Gaming: An overlooked tech subsector primed for an AI boost?

The streetlight effect and post-covid normalisation

An old anecdote tells of a policeman who sees a drunk man searching under a streetlight late at night. The officer asks what the man has lost. "My house keys," the drunk replies. They search together for a few minutes under the light. Then the officer asks, "Are you sure you lost them here?" "No," says the man, "I lost them in the park." Puzzled, the officer asks why he's searching here. The drunk man simply answers, "This is where the light is."

This parable might aptly reflects the current flow in the financial equity markets, particularly in the gaming sector. During the corona lockdowns, gaming stocks soared as people sought entertainment from the safety of their homes. The industry saw unprecedented growth in user engagement and revenues. However, since the peak of the pandemic, these same gaming stocks have fallen out of favor. Even more, they've been overshadowed by the dazzling allure of artificial intelligence and the breakthrough of ChatGPT, which have captured investors' imaginations and capital. Basically, the gaming sector has been pushed into a dark corner by the financial market.

While it is true that some of the past drivers of the gaming industry have matured, the gaming sector remains a strucutral growth sector. Moreover, the synergy between AI and gaming, from AI-driven narratives to dynamic game worlds, has the potential to bring the sector back into focus. For astute investors, this may offer opportunities in an area currently overshadowed by the intense focus on AI advancements. Let’s shine a light.

The gaming sector is still alive and kicking

Gamescom, the world's largest event for computer and video games and Europe's leading business platform for the games industry, held its 16th annual edition at the end of August 2024 at the Koelnmesse in Cologne, Germany. Spanning approximately 230,000 square meters of exhibition space, Gamescom offers visitors the opportunity to experience and play new games up close, discover highly anticipated releases, and celebrate world and European premieres. In a world of artificial intelligence Gamescom is a world where real humans make a connection through shared gaming experiences. The 2024 event featured major reveals, including the long-awaited announcements and release dates for Indiana Jones and the Great Circle, Call of Duty: Black Ops 6, Borderlands 4, and Civilization 7. The event also showcased the prestigious Gamescom Awards, which honor outstanding games, expansions, and trailers presented at the show. In 2024, notable winners included Genshin Impact for Best Mobile Game, Monster Hunter Wilds for Best Sony PlayStation Game, Kingdom Come: Deliverance II for Best PC Game, and Little Nightmares 3 for Best Microsoft Xbox Game.

Gamescom 2024 broke new records, attracting more visitors than ever before. Over 335,000 attendees from around 120 countries flocked to the event, with Friday and Saturday completely sold out. The show's popularity extended beyond physical attendance, as online viewership for the show program reached an all-time high, with over 310 million video views recorded during the closing weekend. These figures significantly surpassed previous records, setting a new global benchmark for gaming events. So, while the financial market has turned away from gaming companies, the gaming community has definetly not.

The gaming market – The pre-covid era

Fair is fair, despite the record-breaking numbers at Gamescom, not all of this buzzing energy has translated into a corresponding increase in the overall economic value of the gaming market (PC-, console- and mobile gaming) . In fact, while the global gaming market grew at an average pace of 15% per year between 2012 and 2019, followed by stellar growth averaging 20% during the pandemic years of 2020-2021, the market has since exhibited very anemic growth, averaging only 1.3% in 2022 and 2023 (with 2023 being the better year of the two). 2024 is also not shaping up to be a blockbuster year, with growth expected to be less than 3%, reaching a market size of about $305 billion. Looking ahead to the period from 2025 to 2030, depending on different sources, the market is expected to grow at a single-digit rate, with some more optimistic observers predicting an average annual growth rate of 10%. The latter would represent an acceleration compared to the 2024 growth figures, but still well behind the pre-pandemic growth rates the industry had been experiencing.

Source: Morgan Stanley, Econopolis

Behind these historical average growth figures lie several key trends that are crucial for understanding the future trajectory of the gaming market. It's important to remember that averages can be misleading; as the saying goes, if you stick your head in the oven and your feet in the freezer, on average, you'll feel comfortable.

