The consolidation the industry has seen lately is also a lot like Hollywood, where big studios have bought up independent film companies. The indies get the financial security and backing of a major player, while the established company gets the intellectual property and creative energy of an independent shop.

Already this year, there have been a number of acquisitions in the gaming sector. In August, EA announced it would buy Phenomic Game Development, the German maker of the strategy game franchises "The Settlers" and "SpellForce." In May, game maker and publisher THQ Inc. acquired the "Stuntman" game franchise from Atari Inc., and Activision Inc. bought video game publisher RedOctane Inc. In April, Microsoft acquired Lionhead Studios of Guildford, England, creator of the "Fable" series for the Xbox. In March, Vivendi Universal announced that its VU Games division completed the purchase of independent console developer, Radical Entertainment, for an undisclosed sum.

There is some good news for independent game makers and publishers: The release of next-generation consoles has sent demand for new titles soaring. Microsoft created a frenzy with the release of its Xbox 360 in late 2005, and anticipation is building for the November 17 release of industry leader Sony's PlayStation 3, though a manufacturing glitch will limit the number of units available. Nintendo's Wii, which will support simpler games with broader appeal, is also slated for a fourth quarter release this year. In addition, all three console makers have or will soon introduce Web-enabling game technologies. Even though the console makers have their own development teams, it's all about volume when it comes to introducing new games.

"It would be impossible for Nintendo to create all the games for its systems in house," says Beth Llewelyn, senior director of public relations for Nintendo of America, which since 1983 has sold nearly 2.2 billion video games and more than 375 million hardware gaming units worldwide. "Game Boy Advance [Nintendo's handheld gaming device] alone has a library of nearly 900 games. Partnering with other companies benefits Nintendo by allowing for a great depth and breadth of games for all our systems."

Despite the brutal competition between Microsoft, Sony and Nintendo, developers often create games that can be played on one, two or all three consoles. Some games might be exclusive to a particular console for a defined time frame or might include special content, available only on the GameCube, for example.

"The Nintendo GameCube version of the Soul Calibur II fighting game [developed by the Japanese shop Namco Ltd.] included our character Link from 'The Legend of Zelda' series," Llewelyn says. "That version sold dramatically better than all other versions."

Midway Games, one of the largest video game creators and publishers, this year has released "Rampage: Total Destruction" for PlayStation 2 and Nintendo GameCube, and "MLB Slugfest 2006" for PlayStation 2 and the Xbox. Known best for such games as "Mortal Kombat," "SpyHunter" and "Blitz: The League," Midway typically signs "a very long, detailed agreement with each of the hardware companies," that spells out technical and standardization requirements, says president of publishing Miguel Iribarren. Like most developers, Chicago-based Midway typically incurs all the upfront costs to make a game for one, two or all of the console makers, working with them along the way but realizing that Sony, Microsoft or Nintendo could pull the plug at any time.

"Those are such close relationships we talk to them every day," Iribarren says. "There's this whole give-and-take process. You are showing them the game at various points along the way and they are giving feedback." Once the game is accepted and coded to a console's specifications, it hits the retail market, where the two companies often share a percentage of the revenues.

While deal terms are rarely disclosed, sources say that for each $50 game sold, approximately $40 of that goes to the publisher, such as Midway, EA or Activision, which either developed the game in-house or cut a deal with an independent developer. The console makers, who rarely make money from the sale of their consoles (the latest versions cost between about $250 and $600), according to industry experts, would get roughly a $10 royalty from each sale of the game. When smaller video game makers partner with big-name publishers to help distribute their games, they also get a cut of the pie, though sources say royalty agreements vary. Every deal, large or small, is structured differently, with options including licensing deals, revenue-sharing pacts, distribution agreements or a myriad of other possibilities.

In the end, the console makers are eager to get as many titles into stores as possible since software is the bread and butter of the video game market. "Their interest isn't in turning us down and restricting the number of games," Iribarren says. "The tough part for us isn't getting the hardware companies to accept our deal."

Instead, video game developers say their difficulties lie elsewhere: competing with each other for consumer dollars. The average price to develop a high-quality game is anywhere from $8 million to $10 million. Cash-strapped startups simply can't survive, long term, with these ongoing expenses, and even publicly traded companies, like Midway, have faced tough roads financially these past few years. In August, Midway posted its sixth straight quarterly loss, with sales of $25.9 million in the second quarter, compared with $36.9 million during the same period in 2005. For the first six months of 2006, the company's net sales have plunged almost 30%.

"Midway Games continues to post operating losses amid rising development costs of next generation games," wrote analyst Brian Sozzi, of Wall Street Strategies, in an August 7 report. "Though it has some compelling titles for the new consoles in 4Q06 and 1Q07, it's hard not to view Midway Games as a laggard." Sozzi says investors in the gaming sector "have endured a trying 12-months of lagging share prices" overall, though signs are emerging that a cyclical upswing could occur.

For the international publishers, producing games based on popular movies, sports or products is an attractive alternative to developing original content. With their built-in audiences and name recognition, franchises are thought to be lower risk.

"It's an important set of relationships because at the end of the day consumers like things such as the ability to go with characters and franchises that are already familiar to them," says Michael Gartenberg, a research director at JupiterResearch.

Competition for these licenses is intense. In 2004, EA decided its "Madden Football" franchise, which has reportedly generated more than $1 billion in revenue over the past decade, was losing ground to "ESPN NFL 2K5," produced by Take-Two Interactive Software Inc. and Sega Corp. To battle back, EA negotiated exclusive publishing, development and distribution rights with the NFL to all interactive games, essentially cutting out the competition.

In other more recent franchise deals, Microsoft entered an alliance with 4Kids Entertainment Inc., the driving force behind properties such as Pokemon, Cabbage Patch Kids and Teenage Mutant Ninja Turtles.

"Microsoft was looking to get their Xbox 360 into a more kid-friendly place, so they approached us about doing similar things as we've done with Nintendo," says 4Kids CEO Alfred Kahn.

Publisher THQ announced it is developing a game based on HBO's series The Sopranos for the Xbox 360 and PlayStation 2 consoles this coming holiday season. Activision announced in May that it signed multiyear exclusive agreements to develop and distribute new video games based on Mattel Inc.'s Barbie doll brand and Sony/EON Production Ltd.'s James Bond character. It also has a deal with DreamWorks Animation for the exclusive video game rights to four upcoming feature films and to possible future "Shrek" films. Activision's alliance with DreamWorks alone has resulted in more than $300 million in video game sales worldwide, the company said in a press statement.

Still, such deals haven't necessarily translated to a more attractive balance sheet for Activision. Year-end revenue between 2005 and 2006 remained relatively flat at $1.4 billion, and the company posted a net loss of $18 million in the quarter ended June 30, 2006.

"This is a really hostile market," says Rob Enderle, principal analyst at technology research firm Enderle Group. "You are only measured by your last great title and if nobody is buying your title, you're pretty much gone, if you're big or small." - Cheryl Meyer

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