The Video Games Industry in Scotland

Written evidence from the National Endowment for Science, Technology and the Arts (NESTA) (VID 09)

NESTA overview: NESTA is the National Endowment for Science, Technology and the Arts, the UK’s foremost independent expert on how innovation can solve some of the country’s major economic and social challenges. Its work is enabled by an endowment, funded by the National Lottery, and it operates at no cost to the government or taxpayer. NESTA is a world leader in its field and carries out its work through a blend of experimental programmes, analytical research and investment in early-stage companies.  We are building a significant body of evidence on the creative industries, which according to our research are worth over £50 billion to the economy every year. Much of this work has focu sed on the UK video games sector, the ch allenges it currently faces and how policy can help to overcome them, as well as practical programmes to support innova tion and growth in the secto r.

EXECUTIVE SUMMARY: The video games industry is an economic success story for the UK. A s recently as 2008, the UK was ranked as the third video games development territory after the USA and Japan, with global revenues worth £2.03 billion and 10,000 directly employed by the secto r. 1

However, the trade sector body, TIGA, reports that the UK risks losing its place in the global rankings: between July 2008 and July 2009, 15% of all video games companies in the UK went under, and the sector shed 4% of its workforce. It is feared that, without targeted support, the UK will drop from the forefront of global development. Indeed, according to industry insiders, the industry has already fallen to the 6 th position globally. This trend has been blamed on the generous subsidies available for video games companies in countries such as Canada or France. However, NESTA believes that there are other factors behind the UK’s decline as a global hub for video games development ; these include skill shortages, unsustainable business models and a lack of innovation. This submission outlines urgent actions to address these problems, including:

· The Livingstone & Hope Independent Skills Review for the video games sector in whi ch NESTA is currently engaged , in close collaboration with Skillset.

· Adjustments to the R&D tax credit scheme to make it more relevant for UK vi deo games companies, and focus on promoting innovation in the sector.

· Changes to existing incentive schemes for investors to attract more external project finance into the sector.

NOTA BENE: This submission seeks to outline the value of the video games sector to the UK economy, and all figures cited refer to the industry as a whole; this reflects low levels of geographical concentration of the industry. Unlike other creative industries, and despite notable clusters such as Dundee or Brighton, no region or nation hosts more than 10% of the video games workforce overall.2

1. A high growth sector where the UK is a global player: The future prospects for video games as a mass entertainment medium are bright. According to available estimates, video games markets will experience annual growth rates of 10.3% between 2008 and 2012- twice as much as film.3 This is a high growth sector where the UK has in the past shown a competitive edge thanks to its creativity and technical excellence4 indeed, until 2008 it held the third position on development rankings by turnover, after the USA and Japan. It is already the second global market in terms of size.

2. The economic contribution of the UK games sector is significant: in 2008, global revenues generated by UK video games were worth £2.03 billion, and contributed £1 billion to GDP.5 It is worth bearing in mind the economic contribution of the sector as an employer: the industry directly employed 10,000 people (and a further 18,000 indirectly) in 20086.

3. But the UK is becoming less attractive as a place to make video games: The trade sector body, TIGA, reports that the sector is in decline, and risks losing its international advantage. Between July 2008 and July 2009, 15% of all video games companies in the UK went out of business, and the sector shed 4% of its total workforce. While the economic downturn has undoubtedly contributed to this decline, the industry view is that this is symptomatic of a longer-term trend which has its roots in an uneven international playing field. It is thought that, if the current trends continue, the UK could drop down to sixth position in the global development territory rankings in terms of revenue. 7

4. Other countries have lavished generous subsidies on the sector in a bid to attract talent and investment. For instance, France and Canada alone have already invested public funds worth, respectively, over £500 million and 180euro million on the sector.

Summary of tax fiscal incentives for interactive content production (including Video Games) in Canada and Europe

5. In addition to the schemes outlined in the table above, territories such as Montreal provide other incentives such as tax holidays for foreign experts, Intellectual Property development funds for independent games studios, and direct subsidies for publisher investments. In British Colombia, tax incentives are available for venture capitalists to encourage investment in the sector.

