Media, Entertainment, Technology: Game On
Date: Sunday , October 27, 2002
AS A LOS ANGELES-BASED VENTURE INVESTOR whose limited partners are primarily out of the media industry, I have been both amused and exasperated over the past five years to watch entrepreneurs and fellow VCs discover how deeply skeptical I am about the investment prospects for digital entertainment-related technologies.
It's not that I don't want to enjoy the fruits of an always-on tsunami of packetized audio, video, games, text, and images distributed seamlessly from every room of my home to my car, my mobile phone, and anywhere I remotely log in to the network. And it's not that I don't believe that this world will ultimately become a reality.
It's just that I believe it will still take a reasonably long time to materialize fully. Entrepreneurs and VCs are right to focus on the "enabling technologies" layer of the stack, but even this strategy gets tripped up by the adoption cycle.
For venture investors, timing is a critical issue. If you are too early to a market, you will lose money. If you are too late to a market, you will lose money. Digital media is an area where, for the past ten years, entrepreneurs and venture investors have consistently underestimated the adoption curve, which will likely continue to lag for several reasons:
•Digital media and entertainment rely on the adoption behavior of millions of consumers, a much more capricious dynamic to judge than the enterprise buying habits of 5000 CIOs or CTOs
• Enthusiasm for new technology in the enterprise realm does not translate into consumer success. The legacy enterprise environment of paper-based workflow or expensive leased-line and frame-relay data networks is much improved upon by IP-networks and applications in a way that the consumer environment has not been improved.
• For U.S. consumers, incumbent entertainment products and options present a significant cost-benefit hurdle for new technologies to achieve market penetration. A video store is within a five-minute drive of most American homes. PCs with 15" screens and always-on Internet access for $21.95 a month are nearly ubiquitous.
• Disruptive and exciting digital media offerings like Napster are continuing to "spoil" music consumers by providing tremendous value for free, making the introduction of commercial, business-sustaining opportunities extremely difficult.
The result is that U.S. consumers have been much more difficult to sell on value-added services such as mobile phone downloads and digital cable options, than their European and Asian counterparts, who do not enjoy the same levels of PC penetration, inexpensive Internet access, and infinitesimally low local connection costs.
This isn't to say that there are no opportunities for entrepreneurs who are driven to succeed in this challenging arena. Thinking about opportunities in digital media requires the use of a matrix of thought: technological capabilities and innovation along one axis, and rigorous application of consumer desire and readiness on the other. Perhaps, the easiest way to organize opportunities is to think about content-types that are familiar to consumers and represent their existing media and entertainment needs: 1. music, 2. television, 3. movies, 4. memories, and 5. games. Lastly, we'll look at opportunities at the network/infrastructure level.
Music: Block Rockin' Beats
Clearly, music has been the advance guard of changing consumer behavior toward digital media. The abundance of free digital music available through peer-to-peer networks like the now-defunct Napster, Sharman Network's Kazaa, Streamcast's Morpheus, Xolox, and Limewire has driven the widespread adoption of Walkman-like MP3 players and stereo-ready PCs. However, the very slow adoption of MP3-enabled alarm clocks, boom boxes, car stereos, and high-end stereo components illustrates the limits of the MP3 revolution.
The business opportunities for entrepreneurs are not completely obvious, given the extreme reluctance of consumers to pay for their new music habit. Some of the digital music arenas that have attracted funding but are still struggling to prove viability are:
• Music distribution and "locker" services (Pressplay, Muse.net, FullAudio, OD2) • Digital radio (Sirius, XM Satellite, iBiquity Digital) • Music provider services (Loudeye, HiWire) • Digital rights protection and management (Intertrust, MidBar Technologies, Verance, Digimarc, Trymedia, ShieldIP) • Database services and search (Gracenote, Singingfish/Thomson, Fast-Talk Communications, Virage)
Consumers, however, are clearly spending money on the devices and players themselves. This area remains the domain of the established, scale-advantaged consumer electronics manufacturers like Sony, Apple, Panasonic, SonicBlue, Philips, Creative Labs, and so on. Expanding the capabilities of the music client is perhaps the most interesting area for venture investment:
• Niche device makers like GameBoy module-maker Songpro do appear, though the road to commercial acceptance and scale is long and expensive. • Within the devices themselves are opportunities for innovation, as DSP providers like Texas Instruments look for more sophisticated firmware. Examples include PortalPlayer and Digital 5. • Software that enhances the technical quality of experience like Octiv, Beatnik, and QSound Labs. • Interestingly and counter-intuitively, one music product on which consumers appear to be willing to spend money is old-fashioned packaged software. Whether for ripping and burning CDs, or managing their growing troves of locally-stored music, consumers are turning to software makers like MusicMatch and Roxio over shareware. The opportunities in the music realm will become increasingly scarce as the focus shifts from the technology to scale and distribution. However, we will continue to see both demand for new clients and the music management capabilities that are in line with actual consumer behavior.
