Videogames: Serious Fun

Courtesy of Nintendo

A cluster of 10-year-old boys loiter beside a ghetto street, waiting. The one in the middle holds a blue gun. When an old white gas-guzzler, most likely a Cadillac, meanders down the street, the boy calmly shoots out its tires. Then he fires at the occupants inside, starting with the driver and then killing the passengers one after the other.

Never fear, parents of America—it’s only boys being boys at San Francisco’s F.A.O. Schwarz toy store. They’re playing a harmless little videogame, the felicitously named Lethal Enforcers, a $70 gem that runs on your kids’ Sega CD system. While this may not be your idea of age-appropriate fun, it has corporate America all excited. Why? Because boys like these form the heart of the videogame industry (so far, girls aren’t a factor). And videogames are a $6.5-billion-a-year U.S. business—bigger than the movie box office take—that’s on the cutting edge of both technology and investment in the so-called electronic information highway.

Whatever else is offered to consumers on that highway—the coming convergence of telephone, television, and computer—you can count on one thing: You’ll be able to play videogames. Lee Isgur, a partner at Volpe Welty, a San Francisco investment bank, has followed the games industry since its creation by the Atari Corp. (see timeline below). Says Isgur: “You can talk all you want about the electronic highway and video on demand, but the only place anyone has ever sold anything interactive is in games.” Walter Miao, an analyst at LINK Resources/IDC, sees the market growing to $7.5 billion next year.

That’s why companies like AT&T (T) , Matsushita, Paramount, Viacom (VIAB), Blockbuster, IBM (IBM), Silicon Graphics, and Time Warner (TWX) (parent of this magazine’s publisher at the time of publication) are trying hard to elbow their way into an industry that until this year was pretty much the exclusive domain of two Japanese giants: Nintendo and Sega Enterprises. In the past seven years, those firms have put a total of 64 million game machines in U.S. households. They have also made or licensed all of the software—i.e., games—that run on those machines.

Nintendo and Sega sell the hardware cheap—that’s how they got just about every kid in America to play. But software drives the profits. A typical game costs $60 and can sell over one million copies. Indeed, software drove the combined 1993 profits of Nintendo and Sega to $1 billion worldwide.

That Nintendo-Sega hegemony has, until now at least, made breaking into the business as difficult as rescuing the princess from Mario’s nemesis, Bowser. But it has also rescued the industry from near oblivion following the great Atari disaster. Years of overexpansion and bad management unleashed a mudslide of dismal titles—notably a pallid 1983 version of the film E.T.: The Extra-Terrestrial—that soured the public on videogames and led to Atari’s dismemberment. Says Nintendo of America senior VP Howard Lincoln: “Atari had a wonderful franchise, but it was irresponsible in terms of quality control.”

Enter Nintendo. The firm single-handedly re-created the market in 1986 with twin gestures: (a) introducing an inexpensive eight-bit player (bit numbers measure how much data a computer chip can process at one time), and (b) carefully, even dictatorially, controlling the quality of the software that could be played on its machines. While competition from Sega and pressure from the Federal Trade Commission forced the company to loosen its software licensing policies in 1990, the quality of games has remained high.

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Nevertheless, the games business can still be as dangerous as a round of Mortal Kombat. Reason: Kids are fickle. Terry Munson, 29, a former paralegal who is now one of the 412 employees at Nintendo’s Redmond, Washington, service center answering telephone queries from stumped players, reports that a really successful title is one that kids enjoy for a month. Says Nintendo of America President Minoru Arakawa (who led a team of investors that bought baseball’s Seattle Mariners last year): “If we don’t supply kids with interesting and new products all the time, we’ll get killed and buried.”

Some would say that Sega has the shovel in its hand. Three years ago Nintendo made nearly nine out of ten game machines sold in the U.S. This year, predicts Sean McGowan, a toy industry analyst at the New York City institutional brokerage Gerard Klauer Mattison, more than half of all second-generation game players—those run by 16-bit processors—will be sold by Sega. Says McGowan: “You can’t make a big distinction in terms of the machines, but Sega’s marketing has been much hipper than Nintendo’s.” Ask your kid: Sega has cooler ads than Nintendo; and Sonic the Hedgehog, the company’s lead character, is faster and less dowdy than Mario, Nintendo’s plumber. (For one 10-year-old’s assessment of the game players available in stores this holiday season, see box.)

