Third-party developers are usually called upon by a video game publisher to develop a title for one or more systems. Both the publisher as well as the developer have a great deal of say as to the design and content of the game. However, in general, the publisher's wishes trump the developer's, as the publisher is paying the developer to create the game.

The business arrangement between the developer and publisher is governed by a contract, which specifies a list of milestones intended to be delivered, for example, every four to eight weeks. By receiving updated milestones, the publisher is able to verify that work is progressing quickly enough to meet the publisher's deadline, and to give direction to the developer if the game is turning out other than as expected in some way. When each milestone is completed and accepted, the publisher pays the developer an advance on royalties. The developer uses this money to fund its payroll and otherwise fund its operations.

Successful developers may maintain several teams working on different games for different publishers. Generally, however, third-party developers tend to be small, and consist of a single, close-knit team.

Third-party game development is a volatile business, as small developers may be entirely dependent on money from one publisher. A single canceled game can be lethal to a small developer. Because of this, many of the smaller development companies last only a few years or sometimes only a few months. The continual struggle to get payment for milestones and to line up the next game contract is a persistent distraction to the management of every game developer.

A common and desirable exit strategy for an extremely successful video game developer is to sell the company to a publisher, and thus become an in-house developer.

In-house development teams tend to have more freedom as to the design and content of a game, compared to the third-party developers teams. Part of the reason for this is that since the developers are employees of the publisher, their interests are as exactly aligned with those of the publisher as is possible. The publisher can therefore spend much less effort making sure that the developer's decisions do not enrich the developer at the ultimate expense of the publisher.

In recent years the larger publishers have acquired several third-party developers. While these development teams are now technically "in-house" they often continue to operate in an autonomous manner, each with its own culture and work practices. For example: Activision acquired Raven (1997), Neversoft (1999), Z-Axis (2001), Treyarch (2001), Luxoflux (2002), Shaba (2002), Infinity Ward (2003) and Vicarious Visions (2005). All these developers continue to operate much as they did before acquisition, with the primary differences being in exclusivity and the financial details.

History has shown that publishers tend to be more forgiving of their own development teams going over budget and missing deadlines than third-party developers.

An in-house development team that works for a console hardware manufacturer is also known as a first-party developer. A company that is closely tied to a console manufacturer (or occasionally a publisher) is known as a second-party developer. Rather confusingly the publishers themselves are sometimes referred to as third-party developers in the context of their relationships with the console manufacturers (Sony, Microsoft and Nintendo). This particular distinction of first, second and third party developers does not generally apply to PC games development.

Another example is a developer that is a separate legal entity from the software being used, usually providing an external software tool that helps organize or use information for the primary software product. Such tools could be a database, Voice over IP, or add-in interface software, among others. This is also known as middleware.

In addition, accessories like headsets can be referred as third party headsets, meaning that the company of the headset is different from the console company. For example, Turtle Beach is a third party headset company to the PlayStation 3 and Xbox 360.

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