Huge Video Game Marks Not “Kids’ Stuff”

pile of money photo: MUCH MONEY pile-of-money-1.jpgVideos games are a big business, a fact that the mainstream media has generally ignored.  Long overshadowed by traditional media channels like television, radio, music, and movies, video games are portrayed as “kids’ stuff” instead of the powerhouse media category that they have become.  Furthermore, while all of these channels have been disrupted by the shift to digital, the video game industry has quietly innovated much faster than its media brethren.  Through AAA-quality content and business model innovation that better aligns the incentives of both video game companies and video game players, the industry has galvanized a massive base of loyal consumers.

At FirstMark, we have a deep commitment to the video gaming industry.   We have invested in developer-publishers ranging from Riot Games (League of Legends – the most played video game in the world) to Lumosity (brain training games with over 40 MM users and one of the top global apps) to Meteor (Hawken – an upcoming mech warfare game) to Proletariat Games (World Zombination – a tablet-first mid-core game). We have also invested in gaming infrastructure with Live Gamer, the leading provider of micro-transactions for digital entertainment that powers over 120 clients in more than 180 countries and the Meteor Storm Platform which enables a turnkey free-to-play environment for third party developers.  Even with these groundbreaking companies in the market, we believe that we are still in the early days of a rapidly-changing industry. There are many great companies yet to be built.

To demonstrate just how fervent the video game industry and its core audience actually are, we pulled together a few fun facts about the September release of Grand Theft Auto V, a title by Take-Two Interactive:

  • On September 17, 2013, the first 24 hours of GTA 5 sales of $815.7M was…
    • $43M more than the top 2 grossing movies of 2013 through that date, Iron Man 3 and Despicable Me 2, which have a combined box office take of $772M
    • $402M more than the entire September 2013 movie industry box office take of $413M
    • $9M more in revenue generated than the New York Yankees and Boston Red Sox combined in 2012
    • $213M more than the combined revenue of the top 3 grossing NBA teams (New York Knicks, the LA Lakers, & the Chicago Bulls) at $602M
    • $201M more than the combined top 3 grossing concert tours of 2012 (Madonna, Bruce Springsteen, & Roger Waters) at $614M
    • More revenue earned in one day than the average daily nominal GDP generated in 2012 by each country in the world except for the largest 35 economies (out of a total of 187 countries)
  • $815M is more than the average daily GDP of countries like Denmark, Malaysia, Nigeria, Israel, Egypt, Greece, Pakistan, Portugal, and Ireland in 2012
  • Alternatively stated…if the first day of GTA 5 sales was a country, it would have the 36th largest one day GDP compared to the average daily GDP of 187 countries in the world in 2012
  • The first 24 hours of GTA 5 sales on September 17th of $815.7M is enough to…
    • Purchase 3,174 Ferrari 458 Spiders
    • Feed every one of the 8.3M+ residents of Manhattan 27 Big Macs each
    • Send every resident of the city of Miami Beach, FL (population 88,110) to a year of college in Florida (average cost of $8,200 per year), with enough money left over ($93M) for each student to spend $1,058 on textbooks
    • Take everyone in the country of Spain (population 97.3M) to the movies, TWICE, with $33M left over to spend on candy, soda, and popcorn!
  • The 11.21M units of GTA 5 sold in the first 24 hours…
    • If each of those units represented individual consumers, it would be enough people standing shoulder to shoulder to stretch from New York, New York to Belfast, Ireland (3,176 miles as the crow flies, with 9 miles left over)
    • Were 3.8M more units sold than the best-selling DVD in all of 2012, The Hunger Games, at 7.43M units
    • Using music recording sales certification terminology, 11.21M units would qualify GTA 5 as a “Diamond” record single in a single day, equivalent to having more than 10M units sold (or 10x “Platinum”, which requires 1M units sold)

Many thanks to my colleague Paul Cianciolo who did most of the work for this post.

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Startups and GIants

A lot of startups very early in their existence get a call from a very large company (which would theoretically be “company making”).    These are often entrancing as they offer validation to an early company and provide a potential case study for the company going forward.

Below is an email that I just wrote to the CEO of one of our companies that is considering going down this path.   The CEO is pre-launch and the Giant is Fortune 50 –

“I have worked with a number of large companies on partnerships (some amazing and company making / some company crushing / most created no value for anyone).   Here are my 2 cents:

•    You can’t change your product road map / rollout for this one, large partner – it will throw you off your game at this critical launch time
•    Don’t let them slow you down – only spend time if it is not critical spent elsewhere

•    These guys have more VPs of Business Development and meetings that can suck out our valuable resource – our time

•    Ask what the critical steps are to close / launch – hold them to the timing
•    You have a limited time to hit your own milestones / they have much more time
•    Push them to start small – “what if next week we just did Manhattan for 20%?”
•    Determine early if there is a lot of momentum – increasingly bigger titles in the room and deal acceleration
•    Are you strategic to them?  – Core to an announced strategy or something that might be a fishing expedition
•    Ensure that time and resources are being put again companies of all sizes in the pipeline – you don’t want this one deal to be the Hail Mary for a financing  / profitability / etc.

Happy to discuss further as these are broad sweeping generalizations.

Rick

Thank You Brandon Marc and the Riot Team

We would like to thank and congratulate Brandon Beck, Marc Merrill and the Riot Games Team on what was widely reported over the weekend – the acquisition of a majority of Riot’s stock by Tencent Holdings.   Tencent recognized a great team and the phenomenal traction of the initial game, League of Legends.  The Founders and management will continue to operate Riot as an independent business and look forward to continuing to invest in the platform to both roll out League of Legends globally and add additional competitive games.

Riot and its founding team had many of the qualities which we look for in investments – a large market ripe for disruption, a unique business model, a great team who thought differently, a focus on capital efficiency, and the desire to think BIG!

We initially invested in the first small institutional round in a small team led by Brandon and Marc almost 3 years ago.  There were a handful of outstanding qualities of the Founders that made the opportunity compelling.  Brandon and Marc had tremendous passion for the product and are avid gamers.  They identified a great market opportunity and they recognized there was a large DOTA community playing on an outdated platform that was ripe for reinvention.  Unlike the dozens of companies that focused on the casual market, they saw a huge opportunity in the mid core segment.  This is the largest segment of the game market ($20 BN) and its users are the most rabid with a great appreciation of quality.  The team disrupted the market in a capital efficient way by focusing on competitive dynamics of the game not expensive bells and whistles.  The team believed in the micro-transaction / virtual good business model, which today sounds obvious but in 2007 had no such precedent in the West as the new gaming economic model.

The Company did a fantastic job executing against this plan.   League of Legends launched about 15 months ago in North America and less than 9 months ago in Europe has quickly become one of the most played and fastest growing core games in the West.    Currently, League of Legends has millions of players and is only behind World of Warcraft and Call of Duty in terms of minutes play according to Xfire.   League of Legends is launching in Asia in the near term and using Tencent as their Chinese distribution partner.

This transaction also marks the beginning of a trend that we will see more cross-border acquisitions in the technology sector.   There are a number of very large companies that are largely ignored by the Western press.   Tencent has quietly built the third largest internet company in the world with a public market capitalization in excess of $50BN.   DeNA has a $4 BN market cap.  Nexon has a chance of be one of the largest technology IPOs of 2011.   These are large, well run companies that will continue their geographic expansion in the West.

I want to thank everyone involved.   This was one of the best Board dynamics (and great guys in Mitch Lasky, Jarl Mohn and David Wallerstein) with which I have had the pleasure working – a lot of experience without ego and a tremendous desire to help.   Brandon, Marc and the team worked tirelessly and with tremendous focus.  League of Legends is a great game which had delighted customers and is just in the beginning of geographic expansion with a lot more to come!!!

Be There

Be There

I have had a number of opportunities over the last few weeks for which I had the choice “to be there.”   Often times (especially with uncertain weather and / or the current air travel situation), it is easy to be busy or just opt out for a call or even a pleasant email.    There are only a certain number times in a relationship with a person or a company that matter – often the timing of these events are unpredictable but when they are foreseeable – it is important to be there at these times.

Not long after 9/11, I was with a group of people and former Mayor of NYC Rudolph Giuliani.    He spoke about the time around September 11th and when everyone remembered he was incredibly present in NYC.  He walked the streets, urged support of our friends and family and even gave away a bride whose father had recently passed away as an early responder at World Trade Center.   He told the story of one of his father favorite pieces of advice– “go to all of the weddings and funerals – but if you have to choose go to the funeral, that is when people need you.”   As a rule of thumb, it is even more important to be there for bad news that is when people need you.

In these few weeks, personally and professionally, I have had the benefit of some great ups and tough downs.   These were tremendous moments in the lives of company founders, stressful times for management teams or family members facing their mortality.   I have done my best to be present and understanding – listening, empathizing or just raising a toast in the celebration.

Be there for your family, be there for your kids, be there for your partners / customers / investors.   It really matters.

Announcing FirstStep – First 10 Seed Investments

The world has changed. There has been a democratization of entrepreneurship. All you need to start a company today is a laptop – everything else is easily available and / or a variable cost (and you can even borrow the laptop). There are a lot of great ideas for companies and this low barrier to entry has allowed many great entrepreneurs to embrace the risks, pursue their dreams and build their own great business.
Today, we are excited to announce our formal seed program, FirstSteps, and the milestone achievement of our tenth investment from the program in the last 15 months. FirstMark Capital has had a long, successful history of investing at the seed level (Riot Games, LiveGamer, Clickable and others) as well as starting companies from scratch (Dovetail, EagleEye, Outlooksoft).

It is clear there has been a fundamental, systemic change in the last few years. Companies can start at a fraction of the costs compared to 10 years ago and can accomplish more with less than ever before. As the entrepreneurial climate has changed, FirstMark wanted to ensure we were able to leverage our considerable resources to partner with the best entrepreneurs at the earliest stage.

What do we look for in seed companies?

• We partner with great people. While we back serial entrepreneurs, we have backed many first time entrepreneurs that have gone on to build great companies. A common trait across both groups is demonstrated excellence and achievement . This could mean being one of the best sales reps in a prior company; being a successful scholar athlete; generating outstanding customer traction with little to no resources. We fundamentally believe that people who overachieve tend to do so consistently.
• We love entrepreneurs with deep domain expertise. It is crucial to have initial products which make their customers ecstatic; therefore, deep experience in the sector (understanding the pain) on a formal or informal basis is vital. If you want to be a gaming entrepreneur, do you passionately game?
• We prefer our founding team to include a technical co-founder. This is the age of constant iteration. Having a technical (co-)founder who wakes up in the middle of the night to code and iterate on the product – optimizing every button, menu and screen is critical.
• We love large markets ripe to be disrupted. Increasingly we are seeing new companies that are technology-enabled and leverage the connectivity of the Internet to launch new business models. For example, Riot Games pioneered Games as a Service and micro-transactions to disrupt the gaming space.
• We want a shared view on capital usage and value creation. Because so much can be accomplished so quickly, we love when entrepreneurs have a very clear view on how much they need, why, and what milestones they will be able to accomplish. Many things will not move in a straight line, but we are now in an era where the cost of planning is significantly higher than the cost of failure.
• We start with capital efficient technology and technology-enabled businesses. The types of businesses we will look to back will mirror the technology or technology-related themes (http://www.firstmarkcap.com/portfolio/) we have successfully invested in over the years.
• Finally, we invest nationally, but prefer to invest in companies that can benefit from our strong NYC presence. We want to ensure we can add value every step of the way.

