“People like surprises” — that’s what Kerry Hopkins, vice president of legal and government affairs at Electronic Arts (NASDAQ:EA), told U.K. Parliament during a hearing on the ethical and legal liabilities of loot boxes. Also known as “gacha mechanics,” loot boxes were popularized by action role-playing games (ARPGs) long before a shade of notoriety would consume the mechanic in late 2017. Originally, loot boxes were designed as randomized drops at specific intervals. But by the time Kerry Hopkins stood in front of Parliament, it was too late. Electronic Arts’ aggressive take on the old mechanic had left its mark.
On the road leading up to Hopkins’ Parliament appearance, EA would launch a beta for Star Wars Battlefront II, a long-awaited sequel to one of its hit Star Wars games. The beta was met with backlash when critics noticed that “epic tier star cards” were stowed away within loot boxes. Star cards were essential to improving the abilities of users’ characters in online multi-player mode. By stashing star cards inside of loot boxes, users had to pay for random multiplayer advantages. Because of their randomized nature and cash-based system, critics viewed these loot boxes as a form of gambling. And since these games were marketed toward kids, the use of loot boxes raised even more ethical red flags.
The Loot Box Debacle
Loot boxes in and of themselves are not necessarily controversial. Trading cash for in-game advantages (often essential), however, is murky territory. So how did loot boxes go from a harmless early RPG mechanic (often derided aesthetically) to predatory cornerstone (with myriad legal and ethical implications)?
Before Apple (NASDAQ:AAPL) released the iPhone and eventually the App Store, in-game transactions, such as paying for high-value loot boxes, were not commonplace. But as free-to-play (or “freemium”) games climbed App Store’s charts, so did pressure to design games with loot box mechanics.
And the evolution of these mechanics was a shift from purely addictive entertainment toward separating casual players from their cash: “The most common mistake I see in the iPhone games I download is that the games are entirely too aggressive in attempting to charge their customers,” writes Damion Schubert of BioWare Austin. “Their ‘free-to-play’ games often ask the player to pay for more energy within five minutes of initial download.”
Mobile gaming, as it were, provided a new axis on which consumers interacted with technology. Mobile gaming thrived on impulse — the impulse to plug and play wherever, whenever — and design culture followed that thread logically. League of Legends, released not long after the introduction of App Store, arguably did more to further microtransactions than any other single game.
Designing the Controversy
Designers scrambled to implement loot boxes that would stimulate the same receptors in a player’s brain that a slot machine could. Matthew McCaffrey, lecturer in enterprise at the University of Manchester, describes it aptly in his paper, “The Macro Problem of Microtransactions: The Self-Regulatory Challenges of Video Game Loot Boxes”:
“The most sought-after rewards are rare, and barring a run of good luck, can only be obtained by repeatedly opening loot boxes, which requires significant time or money. … Opening a loot box is an event in itself, and is typically accompanied by lights, sounds, and other effects intended to make the experience exciting. As a result, a sort of cottage industry has emerged on YouTube and other sites in which players record videos of themselves opening loot boxes for viewers’ entertainment. Furthermore, players can sometimes trade loot with each other within a game or through third party platforms outside of it, meaning that in some cases rewards can be monetized (though this usually violates game operators’ terms and conditions). In fact, in some cases, secondary markets have emerged in which ‘skins’ (which can be extremely valuable) are traded between players, sold for cash, or wagered in online lotteries.”
Despite the prevalence of such microtransactions, EA went too far with Star Wars Battlefront II, and the company knew it. Because Battlefront II’s system amounted to paying “hidden fees” to remain competitive, EA relented. There no longer were star cards within loot boxes.
But when the pre-release trial of Battlefront II appeared, players were greeted with yet another system that encouraged the trading of real-world money for essential in-game items. Simultaneously, players discovered how futile it is to leave regulation in the hands of industry giants. This would become an issue of government intervention.
