Videogame Giant Electronic Arts
Links With Sony, Snubs Microsoft
EA Shows Its Clout and Wariness
Of Letting Xbox Dominate Market
By ROBERT A. GUTH
Staff Reporter of THE WALL STREET JOURNAL
Electronic Arts Inc. became the king of videogames with the likes of
Tiger Woods and John Madden. Now it's using these allies to challenge
the king of software: Microsoft Corp.
The next great battleground for the $27 billion videogame industry is
online games -- and there, Electronic Arts is about to throw its
considerable weight behind Sony Corp. Tuesday, it plans to announce
that when it takes the long-awaited step of putting its biggest
blockbuster sports games online, they will be only in versions for Sony
game machines.
The exclusive deal shuts out rival game-machine makers from access to
the popular EA Sports line in its new online form. It's a particular
rebuke to Microsoft, whose Xbox competes with Sony's PlayStation 2. In
its drive for a dominant role in online games, Microsoft tried again
and again during the past 18 months to persuade Electronic Arts to add
its games to Microsoft's own online game service. But Electronic Arts
executives decided Microsoft was demanding too much control over
Electronic Arts' games and wasn't willing to pay the company for their
use.
The snub by Electronic Arts puts Microsoft in an unfamiliar position.
Accustomed to having the upper hand as the owner of software that all
personal-computer makers need, Microsoft now confronts a cagey software
maker that holds the best cards. Electronic Arts is the world's No. 1
game maker, thanks in large part to its sports hits such as Madden NFL
and Tiger Woods PGA Tour.
The confrontation came to a head April 16 at the Redwood City, Calif.,
headquarters of Electronic Arts. Sitting in his boardroom with Robbie
Bach, Microsoft's videogame chief, Electronic Arts Chairman Larry
Probst gave his final word on the matter: Electronic Arts was going to
"build something big," and it wouldn't be with Microsoft. "There's a
100-foot wall between us," Mr. Probst said in an interview in which he
recounted that meeting. "We are not going to capitulate on this."
The decision to side with one partner is a break from Electronic Arts'
longstanding practice of building games for all major players including
the PlayStation 2, Xbox and Nintendo Co.'s GameCube. It continues to
make games for Microsoft and Nintendo. But in the emerging online
market, Electronic Arts says it will remain exclusive to Sony through
next March. (Sony's success with PlayStation 2 is a rare bright spot
for the trend-setting company.)
The clash is emerging at a critical juncture for the electronic-game
industry, one that could determine winners and losers for years to
come. Most consumers now play videogames as they have for two decades:
alone or in pairs on home machines hooked to television sets. If the
industry can get those gamers online, it could provide a steady revenue
stream through subscriptions, helping level off an industry
characterized by boom-and-bust sales cycles.
Electronic Arts has racked up $300 million in losses on several big
online failures. Today it offers only a handful of games online in a
service that hasn't taken off. But now with broadband connections
becoming widely available and renewed online efforts by gamemakers,
online games could finally be ready to catch on.
Microsoft has invested heavily in its Xbox Live online game service, as
part of a broader mission: to control the direction of home
entertainment in much the same way it does for personal computers.
As Microsoft envisions it, online videogames would create a path to
sell a host of other subscription services as well as software that
links game machines to PCs, handheld computers and other digital
devices. Xbox Live could also put Microsoft in control of customer
relationships with game buyers, wresting that role away from game
makers.
"The time is right for us to establish a position [in online games] and
start setting the agenda for what the future of the digital
entertainment lifestyle holds," says J Allard, the Microsoft vice
president in charge of Xbox Live.
Microsoft wanted Electronic Arts games on its network, but Electronic
Arts executives say Microsoft wouldn't agree to share portions of the
Xbox Live subscription fees with publishers of the games that are
played. Electronic Arts and other publishers argue that could give
Microsoft unfair control over pricing and influence over customers.
Microsoft's strategy "is very simple," says Mr. Probst, the Electronic
Arts chairman. "They collect all the money; they keep all the money."
Microsoft won't comment on its financial arrangement with specific game
publishers. When asked about the dispute with Electronic Arts, Mr.
Bach, the Microsoft games-division chief and senior vice president,
says Xbox Live can help game makers by boosting their sales. To access
the Xbox Live service, players must first purchase the individual games
from publishers.
