The Economics of Video Game Production
Very cool chart here showing the economics of producing the best selling video game, Call of Duty: Finest Hour. This profile shows the economics of "real options" ….
Notice how the investment occurs in stages: pre-production, production, testing, and release. Each stage has different time frames and different investments. Each stage resolves a new uncertainty about the technical or market viability of the product. At the end of each stage the company could choose to re-evaluate their investment and to proceed or not. In other words, they have the "option" to invest or to shut it down. This kind of option is known in academic circles as a "real option" — since it is an option to invest in a "real" asset. The comparision is to a financial option like a put or a call on a security.
Real options and financial options have some similarities in how they are valued, but very different implications for how they are executed. The biggest difference in my experience is the human side of organizational decision-making. A financial option is either in the money or out of the money — you have a clear cut decision about the value of the option contract. A real option, on the other hand, is often much harder to execute. The proof point is the difficulty that most organizations have in killing projects that are way out of the money.
A similar pattern of staged investment occurs in many industries — movie production, pharmaceutical development, and new software products. In future posts, I'll look at how different industries have evolved to manage these risks in different ways.
