PRINT THIS PAGE VC opportunities in interactive entertainment
15/03/2006. Source:Israel Venture Capital Journal (IVCJ). Uri Kareev, CEO of AIseek.
Will Israeli players be able to find a niche in the fast growing computer game industry? In this Israel Venture Capital Journal article, Uri Kareev, CEO of Aiseek, a developer of hardware for accelerating artificial intelligence used by today's computer games, provides some answers. Thousands of years ago our ancestors painted cave walls. This early art form - static and visual - was the dawn of entertainment. From there, advances led to better entertainment. Audio and motion led to music and dance, and language led to story-telling and theater. Technology allowed the next major leaps - films, radio and television. At each step of this evolution, the new form rose to prominence, rapidly becoming dominant.
Today, we are witnessing the rise of a new form. The audience is no longer a passive recipient, but an active and integral part of the experience. Interactive entertainment, or in common parlance, "computer games," is shaping the future of entertainment. The interactive entertainment industry has developed at a breathtaking pace over the last decade, swelling to a $30 billion annual market shared by games software and hardware. This rapid growth continues to open up opportunities for eager entrepreneurs to create value. In this article, I will briefly describe the industry and present a few models that will appeal to technology investors who are aiming to enter the fastest growing segment of the entertainment industry.
The first mass market successes of the industry came from arcade games such as Pong (1972) and Space Invaders (1978). In the decades that followed, the dominance of computer games shifted to home-based game consoles and personal computers. Today, the total console installed base stands at about 200 million. The PC segment is estimated at around 30 million users worldwide, which can be further broken down into 3-5 million enthusiasts and 20-30 million occasional gamers, distinct in spending levels and playing habits. Another important segment is the mobile segment, played on dedicated mobile gaming machines, and on mobile phones. Mobile is the fastest growing game segment.
While heavily based on technology, the computer game industry is first and foremost a content industry. The process of financing, creating and marketing a game is much closer to movie-making and distribution than to the business models we commonly associate with high-tech products. Like movies, a game's success usually depends on the amount of excitement it generates. Asimple game like Tetris generated huge revenues, though its technology was a few generations old. Computer games and related hardware are entertainment purchases and are judged as such by their consumers. Paying $50 for a typical game, which is then played for 40 hours, is indeed a great investment.
The statement heard occasionally that "gamers are junkies who must have the newest thing and will pay anything for it" is a gross simplification on two fronts. First, the game market is clearly segmented by spending habits and game preferences. And secondly, gamers will insist on a new and better experience each time they spend money. The good news is that vendors providing such experiences are generously rewarded.
Over the last 30 years, technology has been the driver behind the computer game industry. Technology advances in audio-visual processing, processor power, and network connectivity quickly translated into immersive multiplayer games. The opposite has been true as well, with computer games becoming the driver of technology. For example, the demand for game audio through the 1990s drove down the price of computer audio, allowing the default inclusion of stereo playback in today's PCs. In other words, emerging technologies drive tomorrow games, while today's games turn emerging technologies into widely available commodities.
Of course, the companies that were fast enough to answer these trends quickly have become market makers. Indeed, these trends continue. Today, computer games are the leading mass-market application still demanding more processing power than is offered by current processors. So where in this market dominated by content and industry giants can Israeli companies find their relative advantage? I will describe four models, which Israeli companies may find a natural fit.
Content-enabling technology
By far, the most lucrative and the most challenging model is that of content-enabling technology. This is the model we follow at my company, AIseek. Content is the heart of the industry, and the higher the perceived value of the technology for content, the greater the reward. Such contributions to content and its delivery may come through hardware, software, or services. Content-enabling technology empowers game developers to build new games, unlike anything that has been seen before. Such game innovation is critical for holding on to the hearts and wallets of the gamers. But developing and marketing such technologies require close cooperation from studios and publishers. Examples include 3D graphics chips, sound cards, and online games - all multi-billion dollar businesses.
