Where does my money go?

Where does the money go when we buy videogames?

It's a question we don't often ask ourselves. When big-budget, blockbuster games are released on any given Friday, we fork out our cash like we put out the rubbish. Whether it's Halo, FIFA, Call of Duty or World of Warcraft, the path our 40 quid takes from wallet to record-breaking sales headlines is a mystery. What percentage goes to the shop selling you the game? How much does the publisher get? How much does the game creator end up with?

There are no simple answers. Different publishers arrange different deals with different shops for different games. Some, such as Grand Theft Auto IV, are made in-house by publisher-owned studios. Others, such as the Slightly Mad Studios-created Shift 2: Unleashed, are developed by independents. And some, like Rare's Kinect Sports, are produced by console manufacturers. But Eurogamer has compiled a rough guide based on information provided by various publishers and developers that can be applied to the sale of most boxed console games in the UK.

If you bought a game in the run-up to Christmas and it cost £39.99 to buy, approximately £7 (17.5 per cent) went on VAT (that figure increased to 20 per cent as of 4th January), while £10.50 (27 per cent) went to the shop and £12 (30 per cent) to the publisher.

The rest goes on what's called cost of goods: the nuts and bolts of videogame publishing. 65 pence (two per cent) goes on distribution, £1.75 (four to five per cent) on marketing, and an £8 (20 per cent) licence fee goes to the platform holder (Microsoft, Nintendo or Sony). All these costs are paid for by the game's publisher. If a third-party is behind the game, approximately £3 goes to the developer, or 25 per cent of the publisher's revenue after deductibles, although developers are often paid in a series of advances as they meet milestones.

The waters are muddied by the various complex deals signed between publishers and developers. If a game is sold digitally, perhaps on Xbox Live, PSN or Steam, there is no need for it to be pressed onto a disc or sit in a warehouse waiting for that magical ship date when it's sent across the world in cargo planes and trucks to the shops that sell it.

If a game is created in-house, the publisher need not pay a developer at all - but bonuses can apply. This is the case for Activision's Call of Duty series, which is produced by internal studios Infinity Ward, Treyarch and more recently Sledgehammer Games, and Electronic Arts' FIFA 11, made by the EA Canada team in Vancouver.

Activision's Call of Duty series is one of the most profitable of all time.

Bonuses often relate to sales and an average review score. This, explains Philip Oliver of YooStar 2 creator Blitz, is why Metacritic has become so important to publishers and developers.

"They will work out the budget for the next Call of Duty, $35 million, and they'll go to the project director and say, 'You better bring it in for less, and I'm going to bonus you on how much less, versus the Metacritic quality,'" Oliver says. "Metacritic is used as benchmarks for quality. It takes the guesswork out of answering the question, 'Did you do a good game or not?' They can use it to say, 'We'll go on that score. If you get above 85 per cent, we'll pay you a bonus of X.'

"We've had several development contracts like that. Yes it does get used."

For independent developers, securing a good deal with a publisher ensures their continued existence. It is essential to their survival.

"We have a great relationship with THQ," Oliver explains. "It's mutually respectful. There are other people at companies, and maybe even THQ for all I know, that almost want to get it as cheap as I absolutely possibly can, and the minute you sign the deal, I'm going to squeeze you on getting more than I paid for. That's their job.

"In fact, a producer did say that recently to us, that that is his sole job, to get the money he's spending down and to get the content he's buying up.

"That doesn't help for a long-term relationship. Long-term relationships respect the other parties need to make a profit."

The fact remains that developers, the creators of the games we love, receive less than 10 per cent of the increasingly bulging revenue pie. The financial reward for creating successful games can obviously be gratuitous: We hear stories of John Carmack's garage packed with Ferraris, Cliffy B rubbing shoulders with US talk show hosts and COD creators Vince Zampella and Jason West signing with talent agencies and think, well, it can't be that bad. But for so many game creators, 10 per cent is as good as it gets. And sometimes, they can end up with nothing.

"If the product never sells more than it takes to recoup the development budget, there are no royalties paid because all those royalties are going back towards what the publisher funded in the first place," Andy Payne, managing director of Mastertronic Group, tells Eurogamer.

Is this situation, this business model, fair?

"If you look at that equation, everybody is taking their fair share," Oliver says. "That leaves you where you are. It's a fact of life."

Payne agrees. "Everybody thinks everyone else is making money out of them. Everyone," he says. "There are a lot of pockets there to fill. It's little bits and pieces. People think it's outrageous because they don't understand what else is in the value chain. There's not much else at retail you can do to cut links out of that chain."

VAT is, of course, an immovable object. But shops decide how much games cost to buy. Could that be cheaper? Unlikely, Oliver and Payne agree. And publishers are set in their ways because of the cost of production. To produce Call of Duty, Activision pays a horde of computer scientists, artists and animators a salary over the course of two years of development - a huge, undisclosed amount.

