As a game developer, Gabe Newell wanted to have a close relationship with his customers. But in the past, the chief executive of Valve had to hear feedback via middlemen. Valve developed a game, a publisher released and distributed it, retailers sold it, and that was it.

To get around this problem, Newell took the profits from his mega-hit Half-Life and invested it into Steam, a digital downloading network that delivers games directly to consumers. Speaking at the Dice Summit tonight in Las Vegas, Newell said that Steam now has more than 20 million consumers downloading games to their PCs.

Steam has been stunningly successful, and now all of the game industry’s PC game publishers use it. There are more than 350 games available on it. In creating Steam, Newell has found a way to disintermediate his middlemen and engage directly with his customers. He can take suggestions from gamers and integrate them into the game right away. This strengthens the social networks that can develop around games inside the Steam community.

Valve’s Team Fortress 2, for instance, has been updated 63 times, and the updates happen automatically. One result: Sales are continuously growing for a relatively old game, and minutes played on the game are growing as well.

The digital download business allows Valve to keep more of the profits, and now it can keep gamers interested in Valve’s games via special offers and other tactics. And while many games are pirated if distributed on disks, Steam requires players to authenticate their identities and verify that they’ve purchased a copy. Cheating in multiplayer games is harder to do as well, thanks to Steam’s security system. Newell notes that these sales are attracting new clients and gamers, since Valve can cross-sell games on Steam.

Game developers can also use Steam to experiment with pricing. When a game’s price is changed, customers can react to it within five minutes. Last weekend, Newell said, Valve ran an experiment with its hit zombie-killing game, Left4Dead. The company offered a discount sale price and saw its numbers shoot through the roof. Sales of the game on Steam increased 30-fold and even exceeded the launch sales of the game last fall. That was a huge uptick in revenue.

The funny thing was that retailers didn’t suffer. Rather, retailers also saw a spike in the revenue at the same time. Newell concludes that the lessons learned from Steam for games are the same as those for digital distribution of movies and music. After an initial period of angst about Valve killing retailers, everybody is selling more games.

He thinks the game industry as a whole is benefiting from digital distribution, just as music is benefiting from the shift from CDs to iTunes and movies from DVDs to Netflix. Not only is he making more money, but he is also correcting the course of product marketing more often, and new users are pouring into the market.

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