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.

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.

Sports Analytics: MIT Sloan Conference Impressions

The fascinating MIT Sloan Sports Analytics Conference which took place in Boston this weekend (and which I had the privilege to attend) is known affectionately by its attendees as "Dork-palooza" -- a celebration of the number crunchers and obsessive compulsive fans of sports statistics. Panelists, researchers, and attendees discussed a wide variety of topics with a very ambitious goal: to change the way we watch and measure team, individual, and business performance in sport.

The presence and influence of the great Bill James cast a warm glow over the proceedings. James' hugely influential work in baseball statistics, and the Society of American Baseball Research's "saber-metricians" remain the best case study of how the geeks can influence a sport. In panels, research papers and hallway conversations many conference participants talked to the broader project of replicating in other sports James' revolutionary success rethinking how baseball is measured and discussed.

A couple of themes stood out for me in the small subset of the conference I got to sample:

New Data Collection Methods. A couple of research papers on the NBA showed how promising the STATS SportVU 3D positional data will be for future basketball analysis. Data mining the 3D positional information of players and ball can provide some intriguing insights. Several panelists and companies talked about re-introducing context to measurement -- think, for example, about the problem of NFL receivers dropping passes when measuring a quarterback's completion percentage. A hockey panelist talked about "contextual +/-" in assessing the influence of a player's time on ice. And a promising company called StatDNA, which presented in the startup competition, uses trained experts to visually analyze soccer matches, coding events with remarkable fidelity and perhaps some interesting predictive power. I didn't attend any of the bio-metrics panels, but it seems equally interesting work is being done with acquiring granular medical data and using it to enhance athletic performance.

New Methods of Communicating. In a remarkable panel called "Box Score Rebooted," the participants talked about the need to focus on, for lack of a better word, poetics, the languages we use to communicate deep, data-driven concepts. For example, Bill James talked about the decision to name the arcane Blown Save Win concept in baseball "BS Wins" to preserve the double entendre. Muthu Alagappam tried to expand the concept of "positions" in basketball beyond the five traditional ones with data analysis and visualization, revealing 13 actual behavioral groupings that were much more evocative of observed play (I got to see an early preview of this research when his company, Ayasdi, presented to us at Benchmark a few months ago). Kirk Goldsberry developed a visual language of NBA players' shooting efficiency -- point production per shot attempt -- at 1,200 relevant positions on the offensive end; he produced a series of heat maps which allowed delightfully intuitive comparisons of the capabilities and tendencies of the league's stars.

Modernizing Old-School Methods. Obviously, the human mind is amazing at visual pattern recognition, and sports are filled with phenomena that are intuitively obvious to people both inside and outside the sports who pay close attention to games, but which would be hard to quantify through statistics or machine learning. Several panelists reminded the audience of the continued vitality of film analysis to players, coaches, and scouts. The ability to digitize and add metadata and search to video clips, as well as the ability to personalize the film session and distribute game film on iPads, may ultimately be more important than whiz bang  innovations like USC's Voronoi Tessellations (cool as they were).

"Fanalytics", Social Media and Business Intelligence. Sports is a business, and cash money rules. While a lot of analysts justified their work because it could theoretically add efficiency to drafting, trading, transferring, and managing salary for players, there was an equally compelling movement to bring data to bear on the customers -- sports fans -- to study their tendencies, behaviors, and spending patterns to better serve them (and get them to spend more, of course).  From the CEO of Ticketmaster, to Mark Cuban and other team owners, to Vegas bookmakers, there was a consensus that data mining and analysis could provide meaningful uplift, and that social media engagement was crucial. The growing importance of social media to the experience of sport cannot be overstated. In particular, the degree to which Twitter is connecting audiences, athletes, clubs, and even the analysts themselves, is astonishing. It would not be a stretch to call Twitter the deus ex machina of modern sport. [Disclaimer: Benchmark is a significant venture investor in Twitter].

In a broader context, the SSAC is further proof of the revolutionary and disruptive business impact of big data, business intelligence systems, and advanced statistical and marketing analytics. These tools have transformed entire market segments -- think about what data and analytics mean to the book selling business after Amazon, or to the video game business after Zynga, or the advertising business after Google, not to mention oil drilling, or inventory management, or Wall Street investing. Several Benchmark portfolio companies like Hortonworks (Hadoop), Domo (BI and visualization), New Relic (application performance monitoring), and others are helping customers solve data/analytics problems, while many, many portfolio companies are using data analytics fundamentally in their businesses to create competitive advantages and enhance customer experiences.

Analytics has become a key business practice across industries. But it's cool to see it flowering in sports, where it uniquely functions both as management tool and a component of the fan experience -- a unique form of content separate from, but enhancing, the core product.

Meteor, Hawken, and Free-to-Play Gaming

Benchmark Capital has announced an investment in Meteor Entertainment, the publishing company that will bring the amazing mech shooter Hawken to market, together with Adhesive Studios, later this year.

This is going to be fun. First, I get to work with a remarkable new talent, Khang Le, and his team at Adhesive Studios in LA. I discovered Adhesive the same way everybody else did -- through their YouTube gameplay demo for Hawken. My brother sent me a link along with a simple message: "Find these guys!" I've been looking at games for 20 years and Hawken is one of the most astonishing things I've ever seen.

Second, I get to work with my good friend Mark Long. I first met Mark early in his career in the video game business, when he had just started Zombie in Seattle. Mark is a pro's pro, and I was honored that he agreed to come on as our CEO at Meteor. He not only brings recent experience creating free-to-play games, but also a deep understanding of the marketing power of transmedia. Mark is an accomplished graphic novelist (Shrapnel, The Silence of Our Friends) and has worked closely with Brian Grazer's Imagine Entertainment developing leading-edge film and television concepts.