The Battlefront II System
Here’s how Battlefront II’s system worked: The game’s two currencies — credits and crystals — were earned separately; credits were earned by grinding (the act of repeatedly playing for in-game rewards), while crystals were paid for with cash. These credits unlocked highly sought after in-game characters, such as Luke Skywalker. And since Battlefront II hid lump sums of credits in loot boxes — boxes which were paid for with crystals; crystals which were bought with cash — players were effectively forced to exchange money for a competitive edge. Kotaku journalist Heather Alexandra described the system as paying for “statistical advantages.” Specifically, she explains that “[w]hen you only have so much time to play and other players can get an advantage from buying crates, the temptation to spend money and get some of your own will be high.”
In theory, you could grind the 60,000 credits needed for Luke Skywalker. But, as Reddit users discovered, you would need to grind for 48 hours to do so. The only feasible option was to pay for the loot boxes. This amounted to gambling, according to public outcries, but the Entertainment Software Rating Board remained steadfast in its commitment to not consider loot boxes as gambling. Self-regulation, the ESRB claimed, was the best path forward. As the uproar intensified, EA eventually removed crystals as an in-game currency from Battlefront II altogether. EA did not remove loot boxes, though, making them part of a random daily award given to players.
EA ended up selling nearly 9 million copies of Battlefront II between October and December 2017, shy of its target of 10 million, and the company eventual reinstituted microtransactions for cosmetic items only in March 2018.
The saga drove a stake into the ground, for both players and Electronic Arts. On the one hand, players catapulted predatory microtransactions such as loot boxes into the global spotlight. On the other hand, EA refused to acknowledge any wrongdoing, comparing loot boxes to blind-bag toys such as L.O.L Surprise! figures.
“We do think the way we’ve implemented these kinds of mechanics is quite ethical and quite fun,” Hopkins said in June 2019. “They aren’t gambling and we disagree that there’s evidence that shows they lead to gambling.”
It seemed that the controversy did not spur the end of predatory microtransactions. It only bought consumers a bit of time. According to McCaffrey, “loot boxes are innovations that cannot easily be understood in light of laws and regulations that were written in light of radically different technological and business possibilities.”
As we enter a new phase of the gaming industry, the edges of the perspective on loot boxes are jagged.
‘It’s In the Game’
Electronic Arts did not become notorious suddenly. Putting profits over users has served as a refrain throughout the storied publisher’s history. And in 2013, EA won its second “Worst Company in America” award. Chris Morran of Consumerist put it bluntly:
“Following last year’s surprise Worst Company In America victory by Electronic Arts, there was hope that the video game giant would get the message: Stop treating your customers like human piggy banks, and don’t put out so many incomplete and/or broken games with the intent of getting your customers to pay extra for what they should have received in the first place. And yet, here we are again, with EA becoming the first company to ever win a second Golden Poo from Consumerist readers.”
Unsurprisingly, EA “won” again in 2017.
A recent paper entitled, “Electronic Arts: Strategic Differentiation in the Global Video Gaming Industry,” authored by Thomas Teeter, a DBA student at the University of Incarnate Word, and Dr. Ryan Lunsford, a professor of the same university, discusses EA’s plan to transform the gaming industry. The plan isn’t all that different from what EA has been doing all along.
As the paper notes, Electronic Arts’ founding in 1982 was a “fundamental shift” in developing and distributing games. Whereas previously, small developers hawked their intellectual property (IP) wares directly to console manufacturers, Electronic Arts had a singular mission: find hitmakers, provide financial backing for game development, package and distribute the game under the EA brand. Rinse, wash, repeat.
Rinse, Wash, Repeat
The model worked. EA successfully built out its distribution networks and began acquiring companies for their technologies, IP and talent. EA stock went public in September 1989 and, since then, shares of EA have gained a whopping 21,248%.
But the company hit a rocky road in 2007. At the time, online gaming reached a mainstream watermark but EA struggled to adapt. Its CEO, Larry Probst, resigned and John Riccitiello took over. However, Riccitiello failed to move the needle, and he too subsequently left EA in 2013. New CEO Andrew Wilson saw the opportunity Riccitiello couldn’t. Under Wilson’s direction, EA feverishly built out its online services using technology from companies it had acquired, and it created a meaningful revenue stream out of in-game purchases and subscriptions. Around the time of its loot box controversy, the study notes that EA’s profits had become “dependent” on its services revenue.