How do we partner with seed companies?

• We look to invest anywhere between $50K and $1MM in our seed companies. Our sweet spot is between $250K – $500K. Total round size is usually between $500K – $2MM. Our investments are typically a simple preferred equity structure.
• We lead transactions, write term sheets, and often help syndicate rounds. The seed round is an opportunity to set up an early and strong network around a company. In order to build a great network with many helping hands we usually syndicate with other seed firms and leading angels, often playing an active role introducing our entrepreneurs to other partners we think are a good fit. We partner with great, experienced co-investors who share the same values. Thus far, co-investors have included: First Round Capital, Metamorphic Ventures, Genacast, IA Capital, Accelerator Ventures, New York Angels, Ron Conway, and others great leaders.

Why partner with FirstMark Capital?

• We have invested for over a decade and made approximately 200 investments. We have partnered with world-class entrepreneurs and helped build many industry leaders. We have been through several economic cycles and helped hundreds of companies start, grow and succeed. We bring our institutional knowledge and those relationships to bear in every deal.
• One of the keys ingredients in building a great company is great people. We have deep relationships and broad networks to help our companies identify, recruit and land the best talent.
• We have created dedicated programs, networking, and infrastructure for our seed program. Our companies are actively engaging and learning from one another, sharing insights and helping avoid pitfalls. In addition, our seed companies benefit from the larger events we host for our entire portfolio. Such events including our Annual Marketing Summit as well as our more intimate targeted events with leaders in various industries. Our seed companies also learn from some of the best practices of a much broader portfolio of companies that have grown to achieve breakout scale.
• Our NYC base leads to deep and exceptional relationships across many of the industries that are now getting disrupted, from financial, retail, education, healthcare, gaming, publishing, advertising, media and others. NYC is the world’s business capital and we leverage that density for our companies’ benefit.
• We have a deep bench of venture partners who have decades of operating and entrepreneurial experience, and often can be mentors to our young companies.
• We support you through fundraising processes. We do not front run, we do not put our interests ahead of the Company’s. Instead, we work with you to identify the best possible partners and help you navigate the complexities of raising subsequent capital. (we encourage you to talk to our companies/ founders and hear for yourself…)

Our portfolio of seed companies has already enjoyed tremendous early success. We invite prospective entrepreneurs to reach out to any of our companies to get a sense for how actively we work with them to build value together. And if you think you’d make for a great investment, feel free to reach out to us through our network or apply here: http://www.firstmarkcap.com/firststeps.

It’s All A Game

In commerce, content and community applications, game mechanics are becoming increasingly important.   All products / applications want to be loved by their users and drive consumptive desire over time.  By adding a game mechanic, applications are tapping into the human competitive spirit as well as the desire to achieve and be recognized for that achievement.   By adding the game mechanic, applications are able to add the constant incentive / loyalty / rewards structure.

Game mechanics are broadly defined.   In the offline world, as illustrated in the film “Up in the Air,” frequent flier rewards over the last 20 years have incented people through both status and rewards.   A clear online example is video games.   In video games, points, rankings, performance (cool swords, tractors) and personalization (new skins, shoes, etc.) incent users.    In core and social games, rewards are used as both a carrot (specialized Olympic items) and stick (before items spoil).   These rewards are fun and rewarding in and of themselves (customizing your café, seeing progress) and social, (leveling up, competitive ranking against your “friends” and medals).

In commerce, Gilt has done a great job building its game mechanic.   It starts by “being invited” incenting you to “join” an “exclusive club.”  “Members” are then socially (“invite your friends”) and financially ($25 referral fee) incentivized to recruit others.   These mechanics continue with sale drops at noon each day (I know folks that have cancelled meetings and changed their lunch hour for the sale drop), and offered dramatic discounts to both enjoy and share with friends.

