Are games overpriced?

GameSpy columnist Raymond Padilla has been debating this issue recently. Here's a copy of a letter I just wrote him on the matter.

You have raised some interesting questions recently concerning game pricing. Obviously, consumers of any stripe chafe at having to pay more for their favorite products. For many gamers, the idea that A-list PC or next-gen console titles will be going for $55 or even $60 doubtless brings to mind visions of publishing executives sitting in dimly lit rooms, cackling maniacly while lighting fat cigars with $100 bills.

Yet we can take a peek at the income statements of a few major game companies to tell us exactly how much dough they are raking in.

For example, Electronic Arts has a profit margin of 18.5 percent. That means that for every dollar they bring in in sales, they spend 81.5 cents on R&D, operations, sales and marketing, etc. Activision has a profit margin of about 10 percent, and Take Two's is less than 6 percent (all of these figures were taken from Yahoo! Financial pages).

Now, I'm no financial analyst, but those figures aren't exactly Robber Baron material. Admittedly, things get a little more complicated as you drill into the figures. EA's net income (basically the end-all, bottom-line profit applicable to shareholders) more than quintupled, to $578 million in fiscal '04 from $101 million in fiscal '02. But revenues only climbed about 50 percent in that time, and rose only 20 percent in the last year, so they were obviously doing a great job of keeping costs down.

Other publishers haven't had nearly the same success, though. Activision's net income went from $52 million in '02 to $78 million in '04. And Take Two's actually fell in that time, from $71 million to $65 million.

Two final thoughts on pricing. First, it's ridiculous to think there is an "appropriate" price for something that you can arrive at by calculating production costs and then factoring in a "suitable" profit for the maker. The market just doesn't work like that. The price of something is what people are willing to pay for it. If you sell a used car, you offer it at the highest price you think a buyer will accept, regardless of the impact that may have on the used car market as a whole. You try to maximize your gain, and that's what every company, including EA, is doing as well.

Second, there's some term in economics that I forget now that refers to the phenomenon of demand for a product actually increasing as the price goes up. Usually this concerns luxury goods like BMWs and Rolexes, where part of the allure of the product is its exclusivity -- if everyone could afford a BMW, would you want one too? I wonder if the same effect might be applicable, albeit in a limited way, to A-list titles like Doom 3. If Doom 3 was $20, would it necessarily sell a crapload more copies?