Square Enix failed to capitalize on its Western studios

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Square Enix is ​​washing its hands of its biggest western studios. The company announced that it was selling Eidos and Crystal Dynamics to Embracer Group. This raises a lot of questions about what happens next with Square Enix, but let’s focus on the why first. Why did Square Enix abandon Tomb Raider and Deux Ex studios? And why for the seemingly low price of $300 million?

The bottom line reasoning for this move is profitability. Square Enix spent a lot of money on these studios, but they couldn’t figure out how to make an income from that investment. In 2021, Eidos Interactive generated its highest revenue in three years. But these revenues did not offset its costs – Eidos had a profit margin of 0.65%. During this same period, Crystal Dynamics also recorded its highest revenue, but generated a profit margin of only 3.6%.

“Square Enix as a whole had an operating margin of 14.2% last year,” said Daniel Ahmad, analyst at Niko Partners. wrote on Twitter.

Square Enix is ​​clearly out of ideas

Companies hate to weigh on their profitability, but that doesn’t mean they instantly sell underperforming business units. Square Enix had the choice of figuring out what to do next with Crystal Dynamics and Eidos. But this deal suggests that Square Enix was out of ideas.

The publisher has already moved from Crystal Dynamics and Eidos working on their own IP to working on Disney’s main Marvel brand. The cost of this license almost certainly contributed to the low profitability of the studios. But more than that, you get the sense that Square Enix is ​​saying, “If Marvel couldn’t make these studios profitable, nothing could.”

As I reported at the time of release, Eidos’ Guardians of the Galaxy seriously underperformed. It sold less than 1.5 million copies in its first two months, even after several retail discounts.

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

EA has repeatedly shut down any project that did not have at least a 15% projected profit margin. This, however, left the studio with fewer and fewer projects each year.

Activision adopted a similar tact to EA, but instead of closing studios, it simply put all of its teams into Call of Duty or Blizzard content farms. Square Enix has already experimented with this. He made a deal to let Crystal Dynamics work with Microsoft’s The Initiative on Perfect Dark.

Why so low?

The low profitability of Crystal Dynamics and Eidos is causing their value to fall. Embracer would get a better return on its money by simply putting $300 million into an index fund. At least if the studios continue on a similar trajectory through 2021.

But both companies know that studios are likely to produce better net income when working on their own intellectual property. Eidos had a profit margin of 7.2% in 2019, for example. And IP addresses themselves have value.

So even when you factor in the cost of running a studio, Embracer gets a lot for a pretty low price. This suggests that Square Enix either has a whole new business strategy or other motivations.

Square Enix has previously said it wants to invest more in blockchain, AI, and cloud gaming. And he probably will. Crystal Dynamics and Eidos probably had no interest or expertise in these areas. The publisher is therefore pursuing a future that did not need these teams.

But it is also important to recognize the context in which this agreement is taking place. Massive conglomerates like Microsoft are buying giant publishers like Activision. Tencent is always looking to make acquisitions. Sony PlayStation has indicated that it wants to keep moving. And all the other publishers are trying to position themselves to be bought out, merged, or acquired something else themselves.

By ditching its underperforming studios, Square Enix is ​​streamlining itself for a potential acquisition. And this is perhaps the continuation of this story.

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