Sony acquires Gaikai for $380MM

Today Sony announced an agreement to acquire Benchmark portfolio company Gaikai for $380MM in cash. In just four years, Gaikai built a revolutionary cloud technology platform for gaming. To see console-quality games streamed from the cloud to browsers, tablets and TV is truly magical. Congratulations to Gaikai on this tremendous achievement, and congratulations to Kaz Hirai and Andy House at Sony for their vision and bold action to make Gaikai a part of Sony, and cloud gaming a part of Sony's strategy in the future.

Benchmark was privileged to lead Gaikai's Series A financing back in the fall of 2009 and to participate in both subsequent rounds alongside Rustic Canyon and NEA. We were early believers in both cloud computing (Rightscale, Eucalyptus, Engine Yard) and next-gen game distribution (Riot, Meteor). We saw Gaikai positioned squarely at the intersection of these powerful trends.

Thanks to the great team at Gaikai for their creativity, diligent work and strategic nous. I had the opportunity to work shoulder-to-shoulder with the senior team on site in Aleso Viejo when I served as executive chairman, and I saw Rui Pereira, Robert Stevenson, Brendan Irbe, Nanea Reeves, Mark Anderson and, of course, David Perry in action. They are all true professionals and fully deserve their success.

I particularly want to thank David Perry, Gaikai's CEO. I first met David when he was making the ground-breaking console game Aladdin and I was at Disney. While we crossed paths over the intervening years, Gaikai was our first opportunity to work closely together. Like all great entrepreneurs, David believed that his idea could change the world, and he went out and made it happen. He has been a relentless ambassador not just for Gaikai, but for the whole category. David saw a future for gaming in the cloud, and his leadership both at Gaikai and now at Sony is going to see that future realized.

NaturalMotion

Today Benchmark announced an $11MM investment in NaturalMotion, a publisher of 3D games for mobile devices.  I am joining NaturalMotion's board of directors.

Many people in the packaged-goods games business know NaturalMotion from their Euphoria and Morpheme 3D animation engines, which have been used in high-end console games to produce incredibly realistic character animation (if you've played Rockstar's Red Dead Redemption, for example, you've seen this in action).  Torsten Reil, CEO of NaturalMotion, recognized that he could port a substantial subset of these technologies to the surprisingly-capable iPhone and iPad platforms, and in so doing leapfrog existing assumptions about what gaming could be on those devices.

The early results, My Horse and CSR Racing (which Apple recently demonstrated on stage at the WWDC keynote), show the incredible promise of console quality and production values matched with the successful free-to-play business models that have taken root in mobile gaming.  NaturalMotion is in production on a slate of innovative products that will stretch the boundaries of some existing genres, as CSR has done with iOS driving games, and also create some exciting new genres we haven't seen before on the platform.

I'm looking forward to working with NaturalMotion, and with an incredibly talented entrepreneur like Torsten Reil, on this exciting endeavor.

Euro 2012 Group Stage Recap

Ok, you can't deny this has been a very entertaining tournament so far.  All of the final games of the group stage had stakes, and every pair of final matches in the groups had real drama. There was even some decent football.

There has been positive play and goals have been plentiful (not a single nil-nil draw in the group stage), including some real gems like Ibrahimovic's or Welbeck's or Ballotelli's (you could put Di Natale's in the mix, or Silva's, or Schevchenko's brace, too). Unfortunately, many of the first-round goals went in against the Irish, whose -8 goal difference and 9 goals conceded in repeated pastings were an embarrassment -- and not a great advertisement for the expanded 24-team format in 2016. Apart from Ireland, there were three 5-goal matches and five 2:1's, a welcome absence of play-acting and diving, and few major complaints about the officiating (save the Ukraine non-goal vs. England).

The fact that every group went down to the last match (and in several cases, down to the last kick in injury time) made for some excellent TV. The final matches went on simultaneously, with the mood of the fans rising and falling as news came into each stadium from the other match in real time via text and Twitter. There were several moments when a single goal could (and did) upend a group.

In Group A, the Czechs beat Poland and the Greeks miraculously beat previously dominant Russia by equally-tense 1:0 scores, sending the match winners through to the quarterfinals against most predictions.  In B, Portugal stylishly beat the floundering Dutch 2:1 to advance (pre-tournament favorite Holland lost all three group matches); Germany beat Denmark by the same score and won the Group of Death. In C, the big favorite Spain won the group, but barely beat Croatia 1:0 in a game they could easily have lost but for Casillas' save of a diving Croatian header (which, had it stood up as the winner, would have knocked Spain out of the tournament).  In the other match, Italy beat the hapless Irish to advance. Finally, in Group D, England gutted out a win over the hosts Ukraine 1:0 and won the group, while Sweden manhandled a lifeless France 2:0 and left the tournament with some pride.

