Video Games Zoom Onto Internet

As industry recovers from two-year slump, on-line market looms as challenge to profits

When Joe and Joan Consumer went shopping this past Christmas, they skipped the computer aisle and went instead to the video-game section. That's why sales of home computers were lackluster last year and video games are suddenly hot again after a two-year slump.

Game-company executives are breathing a sigh of relief. The personal computer (PC) no longer looks like the juggernaut that will take over the video-game industry soon. But another force is rumbling ominously. The Internet and on-line gaming threaten to turn the industry upside down.

"On-line is going to be the mother lode of gaming," predicts Tom Dusenberry, president of Hasbro Interactive, based in Beverly, Mass. "The Internet is becoming a viable mass market."

The company has already turned classic board games, such as Monopoly and Scrabble, into computerized versions playable over the Internet, and it has plans for more.

Other gamemakers are not as upbeat. But all of them are keeping a close eye on Internet gaming. The reason is profits. The Net, where games reside on-line and can be played for free, threatens the traditional model where companies sold their products in boxes at retail stores.

Another challenge is the technology. Because the on-line environment allows dozens, even hundreds of people to compete at once, games will require more time and money to develop, industry insiders say.

"1997 will be a year of experimentation," says Paul Matteucci, president of Mpath Interactive, which sells the popular Quake computer game. "In an interactive world, it should be possible to develop great games for the mass market. [But] the relative return on investment will decline."

The prospect of diminishing returns is daunting.

Still, the industry's perspective has brightened considerably from a year ago, especially for giants Nintendo and Sony, which make specialized game consoles. After peaking in 1993, sales of console hardware and software fell for two years, according to figures from NPD Group, a research firm in Port Washington, N.Y. But in 1996, industry fortunes revived.

Sales of console games rose nearly 9 percent, and the consoles themselves jumped a whopping 80 percent. Much of the increase stemmed from the Nintendo 64, a new game platform introduced in America in September. Nintendo Company sold 2 million of the $199 consoles in three months. And sales continue to be brisk. Nintendo recently said it plans to boost production from 700,000 units a month to 1 million a month through March 1998.

Several American game companies are also seeing a strong upturn. Electronic Arts, the nation's biggest game publisher, recently announced a 25 percent profit jump, year over year, for the quarter ending Dec. 31. Its games for PCs and for the Sony PlayStation console were especially hot sellers.

Another large gamemaker, Activision, saw quarterly profits more than double. Spectrum Holobyte posted a $5.7 million profit after losing money in the same period last year.

The immediate beneficiary of Internet gaming is likely to be the PC game industry, whose 1996 sales of $1.2 billion still lag behind the traditional video-game market.

Because many PCs are already linked to the Internet, any move to the on-line environment will likely be made by PC gamers first. "If Internet gaming starts to charge ahead, that will do wonders for the PC," says Jayson Bernstein, spokesman for ASC Games in Darien, Conn. But "I think everybody really wins."

Indeed, game executives expect that game consoles will evolve eventually to allow multiplayer games on the Internet. One Japanese console manufacturer, Sega Enterprises Ltd., has already launched an Internet service.

But Sega's fortunes in the game industry have sagged of late, and its entry into the on-line world has not helped, according to industry insiders. Two weeks ago, Sega announced it would merge in October with Japanese toymaker Bandai Company Ltd.

Two challenges remain. One is a technical flaw of the Internet, called latency, which creates an unpredictable delay between when a player hits a button and when the on-line game reacts. Although designers predict the problem will be solved soon, the delays are considered an obstacle to attracting action aficionados who prefer the immediacy of today's console games.

The other challenge is to come up with a business model for on-line game companies to make money.

"We're going to have to be very creative in moving product in the retail channels," says Chris Holden, chief executive officer of Kesmai Corp., one of the few on- line gaming companies to turn a profit so far. The Charlottesville, Va., company has teamed up with America Online and the Discovery Channel to make its games, such as Air Warrior, playable by many players at the same time.

"This business has become real in the last 12 months," Mr. Holden says.

Many are skeptical.

"The Internet remains an extremely tantalizing medium," says Doug Lowenstein, president of the Interactive Digital Software Association, a trade group in Washington. "But ... we are still several years away from a verdict about how ubiquitous the on-line entertainment marketplace is going to be."

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