Sega will try to pile on more trouble for Nintendo next year when it test-markets its Sega Channel via cable TV. Genesis owners will pay around $12 a month for unlimited playing time. Most games offered will be old ones, but the company will also deliver teasers of new titles. Sega wants savvy kids, who test before they buy, to rush off then and purchase the new games.

But don’t count Nintendo out. Its tiny Game Boy dominates the market for battery-operated portable machines, and the firm still commands respect. “Nintendo is the Disney (DIS) of this industry, while Sega is the MTV,” says Steve Eskenazi, an analyst at Alex. Brown in New York. “Like Disney, Nintendo is a great company.” One potent reminder that Nintendo is a major player: its new alliance with Silicon Graphics, the $1.1-billion-a-year maker of workstations. The two companies are developing a powerful 64-bit game machine due on the market by 1995. Code name: Project Reality.

That alliance is just one example of the complicated stratagems major U.S. companies are using to get into games. Try to follow the web of AT&T’s investments, for instance. Ma Bell owns portions of Spectrum Holobyte, a gamemaker; PF. Magic, a startup company that will make networking equipment to link Sega Genesis players; the ImagiNation Network, with 40,000 subscribers who play games against one another on PCs; and 3DO, which licensed Matsushita’s Panasonic to produce its new game and multimedia machine.

One of AT&T’s partners in 3DO is Time Warner. US West, which has invested $2.5 billion in a Time Warner subsidiary, will use 3DO technology in an interactive test in Omaha next year. For its part, Time Warner will offer the Sega Channel to its cable TV subscribers. Time Warner also has its own 4,000-home test of an interactive cable network in Orlando, Florida, scheduled for next year. Silicon Graphics chips will power the Orlando television-top boxes. And as noted above, Silicon Graphics and Nintendo are collaborating on Project Reality.

Got that? Lee Isgur describes this as “defensive investing.” Says he: “Interactive is growing faster than any other form of entertainment. If you’re Time Warner or another big company, you can get in now relatively inexpensively.”

How’s this feeding frenzy likely to play out? Here are some major trends that are turning the videogame industry into the fast lane of the info highway:

• Battle of the Boxes

Videogame machines are actually small computers. The 16-bit chip that powers the Sega Genesis also ran Apple’s first Macintosh. Like the PC on your desk, Nintendo’s boxes have ports to which keyboards and modems can be attached. Half a million Japanese have networking devices that allow them to use their Nintendo machines to bank electronically and trade stocks. In coming months, the company will try networking its U.S. game players in a similar fashion.

As the price of putting serious power on tiny microprocessors continues to fall, the potential for the computerization of household electronics grows. Says Silicon Graphics Chairman Jim Clark: “Computer chips will be at the core of all future consumer devices.” Accordingly, after Silicon Graphics bought semiconductor maker MIPS Computer Systems in 1992, he went in search of machines into which he could place his new chips. Clark realized that Nintendo had the country’s largest installed base of chip-driven devices in the home—48.8 million game players, according to LINK Resources. Says Clark: “No one cared in the early Eighties when Intel microprocessors were chosen to be the heart of IBM computers. I think this is the same kind of market, where in ten years you’ll get an ‘Oh, I didn’t realize that was going on’ reaction.”

So far, Project Reality is little more than Project Vapor. Silicon Graphics has not yet sent specifications for the new machines to software developers. And since it takes 12 to 18 months to design and deliver a game, Silicon Graphics and Nintendo could have a hard time introducing arcade versions of their machines by Christmas 1994, as promised. (Game companies often launch products in arcades to generate excitement among the mall rats before making home versions available.) Meanwhile, other manufacturers, including Sony, have announced that they too will make game machines for the home. Even Atari is back; its 64-bit Jaguar game player just debuted in San Francisco and New York, and will go national next year if Atari raises additional funds.

• License to Print Money

3DO doesn’t really make anything. Rather, it licenses its technology to game-box makers (Matsushita, AT&T, Sanyo) and software developers. First to reach the hardware market is Matsushita, with its Panasonic REAL 3DO Interactive Multiplayer. Despite a $700 pricetag, seven times the cost of a Sega Genesis or Super Nintendo, analysts expect Matsushita to sell just under 50,000 machines this Christmas. Meanwhile, more than 400 software developers have signed on. They were attracted by the chance to use sophisticated graphics and by 3DO’s royalties, which are less than half those demanded by Nintendo and Sega. Of that $60 retail price for a typical game cartridge, a developer must pay Nintendo around $20, which covers manufacturing costs and a royalty. 3DO charges a royalty of only $3, and the developer does the manufacturing; but instead of cartridges, 3DO machines use CD-ROMs, which cost only a dollar or two to produce.

