After Netflix Shuts Down AAA Gaming Studio, A Faster and Cheaper Future Lies Ahead
Earlier this month Netflix shut down its Southern California game studio known as “Team Blue”. It was set up last fall and had its own major video game—aka “AAA title”—less than a year into development. AAA games can take as many as seven years to develop.
CFO Spencer Neumann outlined the strategic vision behind this bet at last September’s Bank of America Securities Media, Communications and Entertainment Conference: “[U]ltimately, our vision is to have games that are playable across multiple services, not just mobile, see us starting to do that a little bit with some early forays into being playing -- being able to play on the TVs as well as mobile.”
I wrote in August’s “Netflix, Generative AI Merge Games & Video Storytelling” that its current mobile games-focused model is “faster (two to four months development), cheaper (low to mid six figures) and possibly better (a question only consumers can answer)” than pursuing a AAA game.
AAA games are expensive. During a review of last year’s Microsoft-Activision Blizzard merger, the UK Competition and Markets Authority (CMA) found that AAA games greenlit in 2023 for potential releases in 2024 or 2025 typically received development budgets of $200 million or higher. With marketing costs, those budgets can go up to a billion dollars.
$200 million would have been 0.6% of Netflix’s total content spend of $32.9 billion since October 2022, when management revealed they were building this gaming studio. However, $750 million or more in marketing spend is greater than the marketing spend for Netflix’s entire business in each but two of the past eight fiscal quarters since September 30, 2022.
Presumably, Netflix’s scale and targeting capabilities would have reduced that marketing budget substantially. But, the question for this AAA game and its $17 billion content budget is the same: Why does Netflix still believe it must deliver blockbuster content from blockbuster budgets to win?
Key Takeaway
A future of faster and cheaper TV shows, movies and games for Netflix seems counterintuitive for a platform that once had Disney-like ambitions. Its decision to kill its AAA games business may have betrayed a competitive weakness and an uncertain future.
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The “Jupiter’s Legacy” Legacy
I have long argued that Netflix already learned a lesson with blockbuster budgets from the surprise cancellation of “Jupiter’s Legacy” in June 2021. The show was the first major series from its $50MM to $100MM acquisition of comic-book publisher Millarworld in 2017.
The show was “supposed to go on for several seasons” and Millarworld founder Mark Millar was launching a new 12-issue comic tied to it. Instead, the decision to cancel the $200 million show was announced less than 30 days after the debut of the first season.
I recently argued in “Netflix, YouTube & The New Business of Living Room Content” that this was one of two key pivots for Netflix’s business over the past four years. Before this cancellation, Netflix management had been talking up Disney to investors as their competitive aspiration in animation and the development of owned and original intellectual property (IP).
In that moment, Netflix ditched those aspirations. Instead, "it then built deeper into the more technological aspects of ‘consumer choice’—live streaming, games, advertising—to drive more engagement and consumer choice within its platform.”
From Disney to Gaming
Netflix’s decision to cancel “Jupiter’s Legacy” and its pivot to a gaming strategy are “tied at the hip” in both sequencing and timing.
In May 2021, Netflix was already looking to hire an executive to oversee an expansion into video games. In July 2021, it announced the hiring of former Oculus and EA game development leader Mike Verdu as vice president of game development, reporting to Co-CEO Greg Peters.
Its first gaming studio acquisition—Night School Studio—came in September 2021. It announced the acquisition of the Roald Dahl Story Company and its catalog for nearly $700 million. Then, it stopped acquiring major IP and instead focused on gaming.
About 16 months later, Verdu announced the first hiring for the internal studio which would become “Team Blue”. It went on to acquiredfour gaming studios: Night School, Boss Fight, Next Games and Spry Fox. It built another internal studio in Helsinki.
Netflix has launched over 100 games and told investors on its Q2 2024 earnings call that it has another 80 in development. Co-CEO Ted Sarandos alo told investors on the call that the objective with mobile games is to give “the superfan a place to be in between seasons [of a show], and to be able to use the game platform to introduce new characters and new storylines or new plot twist events.”
The message was that games are a faster and cheaper way to keep audiences engaged between seasons. The closure of “Team Blue” implies that Triple AAA games offered across multiple services and TVs may be “better” for gamers, but otherwise offer little upside to Netflix's business.
Why Did Netflix Bet On AAA Games?
The “Jupiter’s Legacy” precedent raises an important question: Why did Netflix bet on expensive blockbuster games after it had already learned blockbuster Hollywood content was both too expensive and risky for the platform?
There are two obvious answers. The first is economics: Netflix is in a position to shave off much or possibly all of AAA game marketing budgets that may reach $1 billion. A major video game priced at $70 with a combined budget of $1 billion and generating around 50% gross margins is going to require 28 million units sold. That outcome is unlikely but not impossible in gaming.
So, unlike a gaming publisher, Netflix can break even with fewer downloads. Combined budgets are substantially reduced if we assume lower marketing budgets and lower third-party shares of revenue—typically AAA game publishers share revenue with gaming platforms (e.g., Sony, Microsoft, Steam) and retailers (Walmart, Target, Gamestop, Amazon and e-tailers like Sony or Microsoft digital downloads).
Whereas, a gaming publisher will always rely on individual purchases, Netflix can monetize the consumer long after the download of a game through recurring subscription revenues. At an average revenue per member of $11 per month, Netflix would gross $70 per member in six months (assuming no churn).
Second, the “What We Watched” reports reflect a “power law” distribution where the difference between the consumption of the most-watched content and the rest is non-linear and exponential:
In the Hours Viewed for TV series, the top 70 TV titles or 1% of the 6,800 titles drove 20% of the viewing;
For movies, the Top 50 or 0.5% of the 9,360 movie titles drove 19% of the viewing.
There is a “power law” at play in its mobile games, too. According to data from digital intelligence and analytics firm Sensor Tower, games released by Netflix were downloaded 81.2 million times from Apple's App Store and Google Play in 2023. It also reported “GTA: San Andreas” is Netflix's most downloaded game of all time with nearly 10 million downloads since its December 2023 launch.
53% of Netflix’s total downloads came in the fourth quarter alone, implying that“GTA: San Andreas” drove over 12% of annual downloads and helped improve the performance of other games. If the “GTA: San Andreas” outcome is precedent, a blockbuster game with a blockbuster budget can work wonders for the broader Netflix business.
Netflix At A Crossroads
Instead, Netflix’s decision to kill its bet on AAA games may have betrayed a weakness that it is no longer in a position to be a disruptive force in media. On Monday, I highlighted how Amazon, YouTube and other Silicon Valley competitors are in far better positions to disrupt Netflix’s business than legacy media companies ever were.
I concluded:
“…the more YouTube looks and feels like Netflix both in product and in content quality, the more interchangeable the services will become on Netflix’s march to 500 million subscribers. The more both YouTube and Amazon capture advertisers’ spend on video, the more Netflix’s advertising offering will seem suboptimal for buyers.”
As a growing and increasing profitable business, Netflix's future is far from fraught.
But, both its stock price and its debt load have long benefitted from a compelling vision of a post-linear future. A future of faster and cheaper TV shows, movies and games—and where Silicon Valley competition has evolved from competing for attention to competing for consumer and advertiser dollars— seems counterintuitive for a platform that had Disney-like ambitions only three years ago.
It also may be the outcome towards which Marshall McLuhan’s “invisible ‘groundrules [sic], pervasive structures and overall patterns” of the internet have been shaping and driving Netflix's business model.
In other words, Netflix seems less in control of its own destiny.