That Electronic Arts could simply walk away from the negotiating table
with Microsoft is a sign of the videogame industry's new dynamics. Once
a fragmented field with hundreds of small players, it now sees clout
concentrated among a few big players who have the wherewithal to
continually invest as much as $10 million to $20 million in single
games and the sales volume to command shelf space at retailers. Sales
of videogame hardware and software reached $10 billion last year in the
U.S., compared with about $9 billion for movie-box-office receipts.
Electronic Arts has exploited those changes better than any game
publisher. Years ago the company started signing deals with
professional sports leagues such as the National Football League and
big names including Messrs. Madden and Woods and more recently Jason
Kidd of the New Jersey Nets and this year's No.1 NFL draft pick, Carson
Palmer. Under Mr. Probst, a savvy negotiator and hard-nosed leader,
Electronic Arts combined extensive market research with rigorous
development schedules to turn its EA Sports brand into one of the most
profitable and recognized game franchises. It dominates nearly every
major category, including football, basketball, soccer, baseball and
golf.
On that foundation, Electronic Arts has built other winning franchises,
such as games based on movies including the Harry Potter and James Bond
series. Last week Electronic Arts said for the year ended March 31 it
posted a net profit of $317 million, a nearly threefold increase from
the previous year, as the company benefitted from big sales of
Playstation 2 games. Sales jumped 44% to $2.48 billion.
That caps 15 years of compounded annual growth in revenue of 30% and
net income of 36%. At the end of March, the company held $1.6 billion
in cash and had no debt. Its share price has more than doubled over the
past five years. In 4 p.m. Nasdaq Stock Market trading Friday,
Electronic Arts shares were off 24 cents at $61.55.
Game publishers such as Electronic Arts and makers of game machines --
Sony, Microsoft and Nintendo -- are co-dependent: Sales of one rely on
sales of the other. That makes it hard for one side to strong-arm the
other. Also, while Electronic Arts dominates its industry, surprise
hits can come from nowhere. Grand Theft Auto, a driving-and-shooting
game that outsold all other U.S. games in 2002, emerged from a once
little-known New York publisher, Take-Two Interactive Software Inc.
Still, when Electronic Arts flexes its muscles, it can have stark
results. The company's decision several years ago not to build games
for Sega Corp.'s DreamCast game computer was one of the primary reasons
that cutting-edge machine died, inflicting huge losses on Sega. When
Sega countered last year, attacking Electronic Arts head-on in sports
games, Electronic Arts batted it down. During an internal strategy
session in Tokyo last year, Sega executives searched for sports areas
that Electronics Arts doesn't dominate. One conclusion: swimming.
When Microsoft decided, in the summer of 1999, to build the Xbox, one
of its first stops was Electronic Arts' headquarters. Electronic Arts
announced in December 2000 that it would produce eight games for the
Xbox. Both Mr. Probst and Microsoft's Mr. Bach emphasize that this side
of the companies' relationship is still strong. Electronic Arts has
some 15 to 20 Xbox games under development.
But even as Electronic Arts and Microsoft prepared the Xbox games in
2001, differences surfaced in the online business.
One of the biggest obstacles to making online gaming more widespread
has been the huge investment needed in servers and software to run the
multiplayer games. Not wanting to take the risk, many game makers
didn't invest. Those that did -- such as Electronic Arts -- couldn't
make money at it.
Microsoft's answer to that problem was simple -- it would invite game
makers to put their games on a central online service that it would
run. With a single password, gamers would be able play games from any
game maker on the Microsoft system.
Many publishers privately worried about the Microsoft model because it
put Microsoft between publishers and their customers. In traditional
videogames, publishers sell gamers disks at retail stores such as
Wal-Mart. Under Microsoft's online plan, gamers still need the disks,
but the entire online portion of the game would be in Microsoft's hands.
Enter Sony, which last year came up with a counterplan that alleviated
such concerns. Its offering will allow game publishers to run their own
computers and manage their own customers. Sony said it would just ship
to retailers a $40 specialized modem and software for the PlayStation 2
that would let gamers connect using any online service.
