Square Enix did not know how to squeeze profit out of its western studios

Square Enix did not know how to squeeze profit out of its western studios ...

Square Enix is distributing Eidos and Crystal Dynamics to Embracer Group, the largest Western studios. This raises numerous questions about what will be done next with Square Enix, but first lets focus on the why. Why did Square Enix drop the Tomb Raider and Deux Ex studios at a seemingly low price?

Square Enix has spent a lot of money on these studios, but it hasn''t determined how to make an income from that investment. In 2021, Eidos Interactive generated its highest revenue in three years, but that revenue did not offset its costs. During that same period, Crystal Dynamics also had its highest revenue, but produced a profit margin of just 3.6 percent.

According to an analyst for Niko Partners, Square Enix overall had an operating income margin of 14.2 percent last year.

Square Enix clearly ran out of ideas

Companies are afraid to carry around a risk on their earnings, but this doesn''t mean they instantly sell off their poorly-performing business units. Square Enix had the option of starting out what to do next with Crystal Dynamics and Eidos. However, this arrangement suggests that Square Enix was out of ideas.

The publisher shifted from having Crystal Dynamics and Eidos working on their own IP to the development of Disney''s major Marvel brand. Moreover, Square Enix claims that if Marvel were to make these studios profitable, nothing would work.

Eidoss Guardians of the Galaxy was significantly underperformable, selling 1.5 million copies in its first two months, even after a number of discounts at retail.

Square Enix has other limitations if we look to competing publishers.

Any project that does not have at least a projected profit margin of 15% has been canceled repeatedly by EA. This has left the studio with fewer and less projects every year, however.

Activision has adopted a similar approach to EA, but instead of closing studios, it has simply incorporated all of its employees into content farms called Call of Duty or Blizzard. Square Enix has already tested this. It has signed a deal to allow Crystal Dynamics to collaborate with Microsoft''s The Initiative on Perfect Dark.

Why so low?

Crystal Dynamics and Eidos'' low profitability brings down their value. Embracer would get a better return on its money by simply investing $300 million into an index fund. At least if the studios continue on a similar trajectory to 2021.

When working on their own IP, both companies know that studios will likely generate better net profit. Eidos had a profit margin of 7.2 percent in 2019, for example. And the IPs themselves have an advantage.

Embracer is getting a lot for a relatively low price even when it comes to the cost of building a studio. That suggests that Square Enix either has a whole new business strategy or other motivations.

Square Enix has already claimed that it will invest in blockchain, AI, and cloud computing. It will probably do that. Crystal Dynamics and Eidos had likely no interest or skill in those areas. So the publisher is pursuing a future that had no use of those teams.

It''s also worth being aware of the context in which this transaction is happening. Massive conglomerates like Microsoft are purchasing giant publishers like Activision. Tencent is still seeking to make acquisitions. Sony PlayStation has stated that it intends to continue to make moves. Every other publisher is striving to acquire, to merge, or acquire something else themselves.

Square Enix is more flexible for possible acquisitions as a result of the removal of its poorly performing studios. This may be the next feature of this story.

You may also like: