SharkJumping

Eric Zimmerman, the CEO of casual game developer Gamelab, recently published on Gamasutra what he referred to as the Game Developer Bill of Rights.  Gamelab is known primarily as the developer behind PlayFirst's recent smash hit , but Zimmerman has been in the game business for years and is well respected for his creativity and experience.  As a business person, I find the GDBoR to be mostly a blue sky wish list typical in most creative industries, but it's a thought-provoking document which summarizes common issues between developers and publishers/distributors, so it's worth a read for those interested in the casual game sector.

To no ones surprise, Nokia the death of the N-Gage mobile game platform this week.  In spite of repeated denials about its impending demise over the past couple of years, Nokia decided to focus on music and camera-focused phones, while attempting to integrate better game technology into their advanced Series 60 phones vs having specific game-focused phones. 

The company spent an estimated $1B+ on the effort and sold about 2M units, which was way below their goal - it was marked by a misguided initial product (remember sidetalking?) effort which violated practically every known rule about how to launch a console, mostly becuase Nokia didn't employ anyone with previous console experience.  By the time the much improved NGage QD shipped, with better pricing, unique content and an improved feature set, the market had already moved on to either simpler games in standard mobile phones, or more compelling games in handheld platforms such as GBA and PSP.  It's unfortunate since Nokia gave it a valiant effort, producing some of the most interesting mobile online content in gaming () as well as groundbreaking games such as Mile High Pinball and .  However, as I have repeatedly mentioned, the console business is a graveyard full of broken dreams with a seemingly never ending flow of new entrants, the latest being Korean player Gamepark with their  

About the only winner in these types of platform failures seems to be Electronic Arts - Nokia was rumored to have paid millions of dollars (as high as $15M) to EA to incent them to port their sports games to N-Gage.  Given that Gizmondo revealed in their public filings that they commited to pay (they'll never pay it all) EA $6M for similar rights, I'd say EA still comes out ahead in these situations.

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GIven that everyone and their mother is discussing the XBox 360 gameplay experience (which is good, but not mind bending), I'll focus on its utility as a media player since I think it's actually going to be a seminal device in the category.  The premium box comes with what appears to be 8G of video and other downloads pre-installed on the 20G hard drive, particularly a stunning 6 minute Warren Miller HD trailer, as well as some other HD video content such as a Secrets of the XBox and some Titanic thing which we immediately deleted.  You can currently download additional movie trailers (in both 480 and 720) such as Hong Kong and Aeon Flux, game demos, and other video content such as a music video from Audioslave from their .  If you haven't consumed music videos in HD with Dolby 5.1, you are missing something fierce - from my side, it beats HD sports.  How long until a music video service (with the obligatory preview ads) emerges on this system?   Again, I realize you can do all of this on your PC, but it's amazing how different it is when you can easiiy display it in full HD on your TV/home theater system, which is where most people wnat to be entertained.

The only issue we had was that it took almost 30 minutes to download the 6 minute, 300MB, HD music video, which points to some problems with the MS delivery system since our internal network has much more bandwidth than that (has anybody heard of Bit Torrent?  Or is this a potential Brightcove play as well?)  I have seen mixed signals on the XBox 360 forums about this issue, so I assume it's a regional or temporary issue.  But the main issue we had with the media download  (trailers, game demos, video, etc.) process was that it appears to be totally single threaded, meaning that you can't switch away from the download screen to do anything else while it downloads, even if it's taking 30 minutes while your LCD screen burns in...  It may be that I just missed the secret code to do this in my multiple attempts, but I'd be shocked if a multi-core, XNA-based, mini-supercomputer system can't actually multi-thread or multi-task enough to let you go do other things while media downloads take place in the background.  However, as I mentioned earlier, the long tail (had to mention it - go ) possibilities here are endless in the video realm if Microsoft opens it up.

Just received our XBox 360 today at the office, which has not exactly increased productivity, but since the dev team just hit a large milestone, it's a good release for everyone.  Ignoring the obviously powerful game playing aspects of the machine (amazing graphics, fairly good games), what jumped out to me was that the 360 has made massive steps towards becoming the first legitimate cable bypass box.  This means that companies could create viable video distribution models by going through the Internet rather than over the broadcast, cable or satellite services. 

With a 20G replaceable hard drive, a powerful piece of hardware, HD capability, reasonable pricing, and tens of millions of sales guaranteed, it seems clear that the 360 will be an incredible destination device for online video.  Because you can download directly to the machine as well as connect through a PC, it offers the best of both worlds from a capacity and connectivity perspective. 

Unlike other digital media adapters which have not had either the horsepower, the volume, or the HD options, this box will begin to be a viable distribution opportunity for content providers by the end of 2006, especially if MS opens up the system to outside providers, as Ray Ozzie's memo forecasts.  Depending on what Sony does with PS3, these new devices will open up a new competitive threat to today's service providers, as well as provide distribution opportunities for smaller content providers locked out of traditional cable and satellite boxes, and it will be a huge accelerant to the HD marketplace.  It's going to be an exciting 2006.

Record label EMI turned in a good yesterday and as part of the presentation, CEO Alain Levy indicated that he believed Apple would go to a multi-tier pricing scheme next year for its iTunes store, presumably with higher prices for well known artists and hopefully with lower prices for lesser known artists.  He also had the following quote  "We do not set the price, Apple sets the price".  Although technically and legally accurate, it's a misleading statement in the real world since it implies that Apple has looked at its business and has decided that it's better for iTunes to increase prices for better known artists - the question is Who Really Sets Digital Download Prices?

The fact remains is that music labels effectively set retail pricing by setting wholesale prices, with an eye toward expected retail price for rational distributors who wish to make some sort of profit.  Therefore, if a label wants to see a $.99 retail price point, they charge a $.75 wholesale price, giving the distributor a 20-25% margin, similar to what is seen at retail.  If they want to see a $1.49 retail price point for part of their catalog, they will charge a $1.10-$1.15 wholesale price for those tracks.  Now there is no question that iTunes or other distributors can continue to charge $.99 per track (or whatever price they want), but it begins to drive an already low margin business into negative margin territory, which makes it hard for distributors to survive, although you see this occur sometimes with loss leaders on new album releases in retail stores. 

What's interesting is that Apple is in the best position of any digital distributor to absorb potential losses on each music download due to its massive iPod business - therefore, one could map out a scenario where Apple refuses to change retail prices, which then forces all of its competitors (Napster, Real, Yahoo) to remain at $.99, but they can't absorb the losses through other profit centers, and eventually exit the business, which is exactly what the labels do NOT want, since they would prefer to see a lot of players in the market.  This would be more likely if Apple could significantly grow its video download sector, which is an area where it has relatively little competition, and that would offset the possible losses in the music unit due to increased wholesale pricing.

It certainly appears with all of the label signaling (since they theoretically can't conspire - see ) that we'll see different wholesale prices for digital downloads in 2006, with the probable resulting changes in retail prices by rational distributors like iTunes.  With the threat of piracy receding a bit in label executive minds due to a series of legal wins, they now appear focused on:

• Cranking up the focus on DRM - see continuing SonyBMG rootkit fiasco and EMI/Macrovision
  
• Expanding the legal fight to other sectors - e.g. satellite radio rates and time shifting may be the next big battle
• Nudging download prices towards the higher mobile rates - e.g. see NYT review of Sprint Mobile Store at $2.50/track, even though I believe that the price elasticity of this market would dictate another path.

The good news is that the digital market is starting to deliver rewards for music labels, with it now representing 5-6% of revenue, much of that at very high margins, but they still have a much larger declining CD market, so the scramble will continue to increase revenue from other sources.  I've always said, and will repeat, that the labels will end up making more money from digital than they ever made from physical, but it's going to be a rough transition in the next few years due to the different market sector sizes.

 

One way to measure the interest and money involved in a particular sector is to track the rise and fall of its trade show activity since it tends to follow the money.  At the peak of the bubble in 2001, it felt like there were more than five digital music conferences, while 2 years later, the sole remaining Jupiter Plug-In event had a grand total of 5 vendors showing their wares and the conference felt like a ghost town. 

In the casual game sector, the first ever conference was held a few months ago (which was quite successful and which pushed me to start blogging - see post), and now we already have two announced for 2006, cleverly located in the same city 1.5 months apart.  The organizer of this year's Casual Game Conference, Chris Sherman's Game Initiative, will do a repeat performance in Seattle July 13th and 14th.  And now we have a new entrant, supported by the non-profit Casual Games Association, which has split with Game Initative in order to organize a show in Seattle at the end of August.  I'm sure there is some sort of back story involved and I don't have a position on either one, but right now it's just creating confusion among the pretty tight-knit casual games community.

The good news is that the sector now commands enough attention and revenue (will see a lot more investors this year) that it's worthy of this type of competition - but they should probably either merge the shows or separate them out more by time and location to provide enough value to the attendees, not all of whom in this business have large travel budgets.  However, it looks at this point like the game of chicken will continue.

I've posted about the margin difficulties in the digital download business before, by using Loudeye (LOUD) as a public proxy.  Unfortunately, what can you really say about Loudeye's Q3 report that isn't covered in the 10Q?  To summarize it:

• Negative gross margin - yes it's actually negative
  
• Increasing loss from previous quarter
• Decreasing revenue from previous quarter
• 6 months of cash in the bank and a "going concern" doubt
• Market delisting battle continues
• Overpeer unit accelerating downward
• Resignation of Chairman
• Retention of Allen & Co to explore strategic options

The stock dropped 38% today, but still sports a $50M+ market cap.  Given that MusicNow was just sold last month to AOL by Circuit City for a rumored $15-20M, I assume a company will buy Loudeye for some amount between the MusicNow deal and the current market cap due to its European presence (OD2 acquisition) and its mobile deal with Nokia.

Pandora, the new pesonalized subscription radio music service I previously discussed, announced this week that they are now offering a free version that has the identical feature set, but which will eventually be ad supported.  I say eventually, since it doesn't seem to currently have ads in it.  If it were me, I would decrease the feature set a bit in the free version, usually by offering a lower bit rate or limiting some of the features, and then add house ads to the equation right now to make clear the differences between the paid and free options, but I can understand this move in a competitive market. 

Given that it now was free, I went back to try the service again.  It's clear that Pandora is one of the best radio services in the marketplace, but I still struggle with the web page radio concept (vs a client) since my Amos Lee station was abruptly ended today when I clicked on an unlrelated AIM link from a colleague which took me away from the Pandora page, thus killing the stream.  In general, I'm still not entirely sure that Pandora is better than the "good enough" of free competitors such as AOL Radio, Yahoo Radio and MSN Radio, but they're making a great run at proving me wrong.

Little known NTN Communcations (NTN on Amex) today announced their Q3 results, which included profits and a significant refocusing on its consumer-focused Buzztime subsidiary.  NTN is leader in out of home entertainment, known primarily for its games delivered to bars through those small wireless devices.

I am a small shareholder in NTN, having followed it for years, mostly with increasing frustration as it struggled with too many initiatives, executive turnover and declining stock price.  For a company with so many obvious options in the new digital universe, it wasn't executing on any of them.  But it feels like it's finally turning the corner, with a profitable quarter, a potential buyer for its BtoB Hospitality business, growing momentum behind its cable ITV and other Buzztime expansions, and a renewed focus on cost control.  Given that it's now profitable, growing, and well positioned in a couple of hot categories, I think that it will command a valuation higher than its current 1.7x revenues if it can nail a couple of additional quarters.

Articles are starting to turn up on the revamped casual game service XBox 360 Live Arcade as the new console prepares to launch.  Although I don't personally believe that the first few million purchasers of this $400+ (for most bundles) next generation console will have any interest in playing traditional casual games such as Bejeweled (see prior post), it looks like the team under Greg Canessa has made some strong moves to make the service more appealing.   The service will supposedly be available out of the box for all XBox 360 users, will require no monthly or annual fee, will cost only $5-10 per downloadable game, and will have a 50%+ revenue share to developers  - and it will have a broader set of games than just "match 3" clones.

This potentially changes the game a lot from the current PC casual game market.  It's a 50-75% decrease in average retail game price (to $5-10 from $20) while also increasing the market share to the developer (to 50%+ from 35%+) and eliminating any need to download software beyond the game itself.  Assuming Xbox 360 is successful, and especially if PS3 follows with a similar model, I'm not sure how the current PC casual game market sustains itself over time - as I have discussed before, prices are going to inevitably decline in this category, and XBox 360 may be a catalyst for it.

Hysteria is defined in Wikipedia as "a diagnostic label applied to a state of mind, one of unmanageable fear or emotional excesses" and later goes on to say that "is often associated with movements like the Salem Witch Trials..."  On the other hand, Dictionary.com defines the term Hysterical as "Extremely Funny". 

I felt like I had encountered both definitions after reading today's Forbes (would directly link, but Forbes doesn't seem link to cover stories - update:  link here) magazine cover story entitled "Attack of the Blogs" - thus my facetious More Dangerous than Bird Flu Pandemic? title.  But it really reminded me of a similar "mass hysteria" quote (Click Quick Time file: MassHysteria.wav or web link) from the comedy Ghostbusters....

