Why Gaming Is Still A Great Bet For Investors | TechCrunch

Kristian has been at the forefront of the rapidly transforming game industry since 2001.?After serving as Electronic Arts? executive vice president of digital, he left three months ago to focus on startups. Today, he leads seed-stage investments with Initial Capital and serves on the board of Supercell, the #1 iOS grossing game company in the world. Before that, he co-founded, ran and then sold social gaming pioneer Playfish to?Electronic Arts for $400M in 2009. He was also?a co-founder of mobile gaming pioneer Macrospace ? today Glu Mobile (Nasdaq: GLUU) in 2001 through the successful IPO in 2007.

TechCrunch writer Kim-Mai Cutler and Benchmark Capital general partner Mitch Lasky recently wrote two insightful pieces on venture investment in games (here?and?here) ? both expressing some degree of skepticism of venture capital models for funding game startups. I agree venture funding is not for every game startup, and certainly not every game startup makes for a great venture investment. However, I would argue the case for venture funding for games is today stronger than ever.

Here is why:

Why game startups are better off with venture investment than publisher funding

There are broadly speaking three models available for a game startup today: bootstrapping (including crowd-funding), publisher financing and venture financing. For those who can afford the risk and have cash readily available, bootstrapping always trumps the other two. It comes with maximum freedom, control and upside in a success case.

But the risks are very real and significant.?Those unable to bootstrap because of the risks or ambitions of the project should in my view consider venture investment over publisher financing models.

Publishing as an idea for digital pure plays is simply turning out not to work very well. Many have tried it with very little to show for it. This is because the typical publisher value-add of financing, marketing, technology and distribution through retail channels doesn?t translate well to the digital world. It says something that not a single game in?today?s iOS top-25 grossing?has been ?published? by a third party as far as I can tell.

While developers continue to need financing, the rest of the ?publishing services? have become obsolete in four key ways:

• Publishers can?t compete with atomized marketing services by specialists:?As the digital market has matured, player acquisition, telemetry, cross-promotion and other marketing services have become widely available as independent specialist services that compete on price and quality of the service. Companies like?Swrve?(one of our portfolio companies at Initial Capital),?Chartboost,?HasOffers,?Nanigans,?Flurry?and a host of competitors are evolving their services at a blistering speed, requiring only a small set of increasingly available talent at the developer end. Doing it directly is not just cheaper and more flexible as the world changes, it also forces a more profound understanding of player flows and distribution challenges, which ultimately helps uncover product design insights.
• Publisher channel access may accelerate your success, but will not define it: Much has been made out of the advantage that big game publishers have in?terms of access to Apple or Google in terms of promotions. Clearly, being featured helps generate initial downloads. However that success is short-lived if?you are unable to retain your audience and acquire users independently at a profitable cost?of acquisition. Plus, you won?t be re-featured unless you generate the numbers.?A game investor worth their salt will be able to make the right introductions here?anyway. The incremental publisher value here is small.
• Holding on to rights to extend IP has become critical to value creation:?As Lasky emphasizes in his post, gaming even in the games-as-a-service world is inherently hits driven. For a game startup to become valuable over time, it needs to find ways of anchoring its success around building franchises. Ownership of intellectual property (IP) and all extension rights becomes important. Angry Birds-maker Rovio and Moshi Monsters-maker Mind Candy have shown that game originated IP is an increasingly viable base to build out a broader IP following with over 40 percent or revenue from each being attributed to non-game products. At the same time, the halo marketing effect from these non-gaming products can still contribute value to the core gaming product. Publishing deals are typically structured for the publisher to get hold of this.
• Long term margins help you hold onto key talent:?Perhaps most importantly, success in games has always been about key?creative talent. The more cash a game startup is able to create, the more it can?afford to invest in everything from the office to culture to individual, innovative?compensation models for rockstar talent. Signing away a revenue share limits?these options and ultimately is likely to encourage the best talent to leave.

Venture financing from a specialist fund that understands games should therefore be seen as a compelling alternative for game startups. It provides the financing value add, typically at far more flexible terms, without any of the restrictions to value creation that lower margins or complicated IP terms can create. And you could even get good folks around the table for advice how best to build for long term success and shareholder value. It should be no surprise that today?s most promising game companies including?Supercell,?King,?Kabam,?Rovio?and?Kixeye?are all venture-funded.

What about the case for investors ? does it still make sense to invest in games?

