Justin Kwok looks harried. Crammed into a small, fourth-floor office in Toronto’s trendy Queen Street West area, he and his team of seven—collectively known as Blot Interactive—are crunching to get their first video game done.

They aren’t, however, working on a release for the upcoming next-generation Xbox One or PlayStation 4 consoles, due this month from Microsoft and Sony, respectively. Instead, Chat Fu is an add-on Facebook app that turns instant messaging chats into a game. The idea is to trick your Facebook chat partners—who may or may not know you’re using Chat Fu—into typing words suggested by the game. If you successfully sucker them in, your onscreen character chops, punches and kicks theirs. It’s devious fun. It’s also free to play.

Kwok hopes Chat Fu will generate revenue through micro-transactions, in which players can buy new characters and martial arts moves. But his overall financial goals are modest.

“I would consider Chat Fu an incredible success if I was sitting in a coffee shop or bar and overheard a conversation between strangers talking passionately about the game,” he says. “Hopefully, if you touch people in their minds and hearts, their wallets will follow.”

Blot is a case study in what’s happening in the video game industry. The $66-billion business is shrinking—not in revenue, because that’s still growing—but rather in terms of who’s making the products and their respective ambitions.

For much of its 40-year history, the medium has been ruled by huge console makers and mega-publishers, such as Microsoft, Sony, Electronic Arts and Activision. Games have consequently ballooned in scope over the decades to the point where they typically require $100-million budgets, teams of hundreds and several years to produce.

But the big boys now have company, and lots of it. Independent developers—often just a handful of people and sometimes just a single individual—are popping up faster than mushrooms in a Super Mario game, and they’re taking a big chunk of the pie through a thousand little slices. Digital distribution and mobile devices have democratized the field and opened up new audiences and business models, and the little guys are rushing to take advantage. Many don’t want to get rich; they just want to make a living doing what they love.

For Canada, which already employs the world’s third-largest games workforce after the United States and Japan, this is potentially good news. With the shift on to smaller, more independent production, Canada is poised to take an even larger slice of the pie.

Just a few years ago, consoles were the only game in town, so to speak. They were bulky boxes sitting beside the television, into which you inserted discs to play the latest blockbuster games put out by major publishers.

Then, in 2007, came the iPhone, and its app store a year later. With a responsive touch screen, powerful graphics capability and a democratic distribution process that allowed anyone to release an app—from big companies to lone individuals in their basements—Apple’s device became a phenomenon with consumers and software developers alike.

The iPhone “completely changed our perspective,” says Kris Piotrowski, co-founder of Capybara Games. “It solved all the problems we had on mobile.” Piotrowski and two friends had formed their company a few years earlier, in 2003, with a plan to make cellphone games. They had a few minor successes—primarily quick time-wasters tied to Disney movies—but otherwise it was a tough and unrewarding slog. The games themselves were rudimentary, while licensors and wireless carriers called the shots and took most of the money.

“By the time the money trickled down to the developer, there was nothing left,” he says. “If we had stayed in mobile doing contract work, we would have gone insane and driven ourselves into the ground.”

After the iPhone’s release, games quickly became the most common and profitable apps. Within a year of the app store’s launch, there were 6,000 games available—by 2011, a whopping 90,000. With the iPad added to the equation in 2010, the exponential growth was compounded. There are now more than 140 games being released through Apple’s app store every day.

Capybara’s big break came with Superbrothers: Sword & Sworcery, a quirky adventure game that sold for a few dollars on the iPad, in 2011. The critically acclaimed release, which won the Game Developers Choice Award—the Oscars of independent games—was also a financial success for the company, selling 1.5 million units. It was enough to wean the company off commissioned projects and solely onto its own, original games.

“It’s a dream situation to be in right now,” Piotrowski says of the upheaval, “but it’s also totally terrifying.”

The growth of the mobile game ecosystem has largely come at the expense of the large, established players. Nintendo, in particular, has been posting heavy losses—$366 million in 2012—as quick, casual games on smartphones have displaced its Game Boy 3DS handheld. Sony’s portable Playstation Vita system has also underperformed.

The disruption hasn’t been limited to mobile. The PC, where video games were originally born, has also seen a renaissance as a platform thanks to Steam, the online distribution system started in 2002 by Valve Corp., based in Kirkland, Wash. The service—which also allows just about anyone to release a game—has grown to more than 50 million users since, with Valve now looking to expand into the living room with an upcoming PlayStation-like console, the Steam Box.

There’s also Ouya, the Kickstarter-funded, Android-software-based console that launched in June with an aim to further shake up the business by offering inexpensive, independently developed games for the TV. And over all of this looms the continuing possibility that Apple will eventually unleash its gaming catalog on the living rooms of the world by opening its app store to its inexpensive Apple TV set-top box as well.

All of this together represents an unprecedented world of choice for gamers and, crucially, for developers. Consumers can pick between $70 console games that take hours to complete, or quick, free time-wasters for their phone. Developers also have a choice of business models—they can sell their products at console-like prices or give them away like Blot is doing, with an eye to generating revenue through micro-transactions or other methods, such as merchandise.

The fragmenting market has created competitive space for small, independent publishers. Since app stores already keep customers’ payment details on file, it’s often just one or two easy clicks to buy a game for a few bucks. And simpler games that work well on mobile usually don’t require massive budgets and teams of hundreds to produce; smaller development budgets mean they don’t need to sell millions of copies to turn a profit, and there’s more room for creative risk. That has led to a flourishing market for games with quirkier sensibilities—not just the expensive, gory and violent shooters that have become the bread and butter of home consoles. Ultimately, it’s not a zero-sum game; the overall market has expanded by appealing to consumers who didn’t previously think of themselves as gamers at all.