It would be hard to argue that such comprehensive support doesn’t put UK video games companies at a disadvantage against their overseas competitors. This is compounded by the emergence of ‘naturally cheaper’ territories (including Eastern Europe, Singapore or China) as credible development hubs which are attracting significant levels of investment from global publishers.

6. Video Games are thriving in other countries without generous public support: it is worth bearing in mind that other arguably ‘expensive’ development territories are managing to compete without the sort of subsidies and incentives available in Canada or France. Japan and South Korea remain at the top of global rankings without targeted large-scale support, and German games studios have become a force to be reckoned with in emerging online and mobile markets in spite of a marked lack of government support. Likewise, the Nordic countries and Australia have attracted significant levels of foreign investment without the sort of measures available for their Canadian and French competitors. This suggests that tax credits are not the only explanation for the challenges that the UK video games sector is currently facing.

7. Staving off the decline of the UK video games sector: The trend that this submission has described is not irreversible, even in the absence of the production tax credits that the sector has been calling for. But urgent action is needed in several areas.

8. The Livingstone/Hope Independent Review of Skills in the video games and visual effects sector for the Rt Hon Ed Vaizey MP, Minister for Culture, Communications and Creative Industries, will set out actions to address recurrent skill shortages: The UK video games industry has long complained about the low quality of specialist video games courses at universities. Indeed, according to 2007 data, only 18% of those who graduated from these courses managed to gain a job in the sector. A third of respondents in a 2009 NESTA survey reported that ‘skill shortages’ remains one of the main barriers to making video games in the UK. 8

9. Ian Livingstone and Alex Hope’s Independent Review for at the request of the Minister for Culture, Communications and Creative Industrie s, which NESTA is leading in close collaboration with Skillset, is tasked with producing a blueprint to transform the UK into the best source of talent for video games and visual effects production in the world. The Review is examining the talent pipeline for the games and visual effects industries, beginning with schools, through to Higher and Further Education and into industry itself. It will make recommendations to government, education providers and business which will leave the industries better placed to react to and shape future changes in their technologies and markets.

10. The Research and Development (R&D) Tax Relief scheme needs to be made more relevant for UK video games companies: Innovation in technologies, content and business models can make UK video games companies more productive and efficient, and enab le to develop the new products and services to stay ahead of the international competition. By supporting the innovative activities of UK video games companies, policy can help the sector to step away from an unsustainable ‘race to the bottom’ on the basis of costs, and instead continue at the top through the creativity and technical excellence that drove it there on the first place.

11. The R&D Tax Relief scheme is one of the main mechanisms through which the UK government encourages innovation in the private sector. However, many innovative video games companies are unaware of its existence, or face substantial barriers in benefiting from it. The way that the credit is configured means that it is particularly hard for video games companies with distinctive innovation processes to prepare claims, or get them approved; these companies usually lack the scale or in-house resource to access the legal and tax-related expertise required to prepare their claims. In addition to the barriers to application that companies face, there is a degree of uncertainty about whether a claim will be approved by HMRC, as well as its value. Other things being equal, the greater the uncertainty, and the longer the lag between claim and tax relief, the less likely it is that a company will file a claim.9

12. NESTA recommends adjustments to the existing R&D tax relief scheme to make it a more effective means of supporting innovative video games companies. These have the twin objectives of encouraging companies to apply and improving the approval rate from HMRC without opening the floodgates of claims from other sectors.

These include:

· Raising the profile of the tax credit for video games companies, and improving access to information about how to apply: There is a lack of case studies showing how the tax credit can benefit companies in the sector. HMRC and BIS could help by providing examples of innovative video games companies which have benefited from the scheme, as well as templates and guides, describing in more detail than is currently available, the sorts of data and reporting formats that HMRC requires from applicants.

· Clarify the HMRC guidelines about important innovation expenditures in the sector: Currently the status of important innovation expenditures for video games development is unclear: companies need to know whether spend on tools which are publicly available or usability testing (both of which are areas of expenditure the sector considers vital for games development) fall within the scope of the tax credit.

