I heard the rumors over the weekend and hoped that they were not true. But they were. “E3” the video game industry’s amazing annual trade show, is going to be scaled back starting next year. The big, beautiful, booming spectacle of hundreds of gaming companies coming together to show off their amazing new games, platforms and other inventions… is no more. It will be replaced by a smaller show at a smaller location with a smaller crowd.

As a gaming fanatic, it is sad news to be sure. I may be a 37-year-old father of two, but when I was walking the aisles of the “E3” show this May, it was a non-stop, “kid-in-the-world’s-greatest-(eye & ear)-candy-store” moment for me. (My complete review of this year’s show can be found here.

But, after the news set in–and after I had time to kill the pain by getting on XBOX Live and kicking a good friend’s butt in a heated match of “NCAA Football 2007”!–I started thinking more rationally about the economics of trade shows. Specifically, why do industries host trade shows at all? Is it really worth it for them?

Now I’m no expert on the history of trade shows, but I imagine that many (if not most) of them got their start as a small gathering of industry insiders who wanted to talk shop and potentially make some deals. Then, they gradually evolve into bigger and bigger shindigs as a bigger circle of industry friends was invited. And then folks from upstream or downstream industries got invites. And then customers and media reps got invites.

At some point, somebody got a really big idea: “Geez, if I put up a booth over here and highlight some of my new stuff, I bet I could attract some serious attention” That’s probably the point when all hell breaks loose for a trade show because then everybody feels that they need a booth, and that their booth has to be bigger, brighter and louder than the next guy’s booth. A sort of “arms race” then develops between industry rivals to see who can top each other year-in and year-out. The media even starts talking about who “won” or “stole” the show. It’s all a big contest; a high-tech beauty pageant.

And the fans love it. The spectacle of the arms race attracts tens of thousands of ’em who must live with the constant fear that if you’re not there, well then, you’re just not with it, man!

But at some point this model probably has to break down. It’s just too big and too expensive to sustain. At this year’s E3 show, I certainly saw the signs that this was the case. The Los Angeles Convention center was practically busting at the seams from the overflow crowd of 60,000+. Exhibitioners were setting up booths in basements, hallways and even outdoors. Inside the main halls, the booths were massive, and massively expensive, too.

For example, I will never forget my time inside the Electronic Arts (EA) booth this year. It was a wonderful example of technological excess intended to impress the fans and the media. And impress it did. The EA booth featured a fully-immersive gaming chamber that wrapped a giant 360 degree screen around the crowd and placed a rumbling floor beneath our feet. Characters and images whizzed around the room. Superman was doing laps around my head. Bombs rained down all around us when the new “Metal of Honor: Airborne” game was debuted. Virtual stocks cars roared around the room. Virtual football players collided with bone-jarring impact. The floor shook with each exploding bomb, car crash or ferocious tackle. I could literally see the shirt on my arm vibrating.

At the time, I just stood there soaking it all in, but each time I left the booth (I must of visited it 5 times!) I just kept thinking to myself: “My God, how much did they spend on that?!” I’ve seen reports that say many companies budget tens of millions for the show, but I have to imagine that the really big booths cost many multiples of that.

This is probably how the economics of trade shows begin to make less and less sense for an industry: per exhibit operating expenditures greatly exceed potential short- or long-term gain. The cost-benefit analysis for a company cannot be easy. How much is the exposure worth? Creating a “buzz” about a new game, console or product is certainly important, but these days there are many ways to create a “buzz” with spending nearly as much money. Heck, just leak a little news and couple of photos or video clips to a few select websites, and your new product will be plastered all over the Net in a matter of hours.

Of course, much the same thing can probably be said of the other shows like the Consumer Electronics Association’s massive “CES” show each January. It’s much bigger than E3 and (at least for now) still going like gangbusters. But how long is it sustainable? I missed last year’s show but heard some of the same laments I have heard for years: long lines, big crowds, big expenses. Will the CES show ever downsize? I don’t know. At the rate it’s going it’s going to take every other convention hall in Las Vegas to accommodate it. At some point, further growth is just not sustainable and all it takes is a few big names pulling the plug on their participation to start unraveling the show.

That seems to be what happened with the E3. It sounds like the video game industry has decided to return to the original trade show model: small gathering of industry insiders who wanted to talk shop and potentially make some deals. They’ll still be able to get the word out and create a “buzz” about new products in many other ways, and avoid bankrupting companies in the process!

