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Hard-a-port! Is Riccitiello’s strategy to turn the Electronic Arts supertanker working?

By on November 11, 2009
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Electronic Arts’ Q2 announcement yesterday was pretty electrifying: 1,500 jobs lost to save $100 million a year, while also spending $275 million in cash (and up to $400 million in total) to acquire Playfish. Some critics have struggled to understand the strategy (and the Playfish valuation) but it’s really further evidence that the EA supertanker is charting a course through stormy, rock-strewn waters.

Electronic Arts has had a rough ride over the past few years. While Activision has gained on the strength of World of Warcraft, Guitar Hero and Modern Warfare, EA’s stock has tumbled by more than 60% since the start of 2008.

Electronic Arts five year share price

Sourced from Wikinvest

Electronic Arts versus Activision over the last six months

Sourced from Wikinvest

Stormy weather ahead, Captain

Under John Riccitiello, Electronic Arts has been restructuring the business. Since he rejoined EA as CEO in April 2007, he has overseen two massive waves of job cuts. The first saw 600 jobs culled in October 2008, rising to 1,000 by December and adding a further 100 layoffs in February. This latest tranche sees another 1,500 redundancies – by March 2010, fully 25% of the employees who worked at Electronic Arts when Riccitiello came back will have been made redundant.

The restructuring aims to take over $600 million of costs out of the company each year, which will improve the underlying performance of the company.

Financial performance of Electronic Arts over the past five years

Electronic Arts financial performance

Which is entirely necessary, as the chart above shows. In the year ended March 2008, Electronic Arts made a loss of $384 million. In 2009, the loss was $340 million.

(The reported losses – $487 million and $827 million respectively – were much higher due to one-off restructuring costs and “goodwill impairment charges”. Any incoming CEO has an incentive to clear out the balance sheet with lots of financial adjustments that he can blame on his predecessor – the goodwill associated with the Jamdat acquisition being a good example – and Riccitiello followed the usual strategy of “kitchen sinking”)

These cuts not only give the company a chance of being profitable in 2010, they are preparing the company for the strategy of the future: fewer mega-hits taking the lion’s share of consumer spend on consoles and new digital distribution businesses (iPhone, Facebook, virtual goods on the web) offering the best route for growth and innovation.

These be uncharted waters

Unlike its complacent competitors, Electronic Arts knows that it’s sailing into uncharted waters, and it’s getting ready. It’s innovating with new products like Battlefield Heroes that embrace the freemium model of allowing users to play for free but to pay for virtual goods if they wish to enhance their experience.

It invested heavily in the iPhone version of The Sims 3, a game which had a development cycle of 18 months – short by console standards but mammoth for the iPhone. And not only did this title bring high-quality games to the platform, but it innovated with virtual goods on Apple’s handset at the same time.

Most recently (and the timing showed more focus on the views of the stock market than the sensibilities of the 1,500 people affected by the job cuts), EA announced the acquisition of Playfish, the “best” developer of games on Facebook. That statement is subjective since Zynga is clearly much larger, but Playfish has lavished care and attention on its products, shunned the worst excesses of the “offer scams” and clearly aimed to create and nurture long-term, innovative, intellectual properties, something that even the most ardent supporters of its rivals could not say about them.

I’ve already posted about why I think an acquisition of Playfish is a steal for $250 million (the originally rumoured price) or even $400 million (the price including $275 million of cash, $25 of “equity incentives” and $100 million of earnout), but I think it will turn out to be a landmark in the revivial of EA’s fortunes under John Riccitiello.

Land ho!

Taken together, these changes – a reduction of traditional games development/publishing headcount by 25%, investment in new business models like Battlefield Heroes and The Sims 3 on iPhone, the acquisition of Playfish – herald a clear strategy.

Riccitiello has seen the rocks ahead. He’s sounded two short blasts on the whistle and turned the wheel hard to port. EA’s a big vessel and it will take some time to respond.

But respond she will, and she’ll start 2011 (yes, I mean 2011) aligned on a new course – just as Activision, THQ, Take Two and others start noticing that they need to do something about these new businesses that are eating into their profits.

And John will look over his shoulder as he slams the engines to flank speed and leaves them all struggling in his wake.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com