The game publishers would still have to invest in Internet
infrastructure to set up their online games, but they would maintain
control of the revenue and the relationship with the game players. The
publishers would pay a royalty fee to Sony -- which would help with the
development and security of the gaming sites, shoulder some of the
marketing costs and deliver its large audience to the gamemakers'
doorstep.
The Sony plan appealed to Electronic Arts because it offered more
flexibility and a bigger potential market, since the PlayStation 2 far
outsold the Xbox. By spring 2002, Electronic Arts began publicly
distancing itself from Microsoft in the online business.
That was clear last May at the Orpheum Theatre in Los Angeles. On the
eve of the annual industry exposition, Microsoft pledged it would spend
$2 billion during the next five years on the Xbox, including investment
in Xbox Live. Microsoft shined spotlights on its supporters in the
audience. Electronic Arts was conspicuously absent.
The same evening across town, Electronic Arts was preparing an online
version of Madden NFL 2003 for a demo the following morning at a Sony
strategy briefing. During the demo, Minnesota Vikings quarterback
Daunte Culpepper had an online scrimmage with Tennessee Titans
defensive end Jevon Kearse, thousands of miles away. Mr. Madden razzed
the two pros via live video feed from San Francisco. When Electronic
Arts opened the game to the public later in the year, it was one of the
first videogame-machine blockbusters to go online.
Following the expo, Microsoft forged ahead with efforts to sign up
games for its new service. But by October, when Electronic Arts shipped
its first Xbox version of Tiger Woods PGA Tour 2003, Microsoft had
still failed to woo Electronic Arts into its online camp.
In fact, Electronic Arts was growing closer to Sony. That month,
executives at Electronic Arts approached Sony about moving the EA
Sports franchise online in a more serious way. One reason: the strong
response to the experiment with Madden NFL online. While the numbers
weren't large, they showed Electronic Arts executives that the online
market was emerging faster then they had thought it would.
So around that time, Electronic Arts and Sony started working out the
financial details of the online service. Electronic Arts started making
online versions of games that could handle both Sony's and Microsoft's
online systems.
On Nov. 15, Microsoft opened Xbox Live to the world with plans to
deliver up to 14 online games by year's end from game makers including
Sega, Ubi Soft Entertainment and THQ Inc. It still had no deal with
Electronic Arts.
As 2003 got started, Mr. Probst says, "it just became increasingly
clear to us that we were not moving the needle toward our side" in
discussions with Microsoft. In February, Sony announced details that
Electronic Arts had requested: a royalty structure for its online
business.
With the game exposition approaching in May, Electronic Arts executives
at a meeting on March 10 pushed forward the talks to give Sony
exclusive rights to EA Sports online, says a person at the meeting.
With an exclusive deal with Sony in the works, developers scrambled to
ready EA Sports games for the PlayStation 2 online, not Xbox Live.
The last meeting came in mid-April, when Microsoft's Mr. Bach and his
team dropped by to brief Electronic Arts on the progress of the Xbox.
Mr. Bach declined to comment on the meeting. After the team filed out
of the room, Mr. Bach sat with Mr. Probst, who issued the warning that
Electronic Arts was going to build a service. "Robbie, you don't need
us, and we don't need you," Mr. Probst says he told the Microsoft
executive.
At this year's videogame-industry convention in Los Angeles, Electronic
Arts and Sony Tuesday will show how Tiger Woods gamers can golf against
players across the Internet, create computer-graphics versions of
themselves, shop at virtual pro shops and compete for real prizes in
online tournaments. The game is scheduled to ship in the fall following
the release of EA Sports' online versions of Madden NFL and a
basketball title, NBA Live. The service will also include Electronic
Arts' NHL 2004, MVP Baseball 2004, FIFA Soccer 2004 and NASCAR Thunder
2004.
Microsoft's Mr. Bach acknowledges the rift with Electronic Arts but
says Microsoft is seeing stronger-than-expected growth in subscriber
numbers to Xbox Live. "We're growing just fine without them, but I'd
love to see them on the service," he says of Electronic Arts. He adds
that by the end of the year, Xbox Live will feature 50 games.
"We just stay in discussions with everybody, and so far the people
who've gotten on board have been very successful," Mr. Bach says.
Write to Robert A. Guth at rob.guth@wsj.com
Updated May 12, 2003 7:56 p.m.
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