Show Me The Money...Please?

"What game did you pass on that ended up being the most successful?” asked Dan Scherlis. Every ear in the room perked up at this question. “Puzzle Pirates,” said the first panelist to quiet rumblings. “K2 Network,” said the second panelist to heavier groans. After a weighted breath the third panelist spoke: “Guitar Hero.” At this admission the room filled with laughter and grimacing. Panelist number three had passed on one of the fastest selling games of all time. Who knows if another “Guitar Hero”-sized blockbuster is currently in the larval stage amidst the potential developers who attended the recent MIT Enterprise Forum event entitled “Financial Games,” but it is certain that all in attendance hoped their idea wouldn’t meet the same fate.

The evening’s panel and moderator did their best to focus on the subject of venture capital funding for video game companies, but the wealth of ideas explored were scattered all over the digital entertainment arena. The event’s moderator was Dan Scherlis, CEO of Etherplay, an online entertainment company, and a former employee of Turbine, a mega game developer who released the influential “Asheron’s Call” during Scherlis’ time there.

The panel was comprised of three venture capitalists from different firms around Boston: Ryan Moore from GrandBanks Capital, Matt Nichols from Highland Capital and Neil Squeira from General Capitalist. All three have been very actively involved in providing funding for young companies looking to break into the gaming industry.

The discussion began when Scherlis made an insightful observation about the gaming industry, saying that it is unfair to use a blanket label, “video games,” for such a diverse segment of the entertainment industry. He pointed out that linear video (everything from HBO movies to documentaries to pornography) is rarely referred to by an overarching title and that video games shouldn’t be either.

Scherlis went on to delineate the gaming industry into four categories. The first was retail video games -- the games we see on the shelves at Best Buy or Gamestop in packaging to be taken home and played. They typically cost $10-20 million to develop and the average user is a male between the ages of 20 and 40. The second category is casual games. Scherlis defined these games as those distributed online, typically for free, to be most often played through a website. This includes games like chess, Sudoku, backgammon etc. Casual games are very cheap to manufacture and typically are played by women between the ages of 40 and 50. Third, he classified mobile games, which are played on cell phones or PDAs and are very easy and cheap to develop. Currently, this will involve mostly games from the Casual category, but as the last MITEF event on mobile gaming showed, this shouldn’t be the case for long. Scherlis defined the final category as online games. While some of these games are also retail products, they are only playable over the Internet and typically with many other people. Currently, games like Second Life and World of Warcraft are dominating this category and becoming more popular than anything coming out of the other three.

After this list had been compiled, the panel proceeded with discussing the complexities of financing games. They addressed each category from the perspective of an investor and explained what they looked for when pitched by a potential developer looking for funding. The panel was unanimous in saying investors are not interested in retail games. The amount of money that goes into the majority of these games is also beyond what most VCs are going to invest and the work load greater than most young companies can handle.

Instead, VCs are much more interested in the casual, online and mobile gaming genres . These games are usually cheaper and easier to develop and can be just as lucrative given the amount of interest currently shown in such gaming options.

Scherlis then guided the discussion to debate the differences between publishers and VCs as financial backers. Why would a company go through all the effort of pitching to VCs when they would probably have an easier time going to game publishers (such as EA or Activision) and getting the funding from them? The problem with going to publishers, Scherlis said, is that they will take up to 80% of the profits generated by the game and eventually want control of the brand and/or the franchise. With VC funding, however, developers are given more control over a product’s destiny as well as a chance at replicating that success if their product turns out to be a blockbuster. Scherlis closed this discussion saying that game publishers are like “VCs without the upside.”

Also interesting was the discussion of different ways of making money in games outside of the actual selling of the software. Scherlis pointed out that when Turbine released Asheron’s Call, there was more money to be made selling high-level characters and equipment from the game to be controlled by other users than there was from game sales and subscription charges. People would play the game for hours a day, advance the characters in the game to the point where they were very powerful and then sell them for hundreds of dollars on eBay.

This forced the online gaming industry to come up with other means of generating revenue from their product. One example that works in MMOG (massively multiplayer online games) is to assess actual monetary value to the digital items in the game. A character in Second Life could theoretically buy a new outfit and actually pay $20 to the game company for it. With this model, developers could make their games free to play online and expect to make all their money from these sorts of sales.

Another idea that has already begun to take root in games is advertising within the gaming world. This is seen most prominently in sports video games right now as digital replications of real world stadiums and arenas often carry the same ads in the game as they do in real life. This is a great idea on paper, but the problem arises when it becomes impossible to track how much visibility (or how many “eyeballs”) an ad is getting. With a banner on top of a website, Scherlis argued, advertisers can see exactly how many people view their ad, but when an advertiser puts up a digital billboard on a racetrack in Gran Turismo (video below of gameplay with in-game advertising), there is no objective way to determine what sort of exposure the ad is getting.

Ryan Moore pointed out that the same could hold true for a physical billboard on a real race track, but the fact remains that digital in-game advertising is a difficult way to make money because the results are so hard to measure.

After a lot of interesting, if unrelated, video game industry talk, the panel finally shifted gears to address the theme of the night. What were VCs looking for when investing in game developers? Matt Nichols was the first to speak saying that Highland Capital’s first interest was in the project’s management team. “I invest in a management team that has succeeded.”

Scherlis quickly responded, coyly asking, “So if you want the funding to achieve success, you need to have already achieved success?”

The room laughed, most likely a nervous laugh. Considering the number of young game developers in the room, this idea was hardly encouraging as some had no management experience at all, let alone enough to impress a venture capitalist. Other members of the panel were quick to add on. They agreed that a strong management team was the easiest thing to look for when assessing a developer, but that it wasn’t the only way to get funding.

Neil Squeira said there are three things he looks for in a potential investment: the potential developer and his or her network, a creative and exciting approach to what the team is doing and most important to him, the ability to attract technical talent to the project. Experience and past success are clearly beneficial, but all three panelists agreed that if the idea was good and the brains behind it were passionate, creative and connected, then they could be sold on it.

If anything, the discussion left potential developers hopeful that there are people with money out there that want to invest in video games. With the amount of funds and creativity present in the room, it seems that the future of gaming is a bright one.