Television: 50,000 Channels and Nothing On
Bringing interactivity to America's favorite device, as well as marrying it to the Internet, America's relatively new love, has been an obsession of entrepreneurs, corporations, venture capitalists, and the public markets for nearly a decade.
The challenge is that U.S. mainstream consumers want their devices to be extraordinarily easy to comprehend and use. Consumers also like to wait until the devices are established enough to cost $299 or less. Toshiba debuted DVD players in 1996, but it wasn't until 2001 that it had its first strong Christmas season. Even the still-emerging success of Personal Video Recorders (PVRs) like Tivo and SonicBlue's Replay are only evolutionary steps from the VCR, and will likely become commoditized capabilities built-in by major electronics makers. Other young players in this area include Digeo, Metabyte, and InterVideo.
Worlds of complexity beyond the PVR are interactive television and video-on-demand. Again, the challenge remains the willingness of consumers to spend more for digital cable or broadband connectivity, and then secondly, to pay for so-called value-added services. The industry has attracted millions of corporate and venture dollars, making the landscape very crowded:
• DTV software and middleware (OpenTV/Wink/ACTV, WorldGate, Liberate, NDS, MetaTV, Seachange, Diva, Concurrent, nCube) • Interactive program guides (Gemstar, TVGateway) • Digital media distribution (Pathfire, TVN, FeedRoom, Wavexpress, MagRack, Dotcast) • Internet video / MPEG-4 providers (Envivio, Veon/Philips, iVast, Avalon Digital, Real, Microsoft, enScaler, Kasenna, Generic Media, BeHere) • Compression technologies (Digital Fountain, Compressus, On2, DivXNetworks) • Rights and security (DMOD, ContentGuard) • Wireless video delivery (Packetvideo, Hantro, ViXS)
Europe, just as in the wireless services realm, is much more a center of digital television innovation, due to 1. greater penetration of digital satellite and digital cable, 2. lower penetration of PCs at home, and 3. expensive local connection costs. In the U.S., entrepreneurs need to take a much more evolutionary perspective and focus on areas of innovation that reduce complexity for the end-user. Companies like Predictive Networks and Navic are focused on providing filters and agents to digital television viewers, an area that requires substantial improvement, as any Tivo or Replay user will readily admit.
Movies: The Titanic Sails
Closely-related to the digital video arena, but a world apart in its fervor, is the digital distribution of motion pictures. Movies, however, are the preserve of a small oligopoly of behemoth corporations, temporarily protected by the still-vast file sizes of digital motion pictures, and an elaborate choreography among rights-holders and financiers.
The areas in which technology is playing a role remain relatively limited, but the list is growing monthly:
• Digital distribution of home video (Intertainer, Movielink, CinemaNow) • Copy protection (Verance, Macrovision)
• Digital animation (Pixar, PDI, Industrial Light and Magic) • Digital projection (Qualcomm, Sony, JVC, Hughes, Thomson, Texas Instruments) • Database services (IMDB/Amazon) • Electronic ticketing (Moviefone, Fandango)
Digital cinema is an extremely tough area for entrepreneurs, given the pricing power and operational control exerted by the major studios. As the industry's new standards body winds its way through the technical agreements, directors like Spielberg and Lucas insist on some level of digital distribution, and exhibitors feel pressure to innovate and improve margins, startups will have an opportunity to handle areas like exhibition management software, ad insertion, dynamic pricing software, and new developments in display technology. But there is little incentive for moving quickly.
