California Done By the British

Will the economic situation in the US effect the Australian games development industry? Well, I guess we generally expect it to do so, but how much, exactly? I’ll use my modest understanding of economics to make some guesses and some analysis.

Of particular interest in the local development industry are the US:AUD and GBP:AUD exchange rates, for obvious reasons. Almost all Australian development is funded by investment from overseas, and the product is sold on international markets (predominantly to the classically highly consuming Americans), which means that both the initial investment and the returns on that investment are in foreign currencies. This is related to the developer/publisher model of the industry. Though the developer is responsible for the majority of the “intangible” elements of our newly intangible economy, though the abilities of the developer are what makes the difference between a successful and unsuccessful product (at least, in our idealised imaginings), the developer is still generally just a client of the publisher. As such, developers are subject to only being paid in the currency of the publisher, and so suffer on the whim of exchange rates.

The Australian dollar has been appreciating recently, of course. Just a few months ago the dollar was at it’s record of 92 US cents, up from less than 60 US cents just five years ago. To quickly put this in context, let’s imagine a project that might have been budgeted about one year ago for a US publisher wanting to pay a moderate 5 million US. Let’s imagine that 75% of the budget is in the form of milestones, of which there are 12, paid out every 2 months. So, each milestone payment is around USD$312,000. At the start of 2007, when the dollar was at the higher end of a trend that had lasted for a few years, that equates to about AUD$400,000. Today, at just over 90 cents to the US dollar, that’s AUD$346,000, about 15% lower. So, it’s not necessarily catastrophic, but over the course of just one year, it’s the equivalent of several years of strong growth. Over the past year, we’ve also seen a similarly dramatic appreciation against the pound, and so we see the same pressures from both of our two major sources of funding.

Note, however, that this isn’t a flat out 15% reduction in overall funding for the project. Milestone payments are paid out gradually over time, and subject to the exchange rate at that time. There are even financial tricks to makes sure the payments go through when the AUD is weakest. Given that our project cycles are 2 to 3 years, one project can see extreme appreciation or depreciation, and as a result the exchange rate is one of the key factors in success of lack of success of our local industry.

So will the dollar continue to appreciate? I’m no expert, and I’m somewhat out of touch, but there seem to be at least some continuing pressure for the Australia dollar to appreciate. In particular, the extraordinary interest rate cuts in the US, and the almost as extraordinary interest rate hikes in Australia have produced (and may continue to produce) a particularly significant variation in the economic situation between our two nations. The higher relative domestic interest rate is likely to naturally attract more foreign investment here, pushing the exchange rate up further. Note that this extra investment doesn’t have an affect on our industry, because our returns are always from global markets, anyway.

It will be interesting to see the impact that the new government has on exchange rates, also, after the poorly valued dollar of the middle Howard and Costello years. The primary economic goal of our new treasurer appears to be a reduction in inflation. This, presumedly, might bring a rise in unemployment, and it would seem logical that it might also cause appreciation pressures. After all, a less inflated dollar should naturally be a more valuable dollar, and a low inflation economy is likely to import less from a high inflation economy--however, economies don’t always work logically.

Apparently, the reason the Australian economy can support interest rate changes in the opposite direction from the US Federal Bank is due to growing shift to a more Asian-focused economy. This may even allow us to avoid following the US into a recession. But how would it affect our industry if the US, and perhaps Britain, were in recession, and Australia was not?

Well, if the US were in recession, you would naturally expect 3 things: US publishers would be less willing to make risky investments, particularly of the long term kind; US consumption of entertainment media would go down (though, from memory, this hasn’t occurred in past recessions); and, US developers would pitch at lower prices.

The first two have fairly obvious negative consequences (particularly when you consider that Australia developers are seen as, if anything, risky investments), but it is the third that is perhaps the most devastating. The reason for this is also the cause behind the domestic industry’s critical focus on economics, in general. For any developer, or group of developers, to survive in the worldwide market, they need to have some competitive advantage. For a long time, the key competitive advantage of Australia developers has been cost. It has been cheaper to make medium sized games down under than anywhere else in the world, without a drop in quality quite so extreme as that associated with India or eastern Europe. In other words, publishers don’t come to Australia for a product they can’t get elsewhere; they come for the same product, just cheaper. So if our projects are sold on the merits of their price, the possibility of our costs increasing while US costs are decreasing squeezes out our advantage. It should be noted, also, that readjustment of costs doesn’t actually need to occur for us to loose ground--it only has to be expected to occur. As long as publishers expect that at some time over the next 2 or 3 years, Australian costs will go up and US costs will go down, they become more attracted to the less risky prospects in the heartland of game development in the US.

