Brazil: High Taxes and Piracy Challenge the Promising Market for Video Games

If you are looking for a sector to invest in, take a good look at the video games your kids like to play. The video game industry boasts some of the best-performing companies in the entire global technology sector, not just in consumer software. Companies that have placed their bets on consumer entertainment have survived the economic crisis, and registered better results than most other companies.

 

Few sectors have performed as well as those companies that manufacture video games. In 2002, the sector achieved its best results in history – $10.3 billion in sales, of which $6.9 billion involved software. Those numbers were even higher than the ticket sales figures for Hollywood films, a very powerful industry. Even before 2002, the video game sector was enjoying an average annual growth rate that exceeded 15%. “This is one of the few technology sectors that have shown constant growth, especially after September 11,” says César Barbado, managing director of Ingnis Games, a Brazilian firm.

 

Moreover, these numbers are just the start of something bigger. The worldwide game industry did not grow in 2003, maintaining a sales volume of $10 billion, but there is a good explanation. The 128-bite generation game console, led by the Sony PlayStation 2, is ready to pass the baton, four years after its launch. Aware of this upcoming change, consumers have slowed their purchasing, keeping a watchful eye on the upcoming generation. “There is a natural tendency to stop buying before any change in game consoles. Consumers don’t buy the game for the old console because they want to get to know the new one,” says Marcos Cardoso, product director of Electronic Arts in Brazil.

 

Manufacturers are looking around for new markets that are less saturated. According to a recent report by PricewaterhouseCoopers, “The Outlook for Video Games, 2003-2007: A Global Overview,” expectations in Latin America call for one of the highest growth rates in recent years. “Latin America and Canada are starting from a very low base. The projections say that they are the regions where growth will be fastest; an annual compound growth of 16.1%. Production costs in Latin America must rise from $148 million in 2002 to $312 million in 2007,” the study says.

 

Brazilian Folk Legends

Brazil’s manufacturing base is extremely small, and it is limited to PC-format games. Moreover, the country suffers from serious structural problems. Yet Brazil has nearly tripled its sales of locally made video games from $33 million in 2001 to almost $100 million in 2003, according to ABRAGAMES, Brazil’s association of video game manufacturers. This has encouraged multinationals to come to Brazil and consolidate their operations. It has also inspired a surge in the number of local companies and, above all, in Brazilian research and development projects in this sector. “The market is expanding quite a lot,” says consultant Fabio Binder. “The growth still isn’t solid because this has all happened so quickly. But companies that were already here are now managing to move ahead by themselves.”

 

One of the most immediate and visible results has been the response of universities. Following a significant trend in the United States, Brazilian institutions have begun to create academic courses related to the video game industry for undergraduates and graduate students. “These courses are an old dream, inspired by their absence in traditional coursework. In the middle of 2001, as the market was expanding, we saw that it was the right time to set them up,” explains Binder.  A pioneer in this area, Binder is the coordinator of a video-game production course at UnicenP in Brazil.

 

Traditional universities such as the Pontifical Catholic University of Rio de Janeiro and the Anhembi-Morumbi University are also taking that approach, bringing the world of video games into their classrooms. As the number of qualified professionals grows, more and more Brazilian companies can compete in global markets. “Every year, my students are joining software firms. Eight students from my last group are already working in the sector. Each year, we create an average of two video game courses. We cannot say that the market is consolidating because that takes time, but the trend points in that direction,” adds Binder.

 

One such game is called Erinia. Launched recently by Ignis Games, Erinia belongs to the category known as MMORPG (Massive Multiplayer Online Role-Playing Games). Its plot is based on Brazilian folk legends. It took three years and $400,000 to produce Erinia. Aimed at the foreign market, it will compete against such giants as Everquest, which has a base of 800,000 subscribers. “This game has attracted quite a lot of attention in Brazil but we still don’t have any measure of its impact. In any case, we know that we are not going to survive entirely on the Brazilian market,” says Barbado.

 

Erinia, he adds, “is aimed at the foreign market, and we are getting started to sell it in Europe, the United States and Canada. We hope that the Brazilian market expands to the point where it can support games of this type, but the Brazilian operation is more a question of patriotism and respect for the local public.” According to ABRAGAMES, the Brazilian market is still taking its first steps, which makes it quite difficult for companies that are beginning their operations and still don’t have a solid base.

