Over the last couple of months, macroeconomic sentiment has continued to deteriorate as a 12+ year bull market unwinds. Inflation in the United States reached a 40-year high of 8.5% back in March, a weakening job market is driving increased risk of stagflation, and Russia’s ongoing invasion of Ukraine has NATO on-edge. The S&P 500 recently entered bear market territory (20%+ drop from the peak) and is currently down almost 15% year-to-date. Similarly, the Nasdaq Composite has dropped by more than 24% since the beginning of 2022.
All signals across the market are pointing towards an official recession. At Konvoy, we are confident that we are already in one and that the tracking indicators will show that with a 3-6 month lag. Central banks and consumers alike are bracing for the impact this will have on the global economy. Given our position as a gaming-focused venture capital fund, we recently wrote about the immediate effect we are already seeing in the gaming investment landscape. A few effects in early-stage gaming VC that we are seeing include compressing valuations, slower raise processes, and pulled term sheets post-signing.
In this context, it is interesting to note that the gaming market as a whole has generally been labeled a “recession-proof” industry. Given this is a theory that will very likely be tested over the coming months, today we wanted to review the merits of this recession-proof claim, a look-back at the past few recessions, and what is different in the gaming industry as we enter this next economic cycle.
Although gaming is only ~50 years old (relatively new compared to other industries), there are two relevant precedents to look at when considering how the gaming industry will be affected by macroeconomic cycles; the dot-com bubble of 2000 and the Great Recession from 2007 to 2009. Due to the availability of data, we are focusing on the latter. It is nearly impossible to call any industry that relies on discretionary spending “recession-proof”, as it is more about the magnitude of impact and corresponding recovery. That being said, we think there is a strong case for gaming to be viewed as “recession-resilient.”
The core historical metrics we are looking at include hardware spending, software sales, player engagement, and the performance of public equities:
1) Sustained Hardware Spending
The market size of the gaming industry as a whole was relatively unaffected over the course of the Great Recession beginning in late 2007. Consider the following data points:
While the industry’s growth was certainly underwhelming with a mere CAGR of 0.76% from 2007-2010, this demonstrates sustained consumer spending throughout worsening market conditions. This was most clearly demonstrated by the continued purchase of some of the most expensive equipment on the market: game consoles.
Over the course of the recession, unit sales for Wii, Xbox 360, PS3, and NintendoDS all grew even as the hardware aged. It is especially worth noting that there were not any notable product releases during this period as most of the high profile launches came in the years immediately prior.
2) Software: Signs of Frugality
Despite the relatively strong hardware sales, consumers did demonstrate their desire to cut costs where possible. This was particularly prevalent on the software side, as used game purchases saw an uptick compared to new game sales. The increase was particularly noticeable during Spring of 2009 (see below), as the recession had already been going on for over a year. Subscription services (now a staple of consumer SaaS) also gained traction as a budget-friendly approach that prevented players from sacrificing game experiences. During difficult economic times players find cheaper ways to keep gaming, but they do not abandon the industry or cease spending.
3) Player Engagement
In addition to maintaining spending, gamers continued to increase their playtime between 2006 and 2009. While playtime varies across seasons (holidays, class finals, back-to-school, etc), the year-over-year change each April is telling (see below). Average time spent playing video games each week increased by one hour each year, growing from 15 hours to 18 hours per week. There seems to be an inversely correlated relationship between player engagement and tougher market conditions.
4) Public Equities
Like the rest of the market, blue-chip gaming companies saw their stock prices tumble between 2007 and 2009. However, that does not reflect immediate performance issues for industry leaders like Electronic Arts, Take-Two, or Activision.
Looking at the discrepancies between revenue growth and stock prices, it is clear that these companies continued to deliver operationally (with the exception of Take-Two, which saw a very minor top-line decrease). It is a reminder that equity performance is not necessarily a proxy for the current fundamental health of a business. These stock price corrections reflected compressing revenue multiples and general bearish sentiment looking into the future. In line with the points above regarding continued spending and growing appetite for content, gaming corporations continued to thrive in the midst of strong consumer demand for their products.
