Battleblock Theater is the latest in a long-running pseudo-series (i.e. not-a-series) of 2D games set on a stage. Not "stage" as a synonym for "level", rather a raised platform in an auditorium. Take a looksy.
|Note the silhouetted audience...|
|...and the puppets...|
|...and the curtains and shadows|
These theatrical games call to mind a narrative technique as ancient as pizza: the "framing story". The notion that the world we are experiencing is a game within a game, the secondary level of scope being that of the theater patrons. Literature loves this shit: Hamlet, The Rime of the Ancient Mariner, Catcher in the Rye - these all employ framing stories to a varying degree, utilizing parallels between the inner and outer narrative to add thematic complexity. Where these game examples appear to fall short is in making little to no attempt to tell the secondary frame story - the one outside the stage-play. Why the characters are performing their story, rather than living it, is left to guess-work by the player. I can't see how any of these games would change if the extra scenery was stripped away and they were set in the "real" world (the All-Stars version of SMB3 does exactly this, to no observable effect).
As a matter of fact, Battleblock Theater is the only one (to my knowledge) that provides any extra-theater play, and even then remains extremely confusing with its usage of drama. The game is set on an island where the protagonists are forced to participate in a gladiator-like series of platforming challenges for the amusement of a cataudience. But the preceding story, before they get to the island, is also told as a puppet show. How does this make any sense? It's simply an example of how little thought goes into the whole theater thing - it really is just there because it's "unique" (though, as we can see in this post, it's far from it).
The truth of it is that a game set on a stage isn't much of a framing story. Not because of the failure of the aforementioned examples to thoroughly execute, but because of the combination of media. A game within a game should be exactly that: two different games. Not a stage-play and a game. It could be argued that this is done through playable flashbacks in games like The Witcher 2 and Splinter Cell: Conviction, but those are just basic discontinuous narratives. As for mini-games, such as the Game Boy in Super Mario RPG or arcade cabinet in StarCraft II... I guess those are games within games, in a spiral array, but come on. That's a completely trivial example. It's the same situation as the theater setting: yes, technically it's a frame, but with so much dissonance between the two levels that it may as well not be.
I'm currently working through Retro Game Challenge, one of the better framing games I've played - which wasn't something I expected to call it. The overarching narrative places the player as a kid from the present who is sent back in time to play a bunch of 'classic' video games as they are released (classic in quotes because these are fictional games based on real ones). While some players may glance over this entire story thread and view the game simply as an anthology similar to Namco Museum or Mega Man Anniversary Collection, they won't get much from the experience. The frame story, playing as the kid who plays the games, is intended to provide the experience of growing up in the '80s, living through the release of these classics. There are manuals to read, Nintendo-Power-esque magazines to browse, and a friend who provides rumors about secrets and upcoming titles. This is a genuine interactive narrative - the gaming experience is as important as the games themselves.
This strongest aspect of the frame story is that the games-within-the-game have a fixed release schedule. I imagine some players of Challenge will be disappointed to find that they need to play through each of the eight games before the next becomes available. I know that discovery initially left me annoyed. When you realize that this is NOT a collection, but a story about the evolution of games and gamers, it becomes clear how much sense that linearity makes. We all want the next big game to come out, we all wish we could be playing the next Zelda or Vanillaware game today. But until then, we make the most of what we have, pushing us to discover the depth in old games. Which re-emphasizes the purpose of the 'classic' games in the game: to demonstrate the value of the old, and how much it affects our perception of what's new!
That is how a framing story is done. Not by putting a bunch of curtains and hecklers in the foreground.