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There are currently a lot of companies duking it out for control over the future of digital gaming. In particular, I’ve been keeping an eye on OnLive since last Christmas when they did a couple high profile ads to hype their launch of the OnLive game system for the TV, a “microconsole” which allows you to play streaming games purchased in the OnLive environment directly on your TV. For those of you who aren’t familiar with OnLive, check out their own explanation of service here. OnLive have been in the news a few times in the past week, and I want to take this opporunity to examine OnLive, their competitors, and what the latest news says about the future of gaming.

Personally, I’m an active Steam user. Steam–a service from Valve, who also releases games like the Orange Box–is a cloud-esque game distribution platform which allows you to buy the digital rights to a game and then download it to any local computer where you are signed into your Steam account. In contrast, with OnLive, you download an app to the local hardware and then stream the game; it’s much closer to true cloud gaming. The obvious advantage to the OnLive approach is that you don’t have to worry about meeting each individual game’s system requirements. In other words, you could have older hardware with out of date graphics drivers, but the game should still work. For publishers, there is another advantage: if the game is never downloaded locally, it is much harder to pirate. The drawback with OnLive is one of bandwidth. In order to play games through OnLive you need enough bandwidth to stream the games without delays and buffering issues, which requires a high speed internet connection of at least 25Mbps. Such high speed internet connections are far from what I would call “affordable.” And even with these higher internet speeds, streaming games usually have worse graphics than their downloaded or hard copy versions; by lowering the resolution of the game, OnLive et al. can reduce the bit rate for delivery and ensure a more seamless stream.

That being said, I genuinely believe the OnLive approach is the direction this industry is heading. And I believe the world of gaming will be the earliest media industry to make a true transition to the cloud. Both the early start (ie. Steam has been up and running since 2007) and the speed of this transition are due to the nature of gaming as fundamentally technology focused. Gamers, especially PC gamers, tend to be early adopters of the latest and greatest technology. Additionally, digital distribution (including cloud-based gaming) arguably offers higher value for the consumer than traditional retail sales of hard-copies. Thus, gamers are transitioning to more and more digital distribution options, where available.

OnLive is well positioned to take advantage of this transition. They’ve made a lot of smart decisions: they’re playing with multiple pricing models and delivery methods and they’re building smart partnerships. I’m impressed. Don’t get me wrong, they’ve still got a lot more to do. They need to keep building their library of titles and they should be partnering even more. These are essential to building the consumer value proposition and driving customer acquisition. OnLive must realize they are dealing with a product with major network effects. That means, each additional consumer using the “network” increases the value of the network itself. In this case, each new user increases the value, for publishers, of selling their games through the network; as more publishers sell their games through the network, it becomes more valuable to consumers to use that network. With this in mind, OnLive needs to really ramp up their customer acquisitions. A large, loyal customer base will be their greatest defense against the competition, especially gaming retail giant GameStop. GameStop has been buying companies in this area hoping to cobble together a strong streaming offering to launch in mid-2012.

With all this in mind, I now want to examine the latest news stories revolving around OnLive in the past week. First, OnLive was in the press last week over a quarrel with GameStop, where the retailer pulled OnLive coupons out of physical copies of the new release Deus Ex. Then, yesterday, OnLive and GameSpot (the blog) announced a partnership to offer free OnLive game demos within GameSpot reviews. Let’s look at each of these in turn.

First, Deus Ex: Human Revolution was released last week on Tuesday, Aug. 23. OnLive had brokered a deal with Square Enix, the publisher, to bundle a coupon for a free digital copy of the game from OnLive within physical copies of the PC game. Since the game is being sold via OnLive for $49.99, the coupon is not an inconsequential value to the consumer. OnLive presumably hoped to use the promotion to increase consumer awareness and drive customer acquisition. For Square Enix, the deal increases the value of their product without any incremental cost. In fact, because digital copies of games are generally sold for as much or nearly as much as hard-copies, game publishers are incentivized to help build up digital sales in a way that book or music publishers are not. Thus, from a publisher’s perspective, they should theoretically prefer digital sales because revenues are just as high and margins are even higher than for physical sales. GameStop, however, has a vested interest in both protecting their physical sales and preventing OnLive gaining too much of a foothold in the streaming market. For this reason, they instructed their staff to open the Deus Ex PC games and remove the coupons–a move that has enraged gamers and raised questions of the firm’s ethicality.

This week, OnLive began partnering with GameSpot, a popular gaming website. GameSpot will now embed links to free demos from OnLive within their game reviews. So, if you’re on GameSpot and reading a review for a new game called… Awesome Sauce, lets say, you might see a link that says: “Awesome Sauce Instant Demo, Play Now!” That will lead you to a page instructing you to install the OnLive app. From there, you’ll need to create an OnLive account. And, hey presto, OnLive has a new customer. If you like the demo and it plays well, you might even buy the game from OnLive, on the spot. The benefits for OnLive are obvious, but the partnership is good for GameSpot too, because it adds a complementary product to their own reviews. The deal also requires GameSpot to provide reviews and other editorial content to OnLive for their own site. Beyond these basic details, I’m curious about the terms of the deal. I’d like to know whether GameSpot gets some percentage of revenues from games bought by people who linked from the GameSpot Demos. I’d also like to know whether the deal gaurantees GameSpot exclusivity for OnLive demos. Anyone out there got some insight?

Ultimately, both of these stories suggest to me that OnLive recognizes the network effects that will be essential to success in streaming games. OnLive has a headstart right now, and they’re doing some good things to take advantage. Nevertheless, they still face a lot of complaints about streaming speed issues, poorer graphics and a small library of games. They need to step it up, or when GameStop finally arrives on the scene, they could get blown away. GameStop surely recognizes how network effects will play a part in the future of streaming games, thus their typical dicky behavior about the Deus Ex coupons. GameStop plays hardball, treats their consumers like crud and makes a lot of money doing it. I’d rather they didn’t win the future of digital gaming. So… Let’s go, OnLive. I’m rooting for you.

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