Third, I get to join Meteor's board along side Rick Heitzmann from FirstMark Capital in New York. Rick and I were the Series A investors in another well-known free-to-play company, Riot Games, a startup studio that had a monster, worldwide hit with their first title, League of Legends. Riot was acquired by the Chinese internet giant Tencent early last year. Rick and I had a great experience together on the Riot board and have been looking for something interesting to do together ever since. I can't think of a better project than this to reunite the team.

Free-to-play is the future of core gaming. Every month we hear the dire reports from the front lines of the packaged goods business, with sales off 10-30% year over year, a trend that we've seen continue unabated for the last couple of years. The packaged goods business is undergoing the disruption that we've witnessed in many other media businesses (music, newspapers, TV) as the internet, free-to-play models, and micro-transactions erode the traditional brands, retail bundles, and price points. This is a huge opportunity -- perhaps up to $8 billion of core revenue is at stake in this migration to free-to-play/virtual goods in the next few years.

If the other media businesses are any guide, this will happen fast. Some of the incumbents, like EA and Valve appear to understand what's happening and are taking action, but the opportunity is enormous for new entrants built from scratch for free-to-play design and publishing. Riot was able to come out of nowhere and, with a single great title and a deep commitment to customer service, reach over 35 million players around the world (and growing), while generating outsized revenues and profits. They did this without the "reach" of the incumbent publishers, without access to their distribution channels, and without their massive conventional marketing budgets. That was simply not possible in the past.

I think Meteor has a great chance to build a really big business in this space, and that's why we invested. I look forward to getting to work with this great team to make it happen.

Riot Games & Tencent

As was widely reported yesterday, the Chinese internet giant Tencent has agreed to acquire a majority of the capital stock of Los Angeles-based Riot Games, a Benchmark portfolio company. The transaction is a huge validation of Riot's meteoric rise to prominence in the online game business. CEO Brandon Beck, his co-founder Marc Merrill and the team at Riot have executed their business plan brilliantly, and the Tencent transaction now gives them a global platform to continue to disrupt the video game business for years to come. Congratulations!

For those unfamiliar with the company, Riot develops and publishes high quality, online, session-based games aimed at the core video game audience. The games are free to play; the company makes money by selling virtual goods to enhance the play experience. Riot's first title, "League of Legends," was an instant hit in the US and Europe, and will launch in Asia this year. The game has attracted a passionate audience, and by the strictest measure of video game engagement -- peak concurrency -- only the multi-billion dollar "Call of Duty" franchise does better than LoL among session-based games.

Benchmark Capital was privileged to invest in both Riot's Series A and Series B financing rounds. We were attracted by three key ingredients: the team's maniacal commitment to product quality and user experience; their belief that they could create sustainable customer acquisition advantages by delivering modern, upgraded versions of well-established play patterns (i.e., DotA); and the inherent benefits of the free-to-play, virtual goods business model. It worked like a charm -- the company delivered remarkable usage, revenue and profit growth. Hat's off to the team for executing so well against the opportunity.

One quick word about Tencent. I've been lucky to know the company since before their 2004 IPO (Tencent distributed some games from my last startup, JAMDAT Mobile, in China). I have immense respect and admiration for Pony Ma, Martin Lau and David Wallerstein. They are smart, honorable business people. I could not be prouder to see the combination of these terrific companies, and I look forward to great things from Riot and Tencent in the future.

Packaged Goods

I got a lot of feedback about my EA post. Since this blog is normally read by around 50 people, I welcome the new visitors. But because many people are here for the first time with no context, I think it's important that I try to distinguish the forest from the trees. My 50 regular readers know what I mean by "transition to digital" but a lot of the first-time readers don't.

EA has in the past three years invested in a bunch of interesting original IP and has vastly improved product quality. They have many compelling packaged goods games in the pipeline. From a consumer's perspective, there's a lot to be said for that, and many of the comments I have gotten have been centered around EA's turn-around from the hard core gamer's perspective. They have created a ton of goodwill with core gamers.

My point was not about whether Dead Space was a good game or not. It is. But it's largely irrelevant, a bit like winning a hand at a blackjack table in Vegas. The odds are stacked against you long-term. And this is my view of the packaged goods business. We can argue about how long it's going to take, but at some point in the not-too-distant future, the packaged goods games business is going the way of music CDs and books. You may still be buying games for $50 and downloading them (although I kind of doubt that will be the winning model). But one way or another, the games BUSINESS is going to transform into an e-commerce business.

This has many important implications. In an e-commerce world, the mechanics of distribution are completely different. It's about clicks, and visits, and trial (free-to-play) and conversions, and customer acquisition costs. This is a totally different way of thinking about distribution. The old packaged goods mentality of sell-in, inventory management, and crescendo marketing is totally useless in this new arena.

In addition, I think it's highly likely that we see a contemporaneous disruption created by the rise of games-as-a-service. World of Warcraft has shown that you can create an enormous business around a game that was released 5 years ago and then refreshed, updated, and run as a service in the interim. The amazing Zynga has shown the combined power of virtual goods in the games-as-service environment, and the benefit of a blue ocean distribution channel on Facebook.

The digital revolution has struck most media businesses as a form of what I would call "un-bundling." In the music business, this has taken the form of the rise of the internet-distributed MP3 song over the store-bought CD (originally, and mostly illegally on Napster, more recently and legitimately on iTunes). In TV, it was the DVR and cable channel expansion that killed the bundle known as network primetime.

There has been a lot of speculation about what form "un-bundling" will take in the games business. My own perspective is that the internet and digital distribution will create an un-bundling of time in the games business. Right now, the big publishers charge $60 for 40-80 hours of game play. I pay this price whether I play the game for an hour or whether I play it for hundreds of hours. I think that the rise of virtual goods and free-to-play models are leading indicators of this shift to un-bundle game time. So are the rise of casual, social and even mobile gaming. They are ways to capture gamer interest, and willingness to pay, in a manner other than the traditional $60 for 40 hours.

