By John Gaudiosi
FORTUNE -- With the Electronic Entertainment Expo just around the corner, the gaming world will soon be focusing on the next generation of gaming from Sony's PlayStation 4 and Microsoft's Xbox One consoles. Both of those holiday releases are guaranteed to be in short supply this fall. But as exciting as the promise of next-gen gaming is to the hardcore, one of the key growth drivers for the game industry are free-to-play games, or F2P for short. Available across mobile devices, PCs, consoles, and even coming to next-gen, F2P has helped broaden the demographics of the industry. A recent wave of games shows an evolution of F2P, which is now offering "AAA" console-quality gaming experiences minus the $60 price points of disc-based games.
F2P is a model that was born out of necessity in China because of piracy. Somewhat unintentionally, the game publishers who tried it -- Nexon, NCsoft and Tencent -- found it was overwhelmingly successful. They realized they couldn't get expensive monthly subscriptions in China, but they could sell virtual items. The few devoted gamers could support the many. It proved out that non-traditional gamers embraced this model. Although only 10% of players actually invest money in these games, they can easily spend over $60 a year. Given that some of the most popular games attract over 35 million players, the huge audience opens up a nice revenue stream for developers while bypassing the expenses and hassles of the retail model.
This business model has migrated west with successes like Riot Games' League of Legends multiplayer online battle arena (MOBA) game, Wargaming's World of Tanks massively multiplayer online (MMO) WWII game, Meteor Entertainment's HAWKEN Mech shooter game and Crytek's Warface first-person shooter. While these games are growing their audiences, the days of the traditional paid MMO games could be numbered. Blizzard Entertainment (ATVI) has seen its World of Warcraft game subscribers shrink from 9.6 million to 8.1 million from February to March of this year. Many games that launched as subscription-based titles like Sony Online Entertainment's (SNE) DC Universe Online, Electronic Arts' (EA) Star Wars: The Old Republic and Trion Worlds' Rift have switched to the F2P model. Others simply launched their games as F2P like Sony Online Entertainment's Planetside 2 and Cryptic Studios' Neverwinter.
Back in 2006, Riot Games founders Marc Merrill and Brandon Beck made a bet that their new hardcore MOBA experience, League of Legends, would work as a free title with optional upgrades. Five gamers join a team and battle it out in online arenas with heroes that can be purchased through micro-transactions. "This bet was based on the hunch that removing the big, up-front pay wall would result in more gamers willing and able to try the game," said Beck. "It worked pretty well. More players were able to try League of Legends. Lots of them liked it, and as a result, many players have been playing the game for years now."
Over 35 million players are active today with this game, which has also ridden the success of competitive eSports (electronic sports) with a global gaming audience. Riot was purchased in 2011 for a reported $400 million by Chinese technology company Tencent. Wedbush Securities analyst Michael Pachter said the publisher makes as much as $250 million a year with League of Legends globally.
The same investors who bankrolled Riot Games, FirstMark Capital and Benchmark Capital, are now hedging their bets on Meteor Entertainment. The startup publisher was able to outmaneuver traditional game publishers like Electronic Arts to secure Adhesive Games and its F2P sci-fi universe, HAWKEN. Mark Long, CEO of Meteor Entertainment, spent years working on traditional console games for a variety of publishers as the co-founder of Zombie Studios. He said the traditional publishing model, which requires game companies to invest tens of millions to hundreds of millions of dollars into the development of a game, is risky.
"We decided to give HAWKEN the same production value you'd get from a 'AAA' game but offer it across multiple platforms as a F2P title," said Long. "We're bypassing retailers and going direct to consumers globally on day one. This model is a very ambitious leap forward for developers and publishers."
Rather than relying on traditional marketing, publishers like Meteor used a free beta to let early gamers play the game while the developer fine-tunes the experience. The success of games like League of Legends has come from positive word of mouth, which is something that a TV commercial or banner ad isn't going to match. In fact, Long is taking his marketing for HAWKEN into a new transmedia realm. The company is developing a comic book, a live action Web series, and a feature film that will further expand the HAWKEN universe, and ultimately allow gamers to enter this world from multiple paths with zero friction.
The advent of powerful tablets and smartphones powered by NVIDIA (NVDA) Tegra technology has opened new devices for HAKWEN to be played on. New smart TVs and streaming cloud services like Sony's Gaikai will also play a role in how F2P games evolve and reach an even larger mainstream audience over time.
Russian game publisher Wargaming spent 12 years making retail PC games before deciding to go F2P with the WWII MMO World of Tanks. Pachter believes that game, which has over 55 million subscribers, pulls in over $150 million a year. At E3, Wargaming will be showcasing two new F2P WWII MMOs, World of Warplanes and World of Warships. The company will allow players to access all of these games, once launched, through a unified account system on Wargaming.net.
"There will be forums, leaderboards, and statistics for players to check out, as well as tournaments and other types of social events across all three games," said Victor Kisly, CEO of Wargaming. "I can see people jumping from tanks, to battleships, to warplanes, from time to time, just to get a different experience. Warplanes are faster and more adrenaline-fueled with 3-D space maneuvering, while Warships is more of a strategic kind of battling because they're slower and have big guns. Tanks is the classical middle in terms of strategy."
Crytek, the German developer that originated game franchises like Far Cry and Crysis, is embracing F2P with console-quality games like the modern military shooter, Warface. Cevat Yerli, CEO and president of Crytek, believes within three years F2P will rival the console games space from a quality level. Crytek will launch Warface on G-Face, a new platform that will support many new games, including from other developers.
"Over the next five years the core games are going to be social, and most of them will be F2P," said Yerli. "All of our IPs moving forward are being developed as social core games, and we're going to open the G-Face platform to other developers who want to launch F2P games."
Sony has already supported F2P games like CCP Games' space shooter DUST 514 and SOE's DC Universe Online and Free Realms on PS3. The game maker is supporting independent developers like Zombie Studios on PlayStation 4 with Blacklight: Retribution, a next-gen F2P shooter. At E3, additional next-gen games are expected to be announced by both Sony and Microsoft (MSFT).
While Pachter said traditional console games aren't going away, there's definitely a pendulum shift towards F2P as more game makers develop deeper, quality titles for this emerging space. Once gamers are given a choice of playing for free or paying $60 for a similar experience in their favorite genres, the impact of this shift could change the game for everyone.
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