This staggeringly one-sided Fox News-like article paints blogging as "the prized platform of an online lynch mob spouting liberty, but spewing lies, libel and invective." - it's simply mind boggling.  It's as if one couldn't use email, web pages, spam, viruses, P2P technology or other web techniques to cause as much mayhem as blogs do.  Yes, there is no doubt that there are a variety of bloggers who are attacking companies and people out of pure malice or greed, as is exhaustively detailed in the article and quoted by those with a vested interest in this mayhem, but to tar the entire industry in that vein is ludicrous. 

There is no attempt to point to the larger Fortune 500 companies such as GM (Bob Lutz or Microsoft who have made a point of encouraging their employees to blog, or to point to the new companies being created by this new medium, outside of a brief reference to the Weblogs purchase by AOL.   Nor is there a reference to the short but at least even-handed blogging article in Forbes this Summer - it's basically a 6 page cover story beat down on the sector.  However, the article does point out that blog providers or search engines aren't obligated to take down erroneous posts since they usually fall under common carrier status, and that may be hypocritical since a search engine like Google has a code of conduct for its Ad Sense program and deals mercilessly with any site that interferes with its search algorithm.

Now I don't think blogs are the salvation of mankind or a replacement for traditional marketing - the medium is a result of the Internet growth and many of the advances in collaborative tools people have made over the past few years, and much of this amateur journalism should advance the cause of democracy and capitalism, both core tenents of Forbes - but just as you could use a printing press after 1450 to more efficiently libel an opponent than with prior manual technologies, you can use a blog today to do the same more efficiently than in prior years.   I'd advise Forbes to focus on more important issues such as global trade disagreements and to leave the cover story hysteria to the good pilgrims of Salem Mass...

Napster announced their calendar Q3 results today, which was basically a quarter of zero growth once you take out the $2M in one-time hardware sales for the Bell South promotion.  Subscribers were flat at 450K or so and revenue came in at roughly $21.4M, excluding the negative margin hardware sales.   Margins dipped down to 21.4% from last quarter's 31.4%, again due to the hardware sales.  Marketing spend dropped almost 40% due to the need to conserve cash, and gross new subscriber ads apparently dropped a commensurate amount, plus they had a large churn bubble hit due to people coming off their preliminary sign ups from previous quarters.   Loss was $13.6M, an improvement from last quarter's $20M loss, but given the lack of growth, nothing to crow about.  So the company has stopped growing, is still losing money, and faces increased competition due to the Real/Microsoft deal, although Yahoo has at least backed off a bit.

What was the good news?  Well if you do the revenue per paying customer math, Napster is generating an impressive roughly 2.5x the revenue per subscriber that RealNetworks is, given that Napster had 448K subs who generated $21.4M in non-hardware revenue ($48/sub) while Real is claiming 1.3M paying subscribers generating $25M in revenue ($19/customer).  But it's hard to compare the numbers since Real includes the lower revenue but very profitable Radio subscribers in that number, as well as the Comcast ones, which are of unknown revenue and profitability.  In addition, Napster's revenue number is now in striking distance of Real's, which is an accomplishment, at least for this quarter until the Microsoft marketing deal kicks in for Real - they are, of course, all single-low double digit revenue market share compared to Apple.  Other potentially good news was the impending launch of Napster Germany and then of Napster Japan the following quarter since they don't have any subscription competitors there, but it's too early to tell how those deals will do and non-US services can be really tough to profitably scale.  Finally, the initial XM/Napster-compatible devices will ship this Christmas, but the cooler ones which integrate Napster to Go will come later in 2006 - they could really be big wins if the XM audience converts to Napster users given the traction that XM is getting (BTW:  that functionality is going to be dragged into the brewing epic battle between the labels and the satellite radio services over these types of advanced music capabilities)  And the company still has $100M+ cash, which is enough for the next 2 years, according to them.  As a sidenote, it was a little surprising to see a relative lack of focus on mobile and an almost total lack of comment on Best Buy, given how crucial those categories were in the last 12 months, but the market continues to morph and you have to give Napster some credit for morphing with it.

However, the key part of the call (and the new investment thesis for Napster) was that, as predicted in an earlier post, Napster announced that they will be launching a free, ad-supported destination site at Napster.com sometime soon in 2006.  Given that it's been 6 months since the last change in focus (first it was downloads, then subscription, then mobile), this is not a huge surprise, given the favorable advertising trends on the Web.  The often repeated investment thesis is that deploying this unique destination site will take advantage of the large traffic Napster receives at its site to generate high margin advertising revenue, decrease customer acquisition costs and reduce churn since the site will be so compelling. 

