Videogaming’s online explosion

December 20, 2010, 10:00 AM UTC

Online games such as Age of Conan and Farmville are hot. Now industry leader Activision Blizzard is jumping into the fray with a new Internet strategy.

When videogame publisher Activision announced its merger with Vivendi Games in late 2007, analysts predicted that Vivendi’s Blizzard unit, maker of the hugely popular Internet-based fantasy game World of Warcraft, would help Activision migrate to the online world.

Three years later the combined company, Activision Blizzard, is close to rolling out an online platform to support Activision’s franchises, which include Guitar Hero and Call of Duty. And what lessons did Activision learn from the whizzes at its Blizzard division? How to build an in-game universe such as Warcraft’s Azeroth? Time-tested techniques for online storytelling? Try the fine art of data-center management. “This is a supercomplicated business,” says Activision Blizzard CEO Bobby Kotick. “You have to start thinking about where to buy the most efficient power and how to configure servers. They do this every day at Blizzard.”

Such complexity helps explain why Activision (ATVI), based in Santa Monica, has taken so long to unveil its Internet strategy. In techspeak, Activision is transitioning part of its business to cloud computing, a move that has implications for the entire gaming ecosystem. “We’re becoming an online entertainment company that is no longer as dependent on the Nintendos and Microsofts and Sonys,” says Kotick, referring to the makers of the Wii, Xbox, and PlayStation gaming systems, respectively. Indeed, about a third of the company’s 2010 sales (it says it expects revenue of $4.28 billion in fiscal 2010) and half of its operating income will come from digital sources.

Kotick spoke exclusively with Fortune about Activision’s highly anticipated online initiative, parts of which will come to market early next year. He says the company initially will seek to enhance the gaming experience with Internet-hosted applications and tools. So a player of an action game such as Call of Duty would be able to download an app to his (and, let’s face it, we’re usually talking about guys here) smartphone or work computer and crow about his scores or schedule a game with buddies through Facebook-like status updates even when he’s away from his console or home PC. Or, if he’s playing on a computer or on an Internet-connected console like the Xbox 360, he can directly post real-time statistics or even a video clip of a winning kill on YouTube or Facebook.

If Activision is successful, it will basically increase the number of hours players spend obsessing about their favorite games. Company executives compare the experience to that of, say, a golf fan. Hobbyists can play it themselves, watch the pros, and hang out at the 19th hole and talk about their game. An online gaming platform can be like a virtual 19th hole — a forum for discussion — but also a place where casual players can catch clips of hard-core gamers at work.

“We’re trying to transform an interactive medium into a social medium,” Kotick says. He says the core functionality of the platform will be free, but he wouldn’t speculate on how and if Activision would charge for parts of the experience.

Kotick’s online gambit doesn’t make the need for consoles obsolete; in fact Activision is working with Microsoft (MSFT) and Sony (SNE), both of which sell Internet-connected systems, to ensure that Activision’s web-based applications can be accessed on Xbox Live and PlayStation Network. And hardware providers continue to innovate; Microsoft’s Kinect and Sony’s PlayStation Move, two new motion-gaming products — competition to the Wii — launched this fall and are selling well. But Kotick has made no secret of his frustration with console makers — he thinks hardware prices are too high, making it hard for the masses to enjoy his games. More recently Kotick has been touting Internet-connected televisions as a way to expand the pool of consumers who can enjoy videogames. And one major benefit to Internet TV is that game makers such as Activision can establish a direct relationship with the player. They can push through new features, solicit real-time user feedback on how to make games better, and even provide customer service, something Blizzard already does with World of Warcraft.

Besides, consumers have shown a strong affinity for online play, particularly social games such as Zynga’s FarmVille. Console games may yet get a boost from the holiday spending and purchases of the new Kinect and PlayStation Move systems, but Wedbush analyst Michael Pachter predicts unit sales of disc-based videogames will be down 5% or so this year (see chart). Investors have picked up on the trend: A website that tracks private companies values Zynga at more than $5 billion, roughly the same as Electronic Arts’ (ERTS) market capitalization. (EA last year made its push into social gaming with the acquisition of upstart Playfish.) Activision Blizzard’s market cap is about $14.5 billion.

Kotick, meanwhile, is already thinking ahead. Building an online platform for games is another step in his long-stated goal of turning Activision Blizzard into a media company. Gaming online gives Activision a powerful distribution platform for entertainment, for example. “We have 20 million people in the Call of Duty audience who might be interested in seeing us produce a film based on the game,” Kotick muses. “There’s nothing that would prevent us from delivering that film directly to our audience.” Well, nothing that some smart data-center management couldn’t fix.

–Additional reporting by Daniel Roberts