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Why Has the Profit Margin for Electronic Arts Improved?

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Shift in business model

In fiscal 2012, the Digital Business segment accounted for 29.3% of total revenues for Electronics Arts (EA). The gross margin stood at 63.1% and the operating margin was 9.5%. Operating expenses in fiscal 2012 were ~$2.3 billion with earnings of $284 million and free cash flow of $105 million.

However, these business metrics improved in fiscal 2016 as the digital business accounted for 55.4% of revenues. The gross margin improved to 71.4% whereas the operating margin also rose to 28.5%. Operating expenses in fiscal 2016 were ~$2.0 billion with earnings of ~$1.0 billion and free cash flow of ~$1.1 billion. The growth in EA’s digital business was driven by mobile, extra content, and full game downloads.

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Microtransactions becoming increasingly important

Digital revenues have grown rapidly for Electronic Arts (EA). In fiscal 4Q16, digital revenues rose by 18.3% YoY (year-over-year) to $712 million from $602 million in 4Q15. Accounting for over $200 million in revenues, microtransactions present users with the opportunity to buy items that enhance their gameplay.

EA’s strategy is a shift from a premium-price model on mobile devices to one that involves in-app and free-to-play purchases. The company’s strategic shift toward digital and mobile, coupled with cost controls, has enabled the company to outperform the Market’s expectations.

EA accounts for 4.5% of the iShares North American Tech Software ETF (IGV). The other top holdings of this ETF include Adobe (ADBE) (8.9%), Salesforce (CRM) (8.6%), and Oracle (ORCL) (8.4%).

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