"Publishers will try to get as much as they can out of a game," says Eidos life president Ian Livingstone. "That's what they're in business for." And, the better and more popular the game, the "more likely" a publisher will be able to "command a large piece of the pie". "It's supply and demand," the business brains behind Lara Croft says.

Black Ops had numerous pre-launch offers and incentives available, including trading in rival EA's Medal of Honor.

Publishers and shops engage in an endless tug of war over the cost of games, as Oliver explains. "When EA's selling out its games, it's going to have its sales manager on one end of the phone saying, 'This is the wholesale cost of my product.' If you're a little guy and you're dealing direct with this sales person, really you're going to have to pay what EA says or just not take it.

"If you're Tesco or somebody with buying power, you can negotiate a percentage off. But EA isn't going to move much because it knows however much it moves it's always moved that much. If you knock five per cent off for me this time, you've just knocked five per cent off every product going forward. It's going to be difficult to get back from this place.

"So they won't negotiate much. They'll say, 'Other people are taking it. If you don't want the stock, that's fine. We'll sell it to other people.' They have to act pretty hard-nosed, one, to keep their profit margin, and two, to not set a precedent for the future."

Oliver believes publishers could shake things up a bit, however, by selling games at half the price and, therefore - theoretically - shift twice the number of units. But, "It's going to take a brave, maybe even a stupid publisher to reduce the price when they know the consumer is going to pay it."

In some cases we've even seen the publisher raise the traditional RRP. One recent, high-profile case was Activision's Call of Duty: Black Ops. "If I brought out the next Modern Warfare and I know I'm going to sell 15 million copies at $50, am I going to take the punt?" Oliver wonders. "I already know that, and I can bank on that. Am I going to take the punt to drop the price significantly, hoping to get those extra sales, when it's not price that's driving the buying decision? I either want that game or I don't want that game.

"Last year they put Modern Warfare 2 up by five or 10 dollars, saying, 'If you want it, you'll pay it.' And they did."

Payne says publishers could reduce the cost of games by slashing marketing spend - "the best marketing is your mate telling you it's the best game ever" - but Rod Cousens, CEO of Formula 1 creator Codemasters, won't budge. "Essentially, on that model, there's a real risk of losing money," he says. "You pay £12-20 million to create the game. Maybe more. It can be a high-risk business. It's not an equitable deal."

What of Sony, Microsoft and Nintendo, the companies that invest billions into the research and development, manufacturing and distribution of consoles? Could they reduce the amount they charge publishers to release games on their platforms?

"That wouldn't be for me to say," Payne says. "Work that one out for yourself."

Oliver is more blunt. "With the console manufacturers, there is no negotiation there. They're hardly going to allow you to negotiate on those costs of goods knowing if they negotiate once and they change the price once, they're always going to have changed the price."

There appears to be a stalemate, then, with the various players deadlocked as they stubbornly stick to established modes of thinking. But nothing lasts forever. Can, and indeed will, videogame prices go down?

It's a difficult question to answer. The industry is in a state of flux, with self-publishing and the digital space now almost as important as the sale of boxed games and bricks and mortar. The emergence of mobile devices such as iPhone and iPad as profitable game platforms has torn up the rulebook. And the problem the second-hand market poses demands an investigation all of its own. But we can speculate about the future of the 40 quid you hand over in exchange for videogames in shops - if indeed shops continue to exist.

"The whole market seems to be polarising," Livingstone says. "The triple-As, the real blockbusters, seem to be selling more. At the other end of the arc of sales there are niche titles that continue to sell well and budget titles will sell well. But the whole middle-ground seems to be challenged. That's where there will be a lot of price erosion. The middle ground will be compromised. Triple-A games will continue to command a premium price."

Remember when this cost £70?

While it's likely that triple-A games will continue to demand a premium price, in truth games have never been cheaper. Who can forget £70 N64 games, the GoldenEyes and Lylat Wars of the cartridge era?

"As a box I'm not sure it changes other than you get margin erosion and you get lifecycle management through the history of the game," Cousens says. "Don't forget the cost of software has been pretty static for the last 15 years. Mortal Kombat on the N64 we put out at 70 quid when I was at Acclaim, and we didn't have any trouble selling the volume we did.

"Typically it's been £40-50, and yet the cost of development has probably gone up by a factor of five to 10. And you've got a fragmented hardware base to sell to now, so it's more challenging."

Today, supermarket price wars force the cost of videogames down to quite astonishing levels - even at launch.

"Argos or Tesco have said, 'Buy the latest blockbuster from us and it's cheaper,'" Oliver says. "They're making no money on it. It's a loss-leader to get footfall, and hopefully you'll buy other stuff while you're there."

A whopping 63 million console and PC games were bought in the UK last year. In 2010 the UK games market was worth £2.875 billion. It is a huge pie, but increasingly fragmented. These days savvy gamers shop around online for the best prices and specialists routinely slash the price of new videogames at launch while supermarkets undercut each other. There are some astonishingly good deals to be found out there. Gamers, even in these bitterly tough economic times, have never had it so good. But at what cost?