There was tremendous fanfare this week for The Beatles: Rock Band since the game sold just over 600K units across multiple platforms in its first month on the market, according to NPD. Viacom, the parent company of MTV Games/Harmonix who developed the game, has been vocal in touting impressive numbers. Earlier this year, they stated that over a billion dollars in retail sales have been generated by the game series for the first 15 months on the market.

However, what seemed to have been completely glanced over was a recent report by Credit Suisse which highlights some stunning revelations on the music game series. Quite simply, Rock Band has lost a vast amount of money for Viacom. By the end of 2009, Credit Suisse projects that Rock Band stands to have lost over $90 million. The game series simply has not been profitable since day one.

So for a game franchise that has won numerous awards, and is developed by one of the best developers in the world, and has sold millions of copies, how did it end up this way? For a full analysis, read more.

To hear that Rock Band has lost money til this point is shocking to me as a gamer. It just doesn’t seem possible, given how well the game has sold, how strong the marketing has been, and how well received the game has been by the gaming community. But to hear it from Wall Street, it’s not much of a surprise at all. Many analysts were already aware of this situation because Viacom had already disclosed it. So what were the potential key factors that dragged down earnings, and have left a number of investors questioning whether it was a smart move for Viacom to have banked so heavily on Rock Band. Let’s take a look at them below.

1.    When Viacom acquired Harmonix, the developer that originally worked on Guitar Hero, it was to the tune of $175 million in cash. Viacom in essence invested in a development studio to work on a new IP because Activision had already bought the Guitar Hero brand. To put this into perspective, Activision acquired the Guitar Hero franchise for just shy of $100 million.

2.    To provide additional financial motivation, Viacom also paid out another $150 million to Harmonix for hitting sales expectations in 2008. While Viacom may have lost money, it does appear that the Harmonix team has done very well financially, which is great to hear for the developer.

3.    While Harmonix had prior experience making a guitar oriented game, this was the first time they attempted to make a game around a full band. Typical AAA console games could cost as much as $25 million to develop, but it cost well over that amount to develop Rock band, potentially much closer to $100 million according to MTV Games Senior Vice President Robert Picunko.

4.    Speaking about peripherals, unlike pressing CDs for video games which can be very cheap to mass produce, the cost to manufacture the whole band kit is significant, and there are very little savings to be incurred even in mass production. Even though the Rock Band package sold at a premium price, it appears that the margins were still extremely low. Eventually, when Viacom had to significantly cut prices due to excess inventory, the low profit margins then turned into losses for each unit sold.

 

5.    In Q2 2009, Credit Suisse estimated that Viacom had a one-time inventory write down of ~$85 million for Rock Band (USB has the estimate closer to $50 million), which means that they were overloaded with too many products that retailers didn’t wanted. Trying to manage inventory for peripherals has been a nightmare for Viacom. Unlike boxed CD games, which can be replicated and restocked within several weeks if a band kit sells out, it takes months to get peripherals built and restocked. What appeared to have happened was that sales for Rock Band were so strong, that the game was sold out initially. Viacom later then over compensated and produced too many Rock Band 2 band kits believing that there was enough market interest. In reality, sales for music games in general started to decline quite rapidly around that time.

6.    One big factor that music games like Rock Band and Guitar Hero have to face is the huge costs associated with licensing dozens of music tracks for their game. Often times, music labels demand an upfront payment to license their artists, in addition to being paid ongoing royalties. So imagine a game where you have to license + 50 songs, and pay for each one. It was reported that Viacom may have paid out as much as $10 million upfront to acquire The Beatles license alone, as well as paying out up to $40 million in ongoing royalties.

 
On the upside
With these particular issues highlighted, it becomes more clear why Viacom has lost money til now on Rock Band. However it should be noted that Credit Suisse is projecting that the franchise will start to show a profit in 2010. It is possible that Viacom made the strategic choice to invest heavily in the Rock Band franchise upfront, and was counting on cornering a sizeable enough market share before turning towards a business model that was more profitable for them. As an example, digital download sales of songs on the Rock Band online store have been growing strongly, and is expected to contribute to greater profit in the future. Viacom had indicated in July 2009 that over 50 million songs have been downloaded at the time. The question does remain whether the music gaming genre as a whole has peaked, as overall sales of Rock Band and Guitar Hero have been gradually decreasing since last year.

While Rock Band may have won the hearts of many gamers, the general climate on Wall Street is that the game series may have been a risky gamble that has tainted Viacom’s earnings so far.  Being a fan of the game, I hope that MTV Games, the games publishing unit at Viacom, doesn’t abandon the series, or compromise on the quality. For a game series that has won so many awards, it desires better.

Sources: Credit Suisse, USB, Viacom, Harmonix, The Big Money, Wall Street Journal, Gamasutra