Opening the Valve on Console Gaming

Many investors probably aren't too familiar with Gabe Newell, but they should be. As the founder of Valve, a wildly successful game studio that's responsible for Steam, a wildly successful game distribution platform, Newell has been right in the thick of changing industry trends for years. Many top game publishers -- including Activision Blizzard (NAS: ATVI) and Electronic Arts (NAS: ERTS) -- offer games through Steam, which by some estimates controls 70% of the entire PC digital-download market. GameStop's (NYS: GME) rival Impulse platform, by comparison, controls only 10% of that growing pie.

Why should that matter to you? When the creator of the go-to digital download destination starts dropping hints that he wants to enter the console market, it's worth taking notice. A "Steam Box" that could compete with Microsoft's (NAS: MSFT) Xbox 360 and Sony's Playstation platform would bring major change to a console game industry that's already under siege on multiple fronts. The winners could wind up outnumbering the losers, though, thanks to Newell's enthusiasm for open platforms. Read on to find out what might change if the Steam Box goes from eye-twinkling hope to full-fledged challenger.

Broadening the base
It's difficult to pin numbers on the digital distribution market, since it can be conflated with mobile and social gaming, in-game purchases, subscriptions, and game rental services like GameFly. NPD Group tallied all these segments up and found that they generated $1.64 billion in revenue during the third quarter of 2011. That's out of total game market sales of $4.2 billion during the same time period. An analysis by Games Brief pegged digital content at 37% of the total game software market, and 24% of total game revenues, in 2010.

However you slice it, digital distribution looks like a big driver in the game industry, and seems likely to continue gaining steam going forward. But that growth won't be the PC gaming industry, because digital disruption is already well-established on those shores, and there just aren't that many retail sales left to displace. Consoles, on the other hand...

Source: Methodology focuses on retail sales only.

The Xbox 360 and PS3 combined for half of all global recorded game sales last year, and both have their download drawbacks. Sony grappled with hacker takedowns of its Playstation Network for months in 2011. Xbox Live hasn't suffered similar humiliation, but it's still a "walled garden" offering only Microsoft-approved games and updates. Most games -- at least the top-tier megadevelopment games offered by Activision and EA -- are still sold in disc format.

That works for retailers and larger studios, but can shut out smaller developers. Newell takes issue with the "walled garden" approach, which extends to Apple's (NAS: AAPL) tight control over what gets released on iOS. Speaking at a tech conference last October, he had harsh words for restrictive content delivery systems: "On the platform side, it's sort of ominous that the world seems to be moving away from open platforms ... [platform providers] view themselves as more rent guys who are essentially driving their partner margins to zero ... they build a shiny sparkling thing that attracts users and then they control people's access to those things."

Enter the Steam Box
Valve wants to do things a bit differently. More Android than Apple, the Steam Box might well be built by third-party hardware suppliers and supported with Valve's software updates, allowing for some variety and cost competition while still giving Valve the ability to direct the console's strategy. Valve has even extended its commitment to openness into the controller space, having filed a patent for a game controller that could have swappable components.

This would be good for nearly everyone except Microsoft and Sony, as the two companies have sunk billions into their unified hardware, software, and digital ecosystems. It might even be good for GameStop, since the commitment to open platforms would extend to loading up a competitor's software, should users want to. The available games on Steam already extend well beyond the goofy 99-cent games like the ones popular on mobile ecosystems. As a Steam user myself, I've accessed content from Civilization V and Skyrim to smaller titles like Worms: Reloaded. With the right mix of cloud storage and onboard storage, a Steam Box could quite easily eliminate the need for physical discs.

Let's keep in mind two things. These are still rumors, and the console triumvirate of Microsoft, Sony, and Nintendo has spent billions establishing its place in the living room. There has never been a viable open-platform console, but there's also never been so much innovation in hardware standards before. When the first Xbox launched a decade ago, gamers had three serious options (Nintendo, Sony, or PCs), and they were all controlled similarly. Today you can touch, swipe, poke, click, dance, shake, and do all sorts of things with all sorts of devices that were only twinkles in developers' eyes a few years ago. A serious new contender would have to incorporate the advanced control systems gamers have grown used to in addition to offering platform openness.

Nothing is free from disruption, but that doesn't make it easy. Gabe Newell's track record of innovation is one of the best in gaming, so it's hard to not be excited about the possibility of Valve entering the console sphere. Unless, of course, you're a Microsoft or Sony shareholder.

At the time this article was published Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights. The Motley Fool owns shares of GameStop, Apple, and Microsoft. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Apple, Activision Blizzard, and Microsoft. Motley Fool newsletter services have also recommended writing covered calls on GameStop and creating a synthetic long position in Activision Blizzard. Addtionally, Motley Fool newsletter services have recommended creating bull call spread positions in Microsoft and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a thorough disclosure policy.

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