Memories: Won't Fade Away
Amateur photography and video are often overlooked in the “consumer entertainment” category, but remain an awesome part of consumer spending with Kodak estimating a $225 billion “infoimaging” business worldwide. Of all digital media applications, this one is clearly the most mainstream in terms of number of units sold and percentage of households participating. Digital photography has accordingly remained the preserve of incumbent giants like Kodak, Fuji, Canon, Olympus, Sony, Nikon, etc., but with opportunities continuing to present themselves, such as:
• Consumer devices (Ceiva, Digi-Frame) • Device components and software (Foveon, Lightware) • Online photo-sharing services (Ofoto/Kodak, Snapfish) • Consumer/professional software (ACD Systems, Genuine Fractals, Pegasus Imaging, Ulead) • Quality management (LizardTech, eMotion)
Outside of a number of consumer-oriented startups during the “B2C” investment wave (Shutterfly, Zing, eMemories, RIP), this has lately been a relatively unheralded area of investment. Clearly, the large dollars spent along every step of the value chain, the wide range of applications, and ever-advancing need for core technological developments, will make this a fertile area for entrepreneurial activity for some time.
We will see entrepreneurs continue to succeed in improving the capabilities of capture devices, output quality, image management, sharing and collaboration tools, and image distribution, none of which are at a steady-state relative to growing consumer demand.
Games: The Real Fun is Just Beginning
Electronic gaming is a notoriously cyclical industry-one that is in the middle of a tremendous boom year, made more spectacular by the substantial decline of every other sector. Still, this is where the action continues to be in digital media, in terms of innovation, adoption, and dollars spent. However, it is a tremendously difficult area for entrepreneurs and venture investors due both to the cyclicality and to the hit-and-miss dynamic of the business. A few of the areas that emerging players have staked out are:
• Devices (Cybiko, Danger) • Console and PC Titles (EA, THQ, Activision, Sega, Eidos, Microsoft/Rare/Bungie, Take Two, Havas, Rockstar, Infogrames/Shiny) • Alternative development platforms (Pulse, WildTangent, CyCore)
• Wireless game development (Digital Bridges, Jamdat, Versaly, Blue Lava, CodeOnline, Airborne, oPlayo, Mforma/nGame, Sorrent, Cellus, MagusSoft) • Hardware and components (Nvidia, Creative Labs)
There is a great deal of buzz in the industry surrounding online multiplayer gaming, like EA's Ultima Online, NCSoft's Lineage, or Sony's Everquest. Two mass-market offerings are also about to debut: Star Wars Galaxies developed by Sony for Lucasfilm, and EA's Sims Online. The latter is likely due to be the real breakout product due to:
1. the extreme popularity of the PC title, 2. the accessible nature of the content, and 3. the very low bandwidth requirements for high-quality game-play.
A number of startups are looking to the resource demands that these services will generate, and are proposing to step in and assume some outsourcing responsibilities. Included in this bleeding-edge category are companies like RebelArts, Cybernet Systems, Butterfly.net, and Zona.
Most of the gaming-related opportunities will be at the network infrastructure level, dealing with issues of distribution, processing, storage, and latency. However, as games rely increasingly on digital distribution, and environments and game-characters become persistent, needs will arise for sophisticated patch management, secondary markets in game-generated data, and new game development tools. Recent M&A activity among development studios, like Microsoft's acquisitions of Bungie and Rare and Infogrames' acquisition of Shiny, is causing some entrepreneurs and venture investors to take note. However, game development remains much closer to the dynamics of the entertainment business than those of a growing technology company, with huge up-front costs to build a stable of consumer titles that rely on emotionally-driven market feedback.
Break a leg
For the community of entrepreneurs and venture financiers, little is as alluring as the prospect of being part of a company and effort that friends, family, and neighbors can all relate to and be excited by. The universal acceptance and desire for media offerings allow the media industry to capture many, many dollars that can theoretically be spent on new technologies and services. However, consumers are very slow to spend money themselves on new innovations and offerings, which creates limited urgency in the established providers. At the same time, the world we collectively envision in the technology industry will be realized eventually. At some point, we will have persistent and pervasive wireless packet connectivity that will allow a multitude of devices to quietly and seamlessly acquire a nearly infinite variety of content from developers and creators who can affordably produce and distribute in a way that the current value-chain does not allow. Whether this world will look like a pop culture paradise or a shareware hell, it's too early to tell.
Entrepreneurs and investors should keep in mind the old adage, “In the near term, things change a lot less than you think they will; in the long term, things change a lot more than you think they will.” A relentless focus on real end-user behavior and spending patterns will provide a better roadmap to success in this space than a boundless enthusiasm for the newest, coolest thing.
Ravin Agrawal is a Partner at EastWest VentureGroup, where he leads the venture investment arm of the Merv Adelson Trust. EastWest and its affiliates have been investors in over 30 early- and late-stage communications and media-related software companies. He is a graduate of Harvard College and Harvard Business School.