Will Project X be a good game?
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In advance, I want to mention that I am using GTA as a theoretical example in this case. I actually don't remember what it did for difficulty levels - it was just a clear example to explain the terms I'm using.
Something that I've done a lot of thinking about is difficulty modes. Not just because it's something you have to consider on every project, but also because it ties directly into the core meat of system design - what causes your game to be challenging? What level of challenge is fun, and when does it become frustrating?
I find that it's actually a really interesting exercise to look at a game and see how you could make difficulty modes (if it doesn't have them) or make the difficulties more interesting. This is partly because you need to answer two very important questions - what is your core gameplay, and what are the core challenges?
To define those terms as I'm using them:
Core Gameplay - This is the dominant overall experience of the player throughout the game. Core Gameplay can be comprised of multiple parts (for instance, in GTAIV driving and shooting are both part of core gameplay), but it must always be interactive. So, cutscenes are not core gameplay. Additionally, in most cases core gameplay elements are connected and influence each other. For instance, take driving and shooting in GTAIV. If you drive expertly, you can sometimes soften up a target before you kill him by flipping his car or running him over. Or, if you have awesome guns, you can usually blow up his car before he gets a chance to drive off.
Of course, this is a great example of what is NOT core gameplay, too. GTA has a lot of missions where you're forced to just shoot or just drive, and these missions don't generally succeed in my opinion because they actually break core gameplay. GTA's core gameplay relies on choice and interaction between shooting and driving as gameplay elements. Taking either aspect out of the mix fundamentally alters what makes the game work and lessens the play experience (in general).
Core Challenges - These are the individual mechanics - be they mechanical, tactical, strategic, etc. that comprise your core gameplay. These are the things that you have to do in the game, and the sum of your successes and failures at these individual challenges determines your success or failure at the core gameplay as a whole.
For instance, in GTAIV some of the core challenges are Aiming, Ammo management, Proper weapon selection, Cornering, learning the handling characteristics of each car, etc.
Anyways, in my opinion games tend to offer the most interesting difficulty options when they rely on tweaking or even adding new core challenges without invalidating the core gameplay. A great example of this is Thief. Thief's difficulty options added new challenges to their already existing stealth gameplay. They didn't choose to increase enemy health (at least, as far as I remember) because that runs at cross purposes to their core stealth gameplay. Instead, they force you to not kill anyone. This makes the game's environment navigation and perception/awareness challenges much more complex, but doesn't really alter the core balance of the weapons and tools.
The reason why more blunt instruments, like just increasing health and damage, tend to fail IMO is that they don't actually make the game more challenging, they just mess up the pacing. I played an ARPG recently that scaled damage and enemy HP and rather than really being more challenging at higher difficulty levels, it just turned into a massive slog. That's something you really want to avoid at all costs... pacing is key to the game being fun, and hard doesn't mean frustrating or boring, it should mean challenging.
So for instance, if I were designing difficulties for GTA I would probably make the guns more differentiated and single purpose in harder difficulties (IE less general purpose, innacurate guns become more inaccurate, short range guns become more short range, etc.). I might make ammo more scarce, though that can risk hurting your pacing. I might even change the handling profiles of some of the cars to make them more swervy, and a little easier to lose control of. What I wouldn't do is reduce your car's HP or increase enemy HP. I feel like those changes would just make the game more frustrating/dull, not harder.