But I’m still sad to see it go. Oh, if I could just stand in that EA chamber just one more time!

I’ve been out in Los Angeles this week attending “E3,” the video game industry’s annual trade show. It’s the first time I’ve been able to attend the show and I am finding it very interesting. Indeed, as I walk the halls of the L.A. convention center and chat with gaming companies and gamers themselves, I am struck by several things:

(1) This is one heck of an innovative industry. There are some remarkably creative minds working in the electronic gaming sector. As a life-long gamer who was part of the “Pong” and “Pac-Mac” generation, I am just flabbergasted by how much more highly developed games are today (in terms of graphics, narrative and gameplay) than they were 30 years ago when I first started gaming. There was a moment in my life when I thought that games just couldn’t get much more sophisticated than Activision’s “Pitfall” or Atari’s “Adventure.” What a fool I was! Some of the massive multi-player online roll-playing games (“MMORPGs”) I saw at the show were just jaw-dropping in terms of their graphical detail and narrative sophistication. And all of the new high-definition titles for the X-Box 360 and PlayStation 3 are nothing short of stunning. Old favorites of mine like “Madden” football and “Gran Turismo” are now rendered in ultra-crisp 1080p HD resolution. There are moments during those games when you really think you’re watching a live feed from a real football game or road race.

And even the games which featured a more simple premise were exciting. Consider “Table Tennis” by Rock Star Games. The same company that brought us the infamous “Grand Theft Auto” is now producing a decidedly less controversial title based on the classic game of Ping Pong! If you think it sounds silly, wait till you play it. It is addicting in a “Tetris-like” fashion. I hope they eventually make it for my PlayStation Portable!

Speaking of my PlayStation Portable… one of the coolest things I was able to do on the floor of the show was to directly upload games wirelessly onto my PSP from various Sony kiosks around the show. To demo new games, I just turned on my PSP’s wi-fi sharing system, got within 15 feet of one of the Sony kiosks, and then called up numerous “channels” of video game content. The games uploaded directly to my PSP and I was playing them within seconds. Very, very cool.

And Nintendo’s new “Wii” (pronounced “We”) console features the most innovate game controller ever. It’s a little wireless stick that you wave at the screen to move things around on the screen. You can use it to swing an imaginary golf club or baseball bat to hit balls on the screen. Or cast an imaginary fishing pole into the water. Just incredible.

I wish I could also mention all the cool computer and wireless hardware I saw at the show from other vendors, but it would take long. But what I took away from this show was that all this innovation in the electronic gaming sector is helping to drive still more innovation in other sectors ranging from computers, processors, video displays, wireless devices, and various other electronic or computer devices and accessories. It wasn’t surprising to me, therefore, when Electronic Software Association (ESA) President Doug Lowenstein noted in his “State of the Industry” opening address that a new study commissioned by the ESA reached similar conclusions. In “Video Games: Serious Business for America’s Economy,” economists Robert Crandall and Greg Sidak found that beyond the $10.3 billion in sales of video games in 2004, the video game industry stimulates an additional $7.7 billion in spending each year in the US, bringing the total economic impact of the game industry on the US economy alone to $18 billion. So this industry is now a major player in, and contributor to, our modern Digital Economy.

(2) The video game industry and Hollywood are rapidly converging. While I was walking through the aisles of the show, there were moments when I thought I was at a movie convention instead. These days, game and movie development are increasingly going hand-in-hand. Many movies and TV shows now become games (“Pirates of the Caribbean,” “Superman Returns,” “The DaVinci Code,” “24: The Game,” and yes, even “Desperate Housewives: The Game!”) and some games are turned into major motion pictures (“Tomb Raider,” “Doom,” “Resident Evil,” and “Silent Hill.”)

In some cases, games are being used as movie sequels to continue plot lines first developed in famous movies. “Scarface” and “The Godfather” were two prominent examples at this year’s show. Similarly, “The Matrix” and “Lord of the Rings” have spawned several game sequels. Likewise, “Stranglehold” is the video game sequel to director John Woo’s famous 1992 action movie “Hard-Boiled.” Actor Chow Yun Fat reprises his role from the movie in the video game. That’s another sign of convergence: Many major Hollywood actors are now routinely “starring” in video games. Vin Diesel stars in a new game called “The Wheelman,” and The Rock stars in “Spy Hunter.” And even Paris Hilton (if you can call her an “actress”) stars in a new video game. (I think I’ll pass on that one).