This is not impossible, but is certainly a tall order.  The first data point you have to believe is that Napster can deploy a site substantially better or more compelling than MTV, Launch, MySpace, AOL Music, RollingStone,  etc., which are sites which have been delivering strong music services for years at this point.  You must then believe that Napster.com gets a very large amount of traffic due to its brand - unfortunately, most data points I can find show that Napster is a moderately popular site not listed in the 10 Internet music destinations, and if you use the poor man's data source, Alexa, it has only 10% more reach than a moderately popular site like RollingStone.com, let alone the big ones like MTV, and that Napster's traffic has actually declined 50% in the last 6 months.  And finally you have to believe that the conversion to Napster subscription services will be incredibly high due to the great editorial placement of it within the new site - having run RollingStone.com, which is probably roughly comparable to what Napster will deploy, I wouldn't expect the conversion rates to be off the charts and they might be lower than the ones on Napster's current site since users will be going to the new editorial site for reasons other than signing up for a subscription music service.  Those 3 data points don't lead to the obvious new investment thesis that ad revenue will be large, marketing costs will massively decrease, and churn will be lower - it's possible, but unlikely. 

So we're left with a company attempting to do a large pivot to a new business model while still maintaining its irons in the other fires, none of which are large margin businesses due to supplier leverage, and all of which have intense competition.  I always credit CEO Chris Gorog for making a large and incredibly passionate bet on digital music, but I'd say the odds of a winning hand for Napster shareholders are getting increasingly difficult.

today announced its acquisition of Addicting Games, a popular directory of casual games.  It's another signal of the coming consolidation in the casual game sector as the larger players start to separate themselves from the smaller ones through acquisitions, more sophisticated marketing techniques, product portfolio expansions and larger game investments.  Until this most recent deal, the distribution portals such as Yahoo Games, Real Arcade and AOL Games had been recently silent, primarily due to internal issues unique to each company.  That has left room for the mid-size players such as PopCap, BigFish, and PlayFirst to drive forward, raising venture capital rounds, purchasing smaller companies and improving their sites.  I think the larger players will overcome their problems and begin expanding again by Spring, as ASW has just done.

What is partially driving this consolidation is that the growth rate of the "traditional" $20 pay per download games is slowing in the sector (although no one will publicly admit it), but fast growth is continuing in the ad-supported, subscription and virtual item businesses, such as what we're seeing at Puzzle Pirates.  In addition, larger US and non-US game companies are entering the casual game market, and venture firms are starting to fund additional players (e.g. Big Top Games).  In order to continue to grow, the smaller firms must invest in more sophisticated customer acquisition techniques so that they can control some of their own destiny/revenue, and they must be able to hold onto their IP rights so that they can exploit their successes across multiple platforms, such as mobile.  This increased competition is beginning to hit the smaller companies who will have to expand or change their business models in order to survive, as I posted months ago - or realistically, many of them should sell now while they still have good businesses.

The good news is that we will come out of this upcoming period with a small group of diverse, well capitalized, professionally managed casual game companies, a couple of which will hopefully be able to go public by the end of 2006 if they're not sold to a traditional media company.  The bad news is that there will be a lot of pain involved for those who don't make it, unless they're happy with a lifestyle business.

Continuing to outpace Gizmondo (TGTL.PK) in its race into the ground, Infinium Labs (IFLB.OB, home of the aptly-named Phantom console) today that they were withdrawing their 2004 audited financial statements due to basic accounting errors, and that they believed the SEC was probably going to charge their former CEO Tim Roberts for possible involvement in "Fax Blasts" which illegally promoted penny stock companies such as Infinium Labs.  We'll probably see what the exact Aug 15 separation agreement was for Roberts since the public statements allude to an agreement for the company to indemnify Roberts for certain matters, in addition to his 10M share grant in lieu of $250K severance.

I have commented on Infinium Labs before, so it sometimes begins to feel like cruel and unusual punishment to keep doing so, but the company keeps providing more grist for the mill.  At least the stock market has recognized the issues, giving Infinium a $5M market cap, which is probably still too high for a company with $100K in the bank, $9M of short term liabilities, and little chance of ever being successful.   Back to the mantra - do not fund as VC, invest in as public investor, or work at as employee, startup companies in the game console category.