Case 24: Tecmo

The video gaming industry began modestly with the debut of Pac-Man, Asteroids, and Donkey Kong. These games appeared in arcades where teens gathered to drop quarter after quarter for high score bragging rights. In the home video game market, Atari reigned supreme. Technology has made vast improvements since then. As a result, the level of reality experienced in each successive generation of video games has increased exponentially. One of the players in this highly evolving and competitive market is Tecmo.

Not only is the interactive entertainment industry characterized by rapid technological change, no one particular hardware system has achieved long-term dominance. Accordingly, Tecmo focuses its production efforts on the development of software for the hardware systems that dominate the interactive entertainment market at a given point in time or in the very near future. Presently, Tecmo has licensing agreements with three industry leaders: XBox, Nintendo, and Sony.

Tecmo is currently in the design/production stage of a new version of Dead or Alive. Since the previous versions of the game were extremely successful, Tecmo is not greatly concerned with the acceptance of the game by the general public. It is concerned, however, with the hardware platform that should be chosen to distribute the game.

Since licensing agreements are extremely short term, Tecmo wonders which of the three hardware companies should carry Dead or Alive. For example, the licensing agreement with XBox expires in December two years from now. The Nintendo agreement expires in December of this year and the Sony contract expires in December of next year. While these contracts expire and have traditionally been renewed every few years, there is no guarantee they will be successfully renewed or extended in the future.

A further consideration involves the costs charged by each company. XBox, Nintendo, and Sony charge their licensees a fixed amount per unit based on chip configuration, memory capacity, and market price. This charge covers manufacturing, printing and packaging of the unit, as well as a royalty for the use of their respective names, proprietary information and technology. Furthermore, these charges are subject to adjustment at the discretion of XBox, Nintendo, and Sony.

To offset the expenses of licensing fees, Tecmo must speculate on the ability of the three hardware platforms to access enough end-users to make their games profitable. Nintendo and Sony hold a grater share of the market, but XBox charges lower licensing fees.

In general, the product life cycle in the interactive software business is from one month up to eighteen months with the majority of sales occurring within the first three months after introduction. Although titles older than eighteen months may still be available for sale, Tecmo generally actively markets only its ten to fifteen most recently released titles. Mortal Combat represents somewhat of an exception to the rule. Being one of the most successful products, Dead or Alive's most feared competitor will be the prospect of the next version of Dead or Alive. There has currently been no discussion of the number of games that will be produced in the series.

Tecmo's management has assembled the following projected net cash flows associated with the distribution of Dead or Alive. These net cash flows reflect all licensing fees, productions costs, advertising expenditures, revenues, etc.

Questions

1. What is the Payback Period for Dead or Alive when marketed under the three different hardware companies? Assuming a required payback period of 1 year, which company would you allow to carry the new product?

2. Assuming a discount rate of 10%, what is the Net Present Value (NPV) under each system? Under which system, if any, would you be willing produce Dead or Alive?

3. What are the Internal Rates of Return (IRR) under each marketer? Which marketer(s) has/have acceptable IRRs?

4. Thus far we have assumed that Dead or Alive will be marketed through only one hardware system. Under this assumption, the projects are mutually exclusive. If we explore the possibility of allowing more than one company to market Dead or Alive, which company(ies) would you allow to market the product? Base your answer on the three criteria from the above questions.

5. Dead or Alive will have a different life span depending on the hardware system Tecmo chooses. Since the lives of the three projects are not equal, can a comparison truly be made based on conventional NPV measures? Calculate the Annualized Net Present Value (ANPV) for each of the three alternatives. Based on ANPV, which marketer would you choose to sell the product through if the projects were mutually exclusive? What if they were independent?