Square Enix didn’t know how to squeeze profits out of its western studios

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Square Enix is ​​washing its hands of its largest Western studio. The company announced that it was selling Eidos and Crystal Dynamics to the Embracer Group. This raises a number of questions about what’s going to happen next with Square Enix, but first let’s focus on why. Why did Square Enix leave Tomb Rider and Dukes X Studios? And why for the seemingly low price of 300 million?

The bottom-line reasoning for this measure is profitability. Square Enix has spent a lot of money on this studio, but has not been able to figure out how to generate income from that investment. In 2021, Eidos Interactive generated its highest revenue in three years. But that revenue did not offset its costs – Idos’ profit margin was 0.65%. During the same period, Crystal Dynamics also had its highest revenue but generated a profit margin of only 3.6%.

Daniel Ahmed, an analyst at Nico Partners, said “Overall, Square Enix had an operating income margin of 14.2% last year.” Wrote on Twitter,

Square Enix clearly ran out of ideas

Companies hate to slash their profitability, but that doesn’t mean they sell out low-performing business units right away. Square Enix had a choice of finding out what to do next with Crystal Dynamics and Idos. But the deal suggests Square Enix’s ideas are over.

Publishers have already moved Crystal Dynamics and Eidos from working on their own IP to working on Disney’s flagship Marvel brand. The cost of that license almost certainly contributes to the low profitability of the studio. But more than that, you realize that Square Enix says, “If Marvel couldn’t make this studio profitable, there’s nothing it can do.”

As I reported around the time of release, Eidos’s Guardians of the Galaxy performed significantly less. It sold less than 1.5 million copies in its first two months, despite multiple discounts in retail.

If we look at competing publishers, we can see that Square Enix had other options – not the best -.

EA has repeatedly shut down any project that does not have an estimated profit margin of at least 15%. However, this leaves the studio with fewer and fewer projects each year.

Activision has adopted a similar tactic for EA, but instead of shutting down the studio, it has simply put all of its teams into Call of Duty or Blizzard content farms. Square Enix has experimented with this. He agreed to let Crystal Dynamics work with Microsoft’s The Initiative on Perfect Dark.

Why so little?

The low profitability of Crystal Dynamics and Idos lowers their value. Embracer will get a better return on his money by placing just $ 300 million in the index fund. At least if the studio continues on the same path until 2021.

But both companies know that the studio will generate better net revenue while working on their own IP. For example, in 2019, Eidos’ profit margin was 7.2%. And IP has its own value.

So even when you consider the cost of running a studio, Embracer is getting a lot at a fairly low price. This suggests that Square Enix has a completely new business strategy or other motivation.

Square Enix has already accused it of wanting to invest more in blockchain, AI and cloud gaming. And it probably will. Crystal Dynamics and Idos probably had no interest or expertise in those areas. So the publisher pursues a future that those teams had no use for.

But it is also valuable in the context in which the deal is being made. Huge masses like Microsoft are buying huge publishers like Activision. Tencent still wants to make the acquisition. Sony has hinted to PlayStation that it wants to continue the move. And every other publisher is trying to position itself to acquire, merge or achieve something else.

Leaving its underperforming studio, Square Enix is ​​streamlining itself for potential acquisitions. And maybe that’s the front of the story.

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