Do Moats Exist in the Video Game Industry?

Difficulties and opportunities in the video game industry

The recent case of Ubisoft, which has seen its stock drop nearly 90% from its all-time high, coupled with sluggish growth and the underwhelming performance of its latest release, Star Wars Outlaws, highlights a harsh reality: things are changing rapidly in the video game industry.

In this article, we will explore the challenges of many companies in the sector, breaking down aspects of the business model that make it difficult to sustain a competitive edge. We will delve into why large studios struggle to produce successful games and examine what it takes to thrive in today's gaming landscape. Finally, we will identify current competitive advantages in the industry and discuss how sustainable moats might be built in the future.

To understand the industry and its business models / outlooks / main players, you have my article about the industry just here.

The difficulties to create and maintain a moat

A model of exhaustion

I won’t delve into the history of video games, as it would be lengthy and unnecessary for the point of this article. Instead, here is the typical model that dominates the industry:

1. Success. A studio creates one or more successful games.

2. Acquisition. The studio is acquired by a publisher seeking a return on investment.

3. Exploitation. Initially, the studio enjoys creative freedom, but over time, the publisher imposes stricter demands - shorter development cycles, design constraints, multi-team production, and efficiency pressures.

4. Exhaustion. This relentless pace, misaligned with player desires and employee capacity, leads to inevitable commercial failures, reducing the studio to just another poor performing asset.

What made the studio successful fades, raising the question of why it was acquired in the first place. Meanwhile, new, smaller, passionate studios, despite having fewer resources, create hits.

Recent examples include the massive success of Baldur’s Gate 3, 2023’s Game of the Year, developed by Larian Studios, and Minecraft, initially developed by one person and later acquired by Microsoft for billions.

This "exhaustion model," where growth hits a ceiling, makes it difficult for studios to sustain rapid, long-term growth.

Baldur’s Gate 3, named Game of the Year 2023, was developed by the independent studio Larian

Success relies on non-financial factors

The success of a video game often hinges on factors that are difficult to quantify through traditional analytical methods. For example, the triumph of The Witcher Saga by CD Projekt Red was not just due to the internal organization and technical skill of the developers but also because the Polish team had a deep connection with the source material and lore.

Nearly a decade later, The Witcher 3 remains a benchmark for storytelling excellence

How do you create passion? How do you evoke poetry? What will truly resonate with players? These elements are hard to predict and even harder to replicate, even for larger studios with vast financial resources.

Two key challenges put even more pressure on larger studios (or smaller ones owned by bigger companies):

1. Lack of flexibility. Strict adherence to specific guidelines often leads to uninspired games. Mass Effect: Andromeda by BioWare is a prime example. The rigid development process compromised both the creative flow and final quality.

2. Scheduling pressures. Publishers often push for firm release dates for financial reasons, yet game development is unpredictable and frequently takes longer than expected. Rushing to meet deadlines can hurt the final product.

This is just as true for mobile games. Rovio’s Angry Birds franchise started strong with fun, engaging gameplay. However, the shift to free-to-play with microtransactions, followed by increasingly uninspired releases, led to a decline. The relentless pursuit of profitability effectively "killed the golden goose."

The ever-diminushing returns in game development

A major issue for game studios is the diminishing returns they face as development costs rise. Each new game is typically more expensive to produce, but this doesn’t always translate to proportional gains.

• If Game A costs $50,000 to develop and earns $500,000, that is a 10x return.

• If Game B costs $500,000 and earns $1,500,000, the return is only 3x.

As development costs soar, so does the financial risk. To mitigate this, many developers cut costs, resulting in poorly developed games—and often, poor financial returns. This cycle of escalating risk and lower rewards is a major obstacle for the industry.

A competitive advantage?

All these factors make it extremely challenging to establish a sustainable competitive advantage in the video game industry. While some iconic brands, like PlayStation (console), Mario (universe), and Final Fantasy (series), do offer a certain level of brand loyalty and a temporary moat, maintaining that advantage is fraught with difficulty.

Will Mario ever become old?

For these brands to remain powerful, the quality of each new game must consistently meet or exceed expectations. However, achieving that level of quality is inherently risky. Game development is an unpredictable process, where creativity, technical execution, and timing must align perfectly to capture player interest. Even with a strong track record, trends and player preferences can shift quickly, leaving previously dominant franchises vulnerable to obsolescence.