It is my opinion that media companies facing these sorts of market disruptions do better by embracing them early and taking their medicine, even if that means taking the axe to some of your existing businesses and processes. A great example of this is the Chinese game publisher Shanda, who recently changed their business model, took a year of pain and diminished stock price to get there, and then came back stronger than before. It takes a lot of courage to do this, because it's unpopular with your team, unpopular with your investors, and even, short-term, unpopular with your customers.

The US packaged goods companies have collected some important assets that position them on this road to the future. Blizzard, and Playfish, and Pogo, and JAMDAT are all examples. But in my opinion true leadership in the games business is going to mean betting the farm on these models and abandoning the CD-ROM as anything other than an alternative to downloading. Nobody had done that yet. Either it will happen, or a company like Zynga will leverage it's highly-advantaged distribution position into the core games market. The fanboys are going to recoil in horror from that statement, but it may be a lot easier for Zynga to buy up independent core games with e-commerce models (like Global Agenda, for example), than it will be for the major packaged goods publishers to switch to e-commerce models.

EA's Miss

After the bell today, EA announced a massive miss for their fiscal year, reducing revenue and earnings per share expectations. CFO Eric Brown also said in a conference call that they expect the packaged goods business to be flat to down for Fiscal 2011.

For anyone paying attention to the larger trends in the video game market, this could hardly have come as a surprise. A few days ago, Gamestop, a key packaged goods distributor for EA, announced a similar miss. While Activision was setting sales records with Call of Duty: Modern Warfare 2, EA had no major hits -- although, in fairness the COD:MW2 revenue was probably just filling in a sinkhole at Activision created by a music game business that has fallen off a cliff. EA is in the wrong business, with the wrong cost structure and the wrong team, but somehow they seem to think that it is going to be a smooth, two-year transition from packaged goods to digital. Think again.

John Riccitiello, the EA CEO, took over the reins of the company almost exactly 3 years ago. I was a senior executive at EA just prior to JR's return, and had a number of conversations with then-CEO Larry Probst about strategy at that time. As those who follow my blog know, I believed that the video game business had experienced a sea-change beginning in 2004, one that required immediate and decisive action.

My argument to Probst in February of 2007 was to reduce expenses immediately by a minimum of $200MM annually by reducing headcount and cutting back on ridiculous expenditures on risky titles (during my tenure, Spore and Godfather budgets had ballooned to ridiculous levels, and even spending on middle of the road products like The Simpsons and Superman had reached appalling heights). Meanwhile, I advocated hyper-aggressive R&D investment and acquisitions in a transition to digital distribution and games-as-service; combined with an approach to Wall Street that would position EA as a smaller but significantly more profitable company in the near term, with substantially improved long-term prospects when the digital future arrived.

This suggestion was derided by EA execs at the time -- they literally couldn't imagine going to Wall Street with a message of increased profitability rather than top-line revenue growth. They wanted to make the transition to digital while continuing to grow the packaged goods business. Ironically, they saw their looming innovator's dilemma as clearly as any company in the video game business back in 2006. They just weren't bold enough to act on that knowledge.

The old EA model was a basically a three-legged stool: 1) a profitable, recurring sports business (Madden, FIFA); 2) franchise games that produced big hits on a less frequent basis (The Sims, Need for Speed, Command & Conquer); and 3) a collection of digital assets (e.g.: Pogo & JAMDAT, and now Playfish) and distribution/partnership titles (e.g.: Rock Band & Left 4 Dead). Of those, the only stool leg left intact is the third one. Without the digital assets and the EA Distribution titles, they'd be in even more serious hot water.

EA's sports business has been hamstrung by vastly increased licensing costs (as I've discussed before) and failure to transition to a subscription/variable pricing model. This has substantially reduced the profitability of a business that EA used to rely on to fund other, riskier bets.

But by far the greatest failure of Riccitiello's strategy has been the EA Games division. JR bet his tenure on EA's ability to "grow their way through the transition" to digital/online with hit packaged goods titles. They honestly believed that they had a decade to make this transition (I think it's more like 2-3 years). Since the recurring-revenue sports titles were already "booked" (i.e., fully accounted for in the Wall Street estimates) it fell to EA Games to make hits that could move the needle. It's been a very ugly scene, indeed. From Spore, to Dead Space, to Mirror's Edge, to Need for Speed: Undercover, it's been one expensive commercial disappointment for EA Games after another. Not to mention the shut-down of Pandemic, half of the justification for EA's $850MM acquisition of Bioware-Pandemic. And don't think that Dante's Inferno, or Knights of the Old Republic, is going to make it all better. It's a bankrupt strategy.

So now, a couple of months after the board granted JR another $7 million worth of restricted stock units in addition to 140,000 options and EA Games president Frank Gibeau another $2 million in RSU's, EA cuts financial estimates to the bone. And don't believe this is the end of the bleeding. This latest stock drop, if consistent with the after-hours trading, will wipe out virtually all of the gain from 2009. Unfortunately, the loss comes after one of my favorite EA execs, business warrior John Schappert, returned from Microsoft to take over as COO and started firing 15% of the workforce to reduce costs.

With EA's enterprise value down below $4 billion, it's remarkable that nobody has stepped in to put them out of their misery with an acquisition. Certainly, Disney has been looking at them since I was at the house of the mouse back in the early 90's. And there are Chinese companies, like TenCent, that could easily swallow EA whole.

It's equally amazing that the board continues to support the existing management team through this debacle. Since JR took over, the company has destroyed over $11 billion in market value. Certainly, some of that was the economy and the general erosion of value on NASDAQ, but Activision (the blue line below, vs. EA's red line) has experienced far milder effects from the recession:

It's remarkably hard to kill a company doing $4 billion in revenues. But with flat or down stock performance since Q3 2003, how long are the institutional investors going to continue to hope against hope for a turn-around?