· Use data collected as a by-product of development to assess R&D tax Relief Claims: The nature of innovation in the video games sector makes it very difficult to apportion R&D activities to a single stage of a project, making it harder and more expensive to collect data for the purposes of tax relief. HMRC should explore the possibility of using the data collected via the control version systems (CVS) that games companies have in place to manage their development processes as evidence for the purposes of assessing R&D Tax relief claims.

· Provide R&D specialist units with video games specific expertise: There is a perception that HMRC’s lack of sector-specific expertise is hampering take-up of the tax relief. One way to address this is to organise training workshops for HMRC personnel along the lines of those held by Intellect, the trade body for Software and IT. It might also be useful to set up one specialist unit as a single point of contact for video games companies across the UK.

· Improve access to data on the R&D Tax Relief scheme for evaluation and assessment purposes: Currently the information available on the scheme is too high level to assess the benefits of changes to the scheme to particular sector. More consistent reporting and collation of data would enable the ready identification of bottlenecks in the system and the sectoral destination of taxpayers’ money.

13. It is crucial to improve access to external finance for the sector: Past NESTA Research has highlighted that UK studios rely excessively on global publishers as a source of capital for their development activities.10 In most cases, these publishers contract UK studios for specific projects following a ‘work for hire’ model with meagre rewards. There is generally little space for innovation in these projects- Instead of staying ahead of overseas developers through the generation of original IP, the UK is forced to compete on costs, which as was argued above is not a sustainable option..

14. In the increasingly rare occasions where publishers fund the production of original IP by UK studios, they do so through a ‘royalty advances model’ where the developer relinquishes ownership over its original IP in exchange for funding: innovation may happen, but commercial exploitation doesn’t.

15. All of this means that UK studios usually have little to show for their development efforts at the end of a project. Lacking funds to reinvest on innovation and growth, or to buffer themselves against market uncertainty, they fall in an ‘IP Poverty Trap’ which is hard to escape.

16. NESTA believes that external finance focusing on projects rather than companies may have a role to play in enabling the sector to access capital for innovation and growth. Again, relatively inexpensive actions and adjustments to remove biases against the sector in existing schemes could have generate substantial benefits. They include:

· Raising awareness of the external project finance instruments in the UK video games sector, particularly among studios

· Changing the established application criteria to enable external investors who use project finance models to benefit from existing incentive schemes such as Venture Capital Trusts (VCT) and Enterprise Investment Schemes.

· Develop standardised legal templates for project finance to lower the currently prohibitive costs of organising video games project finance vehicles.

Given the economic importance of the sector, we also consider that there are grounds for the redeployment of some of the Lottery finance available for films into video games development.

10 September 2010


[1] GIC (2008), ‘Raise the Game’, NESTA: London

[2] Skillset (2009), ‘Computer Games Labour Market Intelligence Digest’, London: Skillset.

[3] PwC (2008), ‘Global Entertainment Outlook 2008-2012’. PriceWaterhouseCoopers: London.

[4] GIC (2008), ‘Raise the Game’, NESTA: London.

[5] GIC (2008), ‘Raise the Game’, NESTA: London, Oxford Economics (2008), ‘The Economic Contribution of the Games Development Industry’. Oxford Economics: Oxford.

[6] Oxford Economics (2008), ‘The Economic Contribution

[7] Crossley, R. (2010), ‘ Braben fears UK’s drop to sixth in dev league ’, Develop Online 21 st January 2010. Available at http://www.develop-online.net/news/33703/Braben-fears-UKs-drop-to-sixth [Last accessed 10 September 2010].

[8] NESTA (2009), ‘It’s Time to Play’, NESTA: London.

[9] Of course, some of the costs that a company will incur to prepare a claim (i.e. legal advice and consultancy) are aimed at reducing those uncertainties.

[10] Bakhshi, H. and Mateos-Garcia, J. (2010), ‘The Money Game’, London: NESTA.