Kevin Anderson The Guardian, Monday 21 September 2009

While newspapers and the music industry look for new ways to make as much money as they did before the dawn of digital, games makers are celebrating the success of the "freemium" business model. This model means that anyone can play for free, but they have to pay for access to higher levels or enhanced features in the game.

The online game Club Penguin, owned by Disney, probably is the best known freemium games success story. The game, created by a Canadian company, saw phenomenal growth after its launch in October 2005, going from 15,000 users at launch to 1.4 million by the following March. The runaway success did not go unnoticed, and Disney scooped it up in August 2007.

At the time of the purchase, Club Penguin had 12 million users, of which, 700,000 were paid subscribers. Based on the subscriber numbers and a roughly $5 monthly subscription at the time, it was estimated that the site was generating $42m in annual revenue.

A subscription, which has several tiers, gives players access to members-only rooms. Fans can also buy in-game accessories, and Disney, being the merchandising machine that it is, also sells Club Penguin toys, playsets and books. It is a model that online gaming advocates say could challenge the traditional heavyweights of the gaming industry.

The freemium models build on a long-standing practice in the games industry of releasing limited demos, a try-before-you-buy model. Players can play a limited version of the game or play it a few times before having to pay for the full game.

Hardcore gaming has led to a blockbuster culture, similar to Hollywood films, with high production costs. "The time is quickly approaching when development costs escalate beyond viability," says the tech blogger Jared Newman.

Development costs for the current generation of high-end consoles, Microsoft's Xbox 360 and Sony's PlayStation 3, range from $20m to $30m, and development costs for next generation consoles could average $60m, according to Ubisoft's chairman and chief executive, Yves Guillemot. Games often take two years or more to develop.

Although some analysts believed that games were recession proof, sales have fallen over the past six months. However, as sales of boxed video games have declined, online games, such as World of Warcraft and the myriad of games in Facebook and other social networks, are booming.

Kristian Segerstråle, the chief executive of the social gaming company Playfish, says it is moving from a boxed product to a service. According to the trends tracking company NPD, sales of boxed games are down 20% this year while online gaming is up 20%. Playfish produces Flash-based games for social networks including Facebook, MySpace and Bebo and also mobile games for the iPhone and iPod Touch. The market for Facebook alone is huge. The social network announced that it has 300 million users and is cash flow positive ahead of schedule.

The challenge for companies such as Playfish is to stand out amongst the 350,000 active applications on Facebook</a>.

To do that, Playfish has a different development strategy than for most console or PC-based games. For those games, the focus is what is happening on the screen, but Segerstråle says that his company tries to focus on what is happening between the gamer and his or her friends.

Playfish's first game was Biggest Brain, which pitted friends against each other to see who was the cleverest. Many of its titles, such as Pet Society or Country Story, are more about cooperation and self expression. "If you help each other, you level up faster," he says. "It is about reaffirming friendships."

Playfish was launched in September 2007. The company has raised $21m of funding in total with the backing of Accel Partners and Index Ventures. Of that, $17m came last October in a second round of funding, but Segerstråle says: "We haven't touched that." Unlike the heavyweights of the gaming industry, such as Ubisoft, EA or Activision Blizzard, "financial muscle is not necessary," he says.

The company has a very lightweight business. "We don't own a single server. We are all cloud based," he says. Cloud-based computing means that Playfish pays another company only for the computing power and storage it uses. Cloud computing is allowing many start-ups to keep their costs low but still meet demand as they grow.

The games are free to play but offer things inside the games that players might want to buy. It also sells ads inside the games.

Playfish has been successful in persuading a small percentage of players to buy things inside the games. On average, a paying player spends $10 to $40 a month. In Pet Society, it sold 4m virtual flowers last Valentine's day.

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