Moreover, the industry is particularly susceptible to changes in technology, player demands, and competitive innovation. For example, the rise of free-to-play models, streaming services, and mobile gaming disrupted traditional gaming companies, forcing them to adapt or risk irrelevance. This rapid pace of change undermines any long-term advantage, as even the most successful studios and franchises must constantly evolve to stay competitive.

As a result, while some companies have powerful brand recognition, maintaining a competitive edge over the long term is an uphill battle in an industry where the moat is inherently low and the risks are high.

How to succeed

Some companies, however, manage to overcome these challenges and carve out sustainable strategies for success in the video game industry. Here are several approaches that have proven effective:

1. Focusing on small, fast-developing games.
   By limiting development costs and risks, companies can maximize their chances of success by producing a higher volume of games. This model, employed by companies like Playway and many mobile game developers, allows them to experiment with various ideas while maintaining a lower cost-per-project. Even if only a few titles succeed, the overall portfolio can still be profitable. This "quantity over quality" strategy banks on the idea that one hit can generate substantial revenue while mitigating losses from less successful projects.

2. Creating games with expansive gameplay and selling DLC.
   Some companies build games with solid core gameplay, designed to keep players engaged long after the initial release. By offering frequent downloadable content (DLC), expansions, and microtransactions, they generate recurring revenue while keeping development costs under control. The Sims series from Electronic Arts is a prime example of this model, where players continuously purchase expansions and custom content to enhance their experience. Similarly, Paradox Interactive excels with games like Crusader Kings and Stellaris, which have complex systems that encourage long-term play, supported by regular DLC releases that extend the game's lifespan (a deep dive of Paradox is available here).

3. Fostering games with strong, long-living communities.
   Games that foster dedicated communities can remain popular for years, even decades, generating steady revenue over time. These games often receive fan-made mods, updates, and player-driven content that keep them alive long after their initial release. A prime example is The Elder Scrolls V: Skyrim by Bethesda, which continues to thrive due to its passionate modding community, years after its release. This strategy capitalizes on community involvement, allowing developers to benefit from ongoing player engagement without incurring constant development costs.

4. Developing games for the esports scene.
   Esports games have established a unique market with long-lasting competitive appeal. Titles like Counter-Strike, Fortnite, League of Legends, Dota 2, and Trackmania not only generate revenue through sales but also thrive on tournaments, sponsorships, and in-game purchases related to competitive play. The esports ecosystem creates a virtuous cycle: successful tournaments fuel the game’s popularity, which in turn attracts more players, sponsors, and investors. Companies that succeed in this space often build dedicated fan bases that help sustain the game for many years, well beyond traditional single-player or casual multiplayer titles.

Despite their austere nature, Paradox's video games boast incredibly strong communities

Outlook

Looking ahead, e-gaming and cloud gaming present promising avenues for establishing sustainable competitive advantages in the video game industry. Companies like Microsoft are uniquely positioned to leverage their extensive game catalogs and robust technological infrastructure to offer subscription-based models, potentially creating a significant moat. By integrating a broad range of games into a single subscription service, they can offer unparalleled value and convenience to players, while also gaining valuable data on player preferences and behaviors.

Additionally, cloud gaming has the potential to revolutionize the industry by eliminating the need for expensive hardware and making games accessible to a broader audience. This shift could democratize access to high-quality gaming experiences and allow companies that invest early in this technology to capture a substantial share of the market.

In this evolving landscape, maintaining a competitive edge will require not just adapting to technological advancements but also innovating in how games are delivered and monetized. The ability to provide seamless, high-quality gaming experiences through subscription services and cloud platforms will likely become a key differentiator for industry leaders in the coming years.

Conclusion

As we have explored, the traditional model of success, acquisition, exploitation, and eventual exhaustion often leads to a cycle of diminishing returns and missed opportunities. The unpredictable nature of game development, coupled with rising costs and shifting player expectations, makes it increasingly difficult for even the most well-established companies to maintain their competitive advantage.

However, hope lies in the evolving landscape of e-gaming and cloud gaming. These emerging trends offer new avenues for innovation and growth. Companies like Microsoft, with their extensive game catalogs and technological prowess, are well-positioned to leverage subscription-based models and cloud platforms to create lasting moats. By offering comprehensive, high-quality gaming experiences that are accessible and convenient, they can redefine how games are delivered and monetized.

Ultimately, the future of the video game industry will be shaped by those who can adapt to these changes and harness the potential of new technologies. While the path to sustainable success remains challenging, the opportunities for innovation and transformation are abundant. Companies that can navigate these shifts effectively will be well-positioned to thrive in an ever-evolving market.