 

So far, major foreign companies account for 98% of all games sold in Brazil. Clearly, there is a lot of room for Brazilian software firms to expand. “In general terms, companies begin to strengthen themselves at home, and only later go out and sell overseas. In Brazil, it is not at all easy to become strong at home. Some manufacturers look for results in other countries, then return and win over their domestic market. We have to turn that trend upside down,” explains Jeferson Valadares, president of ABRAGAMES and chief executive officer of Jynx Playware.

 

Risks and Difficulties

Nevertheless, it has not been easy for foreign companies to enter the Brazilian market. Despite Brazil’s enormous potential, piracy and high tax rates frighten many who fear they will lose their money. A recent worldwide study by International Data Corp. and the Business Software Alliance showed Brazil is one of the countries where piracy takes its highest toll. According to the study, 61% of all software used in Brazil is pirated, and the annual losses reach an incredible $519 million. That ranks Brazil eleventh worldwide, in terms of losses from piracy. The condition of the video-game sector is even more critical: 9 out of every 10 games sold in Brazil are illegal.

 

“We created a working group for the entertainment sector, including video games. We figured out that this type of software is one of the most often pirated, with piracy rates above 90%. We have worked to provide support for the sector and especially to prevent companies from becoming discouraged about the condition of the market,” notes Jorge Sukarie, president of the Brazilian Association of Software Companies (ABES).

 

“Without doubt, piracy is the biggest problem. Sales volumes would be three or four times higher if the piracy problem were taken more seriously by this country,” says Gérson de Souza, chief executive of Vivendi Universal Games Brasil. “The population is not aware of what’s happening. Unfortunately, most Brazilians do not view piracy as a crime. They don’t realize that they are committing a crime that violates the rights of software authors and evades taxes.” For Cardoso, the absence of specialized officials, mainly along the borders, winds up being the largest void in the tax system. “Sadly, the government is not acting against piracy. They talk a lot about taking concrete measures but most of the war involves only ABES [the industry software industry association].”

 

Piracy is not the only problem. Brazil also collects one of world’s highest taxes on legal sales of software. Taxes account for about 30% of the retail price of software. “Brazil is an expensive place to do business because taxes are high. Moreover, Brazilian labor laws are antiquated and it is complicated to hire a large workforce because of high costs. Production becomes more expensive, and competitiveness drops off. The company must make do with fewer employees, and that leads to delays in getting to the market,” says Valadares.

 

These problems have forced companies to use new strategies. A sizable number of Brazilian firms have launched games for play on the Internet. Erinia is one such game, and it is distributed free. There is no piracy because the company collects monthly subscription fees. “Most software firms have adopted this solution because it allows them to instantaneously validate if software is legal. Nevertheless, we may evolve toward a model that is less stressful for users,” explains Barbado.

 

Although companies such as Ignis and Jynx – which makes FutSim, a football manager game – have opted to distribute online, large companies such as EA and Atari share costs for maintaining their distribution centers with other software firms that are otherwise their competitors. “The biggest problem involves structure and sales volume. If your goal is to deal with all of Brazil, the cost goes up because you need to maintain small local centers,” explains Cardoso. In addition to distributing its own games, Electronic Arts Brasil distributes the games of Ubisoft, Codemasters and Activision.

 

Perspectives for the Online World

Brazilian producers are most excited about their online games. Not only does the Internet provide a different system for distribution, it allows producers to reach several markets at the same time, and differentiate the various rates of return. “The video game market is still in a growth mode. What defines this growth and makes companies change their strategy is the development of these massive online games. Many Brazilian software houses are focused on this segment, which is easier for companies to enter because the worldwide demand is extremely high,” notes Souza.

 

Another positive factor, says Valadares, is that Brazilians have developed a level of comfort using the web everyday. The widespread popularity of online entertainment sites suggests that online gaming can also achieve a similar level of appeal. “Happily, Brazil has all the characteristics of a good online community. Most of the web tools, such as blogs and foto blogs, count on Brazilian users. As a people, we are quite skilled on the Internet. All we need is more money. However, the economy is improving, and when that happens, the possibilities get bigger.”

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