A Costly Price War

I've talked quite a bit in the past about the turning point that the year 2004 represented in the video game business. To recap, in that year the internet revolution finally rocked the game business to its core, with electronic distribution and new business models reaching mainstream acceptance. Between the release of World of Warcraft, the launch of Half Life 2 through Steam, the Shanda, TenCent and JAMDAT IPOs, and several other events, 2004 was a watershed year for the industry. I've argued that the nature of value creation in the video game business, traditionally grounded on intellectual property ownership and retail distribution, was forever disrupted.

But something else of great importance happened in 2004 that often gets overlooked in critical reviews of the business. It was much more subtle and easy to miss -- a publisher launched a super high quality product and offered it for sale at a very low price. This relatively small act of busting the pricing cartel and using QPR (quality/price ratio) as a competitive weapon had profound implications for one of the industry's great companies.

The game was Sega/Take-Two's ESPN NFL 2K5. This American football simulation, developed by Visual Concepts, was first launched on the Sega Dreamcast in 1999. It was considered innovative, but hampered by it's exclusive association with Sega's poorly-accepted hardware platform. In 2001, the franchise went multi-platform, and in 2003 added the ESPN branding to its NFL license. Sega aimed the product directly at one of the most popular and successful video games of all time, EA Sports John Madden NFL Football, with limited results. In 2003, Madden outsold 2K4 over 10-to-1.

In 2004, Sega agreed to co-publish 2K5 with Take-Two. The companies, faced with a daunting entrenched competitor but possessing a high quality product, took an innovative approach: they offered the game at retail for $19.99, less than half the price of Madden. And they sold boatloads. They went from less than 10% unit share of the football category, to well over 30%, and expanded the overall market.

The success of the 2K5 strategy provoked an extremely aggressive response from EA. By the end of December 2004, EA announced a five year exclusive licensing arrangement with the NFL and the NFL Players' Association. By the end of January 2005, they added a 15 year deal with ESPN, effectively stripping the 2K franchise of its branding (and most of it's legitimacy as a football simulation).

But EA accomplished this at tremendous cost. At the time of the deal, there was speculation that EA paid in excess of $300MM for these rights. Let's do some math. Let's assume, for the sake of argument, that number is correct. It creates a royalty burden of $60MM per year for each of the five years of the deal, that must be amortized across units sold. Assuming 5 million units sold at $35 wholesale (it's likely more units at a blended lower wholesale), that's a royalty burden of $12 per unit, or over 33%. Based on my direct experience as an NFL/NBA/MLB licensee at JAMDAT, that's almost twice what we paid for non-exclusive rights to the league and players' association in a typical deal.

Play that out a little further. That's over $25MM annually that would have dropped to EA's bottom line, or around 8 cents per share. Just to give you a little perspective, EA earned 75 cents per share in fiscal '06 and 24 cents per share in '07. They lost $1.45 per share in fiscal '08.

EA accomplished their goal of eliminating the 2K series as a competitive threat (in fact, they eliminated it as a product altogether), but at tremendous cost to profitability from one their most reliable profit contributors, Madden. At the time, the analysts lined up to praise the deal, assuming that EA knew what it was doing and that they could grow the football market to accommodate the increased royalties. But I wonder how many of them would think it was anything other than a Pyrrhic victory now.

Strat Planning

Following up on my post about OODA, I thought I'd expand a little on the reason for strategic planning and some specific methods I've used in the past to facilitate planning.

One of the important lessons that Colonel Boyd derived from his study of military history was the importance of decentralized decision-making and field-level initiative. As the military has applied Boyd's concepts on the modern battlefield, this lesson has been further reinforced. Quoting from the Boyd Wikipedia entry:

"... [T]he most effective organizations have a highly decentralized chain of command that utilizes objective-driven orders, or directive control, rather than method-driven orders in order to harness the mental capacity and creative abilities of individual commanders at each level."

This only works if you have (1) creative, intelligent commanders (or managers in business); and (2) a strategic framework that establishes common objectives and helps establish a context for orientation, the second "O" in OODA. This orientation context is vitally important -- I like to call it a "shared hallucination" of the company's place and purpose. Managers need the flexibility to make quick decisions, but unless those decisions are consistent with the overall strategy of the organization, the results can be haphazard and uncoordinated.

Clear, simple articulation of corporate strategy is crucial. I have primarily used two tools to help me do this: a recursive goal-objective-strategy-metrics approach to writing the annual plan, and a threat map.

In my recursive goal-objective-strategy-metrics approach, the CEO establishes the top-level plan. This plan is comprised of a single, overall goal for the company (a thing to be accomplished, not a mission statement), some key objectives that support the goal, the strategies necessary to achieve the goal and satisfy the objectives, and some metrics by which success can be measured. This top-level plan should fit on a single page.

The recursive aspect of this approach is that each of the strategies from this top-level plan becomes a goal for the next level plan. So if one of the top-level strategies is "Finish the product before Christmas," the VP of production gets this as her goal and will develop objectives, strategies and metrics to reach it. This can get pushed down even further into the organization, so departmental managers get an annual goal and articulate their objectives, strategies and metrics.

The beauty of this approach is that it rolls perfectly back up into the master plan. If you want to know why the art department is outsourcing to China, for example, you can see that it satisfies their goal of delivering all art assets in September for $1MM, which serves the higher goal of shipping for Christmas on budget, which serves the top-level objective of reaching cash flow break-even by the end of Q1. And if one of the lower-level strategies fails, if China outsourcing can't deliver by September, you can change it to something else consistent with the overall goal. And that change propagates up and down the chain.