First, the gaming sector experienced a significant boost from the proliferation of mobile gaming and 4G connectivity during the period from 2012 to 2019. I’m sure you vividly recall the days of Farmville, Angry Birds, and Pokémon Go. During this time, the global mobile player base grew more than fivefold, from nearly 500 million players in 2012 to about 2.7 billion in 2023, and average mobile gaming spending per gamer increased by 4.5 times. In 2012, mobile gaming accounted for just around 9% of total game spending, but today it represents nearly 52% of the $304 billion gaming market. While it's likely that the global player base will continue to grow beyond 3 billion, it is not expected to double any time soon, nor is mobile gaming spending expected to double in the foreseeable future. This indicates that the initial explosive growth phase of mobile gaming is fading, particularly in relation to the overall gaming market.

When excluding the mobile gaming component from overall gaming growth, the average annual growth rates for the periods 2012-2019, 2020-2021, and 2022-2023 were 6.6%, 14.6%, and 1%, respectively. This past growth was driven primarily by two factors: 1/ the increasing popularity of gaming PCs, which likely peaked around 2017 and currently remains well above 2012 levels. Over the same period, the installed base of gaming consoles remained relatively stable. 2/ the average spending per game, followed a different trajectory than the user base development of PC gaming and consoles. While PC gamers are now spending roughly 44% more than they did 12 years ago, console gamers have significantly increased their spending over the same period by nearly 130%. The shift from physical to digital game distribution has played a significant role in this development, as it greatly reduced buyer friction, boosting transaction rates. However, this uplift has largely played out, as the vast majority of game distribution is now conducted digitally.

So, apart from mobile gaming, the gaming industry has benefited from the successful uptake of gaming PCs (you undoubtedly still remember the fight for Nvidia's RTX gaming cards, long before ChatGPT was a thing and Nvidia was an AI-company) and the digitalization of the gaming distribution chain (exit Gamestop and just recently Game Mania in Belgium: Game Mania files for bankruptcy after no buyer could be found).

This winter could spark a gaming comeback: Here’s why

During the COVID pandemic, the gaming industry was in full swing. However, once lockdowns were over, gamers started looking for other things to do and took a break from the screens that had been their go-to entertainment. In our view, this competition for gamers' time has a more lasting impact. As Matthew Ball noted, gaming's challenges likely stem from the reverse effects of Metcalfe’s Law: when a few friends stop playing or play less, it can cause others to play and spend less, highlighting the powerful network dynamics in gaming communities. In that respect, we believe that the upcoming end-of-year season could be an interesting barometer periode. As gamers typically, pick up their digital weapons during this season thanks to holiday releases and more available playtime hours during the dark and cozy fall and winter evenings, this time potentially amplifying the positive community effects of Metcalfe’s Law. Especially, as in the past two years, people may have been more focused on celebrating their regained freedom, lavishly spending their corona-savings on activities outside of gaming. This year, the third winter after the post-lockdown period, might signal a turning point.

The gaming market – The post-covid era

Bringing all these factors together, it’s clear that the gaming industry will not be able to replicate the rapid growth it experienced in the past from the rise of gaming PCs, mobile gaming, and digital game distribution. Even with a resurgence of Metcalfe’s Law this winter, the sector is unlikely to sustain the 10%+ growth rates seen previously. However, it’s reasonable to expect that the gaming market will continue to grow through 2030, albeit at a more moderate pace. We still anticipate an expansion of the gaming console, PC and mobile customer bases in the coming years.

In the gaming console segment, Sony’s PlayStation is expected to maintain its dominant position, currently holding around 45% of the market, followed by Nintendo’s handheld and hybrid consoles at roughly 27%, and Microsoft’s Xbox at approximately 23%. The PlayStation 5, launched in 2020, indicates that a new PlayStation could be on track for release around 2027, adhering to the typical seven-year console cycle. In May 2024, Nintendo confirmed it would reveal details about its next-generation console, widely referred to as the Nintendo Switch 2, before March 2025. Meanwhile, Microsoft has announced that it is moving full steam ahead with its next-generation hardware, aiming to deliver the most significant technological leap yet in console gaming (With the expensive purchase of Activision Blizzard, Microsoft now faces the challenge of proving its worth, also on the hardware side). So, even without substantial growth in the console market, this wave of innovation is likely to fuel a strong replacement cycle.