In July, CEO Andrew Wilson wrote to investors for the company’s first-quarter report:
“We had a strong start to FY20, bringing rich new experiences to our growing communities for Apex Legends, EA SPORTS, The Sims and more. From great new games to live services with longevity, subscriptions on more platforms and competitive gaming for more franchises, we’re pushing to lead with innovation, quality and choice for our players.”
The model, while more evolved, is still very similar to the one that began with the company’s founding in 1982. Develop great IPs and distribute them year after year with minor upgrades and wall-to-wall microtransactions. That strategy is about to become supercharged as the gaming industry settles into the next biggest shift since mobile gaming — subscription services.
The Next Netflix
The video game industry is but the latest in a string of industries to adopt subscription models. Given EA’s increasing revenue in services, it makes sense that it would prioritize a cloud-based subscription model similar to Netflix (NASDAQ:NFLX).
Microsoft (NASDAQ:MSFT) already has Game Pass, which relies on downloads rather than streaming. Sony (NYSE:SNE) has PlayStation Now, which initially only let users stream games; and Electronic Arts has EA Access and Origin Access. Going forward, EA seeks to unify its service offerings. The higher margins these services offer are desirable. And EA sees plenty of ways to continuously squeeze profits out of its users. Despite its missteps with Battlefront II, the strategy has proven effective and EA stock is up 20.6% year-to-date.
Part of EA’s strategy from day one has been to find and cultivate others’ intellectual property. After years of financing and purchasing, Electronic Arts has become home to many technologies and ideas. The company’s plan for “One EA” attempts to unify all of the company’s resources. Teeter and Lunsford write that EA’s model is to “leverage” the company’s history of acquisitions, talent and IP. This will “create a value chain” of uniform game experiences across many platforms.
Actually, the entire notion of a “platform” may vanish altogether. EA’s “Project Atlas” aims to make cloud-based processing a reality that would remove the need for local hardware. This, writes Teeter and Lunsford, is what will help EA “identify ways to improve player experiences.” Considering EA’s track record, that translates into identifying savvier ways of profiting from always-connected gameplay.
The Current Path Forward for EA Stock
The stock’s upward trend since 2017 may have emboldened the company and its stock holders. EA’s unwillingness to change, however, should bother EA stock holders long term. This is especially true when you consider that the industry may just be leaving EA behind.
The current path forward for EA is to create a uniformed environment for users chock-full of AAA games. For this, users will pay a nominal subscription fee and recieve access to a (presumably massive) library of games. Because users are getting an entire library of games at Netflix-like prices, the expectation is that users will accept “surprise mechanics,” cosmetic or otherwise. Take Apex Legends, which launched in February 2019 from developer Respawn Entertainment, owned by EA. Legends costs absolutely nothing to play … nominally. But its Iron Crown event once again proved that EA will try to shove further monetization in players’ faces whenever possible.
“The Iron Crown event went really well except for the, you know, minor backlash,” Vince Zampella, CEO of Respawn, told IGN. “We are running a business and we do want to make money.”
The subtext, according to IGN commentator James Duggan, is that “[EA] is going to do this again.”
But just as Apple inadvertently popularized freemium mechanics and microtransactions such as loot boxes, its newest subscription-based platform, Apple Arcade, is a complete 180 from the freemium, microtransaction-heavy model that Electronic Arts emulates.
The Apple Arcade
For $4.99 a month, subscribers get access to 100-plus games with no ads and no additional purchases. Apple Arcade could redefine the concepts of mobile gaming and microtransactions. If players become used an ad-free, microtransaction-free experience, their tolerance for microtransactions will lower.
As a thought leader in many spaces, Apple’s ability to redefine existing industries and shape consumer perception cannot be discounted. As Kotaku’s Michael Fahey and Stephen Totilo put it, “Apple Arcade Is Mobile Gaming Without All The Bullshit.”
“EA must fix its reputation of putting profits over players,” write Teeter and Lunsford. Which, despite all the many things the company is capable of, doesn’t seem to register a blip on its radar. Whether or not people like surprises, I’d imagine EA’s stock holders not so much. Apple just threw EA’s entire strategy a curve ball even it can’t spin.
John Kilhefner is the managing editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.