In practice, I only used this tool at the top-level and one level down, as a way to coordinate strategy at the VP level. But it worked to keep everyone on the same page. Actually, the process of writing and critiquing the plan as a team was more important than the resulting document, because the process surfaced tensions, fostered debate, and led to a better plan.

The other strategic planning tool I really like is the threat map. The way I create a threat map is to put my business in the center of a series of three concentric circles. The first circle closest to the center represents the immediate, near-term competitive threats, the next circle represents the medium-term threats that might arise in certain circumstances, and the outer circle represents the long-term threats.

Radiating out from the center I draw several axes, representing the things that will make the company successful (or its key vulnerabilities). I then place the competitive companies and market trends on the map, in the temporal bands, near the axis along which they are attacking my company. In addition to clarifying competitive threats, this was actually a great way to see opportunities, set priorities, and think about candidates for alliance, business development, and acquisition.

For example, in the case of JAMDAT, we had three axes: intellectual property, distribution, and game quality/innovation. On our map, we identified EA early on as a medium-term threat to us via intellectual property, so we sought to license the most dangerous of their properties from them, effectively neutralizing their threat and co-opting their advantage against us for several years.

Another example: we identified content aggregators as threats to our direct distribution relationships with carriers. In response, we carefully avoided using them as an alternative to the lengthy carrier sales process, even at the cost of immediate and incremental revenue, so we wouldn't inadvertently strengthen the aggregators' collective market position against us. This is a perfect application of strategy to value creation; the default response of the sales team would have been to simply maximize revenue, but that would have diminished our long-term competitive advantage.

Ultimately, the threat map and the annual plan are just tools. Without intelligence, creative thinking, and decisiveness in execution, the best laid plans are worthless. These tools can help direct a good team, but they can just as easily reveal weak organizational design and bad hires. Caveat emptor.

Disrupting the OODA Loop

I got a lot of re-tweets over the weekend regarding a blog post by Kas Thomas on "The Principle of the Last Responsible Moment." Thomas' post has mostly to do with project planning and the fallacy of the complete specification. But the actual principle he's talking about is a military tactic which is oriented toward threats, or in the realm of business, competition.

I've always been a big believer in strategy, but I'm an equally big believer in execution. They are the yin and yang of business competition; execution limiting and informing strategy, strategy creating the pathway for execution. I've always thought it absurd when somebody describes a business as being either a "strategic play" or an "execution play" -- business competition is inherently always both.

The military has been dealing with the problem of strategy vs. execution for a long time. Everyone has heard the truism that "no plan survives contact with the enemy," but the military has a doctrine to deal with that fact, called "OODA" -- Observe, Orient, Decide, Act. OODA was first articulated by Air Force Colonel John Boyd, and it describes a continuous command and control feedback loop, in which unfolding circumstances inform changes in strategy and execution. It is to the military what agile development is to the software team.

To me, Boyd's key competitive insight is the idea of "tempo" -- the speed with which you can run your feedback loop compared to your enemy. The most profound disruption occurs when you can strategize and execute inside the decision-making window of your enemy. As Boyd wrote about aerial combat:

"Time is the dominant parameter. The pilot who goes through the OODA cycle in the shortest time prevails because his opponent is caught responding to situations that have already changed."

This is a massively important idea. Getting your opponent to respond to your moves prevents them from seizing the initiative and surprising you. I've seen this play out in business many times. In traditional video games, long development cycles created numerous examples of teams that conceptualized new products and delivered them to market while their competitors were mired in delays, grabbing market share and reinforcing brand. We've all seen supposedly weaker technologies vanquish more established ones through rapid, directed innovation in response to market forces.

Time is of the essence. If we've learned anything from the media and technology revolutions of the last 30 years, it's that things happen a lot faster than everybody thinks.

GDC Recap

This week I spent a day at Dean Takahashi's GamesBeat conference (where I did a panel with some sharp investors from other venture firms) and two days at the Game Developer's Conference (including a solo session in the business track -- slides posted here). Didn't get a chance to see many GDC sessions, given all the meetings and presentations, but I was able to see a couple, and walk the floor and check out what was on display at GDC. I also caught up with many old friends and colleagues over the course of my time there, and met with a number of entrepreneurs.

I went to my first GDC in 1993. Literally, the entire game developer community fit into a single banquet hall in San Jose that year. The next year, the "old timers" (Chris Crawford, Ernest Adams, etc.) were both lamenting and celebrating the explosion of newbies. They asked for a show of hands at dinner in '94, which indicated that about half the attendees were at their first GDC. Fifteen years later, with the demise of E3, GDC is now the pre-eminent show on the domestic calendar. This year's GDC was certainly as well-attended as any show I can remember.

What's great about GDC is that despite the huge surge in attendance, it still feels like a "gathering of the tribe" and the speakers are still remarkably forthcoming and candid about their craft -- you rarely feel like you are sitting through a sales pitch when you attend a technical session. I always learn more at GDC than any other conference.

There were a couple of big trends in evidence that I think are worth mentioning:

1) Digital Distribution: between the massively-hyped OnLive launch, the Qualcomm-backed Zeebo, the large number of MMO's and casual game plays, the frothy (and mostly misplaced and uninformed) attention given to iPhone/iPod Touch, and the frequent lamentations about long development times and huge budgets for traditional console and PC games, digital distribution was clearly the trend of the show. It seems to me that the old-line publishers are way out of position on this one. I predict that you'll see a strange detente between retail and traditional publishers (maybe a trade-off on used games vs. digital distribution) as they circle the drain together.

2) Virtual Goods: with advertising on an apparent decline as a way to monetize free games, a worry about how many online subscriptions an average user is willing to take on, and a yawning gap between the retail price points and free-to-play ARPU, virtual goods has emerged as the "white knight" business model for games. Easier said than done. I heard that Don Choi from OGPlanet gave a great presentation on the actual mechanics of virtual goods, but I sadly missed it (Don worked for me as a business development executive at JAMDAT before returning to Korea -- he's a very smart guy).