The digital pure play market growth has recently been characterized by the rapid?rise and occasionally fall of new entrants. Zynga is cited as the key example by both?Cutler and Lasky. A thoughtful?article by Tadgh Kelly about ?Peak Mobile??further?highlights the cycles any individual platform tends to go through. In a world of few?game acquirers and a troubled IPO market, does the venture model therefore need a?re-think?

In my view and that of Initial Capital, which is an?investor in?Supercell,?Brainbow,?Supersolid,?Space Ape Games?and others, the case for continued investment is strong.

Even though some VCs are shying away from games, here are five reasons why I and Initial Capital are doubling down on games:

• A continued virtually unopposed growth opportunity in digital:?The next generation consoles are doing a wonderful job at distracting the big publishers away from the fastest growing parts of the game industry. That clears the water for pure digital plays to gradually build up dominance with new IP on new hardware platforms. Activision Blizzard CEO Bobby Kotick?s?recent dismissive remarks about mobile, and EA?s strategy of ANDs: consoles and?PC and mobile and online (which dilutes their excellent talent across too many opportunities) are cases in point.?The innovators? dilemma confronting the big guys is creating continuing unopposed growth opportunity for new and established digital pure plays alike. That is giving new players time to build up the brand and marketing advantages that big publishers have held for years on what are rapidly becoming legacy platforms.
• There are plenty of ?blue water? opportunities on new platforms:?Very few game play styles or categories on personal screens, like four- to seven-inch screens across mobile phones and tablets, feel mature at this point. Clash of Clans? take on the tower defense genre, Candy Crush Saga?s interpretation of Match Three games and Hay Day?s way of approaching farm games are possibly the most mature examples out there. But who is making the category-defining racing game, the best first person shooter, sports game, real-time strategy, monster breeding or puzzle adventure game on these platforms? The console guys are hamstrung by their lack of focus.The starlets who already dominate one or two categories will have similar focus?challenges due to successes to date. Seldom have there been such clearly profitable, well-defined opportunities for new startups to re-imagine these experiences for personal touch screens.
• The opportunity has gone global:?The traditional gaming ?Galapagos Islands? of Japan, Korea and China have been overrun by the great global equalizers of Android and iOS. This creates unprecedented opportunities to go global. Supercell?s Clash of Clans is currently the #1 game on iPad in China and #11 in Japan. For Candy Crush, the same positions are #64 in China and #4 in Japan. This is not to belittle the differences in local tastes, marketing channels and in some cases app stores or distribution mechanisms. But the opportunity to reach the other half of the game industry that these countries represent has never been more tangible.
• Unprecedented margins:?Because of the margin structure and low headcount requirements of the industry, companies can become very profitable very quickly. Recent lessons from other companies that have grown too quickly are causing newer companies like Supercell to be more thoughtful. They are banking their profits, stabilizing their mid-double-digit operating margins and re-investing carefully into nurturing and expanding their talent base. This is also great news for top talent as it gets to increasingly share in the financial success both through company perks, private and public share sales and also dividends.
• The M&A and IPO markets will be back. And there?s nothing wrong with dividends either:?It will just take time. Large M&A deals in games are unlikely to be on the horizon. The traditional console folks are too busy fighting each other and do not have the resources to acquire an increasingly confident set of digital pure plays. The leading pure plays on the other hand are mostly focused on ensuring their own model scales before embarking on aggressive M&A. M&A is particularly hard an industry in the middle of a disruption where talent and inspiration are more important than scale. While Zynga?s troubles may have damaged the IPO prospects for the next 18 months or so, if the new generation of companies can show sustained profitability, they will be in an incredibly strong position to consider listing later. Some will undoubtedly choose to stay private and pay out dividends in the medium-run, which is fine from a venture investors perspective. But the option will be there.

The next few years for games will be choppy. But the fundamentals for gaming investments are stronger than ever. As Lasky says, you have to be building a game company and not just a game for venture funding to make sense. And for a venture fund to consider gaming investments, you need to understand the sector.

But neither of those mean that venture investments in games aren?t alive an well. In fact, the team at Initial Capital remain as bullish on the sector as we led the seed round into Supercell. We continue to seek out the very best, most inspired design and coding teams who want to define where games will go next and help them get started with capital, advice and structure.

Source: http://techcrunch.com/2013/06/17/gaming-venture-capital/

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