Numerous success stories have arisen amid this fragmentation, with San Francisco-based Zynga leading the way. Founded in 2007, the company soared to an initial public offering in 2011 on the back of its most well-known property, the micro-transaction-driven Facebook game Farmville. Despite cutting its workforce by 18% in June, the company still has nearly 3,000 employees and a market capitalization of more than $2 billion. And in a true sign of the times, the company lured Microsoft’s Xbox boss and Vancouver native Don Mattrick—the most powerful man in video games—to take over as chief executive in July.

Seattle-based PopCap, meanwhile, was acquired by giant Electronic Arts in 2011 for $750 million, and Finland’s Supercell, which currently rules the mobile roost with its hit Clash of Clans, last month netted a cool $1.5 billion after Japanese telecom provider Softbank purchased a 51% stake, which values the company at $3 billion—or bigger than Zynga. Whether these companies eventually end up stumbling in the face of notoriously fickle gamer interests, as Zynga looks to be doing, is anyone’s guess. But they are emblematic of a paradigm shift: the games business is far from the stolid, guaranteed money-maker it once was. It’s very much a digital Wild West now.

Throughout this change, mobile and online games have gone from around $12 billion in global revenue in 2007 to about $30 billion this year, according to tracking firm PwC. The overall games market will continue climbing to $83 billion by 2016, but mobile and online will increasingly make up the lion’s share after surpassing consoles and PCs this year.

The shift is reflected in Canada, where the total number of employees in the industry in 2012 rose 5% to 16,500 over a year earlier, according to the Entertainment Software Association of Canada. While big multinational studios such as Ubisoft Montreal and EA in Burnaby, B.C., accounted for most of those workers, they were but a small minority of the total 329 companies in operation.

The overwhelming majority of those smaller businesses—84%—are working on mobile games, nearly half on web games and almost a third on social-networking games. Almost half of developers are still devoting their energies toward consoles, but the input differences are huge—high-end games are requiring an average of $8.7 million, 65 people and 583 days to produce, compared to just $300,000, seven people and 156 days for mobile games.

Not surprisingly, many game creators—such as Blot and Capybara—aren’t aiming to be the next EA, Ubisoft or even Zynga. They’d rather stay small.

“The golden age of gaming is gone,” says Alain Tascan, chief executive of Montreal-based Sava Transmedia. “The time of humongous studios with a thousand people working on a few big games, I don’t think we’ll see that again any time soon.”

Tascan was a founding executive at Ubisoft Montreal in 1997 and then head of EA Montreal. He left in 2011 to form his own company that could fill a void he saw in the Canadian games market. Despite being one of the biggest development sources in the world, the country had virtually no publishing clout.

“It’s about ownership,” says Tascan. “Especially in rough times, if you want to keep the expertise and the jobs, you need local ownership.”

In the world of blockbuster console gaming, that was a difficult prospect. Huge costs made developing a game a risky proposition, and even one flop could sink a mid-size company. Those that survived were often bought out by larger global publishers, whom governments were happy to court.

Provincial tax credits have been a cornerstone of the business in Canada. British Columbia led the way, with EA Canada providing a focal point while employees who left spun off studios like Radical and Relic. Half a billion dollars in incentives later, the local scene had grown to more than 6,000 highly skilled and paid jobs. In 1997 Quebec followed suit, luring France’s Ubisoft into setting up shop in Montreal with the promise of hefty tax credits. Ontario joined the subsidy game in 2009 by offering Ubisoft more than $260 million in tax credits over 10 years. The idea was to make the French company’s Toronto studio, which is aiming to create 800 jobs by 2020, an anchor that will spark the same sort of ecosystem.

The Entertainment Software Association of Canada says all these credits are working. The average age of those who work in the industry is 30, while the average salary is $72,000; ESAC puts the total contribution to the Canadian economy at $2 billion a year. But since the biggest companies are foreign-owned, profits seldom stay in Canada. And when profits falter, branch plants make easy targets for head office.

Publishers are also finding that when you live by the tax credit, you can die by it too. B.C. has refused to ante up and match Ontario’s and Quebec’s rates, and a spate of closings and layoffs has swept Vancouver’s mid-size studios in the past few years.

Digital Extremes, based in London, Ont., is exactly the kind of operation that is on the endangered species list. With 180 employees and a focus on console gaming, it’s watching with alarm as the marketplace it was built on erodes. But rather than folding, founder James Schmalz is reorienting. The company is this fall launching Warframe, a shooter for the PlayStation 4, that will be free to download and play. Just as with Chat Fu, the revenue will come—hopefully—from micro-transactions.

“It’s super hard for studios of our size,” Schmalz says of Digital Extremes. “The solution to that, we’ve found, is in changing the product that you’re working on.”

For Capybara Games, just two floors down in the same building as Blot Interactive, control over games is about much more than just keeping profits or jobs. It’s also about controlling destiny.

The 25-person company now has three of its own games under development, including Below, an adventure game for the Xbox One that was highlighted during Microsoft’s press conference at the Electronic Entertainment Expo this summer. Microsoft Studios head Phil Spencer even wore a Capybara T-shirt onstage.

Piotrowski is now free to determine new frontiers for his company, including possible game sequels, merchandising and licensing opportunities. In the true indie spirit, though, none of the company’s principals are much interested in making the big money through getting bigger or selling out in an acquisition, like many of their forebears did.

Talking to indie developers across Canada elicits a common theme: the games themselves are the reward.

“For us, success is if we make our budget back because that means we can make another game,” Piotrowski says.

Blot Interactive’s Kwok agrees. “When I’m 90 years old, I’ll still be making games. That’s what I love to do,” he says. “It’s the essence of the indies. We’re not in it to make a ton of money.”