Remember the first time you paid $60 for an Xbox 360 game? You know, right before you knocked over the magazine stand and stormed out of GameStop in disgust, swearing to the heavens that you were going to play the crap out of that game? Sure, it’s a lot of money, but the cash you forked over isn’t just filling up some fat-cat executive’s wallet — making games these days isn’t cheap. Then again, it doesn’t all go toward development of the game; everyone wants a slice of this pie chart. So where exactly does your $60 go? We spoke to Wedbush Morgan analyst Michael Pachter to get the inside word. When you fork over the money for a game, who gets rich — and who might die tryin’? The answer might surprise you.

RETAILERS
Let’s start with the most obvious part — when you buy a game, the retailer is making a profi t above what they paid at the wholesale price. Generally, this is around 20 percent of the total cost, so, when you’re paying $60 for your copy of Halo 3, the retailer is making $12, since a full-price game at its wholesale price costs only $48.

There are exceptions to this rule, though, according to Pachter. Retailers will sometimes be given a “vendor allowance” — a discount of around $2 — for advertising at the point of sale. Those big banner ads and Master Chief cardboard cutouts that you would probably kill to have in your living room are allowing retailers to make even more money. In fact, a really high-profile game like Halo 3 might have a vendor allowance of more than $2. “They’re certainly doing it for Halo,” says Pachter.

“They’re certainly doing it for Grand Theft Auto — even Spider- Man: Friend or Foe is going to do it at Target or Wal-Mart or something. Vendor allowance dollars are provided, and sometimes those are give to a firm like Best Buy to feature Madden on the photos of television sets that they show in their weekly circulars. So [running the video] may not have a real cost, but Best Buy is collecting [ the allowance] to frame that advertising.”

MANUFACTURING AND LICENSING
For the sake of argument, we’ll assume that $2 vendor allowance is pretty standard for most games, which leaves the publisher with $46 from every game you buy. From that $46, it then has a number of other costs, including the licensing royalties they pay to Microsoft for, as Pachter puts it, “the privilege of putting the game on the console.”

This is how Microsoft makes its money from each game, and why it has just as much interest in seeing third-party titles like THQ’s Stuntman: Ignition (just for the sake of a random recent example) succeed as it does with first-party games like Halo 3. It’s not pure profi t for Microsoft, though: part of that money is used for the manufacturing of the game, although that’s not a terribly expensive part of the process.

“Manufacturing cost is literally 70 cents a disc, the jewel case is 15 cents, and the packaging materials are probably another 15 cents, so we’re really talking about $1 per disc,” Pachter explains. “That’s incorporated into Microsoft’s charge — they do that for you. The reason they do the manufacturing is that they want to make sure they collect that big fat royalty on every game on the 360. They don’t say: ‘Okay, THQ, go to Technicolor and have them stamp out your DVDs and we’ll trust you as to how many you’ve had made. You can just send us a check.’ They say: ‘Want to order 500,000 units from us? We’ll make them for you. We’ll deliver them when you pay us.’ That’s really what their business is. The reason anyone is in the videogame industry is to collect these royalties.”

However, just as some factors can change the wholesale price of games, other factors can reduce the licensing and manufacturing fee charged by Microsoft. “When I say $12 for royalties,” Pachter notes, “I’m sure there are some guys who pay $10. I’m sure that EA has negotiated a better rate for Madden or FIFA or something. I’m sure some deals are cut for exclusives, so when Splinter Cell Conviction comes out, the Ubisoft guys are pretty astute: you don’t give an exclusive if you don’t get a break.”

MARKETING
At this point in our math, the publisher is looking at making $34 for the game, assuming they haven’t received a discount from Microsoft. There are still more costs, though, including the actual marketing of the game. Magazine ads, bus-stop billboards, website banners — who knows, maybe even forum viral marketers.

Generally, Pachter says, the “average spend in the industry toward marketing is around 14 percent or 15 percent” of the wholesale price, which works out to about $7. Most companies will actually include the vendor allowance in the marketing budget, though, so since we’ve already added that to the tally, we’ll leave the marketing budget at $7.

RESEARCH & DEVELOPMENT
That leaves us with $29 — almost half of your out-of-pocket price — but our publisher still has to actually pay for the development of the game, and as we said earlier, that’s not cheap for a next-gen system. A typical game for Xbox 360 costs around $10 million in development costs, which is why making a game that’s going to sell lots of copies is so important in the current market.

Going back to our example of Stuntman: Ignition, if the game does prove successful and manages to reach million-seller status — something only 12 Xbox 360 games have currently done — then THQ will have put $10 from each copy of the game toward the development cost. If it sells 2 million copies, then THQ will be infi nitely happier, because that means they only have to earmark $5 from each game toward development.

We arbitrarily chose Stuntman: Ignition for our example; please note that our data isn't bases specifically on that game's retail performance or business deals.

“So, a million-unit seller is pretty much what people hope for with a next-gen game, and it’d be about $10 per copy,” Pachter says. “But they have to have a contingency plan in case their best effort ends up selling only 500,000 — they’re going to plan, for budgetary purposes, that the cost of R&D is $20. That leaves them with $9 to cover their overhead — that is, the cost of doing business as THQ.”

“Doing business” means paying salaries and paying the rent, but at just $9 profit per game, a publisher has to make it up with volume. In other words, the only way to make big bucks is to sell oodles of games. Everything needs to be a hit.

MONEY MATTERS
“So,” concludes Pachter, “when a gamer says, ‘I don’t want to pay $60; I want to pay only $50 for that game,’ THQ’s going to respond: ‘If we get $10 less, we can’t afford to make it. That’s the margin — too thin for us to take the risk of making the game.’

“The biggest driver of the increase in price from $50 last-gen to $60 this time is that R&D essentially went from $5 million on the Xbox and PS2 to $10 million on the Xbox 360,” he continues. “That’s really it. So when we concluded that R&D was about $20 per copy on a 500,000-seller for a $10-million game, it would have been $10 per copy for a 500,000-seller on Xbox, because the game cost half as much to make. That $10 difference, though, really is the difference in price these days.”