I can't move on from the group stage results without mentioning the utterly baroque tie-breaking rules for the UEFA tournaments. I've read the commentary on both sides of this issue, and I appreciate the potential unfairness of the UEFA rules. It's lame that most fans couldn't figure out the various permutations for advancement in a major tournament without a computer.

That said, the mini-leagues and UEFA coefficients produced some unexpected results, and I would argue that the net result was a meaningful forcing function in favor of winning the final matches rather than drawing (and the fact that there were no draws on Match Day 3 seems to support that -- despite the fact that draws would have been just fine for many teams). I think that made for a better viewing experience. By the way, the best and simplest fix for this that I heard was to use UEFA rules for two-way ties (head-to-head) and FIFA rules for three-way ties (goal difference).

As good as the group stage has been, the tournament looks set up for a great finish.  On one side of the bracket, Germany play Greece and Italy play England. On the other side, Spain play France and Portugal play Czech Republic. I'd love to see a Portugal-Spain semifinal, with Ronaldo going against his Real Madrid teammates, and a Germany-Italy grinder. But I can imagine England getting past Italy to face Germany, and I wouldn't be surprised by a Czech victory over Portugal in a low-scoring game.

The Spain-Germany final looms. They are clearly the two most in-form teams in the tournament so far, and I can't really see any of the remaining teams beating them if they play at their best. But there may be a lot of twists and turns left in this tournament before we get there.

thatgamecompany

If you've played Journey from Jenova Chen's thatgamecompany (TGC) you know you have experienced something strange and magical, something that feels totally unique and yet fun and full of the pleasures that games can deliver (and if you haven't played it, and you own a PS3, stop reading this post and go download it). If you've also played Flower and Flow, you know that Jenova is one of the most ambitious and creative forces in games.

I first encountered Flow seven years ago as a PC game Jenova made when he was a student at USC. At that time, the company I worked for was trying to figure out how to make a mobile version of EA's Spore, and we were struggling with the design. The simplicity, logic and depth of Jenova's game just shamed us. It was beautiful -- meditative but tense in the perfect way.

Today, I'm delighted to report that Benchmark Capital invested $5.5 million in a Series A financing for TGC.  I will be joining TGC's board of directors.  The intent of the investment is to provide the resources for TGC to remain independent, so they can innovate with complete autonomy from the pressures of platforms and publishers. I am really excited about getting to work with Jenova and his team to help build TGC into a global entertainment company.

We believe fundamentally in TGC's vision for interactive entertainment: to bring to games a little of what Pixar films brought to animation -- emotional depth, engagement with fully-realized worlds, and a strong sense of authorship.  In the modern, hyper-connected games market, we believe TGC can reach the broadest possible audience if that vision can be fully controlled by the company.  We're excited to be able to help to make that happen.

Investing in Content

The other day, a friend sent me an introduction to a game company with a note saying, in effect, "I thought you might be interested in this since you invest in content."

Certainly, looking at some recent investments Benchmark has made, you might get that impression. Riot Games, Meteor/Adhesive, Red Robot Labs, and two as-yet unannounced new investments [subsequently announced: Jenova Chen's thatgamescompany and next-gen mobile publisher NaturalMotion] are all companies with core competencies in game design and development.  Yet, in none of these instances would our investment properly be characterized as an investment in content.

Why the misunderstanding? A lot of it has to do with the changing nature of publishing in the video game business in recent years.

In the past, publishers played four key roles in the video game value chain:

1. Product development capital. Until recently, publishers were the sole source of development dollars for the creation of new products (unless a studio had the resources to self-fund development). Large, expensive development teams, often working for years before seeing any revenue, required lots of deficit spending.
2. Marketing reach.  Publishers not only spent millions of dollars on conventional media buys (magazines, television) but also managed a ton of channel marketing, spending on merchandising (end caps, marketing circulars), co-marketing with platform providers, and point of sale promotion.
3. Physical goods distribution. Publishers provided the capital and logistical support necessary to build the retail inventories of packaged products. They pre-paid platform licenses (which often required letters of credit to the tune of millions of dollars before a single disk was sold at retail). They organized the shipment of packaged goods to stores, and managed returns of unsold or defective inventory.
4. Intellectual property management. Often publishers managed "franchises" -- video game brands deployed across a number of platforms, requiring a number of localized versions. Generally, the core development team would concentrate on one or two key platforms and the publisher would manage development of ports and localizations, and control sequels. In addition, publishers could pay for and manage the substantial costs associated with major brand licenses (like sports or movies). 

