Analysis: Fortnite may be cannibalizing the biggest franchises

[CORRECTION: this article previously referred to “total digital console sales.” This analysis is specific to in-game additional content (microtransactions, DLC, etc.)]

TL;DR: Despite claims of an industry-wide growth spurt carried by Fortnite’s success, several signs indicate material cannibalization across top incumbent franchises.

In the lead-up to this quarter’s earnings cycle we are revisiting some recent industry developments to gauge their impact. One that stands out above all is Fortnite.

Epic’s success needs little introduction: Fortnite has managed to break records in a short amount of time and dominated headlines for months now. During Q2 Fortnite continued its impressive run this quarter, and we’re now seeing signs of wallet-share shifting away from other top console franchises. This lends credence to the narrative that Fortnite is growing the overall pie to some degree by bringing lapsed and new users into the mix, but also that there is a clear impact being felt across other top games. Particularly in a post-E3 market that is gearing up for its final sprint toward the holiday season, persistent growth and continued success (over $1 billion in lifetime earnings) raise the question whether or not Fortnite’s success carries a strong downside for incumbent publishers.

At last quarter’s earnings, executives from two major publishers acknowledged Fortnite’s meteoric rise but beyond welcoming its innovative game play mode did not attribute any erosion of their own titles as a result. Activision Blizzard (ATVI) reasoned that its players  “always come back to the franchises that are the foundation of the communities that they are a part of,” and Electronic Arts (EA) argued that “it’s bringing younger people into the marketplace and younger people into first-person shooters.”

This is consistent with the broader industry trend of a growing addressable market. Over the past decade the popularization of smartphones, online connectivity, and business model innovation has greatly expanded the number of people that play games. Moreover, online multiplayer games tend to benefit from network externalities that facilitate an accelerated momentum in the growth of their user base. Fortnite’s platform agnostic approach of releasing on every available platform (ie. PC, Nintendo Switch, Apple iPhone, Sony PlayStation, Microsoft Xbox) has so far ensured a strong initial momentum. We expect Epic to continue to benefit from this strategy based on its announced $100 million investment in esports and other activities.

The response from incumbent game companies has been one that attributes the title’s success to the phenomenon of “all boats going up” and refuses to address the issue of market competition. There are signs, however, that warrant concern.

First, there exists considerable overlap between the consumer profile of a Fortnite player and that of people playing League of Legends, Counter-Strike: Global Offensive, and Overwatch. Audiences that like these titles generally also enjoy watching others play on streaming sites like Twitch. In terms of online viewership, we’re observing the following: in Q2 total hours watched were up +59% for Fortnite, compared to League of Legends (-19%), CS:GO (-51%) and Overwatch (-16%).

Granted, some of these are highly dependent on tournaments and experience fluctuations around them. Esports-heavy titles draw much larger online audiences around and during events. But that does not negate the fact that a relative newcomer has successfully managed to push incumbent titles down the rankings. (This should be of particular interest to Activision Blizzard as it readies itself for the final of its first Overwatch League this week, which will serve as an important proofpoint for the first batch of sponsors that has invested in the contemporary esports advertising model.)

Second, the release as a free-to-play console title has facilitated remarkable growth patterns. Last week, Microsoft reported a +39% increase in earnings from its gaming division, which it attributed largely to ‘third-party publishing’. In its earnings call, the company declined to divulge what titles were responsible for this growth. This comes at a particularly notable moment as console gaming has entered the final stage of the current hardware life-cycle and platform holders are looking to transition to a service-based model. Fortnite presents an important component in the future strategy for console manufacturers Microsoft, Sony, and Nintendo. Recently, Sony’s refusal to facilitate cross-platform multiplayer gameplay met with consumer disappointment.

Looking at additional content console sales the following image emerges: Additional content sales, here defined as the combined total in-game sales for Sony PlayStation and Microsoft Xbox, were up +49% year-over-year compared to Q2 2017. Quarterly sales for 18Q2 were +1% Q/Q sequentially compared to +7% for the same period last year. Removing revenue generated by Fortnite on console changes that picture considerably. Without Fortnite, additional content revenues in 18Q2 declined -6% year-over-year. (See graph.)

Preliminary data suggest that Fortnite in itself is not a problem. Rather its success is the result of macro-trends reshaping the industry, which, in turn, raises questions regarding the “digital readiness” of incumbent titles and major franchises. Where previously no execs admitted to a loss in player activity or spending, it is increasingly clear that the newcomer is taking market share from existing titles, in addition to adding new players to the market. After a period of growth, the market is set to return to its usual zero-sum dynamic. More so, instead of raising all the boats, several of the big tentpole titles are seeing a decline, suggesting that Fortnite has been obfuscating a broader market correction among incumbent game makers.

In the run-up to this quarter’s earnings cycle, we expect publishers to provide more detail on this as they have different degrees of exposure to Fortnite’s success, especially those relying on revenue from multiplayer shooters and adjacent categories.