Foursquare has a great game mechanic which ties the real and the virtual world and probably, in the future virtual and real world rewards.   As an active Foursquare user, although I’m less interested in where people are at that moment to meet up, I’m incentivized to accumulate points, medals and shriving for mayorships.   In the future, I would assume that these incentives are not only virtual rewards (badges) but also tied to real-world rewards – free coffee for mayors, discounts / events for frequent check-ins to deepen relationships.

There will be an increasing blend of rewards for both real and virtual achievements.   Badges and virtual rewards are given at weplay for real world achievement including attending baseball / softball practices and there will be real world rewards (draws for Derek Jeter autographed baseballs) for online achievements such as sharing media and adding friends.

There is a range of rewards and Pavlovian incentives to get people to achieve them on and offline.   The game dynamics will get better and the dance with users more complex.   Applications will advance and more complex tools created, driving behavior across all facets of media and commerce.  This will be multi-year trend and we will continue to be investors and partners in the space.

Pixie Dust Lives in NYC

I am a regular user of Foursquare – not obsessive, but several times a week – enough to have more points / badges than most of my “friends.” I am still waiting for FirstMark to arrange an incentive / gift card for my pending mayor ship of our offices. Foursquare, in addition to all of the press and community adoration is important because it is the beginning of the next wave of consumer companies which is expanding the start up footprint of New York City. Foursquare illustrates NYC’s ability to build and drive traction and adoption of the new consumer technologies.
In the start up / venture industry, we often wonder why certain ideas become huge and others fail when, superficially, they are the same idea. How did YouTube beat Pure Video and Motion Box or Yelp destroy CitySearch and InsiderPages? One way to look at it is momentum.
Historically, the Bay area had a competitive advantage for their start ups given a core group of early adopters who provided initial critical mass (kindling to help get the fire started) for their consumer start ups in competitive situations. Yelp was able to organize a core group of San Francisco local captains. YouTube was able to ride the Silicon Valley wave of early web video users. Successful start ups can pop up anywhere, but those outside core tech communities have thrived given a uniqueness in their business model (Angie’s List provided a higher quality subscription service) or foothold within the geography (MySpace focused on a Los Angeles-based competitive advantage, start up bands).
New York has a number of successful emerging technology companies which were able to get initial traction due to their geographic competitive advantage. SecondMarket was able to get buyers of illiquid securities from the institutional investment management community (hedge funds). Gilt was able to source initial products from the retail community (labels). DoubleClick gained initial traction through NYC-based ad agencies.
FourSquare is important because, as a pure consumer play, it has been not only able to build a great product but also achieve tremendous traction, critical mass and momentum largely by leveraging a NYC based consumer network of early adopters. As the NYC start up community continues to grow and the network effect mushrooms, I would expect many more, large consumer companies to emerge.

FirstMark Online Marketing Summit

We just completed our First Annual FirstMark Capital Online Summit.   We were able to pull together best in class web marketers from Clickable to Conductor to Omniture to help our customer to better run online customer acquisition and pipeline management.

Thanks to my partner Amish Jani who pulled the program together while I was playing League of Legends.

Links to come!

You Need to Outrun the Bear

You probably have heard the old joke about two campers in the woods ….

Two campers are in the woods and see a bear.   One camper immediately puts on his shoes.  The other camper turns to him and asks, “Why are you putting on your shoes? You can’t outrun a bear.”

The first camper answers, “ I don’t need to outrun a bear.   I just need to outrun you!”

I have seen a similar dynamic over the last year or so in traditional media.    When I ask traditional media executives how are they are dealing with the recession or dwindling advertising dollars for traditional media, the response is usually that they may have seen a downtick in their business but the other guys are in much deeper trouble because they have (pick one or more of the following) – public shareholders, a smaller sales force, younger publications, a too focused demographic, a too broad demographic, a bad haircut, etc.   The assumption is that the other guys are worse off and will fail first; therefore, they will be fine due to less competition.    This is even worse than just trying to outrun their competitors – they are just trying to tread water and hoping their competitors will trip and fall.