3) The Economy: not what you'd think. It was really the profound lack of visible concern about the economic melt-down that was so startling. Attendance was up. The "job fare" aspect of GDC seemed to be in full swing. Certainly the venture appetite for games is not what it was two years ago, but I got the distinct vibe that the industry expected to make it through the down-turn, with most job losses hitting the big publishers rather than the indy/next-gen developers.

4) Hardware Transition: again, significant by its general absence from the discussion. We're 4 years into this cycle, and historically at this point we would have been obsessing about Xbox vs. PlayStation vs. Wii, speculating about hardware and who was getting early access to dev kits, etc. I heard none of that. I saw a lot more MMO-enabling technology than console-enabling ones. It begs the question whether there will actually be a transition in the traditional sense. With the X360 and PS3 already moving well in the direction of being living room set-top boxes and home media hubs (with music, online services, Netflix, etc.), could we possibly see a disc-less PS4 from Sony?

Powerball vs. Moneyball

My friend Rick Heitzmann sent me a blog post by Stephen DiMarco from Online Metrics Insider titled Powerball vs. Moneyball Marketing. It is interesting reading. DiMarco's point is that there are two approaches to marketing: the Powerball approach, which is a high risk/high return, "swing for the fences" strategy; and the Moneyball approach, which (hat tip to Michael Lewis) is a metrics and measurement-driven strategy designed to "engineer outcomes."

I'm no marketer, so I can't really comment on DiMarco's post from that perspective, but I think his analogy is broadly applicable to the current state of the video game business. The packaged goods publishers are playing a lot of Powerball -- buying lottery tickets for new IP, spending horrendous sums of money up front with very little understanding or measurement of audience dynamics, and hoping for home run outcomes. The fact that every so often a new game becomes a monster success keeps everybody buying lottery tickets.

Conversely, the approach that companies like MiniClip, or some of the social network-based publishers are taking looks a lot like DiMarco's Moneyball strategy. I'd be willing to bet that MiniClip knows exactly the amount of traffic they can drive to a game featured on their home page, and structures their economics accordingly.

We once had a meeting with some senior executives from a well-known video game publisher when we were running JAMDAT. The head of studios for that publisher finished getting demos of our best-selling products and famously said, "A monkey could make these games." What he was responding to was the lack of whiz-bang 3D graphics, the lack of fanboy, nerd-core "innovation". He was used to playing Powerball. We, on the other hand, were playing Moneyball. We knew from studying our customer data that our audience didn't care a rat's ass about the kinds of things that Gamasutra editors cared about. They wanted simplicity, accessibility, and value. So we made products to "engineer" that result. And we acquired IP that fit into that mold, like Tetris.

What Michael Lewis described the Oakland A's doing in Moneyball -- buying players who were undervalued by other clubs but who were overachievers in the metrics which actually produced results -- is really quite similar to the the ideas of customer acquisition leverage and audience measurement in the entertainment business. I think there's going to be a lot of value created exploiting this in the future.

Riot Games Releases "League of Legends" Trailer

Very cool stuff.

Pinch Media on iPhone App Usage

Pinch Media released an awesome presentation about iPhone app usage. I haven't validated their data directly, but if it is accurate it has some very important implications for the companies who think they can make a business with free, ad supported apps.

Check it out:

Most of this is pretty well-known to entertainment and e-commerce people: the hit dynamics, the seasonality, the pricing strategies. But the sharp usage drop-offs suggest that for most apps -- not the highly used, sticky ones, but the vast majority of apps -- too few impressions are being generated to justify an ad model. The key slides are #23-#25.

What I Learned About Platforms From Working With Carriers

Almost two years ago, I predicted that the future of the internet may look more like mobile than vice versa.

I was referring specifically to the growing influence of platforms -- i.e., large traffic aggregation points with API's and/or application eco-systems. It seemed inevitable that these platforms would end up playing a similar role in the internet to the role of the carrier in mobile. That role is something of a double-edged sword for the smaller companies in the eco-system: on the one hand, a phenomenally efficient means of customer acquisition; but on the other, a powerful and potentially capricious master, who controls the flow of money, owns the customers, and can snuff your business out like a candle if need be.

The precipitating event for me back then was Myspace's power move on Photobucket, where the social network blocked the photo sharing site for violating terms of service relating to advertising. Myspace was probably a third of Photobucket's business at the time. Thirty days later, Photobucket was acquired by Myspace's parent, News Corp. That felt to me like the kind of thing a mobile carrier would do to a vendor. Show 'em who's the boss.

Since then, my prediction has largely come true. I was talking to the CEO of a company the other day who makes applications for a large social network, and I had an uncanny sense of deja vu. He was losing sleep over whether or not the social network would change its terms of service, alter the economics of customer acquisition, or choose an incompatible monetization strategy and effectively kill his business. I remember having those same fears when we were launching services on the US carriers in 2002-3.

So, what did we learn from being in this position and growing a valuable, public company under this Sword of Damocles?

• Brands Matter. First, when we were jockeying for position with our largely undifferentiated peer group in the early days, having recognizable and desirable brands under license really helped us. Having exclusive rights to branded content cemented our distribution -- while other companies were offering generic, easily replaceable card or puzzle games, or original intellectual properties that nobody had ever heard of, we brought Tiger Woods Golf (interestingly, it mattered way more to the carriers than to customers -- JAMDAT Bowling consistently outsold Tiger). Later, the power of our own publishing brand, which had become increasingly recognizable and synonymous with quality and value, gave us a similar kind of brand leverage to what MTV or HBO had vis a vis the cable companies. If you were launching a new games service, you had to have us in the mix.
  