PC gaming is also set to continue evolving and growing through 2030, though at a more moderate pace compared to the pandemic-fueled surge. Key growth drivers will include advancements in hardware—particularly in CPU/GPU technology, ray tracing, and AI-enhanced graphics—along with the broader adoption of cloud gaming services and the increasing integration of VR/AR technologies.

Mobile gaming remains a dominant force in the gaming industry, representing the largest share of global gaming revenue, especially when mobile in-game advertising is factored in. With nearly 4.9 billion smartphone users worldwide (or close to 7 billion smartphone subscriptions), projected to grow to 6 billion users and 8.1 billion subscriptions by 2030, the mobile gaming market still has room to expand, particularly in regions where console and PC gaming are less prevalent. In fact, mobile gaming is already the leading platform in China.

Key drivers of mobile gaming's continued growth include the increasing power of mobile processors, enabling console-quality graphics and experiences on smartphones and tablets, along with the ongoing development of mobile networks, particularly the global rollout of 5G. The upcoming iPhone 16, set to be unveiled on Monday, September 9 at Apple's 'Glowtime' event, is expected to feature a number of advancements for mobile gaming.

Source: Apple

Moreover, the rise of cross-platform play, where games can be played seamlessly across consoles, PCs, and mobile devices, will further blur the lines between traditional gaming platforms, with mobile gaming becoming increasingly integral to the overall gaming ecosystem. Take-Two Interactive Software, for instance, has made its 'console-to-mobile (CtM)' business a central focus of its strategy. Additionally, game-based TV series and animations are becoming more prominent, with 'The Super Mario Bros. Movie' standing out as a major success. Another notable example is the animated spin-off Cyberpunk: Edgerunners, which aired in September 2022 and significantly boosted the user base of the AAA game Cyberpunk 2077.

Gaming and the competition of short video applications

While this cross-platform strategy makes perfect sense for the gaming sector, it also reveals a challenge. Traditional entertainment is being disrupted as consumer preferences shift and technology transforms business models. Gaming time is a finite resource and cannot be separated from the overall time budget available for entertainment. For years, mobile games enjoyed massive popularity, serving as quick entertainment snacks for both younger and older audiences. On the train, in waiting rooms, or even under the covers in bed, people everywhere could be seen gaming on their phones. However, in recent years, many of these same people have shifted their attention away from games and toward scrolling through what are now called short videos. Users, especially the younger generations, increasingly prefer short, engaging videos that provide quick thrills and easy interaction.

Source: Gamescom

One of the main drivers of this trend is the meteoric rise of platforms like TikTok, and more recently, Instagram Reels and YouTube Shorts. These apps have revolutionized how entire generations consume content on mobile devices. Short, endlessly scrollable videos have proven to be incredibly captivating. Users spend more and more time on TikTok and the likes, receiving instant gratification through the rapid content changes, with algorithms fine-tuning selections based on their interests. This form of entertainment has started to replace other ways of spending time on smartphones, including mobile games and AAA-gaming, which demand more attention and sustained engagement.

Source: Gamescom

AI: The game-changer for combating cost inflation in gaming

When asked about the impact of the macro-economy on the gaming sector, Take-Two Interactive CEO Strauss Zelnick emphasized that the entertainment industry tends to be fairly resilient during consumer-led recessions. However, he also acknowledged that the gaming industry is not totally immune to economic downturns, and in the event of a severe recession, the sector would likely be negatively affected. Economic dynamics do indeed influence the gaming sector. Since the onset of the pandemic in the Western world in March/April 2020, inflation in Europe and the US has risen by 20% and 22% cumulatively. Despite this, the retail prices of most blockbuster games have remained relatively flat. Over the past 10-15 years, prices have only increased from around €/$60 to €/$70 per game. This suggests that consumers may have a psychological barrier when it comes to paying above the standard price point.

