Analyst sees big upside in next-gen Xbox Marketplace

Over the past two years, a financial reporter could have gotten rich if he collected a dime for every time a game industry CFO mentioned the word "micropayment" in a quarterly earnings calls. Commonly viewed as a way to drive revenue for a game long after its initial release by charging for in-game items and new content, micropayments were previously the subject of more talk than action.

Already, micropayments have become a core tenet of many a publisher's business model in Korea and other parts of Asia. There, companies, including Korea's NHN Corp and China-based NetDragon, have long published games with a micropayment model as the sole basis for generating revenues. NetDragon has even exported one title, Conquer Online, to North America in an attempt to test the waters of this nascent business model. But apart from NetDragon's experiment, few AAA publishers have moved beyond the talking stage. Until now.

Last week's GDC keynote from Microsoft exec J Allard suggested the time for talk may be coming to an end. Allard said the next generation of Xbox Live will sport something called the "Xbox Marketplace." As reported earlier by GameSpot, Marketplace will provide a one-stop shop for consumers to purchase new levels, maps, weapons, vehicles, skins, and other Microsoft- and community-created content...for a price.

"Micropayments, which allow a gamer to buy a new item, weapon, car, detail, etc., may not necessarily be material to a video game publisher [today], but certainly [they have] the potential to make a game more immersive, more 'sticky,' and certainly more personalized," American Technology Research analyst PJ McNealy wrote in a memo shortly after Allard's presentation.

His lukewarm interpretation that such a model might add $200,000 in incremental revenue to a game that might have generated $50 million in initial revenue struck him as something that "could be a nice benefit." Not exactly a pronounced vote of confidence.

This week, however, McNealy changed his tune, saying the micropayments hold far greater potential. "An online marketplace will provide varying high-margin incremental revenue opportunities for all of the major video game publishers with the Xbox 2 over the next five years," he wrote today.

Drawing on hypotheticals that flowed from his meeting with Activision CEO Bobby Kotick, McNealy sees an easy $3 million upside for a game that retailed at $59.99 and might have already sold through a million copies. That figure is based on an extra level being offered for the price of $3. McNealy places margin at 50 percent, with a revenue split that goes in two directions: the publisher and Microsoft. The business model, however, doesn’t exclude the retailer completely. McNealy envisions the potential for retailers to sell "stored value cards," whose value could be applied to purchases made online.

But the big winners in this Marketplace equation clearly are the publishers and Microsoft. "We believe that Microsoft wants to extend its back-end billing relationship with gamers," McNealy wrote. Again, according to McNealy, the revenue split would initially favor Microsoft, which would use these monies to "recoup on its back-end infrastructure research and development dollars." Over time, publishers would be granted a bigger piece of the pie, according to McNealy's forecast. "It could all lead to incremental revenue for the publisher and likely for Microsoft as well," McNealy said.

Interestingly, the model needn't be employed for content as deep as an extra level. "It is our position," McNealy said, "that a publisher could also sell smaller game parts to say, personalize a skateboard, for $0.10 each, or articles of clothing for $0.25 each."

But will the model take hold? McNealy says there's no turning back. "Xbox 2 has the billing infrastructure ready because of the Xbox Live subscription payments, broadband penetration has risen (especially with hardcore gaming enthusiasts), home networking has grown, and Microsoft has learned to foster other online buying and selling through its PC gaming Web site and MSN."