All of these publishing services benefitted from economies of scale, and publishers had incentives to aggregate products in order to spread cost and risk across a portfolio. Publishers with lots of good product flow got better treatment from platform providers and from retailers, too, further reinforcing the benefits of aggregation. The supply-chain nature of the packaged goods business created an environment in which these services could demand a substantial premium, both in revenue share and, ultimately, in equity value.

Think about what has happened to this model in the last seven or eight years. Capital is now more readily available for game development than ever before, and, further, modern games (and not just mobile or social games) require much smaller teams and much shorter development cycles, and therefore far less pre-revenue capital expenditure. The internet profoundly alters the nature of marketing reach, frequently to the disadvantage of incumbent publishers, and certainly changes the nature of channel marketing. Games are increasingly delivered as services rather than goods, and even when they are delivered as goods they are delivered electronically with a distribution infrastructure that can be rented from cloud providers like Amazon.

So, what is a modern video games publisher? What is the new set of skills and assets that a modern publisher must possess? The new paradigm of online, free-to-play gaming based on virtual goods sales has completely invalidated most of the old value-creation mechanisms (this should be obvious to anyone who has looked at market cap as a multiple of sales for EA or Activision vs. Zynga or TenCent).

In my opinion, the four traditional publishing values have collapsed down to two completely new ones:

1. Customer acquisition leverage. Selling games-as-a-service, generally free-to-play and actualized by the internet, has more to do with traditional e-commerce than with traditional packaged goods distribution. A key component of e-commerce is funnel management. You need to find or create demand, aggregate that demand through downloads and activity, and direct a portion of that engagement and activity to sales. The key skill in this new environment is leveraged customer acquisition -- i.e., a competitively advantageous ability to get customers into the top of the funnel in hopes of selling them something along the way. And, by the way, I don't consider the ability to buy traffic slightly more efficiently than your competitors as a sustainable competitive advantage. CPI marketing is like SEM -- good for a short-term arbitrage and cash-flow generation, but bad for long-term value creation. To foster true organic customer demand, content must be at the core. It is both the honey-pot attracting new users and the motor for on-going engagement.
2. Integrated merchandising and game design. In the old packaged goods days, development teams made games, and sales and marketing teams figured out how to get people to buy them. If customers played them a lot, that probably generated some good reviews and good word-of-mouth for marketing, but ultimately publishers only really cared about generating enough buzz to get a customer into an EB or Target to plunk down $50, whether that customer played the game or not. Now, not only do the games have to be engaging enough to get customers to want to buy virtual goods to enhance the play experience, the games themselves need to be created with the merchandising of virtual goods as a core design value (as well as all the e-commerce instrumentation and analytics). Again, content is central; the store and the game are, in the best sense, one.

The companies that figure out next-gen publishing will create the greatest venture capital returns. Whatever you think about its current stock price, Zynga has clearly validated this concept, and scores highly against my two core next-gen publishing values. Conversely, companies that develop next-gen content alone can produce cash flow (look at just about every successful company selling one-off games on iOS, for example), but rarely high-multiple equity value. By way of example, look at the recent large acquisitions in the mobile games space, where companies sold for between 2-3 times annualized revenue run rate; versus over six times run rate for a company like Riot, that had deeper control over commerce and audience.

So, in a round-about way, this is why I back games companies that develop content. I am really backing platform-based publishers, and my goal is to see them scale to multi-product powerhouses.  But I don't believe you can create publishing leverage by starting with the platform. I think it fundamentally starts with great content.

As much as I admire and appreciate pure game development platforms, I think they will struggle to cross over from tools companies to publishers or distributors without creating partner friction. Meanwhile, companies like Valve are using must-have content (Half Life, Portal, Counterstrike, DotA) to aggregate large audiences (on the Steam platform); those aggregated audiences then create customer acquisition leverage for future Valve titles and also for titles from third parties who pay a toll for access to that highly-qualified audience.

That, for me, is the essence of value creation in the games business, and that's what's guiding my investments in these great and diverse companies in the Benchmark portfolio.