However, a significant portion of the costs associated with operating a gaming business—including labor, equipment, and other inputs—are subject to inflation. Therefore, it is not surprising that the video game industry has experienced widespread layoffs. Niantic’s CEO, John Hanke, aptly summarized the situation, stating, "We have allowed our expenses to grow faster than our revenue". In 2022, the industry saw approximately 8,500 layoffs, followed by over 10,000 in 2023. In just the first eight months of 2024, around 12,000 jobs have already been lost. Layoffs have impacted various parts of the industry: Niantic cut 25%, Epic Games 16%, Unity 15% last year and another 25% in 2024, Riot Games 11%, CD Projekt Red 10%, Microsoft’s gaming division 8.6%, Sony PlayStation 8%, Bungie 8%, and EA 6% in 2023 with an additional 5% in 2024. Amazon laid off over a thousand employees across its gaming divisions, including Twitch, and the collapse of Embracer Group continues to affect many. ByteDance, despite reaching $100 billion in annual revenue in 2023, shut down its gaming divisions.

In addition to inflation, there is a growing trend to extend the scope and complexity of games, which significantly increases development costs. As games become larger and more ambitious, the resources required—both in time and labor—drive up expenses even further. Over the past decade, the cost of developing AAA games has skyrocketed from €30-100 million to a minimum of €100 million, with some budgets exceeding €300-400 million. The scale of these projects has expanded dramatically, requiring teams of over 1,000 developers for the largest titles, compared to the 200-300 developers typically needed in the past. Despite this, development timelines have remained relatively stable, with modern AAA games still taking about 3-4 years to complete, only slightly longer than the 2-3 year cycles of earlier years. The "crossmediale synergie" strategy, referring to how different media like games, films, TV series, and animations complement each other and collectively reach a wider audience, also brings additional costs.

In this context, we believe the gaming sector is uniquely positioned to benefit from the use of generative AI. Generative AI has the potential to drastically reduce the unit costs of game production while significantly improving efficiency across various stages, including development, marketing, and publishing. For instance, AI can aid game planning by creating environments, assisting in dialogue generation, and ensuring coherence in character settings. It can also optimize game art by reducing repetitive tasks in design, rendering, and modeling. In voice acting and sound effects, AI can generate realistic voices, reducing the need for actors, while automatically creating background music and environmental effects. Furthermore, AI can help streamline game development by automating bug detection and generating reusable code, while in game publishing, it can support immediate marketing strategies and generate tailormade content based on real-time feedback.

As such, the use of AI is expected to accelerate game development, allowing for faster and more cost-effective releases. This would enable studios to release a higher volume of games each year, thereby reducing the financial risk associated with any single game's failure. As a result, companies will no longer have to rely that heavily on a small number of aging titles for revenue, creating a more diverse and sustainable business model.

A perfect example of this was recently highlighted by Electronic Arts’ CEO, Andrew Wilson, during the company’s second-quarter 2024 results publication. After resolving a portrait rights dispute that lasted 11 years, EA launched EA Sports College Football 25, a game based on college football. Given the long interval, the company had to incorporate 11,000 new star player heads into the game. Typically, EA develops about 500 to 1,000 star heads for a game each year, making the task of integrating 11,000 heads a massive challenge. However, thanks to AI-driven processes, EA was able to efficiently manage this workload, showcasing the potential of AI to dramatically improve content creation speed and reduce development costs.

Source:EA

An AI hallucination or the near future: fully autonomous vehicles as a new gaming platform

As a final thought (hallucination), and looking into the future, fully autonomous vehicles could transform how we spend our time during commutes, opening up a vast, untapped opportunity for the gaming industry. With passengers no longer needing to focus on driving, cars will evolve into new entertainment hubs, offering idle time for activities such as gaming. This shift would make the car a new computing space, where immersive gaming experiences could be seamlessly integrated into the travel routine. Gaming companies could capitalize on this by developing innovative, location-based, or time-specific games that cater to the unique environment of being in a vehicle. Additionally, advancements in cloud gaming and AI could make high-quality gaming accessible on the go, regardless of the hardware limitations of the car itself. As autonomous driving becomes mainstream, this new gaming ecosystem could revolutionize the way games are designed, distributed, and consumed. Play on!

Source: MidJourney