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.

Americans Abroad

Texan Clint Dempsey has been getting a lot of headlines in England for his good run of form at Fulham, particularly his double against Chelsea which allowed the Cottagers to steal a point in the west London derby. While he didn't seem to be particularly in favor with Fulham's dour coach Roy Hodgson early in the season, now he's a consistent starter and co-leads the team in goals.

However, the big news over the Christmas break was LA Galaxy star Landon Donovan's loan to my favorite team in Germany, Bayern Munich. Donovan joined the team on a tour of the Middle East where they played a few friendlies against local club teams. He scored a goal on the trip and seemed to get a fair amount of playing time.

With the winter break coming to a close, Bayern returned to Germany and played a couple of friendlies against top 2nd division Bundesliga teams Kaiserslautern and Mainz. On Monday against Kaiserslautern, Donovan came on as a sub for Toni after 60 minutes and promptly scored a terrific header (and performed a much subdued celebration from his Galaxy standard):

Then, yesterday against Mainz, Donovan scored the third and fifth goals in a 5-0 Bayern route. Here's his first goal, another superb header:

Bayern starts up the Bundesliga campaign again next Friday against Hamburg. Should be fun to see if Donovan can play at this level. He famously left Germany at the beginning of his career for MLS, seeking the chilled lifestyle of LA, more playing time, and the company of his actress girlfriend over freezing weather and bad food. Interesting to see if he's tempted to stay in Europe this time.

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.

Mac & iPhone Apps I Like

I'm currently a Mac/iPhone user, and I have some applications that I have found extremely useful over time. For those new to these platforms, I thought I would share my favorites:

Communications

Adium (Mac): really nice IM aggregation client. Beautiful, extensible interface. Wish it did video ...
Blogo (Mac): my new favorite blogging client, which has taken over from the venerable MarsEdit. Love the Twitter integration. Blogo's microblog view has replaced Twitterific for me.
Skype (Mac): combined with my Audio-Technica AT2020 mic and my CEntrance Microport Pro USB preamp, I sound like I'm doing phone calls in a recording studio. It's awesome.
Facebook (iPhone): very nicely implemented version -- just what you need in the mobile app.
Twitterific (iPhone): great little microblog browser on the phone. Particularly speedy at loading linked sites.
BlogPress (iPhone): since I am still on Blogger for the time being, this is the best iPhone blogging tool I've found. If I ultimately go to Wordpress, they have a nice looking iPhone app. Both let you post iPhone photos to your blog.

Productivity

Evernote (Mac & iPhone): billed as a memory extension tool, this is really simple but profound. Easier to see than describe, I use it to keep track of all those little bits of info that you end up looking up ten times a year (i.e., opening times for the zoo). Highly recommended, particularly given the Mac's awesome ability to print anything to a PDF.
OmniFocus (Mac & iPhone): the Swiss Army Knife of GTD.
Quicksilver (Mac): I'm still figuring out all the cool things that this can do. Basically, it runs as a background process on your desktop, and can be used to quickly launch apps. But that's like 1% of what you can actually do with it. As close to geek magic as software gets.
JungleDisk (Mac): a really nice front end to Amazon Web Services S3. Storage in the cloud, represented as a drive on your desktop.
MobileFiles (iPhone): if you use the iDisk feature of Mobile Me, this rules. Let's you access your iDisk in the cloud from your phone, view files, download, etc. The upcoming pro version will include viewers for the Microsoft Office suite.
1Password (Mac & iPhone): the Ferrari of password vaults. Really, more of an identity management solution. Integrates with your browsers on the desktop (although not on the iPhone). Generates strong passwords that you don't have to remember. Fills out forms. If you do a lot of login/ecommerce, this is a must have.

Media & Entertainment

NetNewsWire (Mac & iPhone): my all-time favorite news reader and feed aggregator. Syncs to cloud so you can use it on multiple devices and not miss anything. Nice interface, even on iPhone.
Yelp & OpenTable (Web & iPhone): two great tastes that go great together. The Yelp iPhone app is not as sexy as UrbanSpoon, but it has better reviews. OpenTable's iPhone implementation is great, and it's one of the most useful services around.
Chroma (Mac): very pretty movie player that supports avi's as well as quicktime and DivX. Has some cool movie-specific features. Also nice substitute for the built-in DVD player.

Development

TextMate (Mac): an integrated development environment masquerading as a text editor. An essential tool for coding Rails. Highly recommended.
CSSEdit (Mac): an amazing single-purpose product for editing cascading style sheets, the visual language of the web.
Sequel Pro (Mac): the new name for the wonderful CocoaMysql code base. A powerful, easy-to-use front-end for Mysql databases.

Hope Against Hope

It's December 7th, and Fulham FC are 9th in the Premiership table with 20 points and a positive goal difference after 15 matches played. Yes, that's not a series of typos. Fulham are a top 10 side, with more than half the points they'll need to stay up, and not even half the season gone. Last year, the Cottagers didn't hit 20 points until March. They only won 8 out of 38 matches all last season, compared to 5 out of 15 this year.