If the Bear in the story is innovation in emerging media (pick your type and format – iTunes, YouTube, Facebook, etc.), just out running the other traditional players will not work.   Companies need to innovate and push themselves – even if it means cannibalization – to stay ahead of the innovation curve.

Even when the Innovation Bear has gotten the weaker runner – it is still not satisfied.   We have seen examples in the past of the stronger runner acquiring the weaker competitor in order to gain scale and fix the core business.   It has been tried in a number of ways – geographic focused traditional newspapers (consolidation of the Philadelphia local papers), building national radio footprints (Westwood One) and cross geography (Cablevision’s acquisition of Newsday), etc.   These examples all resulted in failure because they did address the core issue of fundamental innovation and instead relied on a short term, tactical quick fix or band-aid.

The Bear of Innovation in emerging media is smart, getting stronger and has a number of fundamental trends at its back (consumption patterns, demographic shifts, trackable advertising, etc.)  Out running other competitors may be a good way to tread water and buy time as we wait for the economy to recover, but the Innovation Bear will continue to come until the core issues are addressed and the Bear is face down.

Figuring Out the “Money Machine”

Especially in this challenging fund raising environment, when companies set off to seek the next (or even first) round of financing, it is critical to effectively prove out their business case to investors.  An entrepreneur must prove out the basic mechanics of the “money machine” or economic engine of their business (even if only in pieces) and put in place the building blocks of the long term business model.

To oversimplify the framework – the money machine has a handful of different components: the cost of making and delivering the product (cost of goods sold), new product development and support (research and development) and customer acquisition (sales and marketing). For the purpose of this analysis we will leave out G&A or the fixed general and administrative expenses, which would appear as separate components of the income statement.

  • Cost of goods sold should be easily understood and fully loaded (allocated with all costs) for all of the direct costs.  Included in cost of sales are the cost of the product (whether physical materials that are part of a storage box or incremental copy of software), the delivery of the product (for example, hosting), and certain other costs (for example, the cost of payment processing) including any cost of third party services (cost of shipping, customization of software, etc).  At scale, good target margins for software and emerging media (content) companies are 80%+ and services companies are 50%.  Fortunately, most software and emerging media businesses have a very high gross margin given their low marginal cost of each incremental item or instance.
  • New Product Development and Support (R&D) includes the cost of engineers that do not only make your product sell today but also ensure that you have an evolving / leading product in the future.   You can’t cut engineers today assuming a perfect (that needs no further feature or functionality) product and expect revenue to grow.
  • Customer Acquisition (Sales and Marketing) includes both people and any customer acquisition – primarily direct response marketing or direct sales people.   In this era of online advertising and sales funnel management tools, the company should be able to track total customer acquisition expense very simply both on an aggregate and individual traction basis.  Additionally, company will higher margins or who have line of business with higher gross margins can afford higher sales and marketing costs.

When we know the contribution margin, you figure out what you are willing to spend on customer acquisition (leaving lifetime customer value and repeat usage aside).  In this model, if you spend $1 on customer acquisition and drive $2 (or even $1.10) of incremental contribution margin — your world suddenly changes!

Once you figure out the money machine, not only does your business become easier to manage and more automated, but fundraising becomes easier … if even necessary at all.   Who wouldn’t want to invest $1 to get $2 back?

Everyone understands that this is easier said than done, but the goal is to figure out parts of the money machine to maintain better control on the business (including capital allocation) but further puts you on the road to self-sufficiency and profitability – the holy grail!

At Scale Business Model Goals
Software Hardware Services
Revenue 100% 100% 100%
Cost of Sales (Direct Costs) 20% 40% 60%
Gross Profit 80% 60% 40%
Operating Expenses
Sales and Marketing (Customer Acquisition) 25% 20% 15%
Research and Development 20% 15% 5%
General and Administrative 10% 10% 10%
Total Operating Expenses 55% 45% 30%
Contribution Margin 25% 15% 10%