Steel_Wind, I sounds like you know what you are talking about. It still amazes me, though. TQ turned a profit, no? Despite 90% piracy it turned a profit.
Well - maybe it did - maybe it didn't. I really don't know - but I presume it did - though I am sure it was not a huge money maker.
Thing is, you need to appreciate how the business of game development works.
With a studio that cannot self-fund its game, the dev contracts with a publisher to get their gig through non-refundable advances against royalties. A large chunk of the total contract money for the title is paid on contract signing (from 20-35%, depending on the deal and the amount of the total contract). As much as 40% is held back until the game goes gold. The balance is paid over time as the game meets milestones in its development.
Burn through too much of that money too quickly, and as the bank account is dwindling, the pressure to meet the next milestone becomes intense. Longer hours and crunching two-thirds through the title , especially in new studios, is a frequent problem.
Then - after all of that, you've shipped your product. On a 5 million dollar budget title, you might have $500k left over in profit after you have paid the staff and the rest of your overhead. (Sometimes it is more in percentage terms and sometimes it is less). For a new studio, you can bet they did not have a whole lot left over as their startup costs for overhead were significant and productivity on new hires and new teams is always lower.
Now - you don't get royalties until your game recoups all development manufacturing and marketing costs and earns out. On a million unit selling title, assuming that 65% of that was sold at full markup, your royalty rate is going to be relatively modest as a new studio. Call it seven dollars to make the math easy, okay?
On full price, 650k copies x 7 dollars = $4,550,000.00 Woohoo! You just made 4.5 million dollars in royalties! Porsche time for the owners, right?
Wrong. They have not made a cent yet. The title has not yet recouped its development cost+ marketing+ mftring costs. In fact, even at a full $7.00 a copy across the whole million copies sold, the royalties will amount to 7 million to be applied against total cost of recoupment.
I'm telling you - that won't cover the costs of development, mfrtring and marketing. You'll be about even on a five million dollar if you are lucky. Probably still behind, actually.
Now, obviously, the position of the developer changes greatly if the royalty rate is higher than, say, $7.00. For a major studio, it might be a lot more than that. But for a starting studio? $7.00 would be pretty low - but not impossibly low. Call it $10.00, and it is looking close. But you won't get the full $10 on the title if the publisher had to sell the title at a discount to ship those number of copies. When those copies sold and for how much matters a lot.
Suddenly, 300,000 more copies at full price is the difference between making $2,000,000.00-3,000,000.00 in royalties and making nothing.
Generally, all startups (and TQ was Iron Lore Entertainment's first title) plan extremely conservatively and do not plan on earning a cent from royalties (at least – they
shouldn’t). Even if you do theoretically earn royalties, publishers can futz with the numbers, under-report, apply to your recoupment costs as a charge back a ton of hint books never sold. There are racking fees distributors and publishers eat that are charged by major retailers. (And here's a hint - some unethical publishers will charge that fee against more than one title, double,triple or quadruple recovering the charge and as you don't audit the *other* titles they are charging it to - you can't easily discover that.
The Bastards.).
So yes, it can get real ugly. Plus, those royalties come in late, paid quarterly from the prior quarter's sales so you will be as much as 6 months behind your ship date before the royalty payments even being to get applied to be paid against recoupment.
And - if you overshot your dev time and were in burn, you may have had to finance your payroll yourself temporarily - so even when you get your "profit" from "going gold" that may well have vanished to pay down your line of credit.
And then there are publishers who rip you off and don't pay when they are supposed to. God help you if you are still in bed with that a troubled publisher that is employing creative accounting while working on a sequel for them and depending on that publisher’s ongoing milestone payments on the sequel to keep you afloat. (This is where a significant number of developers do find themselves, btw.) What are you going to do, start a lawsuit over the royalties the publisher is ripping you off on
and pay for a forensic audit? With what? Using the milestones the publisher now threatens it won't pay or the royalties they didn't pay? Litigation is expensive, bad for business and cash flow is everything when your main assets are your employees. Lawyers and accountants cost a lot and you are at the mercy of the people who are ripping you off. Your maneuvering room is tight - and you are going to get into litigation with the guys whose money is going to pay staff and keep the lights on? Not a happy choice. (You now appreciate the vulnerability BioWare faced when they got into an ugly dispute with Interplay in 2001 over royalties from BG1 and BG2 whilst BioWare was developing NWN using milestone payments from Interplay).
A few more things become obvious here: your royalty rate can matter a lot. But startup devs have to take contracts with poor royalties.
The next most obvious thing which should emerge form all of this is that this cycle feeds on - and depends upon itself to be sustaining over the long haul. In order to keep a studio afloat on publishers’ advances and milestones payments - you absolutely MUST be starting development on a new title before the last title ships. If you don't have that new signing bonus payment to fund your operations waiting for you when you ship - you are screwed. You have a staff of 60-120 people and nothing to pay them with. Ideally, you want a dev staff high enough to be able to work on three titles at once, so one is always being released per year. But it’s a tough slog to get to that size.
If you don’t have a new contract coming online when the old one ends, it’s lights out. This - more than anything else - was what put Iron Lore out of business.
The last thing you might be curious about is how a developer escapes from this cycle of dependency on living off of advances against royalties. Two things:
1 - Get a hit - and use the royalties from that hit early on in your dev career (combined with the now uber_reputation to bargain for a higher royalty) so you can make increasing amounts of money from your titles; and,
2 - Use that increasing amount of money to self-fund. When you are in a position as a developer to be able to fund your own development - or at least a goodly portion of it - your royalty you command skyrockets
and the amount the publisher deducts before its own costs are recouped and you earn out drops like a rock. That's when you can start to make some serious coin and move towards full self-funded titles. You can then pick and choose your own destiny and keep the vast majority of profits from a title to yourself.
Of course, when you self-fund, you take the risk as well. Bet large on a Triple A title that corkscrews into the ground with poor sales – or that goes over-budget and does not release when expected - and you may never recover.
From the publishers’ perspective - most games lose money - or barely break even. (Developers want as much as they can as a non-refundable advance against royalties that they will never see.) For every hit - there are 2 or 3 that lose money and a few that do moderately well. Too many duds for a publisher and they go under. The annals of computer gaming has a weighty list of publishers that have gone under despite churning out some hits. (Mircroprose, I'm looking at you.)
When piracy can turn a moderate 500k-700k unit success into a 150k-250k unit loser - you look to move your titles to platforms where there are a lot less 150-250k losers and a lot more 500k-700k moderate successes. That's why the PC game dev money has dried up. It's not the million sellers that has the publishers scared - it's the 150k sellers. And there are a lot more of them in PC land then there is in console land. That's the effect of piracy on the hobby’s health.
Add to that vastly larger profits when you get a 5 or 8 million selling console hit - you see why PC Gaming is in dire straits.