• Grab Market Share. Immediately after the launch of BREW on Verizon, we had >70% market share of the games category. In the US broadly, by the end of 2005 when we sold the company, we had close to 30% market share (this is huge share; my rule of thumb in media businesses is that the winner in every category -- music, video games, TV, theatrical box office -- aggregates roughly 15-20% market share). By 2005, mobile games were no longer experimental; our partners at the carriers had P&L's and were being compensated on the basis of financial performance. Therefore, with our huge share it became harder for them to mess with us too much and their relationship with us became more symbiotic (the proverbial "win-win"). Had we been a <5% player, they could have eliminated us without significant consequence.
  
• Understand Their Strategic Needs. The carriers had their own businesses to run, of which we were a very small part. But the mobile games category fit into a larger story they were telling their shareholders about the future, and it was imperative for us to understand their strategy for mobile data broadly and help facilitate its execution. For example, they needed to be able to show that they could attract world-class content, so our investment in globally recognizable brands played into their strategy. We tried to help anticipate and solve their problems. We always tried to see ourselves from their perspective.
  
• Don't Be Piggy. Our peers constantly complained about the revenue splits that the carriers were taking (in our case, 20-40% of revenues). We watched those splits closely, and argued fiercely to maintain them, but we were always cognizant of what we were getting in return: relatively frictionless customer acquisition, billing and collection, the benefit of handset subsidies, etc. If we did the math realistically, the toll we paid to the carriers was a relative bargain. As many of the iPhone companies are soon going to find out, trying to run a nationwide marketing campaign -- even a viral one -- to attract people to your content is very, very costly. Our better carrier partners would embed demos of our games with a link to buy on tens of millions of handsets every year -- reach that would have cost us millions of dollars in marketing if we had to pay for it directly.
  
• Plan for End Times. We understood the fragility our our place in the eco-system. Even when we had 30% market share, 4 of the top 10 games, including the clear #1, Tetris, a highly profitable $120MM a year business, etc., we were paranoid. About everything. We constantly talked about threats to our business -- direct or indirect, internal or external or orthogonal. In fact, we had a "threat map" to help us visualize our paranoia. And in every area that mattered to our business -- content innovation, distribution, brands, business model -- we tried to develop defensibility and a fall back position in case of disaster. When you are not in control of the platform, you need a resilient business and a Plan B. The rug could be pulled out from under you at any time.

Fascinating Mint Stats

If you don't use Mint, the personal finance site (disclaimer: a Benchmark portfolio company), you should. It's a killer service. Mint provides a simple, powerful, web-based alternative to the bloat-ware that Quicken and Microsoft Money have become as a result of the "feature war" they commenced a decade ago. In this environment, where everybody is taking a second look at personal spending, Mint is a great tool for gaining insight into your finances and patterns of behavior.

Mint CEO Aaron Patzer wrote a guest column for TechCrunch today, providing some recession stats derived from Mint's 900,000 users. It contains some really fascinating data from real people, a counterpoint to the data we're getting about the recession from politicians, TV talking heads, and bankers.

Aaron sees the data revealing a recession that's less dramatic than the "Great Depression 2.0" news reports would have us believe (i.e., 10% spending declines across the board). But it looked pretty bad to me. A couple of grim numbers for consumer companies:

• Entertainment spending down 22%
• Home (services, furnishings, etc.) down 21%
• Travel down 24%
• Cash savings cut in half
• Debt up 10%
  

The gas/fuel decline of 32% isn't as meaningful to me, because it's likely driven more by the decline in gas prices since August than by changes in consumer behavior.

The decline in cash savings -- from roughly $11,200 to $5,500 augurs a much more troubling first half of '09. That number suggests that consumers have been deficit spending to the tune of $700 per month since the recession hit. Once that cash cushion is effectively gone, we could see the current average spending declines of $400-500 per month drop to over $1,000, or closer to 25% across the board. Since expenses like rent, utilities, and food are less susceptible to cuts, that extra $500 or so of reduced spending is going to hit discretionary categories -- entertainment, shopping, travel, dining out.

Whither Open

PocketGamer reported today that Apple will create a "premium" area of the iPhone app store for games priced at $19.99, and will restrict distribution to a "number of large publishers, rather than the thousands of smaller developers currently selling their titles on the main App Store." The move is reportedly to help combat the race to the bottom that I wrote about last summer. To me, it suggests recognition by Apple that there is some benefit to a managed platform.

This is something that the console manufacturers learned after the tidal wave of bad content killed the market in the '80's, resulting in the famous "ET in a landfill" period of the video game business. Nintendo brought the market back with tight gatekeeping of 3rd party publishers and the quality of the content they distributed. Since then, the symbiosis of platform management and marketing combined with publisher quality and standardized economics, produced an order of magnitude greater business opportunity than the more "open" PC gaming platform.

There is an article of faith in the venture community that open eco-systems create more valuable companies, and the example of the internet certainly gives credit to that viewpoint. But, as I've said before, the App Store itself is the "killer app" for iPhone -- the 15,000 apps available on the App Store primarily benefit Apple, rather than any single publisher or developer. It is extremely difficult to build sufficient market share to create enterprise value for a company when there are 20 free, me-too products in every competitive category.

Value Creation & Distribution

I read this interesting piece on Gamasutra today and it motivated me to write about the keynote I gave at the SMU-Guildhall conference on video game law and business earlier this month.

My topic was, broadly, the fallacy in the video game business that content innovation creates enterprise value. By enterprise value, I mean a return on equity for shareholders, usually at some multiple of revenue or earnings. Instead, I argued that while content innovation expands audiences and generates revenues, distribution innovation has historically driven outsized enterprise value creation in the video game business.

Here are my slides -- you can get the idea:

Ok, not that remarkable. I've spoken on this subject twice before -- once to an internal EA audience at their Vancouver online summit a couple of years ago, and I talked at some length on this topic on a panel that Dean Takahashi led at UC Berkeley last year.