In general, recessions have a tangible impact on daily life through more disciplined consumer spending. People not only become more conscious about how much they are spending, but also what they are spending their money on. Entertainment as a whole is a notable exception to this, as it remains resilient across market cycles. In fact, entertainment spending as a percentage of total household expenditures can actually increase during recessions. For example, this spending allocation was 5.6% in 2008, 4.9% in 2013, and 4.8% in 2020. This pattern dates all the way back to the Great Depression where entertainment spending was 5.4% of household expenditures.
It makes sense that the demand for entertainment is relatively inelastic during periods of instability, as people naturally seek distractions and sources of comfort. Within the broader entertainment space, gaming is particularly well-positioned given the amount of time value you can derive from a single experience at home. Rather than watching a 2-hour movie, you can play a 33-hour campaign such as Skyrim or infinitely replayable multiplayer titles like Call of Duty or League of Legends (both are free to play). As a result, it is not surprising an NPD report back during the Great Recession suggested that 65% of respondents intended to spend at least as much on video games in 2009 as they did in 2008. In the end, one out of every four dollars spent on entertainment went toward video games in 2008.
In short, it is clear that gaming is not impervious to macroeconomic cycles yet it is certainly not at the mercy of the broader economic climate. We believe gaming is essentially recession-resilient with strong fundamental tailwinds that are counter-cyclical in bad times and accelerated during bull markets.
Even in challenging economic climates, innovation in gaming continues to thrive. In 2008 alone the launch of the App Store fundamentally altered the course of game distribution, and legendary games such as Grand Theft Auto IV, Call of Duty: World at War, Dead Space, and Fallout 3 hit the market. Players will continue to pursue gaming as a core source of entertainment and also as a way of being social with their friends, family, and communities. As a result, we want to emphasize that consumer demand in gaming is not determined by price sensitivity or relative purchasing power, but rather driven by engagement.
2022: What’s Different This Time?
As we turn to the future and consider what an impending recession could mean for gaming, it is critical to acknowledge how much this industry has evolved since the last cycle. Here are some of the core advancements that we think will fundamentally change the way we experience a downturn.
1) Mobile Gaming: Over the last decade, the proliferation of smartphones has been a core driver of increased gaming adoption. This can primarily be attributed to the increased accessibility of video games, as players are not required to purchase separate hardware upfront (just play on your phones). Today, there are approximately 2.1b mobile gamers, 1.1b PC gamers, and ~700m console gamers (note: many people game across multiple platforms). Beyond adoption, mobile gaming also changes the way we interact with games by weaving them into our daily lives in a more seamless way. Unlike in 2008, the mass adoption of smartphones is going to be a key driver for gaming’s continued success in this current recession.
2) Emergence of Free-to-Play: During the last downturn, virtually every game title still operated on a premium model that required fixed upfront purchases. Since then, a number of games across mobile, console, and PC have switched to free-to-play business models that depend on advertising and in-app purchases. The size of the Free-to-Play industry is now approximately 78% of the gaming industry today.
Removing the upfront barrier to entry in a time where consumers are generally more cost conscious is likely to result in more consistent and predictable adoption of games. The advertising-based approach provides game developers more flexibility and downside protection as less of the financial burden is placed on players. These same players should be more willing to spend on games they already know and enjoy (this is the entire thesis around in-app purchases). However, free-to-play has never existed at a time when purchasing power and economic sentiment was low. We will see if these game titles encounter reduced advertising budgets (plummeting CPM) or a general “free-loader” problem of gamers playing without spending.
3) Gaming Viewership: The rise of gaming viewership (Twitch, YouTube Gaming, Facebook Gaming) has enabled a more passive way for gamers to participate in game communities and be monetized. This means that even non-players and non-spenders are becoming more valuable to the ecosystem as a whole. It is not entirely clear if this will be a net positive for the industry, as more cost-conscious players may turn to this form of entertainment. While game developers and brands can still attempt to derive value from them, it will generally be more challenging and less impactful.
Takeaway: Although historical indicators are certainly a valuable resource to understand how gaming has reacted to prior economic downturns, we are living in a new era of the industry. Business models have evolved, the social stigma associated with gaming has been greatly reduced, and video games continue to be a key source of entertainment and social engagement. We believe that the historical precedent from the last cycle and general advancements across the industry have positioned gaming to perform well throughout this current macroeconomic turbulence.