Naturally, the holy grail for a content enabler is an evolving technology, i.e. a technology for which one can produce, in a reasonable time frame, a next-generation product that significantly improves user experience relative to the current generation, driving a new buying cycle and ensuring business viability and sustainability. Since these technologies depend on the collaboration of the content providers, their initial introduction is especially challenging. It requires vision, patience and determination from investors and entrepreneurs alike. Graphics chips illustrate this clearly. 3Dfx, the pioneer of 3D graphics chips, struggled bitterly to introduce its chips until it found the only two studios that saw the potential for next-generation games.
The first was Id Software, which rewrote the engine for its Quake2 game to support 3D chips. The other was a then unknown South African studio developing a franchiseless title called Tomb Raider. Both games became huge hits, selling millions of copies and thoroughly rewarding the efforts of all involved. The annual sales of 3Dfx grew dramatically: $4 million, $22 million, $130 million, $400 million. Even though 3Dfx later faltered, eventually being overtaken by NVIDIA, the successful introduction of major content-enabling technologies by 3Dfx and others provides valuable lessons. To succeed in penetrating the market, content-enabling technology start-ups must take advantage of the particular characteristics of the market:
Segmentation - The market is segmented on the content, platform and gamer fronts. Do not tackle the entire market at once. Penetrate via those segments that will benefit most from your technology and that are willing to accept it. Look for those market segments for which your technology creates the highest perceived value.
Not all studios and publishers are equal - Know your market. Do not rush blindly for the big names. You may need to look for content developers differentiated as innovators to find a receptive ear.
Leverage - Interactive entertainment is a multi-linked chain. If your technology is solving an acute problem, you can be highly leveraged by established players that benefit from your technology. The extent of this is surprising: NVIDIA, the graphic chips behemoth, promotes better retail shelf placement for games that support its chips.
Content risk minimization - The only risk the content developer should take is funding the support of your technology. Adoption of new technology by the game studio must not adversely impact other aspects of the game.
Content-enhancing technology
A somewhat easier niche is as a provider of technology that improves games, but does not create radically new experiences. Graphics enhancement, better speakers and middleware are examples of such enhancers. The level of cooperation required from the content providers will vary according to the technology in question - from moderate to none at all. Market education should be simpler. Finding companies in the field to work with will also be easier, and an early M&A may be a natural exit strategy.
On the downside, the chances of being a market maker are slim. In the case of enhancements to an existing technology, the IP portfolio developed may be of lower value, and the existing players may already have interfering IP in place. As always, the lower your contribution to content, the less money the end customer will pay for the technology. Last but not least, expect a rapid competitive reaction.
Services not related to content
Another model that may be of interest to Israeli start-ups is one that avoids any direct effect on content. This can be the case for major technology developments, such as online server farm tools or copy protection, and alternate business innovations, such as in-game advertising. While these businesses may not share the allure of a direct impact on content, this model does offer some very large financial opportunities. Companies like Double Fusion, targeting the in-game advertising market, have a total available market potential to satisfy even the hungriest of investors.
Discipline crossing
Another area in which Israeli high-tech has proven very strong is multi-disciplinary thinking - transferring a technology from one segment to another. The interactive entertainment industry, being as young and evolving as it is, offers quite a few opportunities for such moves. In the domain known as serious games, computer games technology is applied to the worlds of computer-based training and simulation. Machinima, another cross-over example, is the art of creating animated movies using game engines. Opposite cross-over examples include EyeToy's transformation of the Web cam into a game input device, and Epos offering of local positioning technology for game controllers. Both are true content enablers.
Summary
As computer games evolve from a teenage past-time to a global tech-driven entertainment industry, the interest of technology investors in capitalizing on this market continues to grow. We have reviewed several business models that are well-suited for technology entrepreneurship in this area. Already, in the last couple of years, a few start-ups in the field have emerged in Israel. We have good reason to believe that the same advantages that brought Israeli high-tech to prominence in traditional high-tech will translate into a strong Israeli presence in the interactive entertainment industry.
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
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