So, Hollywood and the video game industry are really coming together. So much so that there was even a workshop held during the show called “When Media Giants Muscle In: Why the Game Industry Should Care About the Acquisition Appetite of News Corp., Viacom, and Others.” (Seriously, I’m not making that title up). But I don’t think the industry has anything to fear from movie and media studios getting more involved in this industry. It will just mean even more capital will start flowing in their direction.

(3) The gaming industry cares as much about intellectual property law and enforcement as much as Hollywood. A lot of people like to demonize the music and movie industry for taking steps to better protect their copyrights. But it’s funny how no one ever talks about the importance of IP rights to the gaming industry. People certainly were talking about it at the show, however. In light of what I said above about the convergence of the movie and gaming sector, this really isn’t surprising. There’s an enormous amount of IP and licensing rights tied up in games today. Consequently, when hackers sell pirated games or “chip-mods” are made to consoles that allow pirated games to be played, it really can hurt game developers.

Todd Hollenshead, CEO and Co-Owner of id Software (makers of “Doom” and “Quake”) really drove that point home while speaking on a panel entitled “Game Piracy: Latest Strategies to Protect Your Product.” He noted that it was obviously impossible to stop all piracy (especially since many games are leaked by developers during production), but that catching the most egregious offenders was important to shore up the problem and send a message to others. But he and others noted that it’s really becoming an uphill battle because the cracking tools are growing more sophisticated, the hackers are getting more aggressive, and distribution systems and networks are growing faster and more ubiquitously available. Offshore piracy was also an issue that panelists said they are struggling to address.

I also chatted with developers and attorneys with Sony, Nintendo, Activision, and other game companies who talked about how they have used the DMCA on occasion to try to deter “chip-modding” (console hacking) and some other activities. During the panel discussion, I got up and asked the speakers if they planned on being more aggressive in their use of the DMCA but didn’t really get a clear answer. Some said they are already using it as needed, but others said even when they do use it do it doesn’t help as much as they wished. Sony, for example, recently won a $6 million civil judgment against a chip-modder, but because the guy has no real assets, there’s not really any way to enforce it effectively and recover damages.

Regardless, I think the video game sector is poised to become far more aggressive on the enforcement front to defend their copyrights. But it will be an uphill challenge. One possible solution that was discussed during the piracy panel was the idea of using more “CD key authentication / registration” techniques for consoles like users already do to register their legitimate copies of games and other software. But this would require that the consoles be connected to the Net, something that some gamers might not want to do.

(4) The debate over the impact of gaming on kids / society is only going to get more intense in coming years. I’ve been writing some papers this year about proposals to regulate video game content. There are dozens of measures pending at the federal, state and local level that would regulate the industry in one fashion or another.

The industry has won a string of solid First Amendment victories after challenging some of the major state and local enactments over the past five years. But that’s not going to stop legislators from proposing more regulations. That’s especially the case in light how much more life-like games are getting. I’m not going to get into all of this again right now, but there is no doubt in my mind that as gaming gets more and more like the “holideck” on Star Trek, legislators are really going to start turning up the regulatory heat. It’s certainly going to keep First Amendment advocates like me busy for years to come!

(5) Gamers are normal people (for the most part!). There are a lot of misperceptions out there about gamers. Most generalizations you hear are way off base. Indeed, gamers are now as diverse as the American population itself. Back when I starting gaming over 30 years ago, it was mostly the province of geeky white kids like me who had a great deal of familiarity with pocket protectors and 20-sided dice! (Yes, it’s true… I was Dungeons & Dragons nerd before I was an electronic gamer. I won’t reveal the name of my ranger character because it would qualify me for the Dork Hall of Fame.)

Today, by contrast, I see all races, sexes, ages and cultures represented in the gaming community. And the vast majority of gamers strike me as very level-headed, well-adjusted and quite productive members of society. As a first generation gamer who is raising a couple of third-generation gamers, I think video games are on their way to becoming almost as commonplace and widely accepted in our society as music and movies. It’s not just kid’s stuff anymore.