But it's amazing how many people didn't get it. One person from a well-known market research firm challenged my thesis, arguing that "shiny disks are still a multi-billion dollar business." Well, so is the grocery business. So is the automobile business. But investors don't ascribe high multiples to those revenues.

Don't believe me? Do the math. THQ is currently trading at a $270MM market cap, despite $1B in trailing twelve month revenues -- .27X. Take Two is at .37X. Even EA is down to 1.22X.

The current valuation multiples in the video game business are predicated on earnings or revenue growth, and that's the context in which content innovation is linked to value creation. Activision gets a bump from Guitar Hero because that franchise supports Wall Street's revenue growth estimates, and because hit titles produce economies of scale that drive better margins and thus earnings growth.

But content innovation rarely produces long-term, defensible competitive advantages in the way that distribution innovation does. When EA created their global direct retail distribution platform in the early 90's -- highly innovative at a time when most of their competitors were still working through aggregators -- they created sales leverage that lasted for a decade, and created a market share and earnings multiple advantage that none of their competitors could match. It wasn't that EA had Madden & FIFA, it was that EA had those titles and could sell them in the four corners of the planet.

Meanwhile, the companies that have recently built innovative digital distribution platforms, often based on virtual goods sales or subscription revenues, are thriving, maintaining buoyant revenue multiples despite the downturn. Shanda, the Chinese MMO company, is trading at a 4X revenue multiple.

Content innovation is sexy. It's spectacular. It's what every editor wants to write about and what every gamer wants to play. But as an investor, you are better served looking for companies that are innovating on distribution.

What to do with Yahoo!

So, Jerry Yang has finally stepped down. The search for a new CEO has begun. I have to say I'm puzzled by most of the candidates that have been rumored so far. Yahoo is at a crossroads and requires a true change-agent. Someone who will ignore the past and play the ball as it lays.

Yang's decision to play chicken with Steve Ballmer will certainly go down in business history as one of the costliest CEO moves ever, particularly now that the economic crisis has only reinforced how rich the Microsoft offer was. Now, with a yawning $30B gap between Yahoo's current market value and the implied value of the Microsoft deal to Yahoo's shareholders, the departure of many senior executives, and a sense that the last best chance to create shareholder value has come and gone, the company is in ruins. Yang will forever be characterized as a reckless Ahab intent on pursuing his personal Moby Dick (Google) to his company's destruction.

But not so fast. Despite everything, the skeleton of a great business remains. The company is still on a $6.5 billion revenue run rate, and quite profitable even given the many squandered opportunities and mediocre execution. The next CEO of Yahoo needs to understand what Yahoo's value creation vector really is, and refocus all of his or her energy on growing precisely that business. Here's what I think the next CEO needs to do to get Yahoo back on track:

1. Maximize the exit value of the search business, and don't get hung up on competing with Google. Face it, Google won. There are plenty of ways to make an honorable exit from the search business, raise a significant war chest of cash, and cut a favorable deal with Google for the Yahoo ad and search inventory (while maintaining the ability to maximize future revenues from search-related monetization as the search business gets more complex over the next decade). Don't waste time on this one -- cut a good deal, preserve upside and flexibility, and be done with it. Yahoo's future is not in search.

2. Understand what it means to be a next-generation online media company in the modern world. Hint: it means being a marketplace. Make Yahoo a customer acquisition engine for web/media companies. Customer acquisition is the defining problem of the modern web. It's the wind behind Google's revenue sails. The massive investment by companies in virality and SEO are two common ways to attack customer acquisition without paying Google. But a huge amount of interesting internet content is not really susceptible to viral distribution or SEO, and doesn't really lend itself to discovery through Google search marketing. Yahoo could own this space.

The future of the internet (and IP-enabled media) is going to be dominated by what Anthony Noto used to call "access platforms." These are the traffic aggregation points that normally serve as an initial point of contact with customers and a jumping off point to further interactions or explorations. Examples include Google, Facebook, Myspace, iTunes, Xbox Live, and all the smaller finance, weather, sports and news sites that people access directly. As the internet gets even more fragmented and innovative, these aggregation points are even more valuable.

Yahoo is a massive traffic aggregator -- 500MM monthly uniques. Its finance, sports, email, news, IM, mobile, photo sharing, groups, and games are huge direct on-ramps. There's an opportunity to leverage cross-platform identity (think TenCent/QQ), the fire-hose of traffic to new content (think MiniClip on an order of magnitude larger scale across multiple content types, not just games), and a place people go to discover new content in a hierarchical, taxonomic way rather than noisy Google search (think Comcast). This is how Yahoo can fight Google: by not trying to beat them in search, but rather in all the things that are not best served by search.

3. Cut costs to the bone and really clean house in the executive ranks. This can be a significantly more profitable company with some strong leadership. Brad Garlinghouse said it very well in his "Peanut Butter Manifesto" -- this is a company where multiple fiefdoms, unfocused acquisitions, and overlapping operational responsibilities have led to insane redundancy of effort. This doesn't just duplicate costs, but also creates lassitude and absence of ownership for key verticals.

Fixing this will be hard, because it will involve the firing of a lot of decent middle management and talented engineers. But it is absolutely necessary. In my experience, the preservation of a few good people in a company this fucked up is never worth the risk of organizational paralysis. If you put a weak CEO in here, who will try to "inspire the existing team" you might as well shred your stock certificates. You need a ruthless ass-kicker, who will sleep well at night after firing a couple thousand people, including many senior executives.

I've heard cogent arguments that Yahoo would be best served by being chain-sawed up into it's constituent parts and sold off. That seems like a terrible waste to me. It's really, really hard to aggregate as much traffic as Yahoo has -- it feels wrong to atomize it when it could be such a wonderful revenue engine.