Many Australia industries must have to deal with the same kinds of pressures, I guess. However, many of our export industries have a clear course of action in response. That is, they can change their focus to the growing Chinese and Korean economies. However, this is not a reasonable solution for us. For Asian economies to work for us, we would need to sell product there--it doesn’t matter if the publisher is Chinese or American or British. However, it’s unreasonable to expect that would be able to produce games that have any great credibility in a Korean or Chinese market which, like the Japanese, traditionally reject western entertainment media in preference for their own (furthermore, there is a hesitation associated with the widely accepted perception of IP-lawlessness in some regions). Though Australia is geographically close, and in some ways feeling more Asian as every year goes on, we’re still fundamentally western; if perhaps to our great detriment.

On a side note, perhaps this phenomenon may help put some weight behind the growing industry in Singapore, however.

So, the exchange rate, and the economic situation in the US are of particular interest and focus to Australia game developers. US politics, also, can play a roll. For example, 2008 is an election year, and it looks like many Americans are going to be particularly anxious about this one. Consider if there’s one candidate, later on in the year, that comes to be considered an “unsafe bet” in regards to the economy. Think of McCain’s recent admission that he knew little about economics, or Obama’s relative inexperience. I don’t know how the US election is going to turn out, but it seems like economic will be a major issue, and an election like that can cause publishers to hold off on new investments around for a time, which can have run on effects down here. Generally, we’re bound to the temporal boldness of the American publishers, even if there is no direct local economic effect.

So what happens when the exchange rate is out of our favour? Well, one answer is to say we need to tighten our collective belts. Another is to realise that different solutions can start to look more economical. For example, it can become more economical to use more foreign outsourcing and middleware components. That is, more economical, but not necessarily cheaper. This is the case for middleware, because many major middleware companies are in the US or Britain, and they can be paid directly by the publisher, without any currency exchange. It also holds true for art outsourcing, audio outsourcing, QA, contracting off site programmers, and other similar arrangements.

The common effect of all of these things is they reduce the amount of any given game’s budget that is being spent in Australia. While this may get the game done quicker, it also shrinks the size of the Australia industry, just as effective as reducing the number of projects. Furthermore, we can see this is as a big barrier of entry for any Australia middleware companies, particularly since publishers are used to paying for middleware in their own currencies. There may be an angle here, however, as while there are no Australian publishers to buy Australian middleware, selling middleware to Asian companies has been met with some moderate success.

So, what can we do to avoid impending disaster if things get worse? Well, I hate to say it, but no-one should be particularly surprised to find publishers becoming even more risk adverse. This presents opportunities in itself, given that a project idea that is particularly risk-free is a competitive advantage. It will be interesting to see if this turns out to be an advantage for Nintendo; given that their business model seems apparently significantly lower risk. That is, Nintendo can claim many quarters of profit, with few exceptions, and the games market appears to be less hit-focused. That is, a higher percentage of games are successful, though a lower percentage of games are extremely successful (I haven’t got access to the research figures to back this up, though). Furthermore, Nintendo’s very short hardware life-cycle and the very minor evolution of components we might expect from Nintendo in the future (as demonstrated by the step from Gamecube to Wii) are inherently less risky. To contrast, each hardware generation from Sony and Microsoft throws the entire industry into an extended period of uncertainty and risk (for both hardware and software companies)--it’s something we’ve come to expect and live with, but it can still be scary if you’re money is riding on the back of the success of one of the two. Lastly, and critically, Nintendo don’t have a direct competitor. They’re blessed with a market all of their own, and don’t currently run the risk of becoming marginalised by an upstart.

It seems unlikely that Australia would be able to gain a cost advantage on a level playing field, due to the economies of scale that are enjoyed in the core development areas. However, perhaps breaking free of the low-cost mould might allow an Australia developer the opportunities to market itself based on something else--perhaps appeal to a niche market, a unique approach or style. And yet, that’s just fashion--right? That’s where everyone wants to be.

So; the exchange rate and economic and political health of the US and Britain are of vital importance to any member of the Australia games development community. As long as we don’t have a domestically owned and funded publisher, we’re bound to the whim of overseas interests. Over time, this plays a large part in determining the periods of growth and contraction we see domestically. Eventually, we’re drawn back to the question of: what is it that’s unique about being an Australian game developer? What can we do here, that can’t be done elsewhere? And, from there, inevitably we’re draw to the even less answerable question: what’s so unique about being Australian, anyway?