The difference thas been their defending. They've only allowed 12 goals in 15 matches, the fourth best in the league. Only the perennial powerhouses Chelsea, Liverpool and Manchester United have allowed fewer goals than Fulham. They have not lost a match yet by more than a single goal. Their tougher defending has allowed them to take a few points on the road (3 in 7 matches), and win 5 matches at home that they may have drawn or even lost last season.

The other revelation has been their performance against top 10 teams. Last year Fulham just rolled over for most of the season when they met up with a quality side -- except for a 0-0 draw with Chelsea early in the season, a couple of draws against Blackburn, a win against Everton and Aston Villa, and their late-season "great escape" heroics, they were totally hapless. This year, so far, they've beaten Arsenal, Bolton, Wigan, Newcastle and Tottenham at the Cottage, and grabbed away draws against #1 Liverpool and #5 Villa. If you didn't know better, you'd think they were actually good.

With upcoming away matches at Stoke and Spurs, and a home match against an under-achieving Middlesbrough before Chelsea arrives at Craven Cottage on December 28th, they could even take a few more points into the new year at the mid-point of the season. Given that 40 points has usually ensured safety in the top flight, if we finish the year at 23+ points and a positive goal difference, I may even allow myself to be mildly optimistic about the spring. :-)

Four Interesting Things About the Election

1. Only 22% of America's counties voted more Republican in this election than in 2004. Where were they? Primarily in Appalachia, northern Alabama, Tennessee, Arkansas, Louisiana and eastern Oklahoma. As one commentator put it: "Obviously concerned about marginal tax rates for those earning over $250,000 a year, I suppose." Heh. This was the Palin base, the rural rump at whom all the coded crypto-racism was aimed. It worked, but thankfully for only a sliver of the American electorate. Evidence, I guess, that the old Confederacy has retained its dunces.

2. Bush won Indiana, North Carolina, and Virginia in 2004 by an aggregate 1 million votes. Obama won them in 2008 by relatively narrow margins. But he flipped roughly 10% of the electorate to do it. Huge.

3. Obama won New Mexico by 15%, Nevada by 12%, and Colorado by 8%. Hispanics moved Democratic nationwide by 25% points. This is really, really bad news for the Republicans, given US demographics. I predict that Texas may be the motherlode swing state in the 2032 election.

4. While the idiot mainstream media went all self-congratulatory about the civil rights implications of the Obama victory, and while it was moving to see the election through the lens of slavery and the African-American experience, I thought this was the best summary of how I saw the election:

"But relief today is not about Americans choosing an obviously black man over a white man, which proves we can come to terms with our past. It is about our choosing an obviously brilliant, reciprocal man over a thick, cynical one--a man who articulates a coherent vision of global commonwealth over someone advancing vague, military patriotism--which proves we can come to terms with our future."

Prediction Time

Election is Tuesday, for those of you who live off the grid. At this point, the biggest unknown is the youth turnout. Early voting patterns have firmly established the fact that the Dems in general and African-Americans in particular are motivated to deliver a large turnout. Probably augurs a large Republican turnout as well. Here's my prediction for the outcome:

Electoral Vote: O:338, M:200 (Obama wins Ohio, Pennsylvania, Virginia, Florida, New Mexico, Colorado and Nevada; loses North Carolina, Indiana and Missouri; no second-tier swing states like Georgia, Arizona, North Dakota or Montana swing blue).

Popular Vote: O:51.7%, M:47.3%, others 1%

Senate: Dems: 57 seats not including Leiberman and the socialist dude.

Upside Scenario: Obama wins popular vote 53% to 46%, wins electoral vote 375 to 163, with Indiana, Missouri, North Carolina going blue and no other states swinging. Insane (and kind of irrational) Upside Scenario: Obama wins popular vote 54% to 44%, wins electoral vote 406 to 132, picks up Georgia, North Dakota, Montana and Arizona, and has near-miss in one of the southern states like Louisiana, Mississippi, or South Carolina.

Downside Scenario: McCain loses popular vote but wins electoral vote 273 to 265, with Obama trading Pennsylvania for Virginia and McCain running the table in every swing state. More Likely Downside Scenario: Obama wins popular vote 50.5% to 48.5%, wins electoral vote 306 to 232 by holding Pennsylvania, Ohio and Virginia.

State to Watch: Indiana.  Polls close early, so we'll see some data before other swing states. High early voting (450K through Halloween -- 10% of registered voters and in some counties 3X 2004 early voting turnout). We should therefore get a sense of general election turnout and demographics that could be a preview for other states where we've seen similar early voting patterns (North Carolina, Georgia, Nevada, Florida, etc.).  If Obama is close or leading in Indiana with most precincts reporting, he's going to have a big night. If McCain blows him out by 5%+, this will be a nail-biter.

Trend to Watch: Pundits over-valuing early voting results. To the extent these early votes are reported before election day votes, you may see sizable Obama leads that evaporate as the night wears on -- in Louisiana, Georgia, and other states. North Carolina may look like a blowout (Obama +8%) when polls close, and may end up with <1% popular vote separation at the end of the day.