Batman: Arkham Asylum was first announced in August 2008; it was developed by British studio Rocksteady Studios under the aegis of Eidos Interactive and Warner Bros. Interactive Entertainment. Eidos obtained the rights to make a Batman game in spring 2007, and approached then little-known Rocksteady after viewing the developer's prototype. At Eidos' request, Rocksteady presented their approach to the Batman license, and by May 2007 they had begun developing the game's concept, with full production beginning in September. Writer Paul Dini (Batman: The Animated Series, Detective Comics) was first approached by DC Comics around late 2007 about the prospect of creating a story for an original Batman video game. Dini found the idea intriguing, believing that few Batman games were based on an original idea, instead being adapted from film or television. DC Comics asked Dini what his approach to writing a new Batman film or graphic novel would be, but one that was designed for game play. He later met with the Rocksteady team, where it was decided that Dini's ideas were in line with what Rocksteady wanted to achieve. By the time Dini joined the project, Rocksteady were investigating the idea of setting the game within Arkham, and had produced preliminary designs depicting it as a huge estate on an island connected to mainland Gotham City by a bridge. The cast had not been finalized, but given the setting it was certain that the Joker would play a large role. The game and story were developed together, with the limitations of game play mechanics requiring the story to be built around them. The core aim was to make the game engaging enough for players to spend 8–10 hours completing it, especially those uninterested in Batman-franchised media. Rocksteady would guide Dini when they thought he was writing too much story or character motivation.
Among various Neal Adams and Frank Miller-penned Batman stories, Grant Morrison's Arkham Asylum: A Serious House on Serious Earth was an inspiration for the game's design. Producer Nathan Burlow said the narrative and atmosphere of the 2007 game BioShock influenced Arkham Asylum's design. Director Sefton Hill said the influences of the gadgets and abilities that can be combined and used in different ways in The Legend of Zelda and Metroid. The design team isolated the components that they felt made Batman, and exaggerated these elements. Design ideas which contradicted these facets of the character were dropped, and other elements of Batman, such as his refusal to kill his enemies, were strictly enforced, which provided additional challenges in allowing the player to have complete freedom in the game without transgressing on that fundamental aspect of the character. Arkham asylum was chosen as the setting because it confined the player to an area containing several enemies, whereas in an open city setting he could receive help, return to the Batcave, or otherwise be able to distance himself from his opponents.
The development team wanted to include iconic aspects of the Batman mythos, and decided early on in production to have Conroy, Hamill, and Sorkin reprise their roles in Dini's Batman: The Animated Series as Batman, the Joker, and Harley Quinn respectively. Hamill has thousands of lines of dialogue in the game, and Conroy has relatively few in comparison. After seeing character models of the Joker's Arkham Asylum appearance, Hamill decided to portray the character as dark and gritty while retaining a clownish and playful nature. Although the game features references to plot events in both The Animated Series and Batman comics, the story does not directly follow any singular story or depiction of the character.
The game took approximately 21 months to complete; Rocksteady began development with a team of 40, which had expanded to around 60 by the game's completion. Rocksteady originally developed the game's combat as a full rhythm action game. It was later set in 2D, which involved colored circles crashing into each other during fights; the final system was based on this 2D model. Combat was considered one of the greatest challenges in developing the game; the system went through three iterations. Combat was designed to be unique for Batman, and was given a simple control scheme to reflect the ease with which Batman can perform the moves. Arkham Asylum was built on Epic Games' Unreal Engine 3. Eidos president Ian Livingstone said one developer spent two years programming Batman's cape, using over 700 animations and sound effects to make it move realistically.
The developers intended to use some Batman characters in the game, but these were removed when it was decided they would not work within the story. For example, Batman's enemy Mr. Freeze did not fit because the character has different motivations to the Joker. Unlike the Riddler,who is obsessed with proving his superiority over Batman, Mr. Freeze does not hold a personal grudge against Batman, and Mr. Freeze would not care about the other villains' plans. A garden maze under Poison Ivy's control was considered as a location; she could grow in different directions. In its center, Batman would find the Mad Hatter hosting a tea-party, but the developers decided these ideas would not match the game's tone and were dropped. Batman's vehicles, the Batmobile and Batwing, were considered for inclusion in the game but developing unique control mechanics and gameplay segments for them would take too much time and would compromise its quality; the vehicles were included in the game's story but remained outside the player's control. Rocksteady began conceiving ideas for a possible sequel, which became Batman: Arkham City, approximately seven months before development of Arkham Asylum was completed. Rocksteady developed ideas for the sequel's story and setting so the games' narratives could be effectively connected. Arkham Asylum's musical score was composed by Ron Fish and Nick Arundel, who also composed the soundtrack for the sequel, Batman: Arkham City.
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