft for a mere 1.6 percent stake (plus the right to sell third-party ads on the Facebook network), valuing it a some $15 billion. But what about that business networking contender, LinkedIn? Could 2008 be the year of business networking?

Maybe — but only if LinkedIn doesn’t fumble its position by failing to address the worldwide Internet user base, about 80 percent of which resides outside of the U.S.

LinkedIn seems to have built some momentum while everyone was gawking at Facebook. LinkedIn CEO Dan Nye predicts the company’s revenues could grow to $100 million next year. News Corp. (apparently) wants to buy it. And on a year-over-year percentage basis, as of October, LinkedIn grew faster than Facebook.

Facebook’s sober cousin seems well-positioned for any economic weakness that could emerge in 2008, because it doesn’t depend primarily on advertising, but rather makes money by selling premium services to subscribers and their employers. And if people start losing their jobs, they’ll be all the more interested in LinkedIn’s services.

LinkedIn faces challenges, of course. I spoke with Konstantin Guericke, LinkedIn co-founder and Jaxtr CEO, not as an official spokesperson for LinkedIn but as an interested observer and investor. He said that English-only LinkedIn needs to push forward aggressively with internationalization and localization in 2008. It competes with Xing in Germany and Viadeo in France, both of which support multiple languages.

From an international perspective, Facebook doesn’t look so exciting. It competes with a vast array of social networks including hi5, Bebo, Orkut, Mixi, QQ and more. Besides that, it could have permanently offended many of its users with its ham-handed attempts at social advertising. For LinkedIn, advertising is a source of revenue secondary to providing services its users find valuable enough to pay for. On that basis alone, I hope that 2008 is the year of LinkedIn rather than Facebook, at least if we’re talking about networking online in one forum or another.