(With apologies to Dr. Strangelove)
They say every cloud has a silver lining, here's this one's.
For some businesses it MAY be very good. Here's why.
Let's take two iPhone game companies as an example, Company A and Company B.
Company A manages to get a few $million or so from a VC in the summer to build games for the iPhone market. They setup offices in Silicon Valley, driving distance from Sand Hill Road, and put one of the VC guys on the board. They hire people, start working on iPhone games. Last week they ship two very nice titles, one is free, one is around a buck. My guess is they will be lucky to see 10,000 unit sales, or gross receipts of $7000 on that paid title, and that is optimistic. Honestly, they will probabily make less (based on what I have heard from other developers). Knowing salaries, rents, overheads ... the paid title has a burdened cost of $50k to $100k. I'm sure the plan is to continue production but not be cash flow positive for a number of years. Spend the raise, put out titles, build I.P., get to a 'hit'. The typical B, C, round scenerio.
Company B doesn't raise $$$ from anyone. Instead it uses the profit from development projects to fund title development. They ship their first title when the iPhone app store opens, modest sales. The title acts as a showcase allowing them to secure more development deals. They don't move to Silicon Valley, they don't hire a bunch of people, they run off cash receipts. The development deals improve the skills of the team as well. Because of this they build an efficient system that produces quality titles at a fraction of the expense of Company A. They begin releasing a stream of quality titles for the iPhone that become profitable with even modest sales. As long as they maintain cost control they are profitable on every title and maybe even get a hit or two. Cash flow positive.
Fast forward several months.
Maybe Company A doesn't get round B (see Sequoia Presentation). They have to cut staff, expenses, try to make a profit on their highly burdened titles.
Meanwhile Company B just continues the flow of products, still brings in dev deals ... people get paid.
Who just benefitted from the Crash?
Let's take two iPhone game companies as an example, Company A and Company B.
Company A manages to get a few $million or so from a VC in the summer to build games for the iPhone market. They setup offices in Silicon Valley, driving distance from Sand Hill Road, and put one of the VC guys on the board. They hire people, start working on iPhone games. Last week they ship two very nice titles, one is free, one is around a buck. My guess is they will be lucky to see 10,000 unit sales, or gross receipts of $7000 on that paid title, and that is optimistic. Honestly, they will probabily make less (based on what I have heard from other developers). Knowing salaries, rents, overheads ... the paid title has a burdened cost of $50k to $100k. I'm sure the plan is to continue production but not be cash flow positive for a number of years. Spend the raise, put out titles, build I.P., get to a 'hit'. The typical B, C, round scenerio.
Company B doesn't raise $$$ from anyone. Instead it uses the profit from development projects to fund title development. They ship their first title when the iPhone app store opens, modest sales. The title acts as a showcase allowing them to secure more development deals. They don't move to Silicon Valley, they don't hire a bunch of people, they run off cash receipts. The development deals improve the skills of the team as well. Because of this they build an efficient system that produces quality titles at a fraction of the expense of Company A. They begin releasing a stream of quality titles for the iPhone that become profitable with even modest sales. As long as they maintain cost control they are profitable on every title and maybe even get a hit or two. Cash flow positive.
Fast forward several months.
Maybe Company A doesn't get round B (see Sequoia Presentation). They have to cut staff, expenses, try to make a profit on their highly burdened titles.
Meanwhile Company B just continues the flow of products, still brings in dev deals ... people get paid.
Who just benefitted from the Crash?
Thank you for posting this:
I didn't mean to imply that Company A is stupid or that Company B is brilliant.
These examples are archetypes, based on real examples but exaggerated to make a point.
The point is that in a conventional VC scenario, Company A isn't expected to become cash flow positive after round A (much less B or C). The plan is to create value, in intellectual property and people. The problem that they may face now is that a followup round isn't a sure bet. Company A, as the Sequoia presentation makes clear, will have to make drastic changes or face the "death spiral" as outlined in the presentation.
However Company B can only prosper in a "no marketing funds required" ecology, which existed when the iPhone App Store first opened. The iPhone market is evolving away from that, there are over 1600 game titles alone. Company A can afford to place ads in iTunes etc.
Company B is really two companies in one. It's 'services' business is the cash cow that funds the title publishing business. That takes management resources and impacts the title side.
The real advantage of Company B is the lack of 'interference' in its decision making process. There's no venture board member to answer to. Of course they can make bad decisions as well.
The real advantage is that Company B evolved to have a efficient cost structure and Company A must now adopt to the realities of the Venture Capital and reduce their cost structure in a major way.
It all comes down to how much does it cost to produce a title and how much can that title can be expected to sell.
If we assume that out of the 100m App Store downloads that 10m are paid and 5m are games, that means 1600 game titles are driving an average of 3,125 unit sales per game. We know from traditional game markets that the top 10 games drive at least half of the sales so the picture is even more bleak that that. Maybe an 'average' game is selling 2000 units or less.
That is the 500lbs gorilla in the room.
Both companies have to find clever promotional campaigns and find niches they can own.
Here's a good blog on the consolidation in the game industry due to these financial events:
http://www.bruceongames.com/2008/10/20/game-industry-consolidation-during-the-economic-downturn/
Thank you.
Posted by: bikingbill | November 02, 2008 at 10:33 AM
Totally unrealistic and massively biased; you've described company A's scenario as if it had an exceptionally stupid / poor management team (if they managed to raise that much money yet only get that low sales, they're obviously exceptional BS'ers), and described company B's scenario as if they were run by one of the most skilled management teams on the planet (what you describe is exceptionally difficult to achieve, especially on low receipts, in software generally, let alone in teh games industry).
In reality, with equally skilled teams, A would probably take some of the money and buy customers (probably through partnering with other companies that had a captive audience / wanted to cross-promote products), and B would see that their income was flat while inflation (economic) and development inflation (industry expecations, skills required, infrastructure costs) made their cost base increase each year more than they could reduce it through savings.
Eventually, some company that is better resourced than B (probably because they "got lucky" with one game; quite possibly a company A, but equally could be another copmany B) will come along and *destroy* B, since B's only value is in their cashflow.
A will survive, because they've used their money to build up defensible features of the company.
Basically: Company A, run even half as well as Company B, gets the same opportunities, but gets a second chance each time they screw up. Company B never gets second chances.
IMHO. As someone who's worked for both types of company.
Posted by: Adam | November 02, 2008 at 04:21 AM
Great observations; what I like is how powerful the Internet has “Leveled” the playing field. Flawed markets living on “Leverage” can no longer survive. Innovation and Performance Trump “FOD”.
Got to love it!!!
Posted by: Mark | October 27, 2008 at 09:07 AM