• Hooray for Hollywood

Many gamemakers believe the future lies with CD-ROM (for compact disk with read-only memory). Not only are the disks cheaper to make than cartridges, they can store a lot more data, including film and photographs. That means games that are beginning to resemble movies.

Tom Zito, CEO of tiny Digital Pictures, is one of the first to take advantage of the technology. Zito, who used to write for the New Yorker and Rolling Stone, spends some $2 million filming real actors for his CD-based interactive games. Corey Haim (The Lost Boys) and Debbie Harry (Hairspray) are among the performers who have starred in his miniproductions. His most interesting title this Christmas is Prize Fighter, directed by Ron Stein, who choreographed some boxing sequences in the 1980 Martin Scorsese classic, Raging Bull. Besides trying to knock out a series of actors portraying boxers, you the game player become part of a story. In this case, a crippled boy on the sidelines cheers for you. In Double Switch, actor Haim tells you exactly how he wants you to help him escape from the basement of a haunted mansion. Free him and he becomes part of the action, another character under your direction. Zito thinks that kind of interaction will transform the industry. Says he: “Right now kids are exposed to this mind-numbing medium day after day. But when they can interact with a live actor, they take back control. Seeing that you can change what happens on TV tells you that your imagination counts.”

• What About the Girl?

Most of the population—women—have largely avoided videogames, and small wonder: The leading titles are based on such activities as street fighting, car racing, and football. Sega of America CEO Tom Kalinske, for one, would like to change that. He has formed a task force composed of the top female marketers and game developers in his company. Their goal: software products available by next fall that appeal to female tastes.

Kalinske suggests that such titles might be offered on CD-ROM, where they can have more developed, interactive story lines than games currently available on cartridges. But Kalinske is largely out of the loop on this development effort. The women in charge won’t let him sit in on task force meetings, and he reluctantly endorses their decision. Says Kalinske, who once marketed Barbie dolls for Mattel Toys: “They will develop this on their own, even though I’ve probably sold more product to women than anyone in this company.”

• Your Reality Check Is in the Mail

Several companies are scrambling to make real money out of virtual reality. The technology immerses you in a computer-generated 3-D world. High-powered microprocessors relate your movements to that environment, giving you the feeling of interacting with an imaginary universe, not just a TV screen. This year thousands of people have been exposed to virtual reality in arcades around the world, ranging from Sega’s entertainment centers in Japan to a three-month show at Boston’s World Trade Center, where 90,000 visitors paid $20 a head to blast away at each other in a virtual shooting gallery.

To see that interaction in action, observe the dozens of lunchtime spectators who surround CyberMind, a temporary virtual reality game center in the lobby of San Francisco’s Embarcadero Center. There helmeted executives, hands waving and neckties flying, twirl around in circular pods to no apparent purpose.

But inside those helmets, businessmen paying $5 to play four minutes of Dactyl Nightmare see 3-D guns in their hands. When they pull the trigger they see gray bullets fly in the direction of, say, the green 3-D representation of the fellow in the green pod nearby. Spectators can tell when a computer-generated pterodactyl flies down and carries a player away—the man in the pod looks disconcerted, almost weightless. He also looks really dumb.

Expensive and cumbersome pods and helmets won’t work for the home market. Says Kicha Ganapathy, head of the machine perception research department at AT&T’s Bell Labs: “At home, people are couch potatoes. They want interactivity without slipping on a body suit or a helmet.” Now, he says, Bell Labs has developed a technology that will allow users to interact with games in a virtual world without wearing cumbersome equipment. He’s mum about what makes it fly but says AT&T would like to have a virtual reality product on the market soon. By next Christmas, Sega should also be offering its Sega VR, a set of virtual reality-inducing goggles it promises for under $200.

Ganapathy thinks that such gaming efforts will help lead virtual reality into all sorts of other fields, including surgery and education. That kind of crossover is already under way. Evans & Sutherland and Martin Marietta, which create highly sophisticated flight-simulation technology for the aerospace industry, are working with software developers to bring those techniques to the games world. Coopers & Lybrand, the consulting firm, has called on Maxis, a developer of PC games, to produce a simulation that will teach Coopers employees about the telephone industry, as well as help client companies train new workers.

The strangest crossover of all may be sitting in an office near you. A generation that played the early Nintendo machines in high school is just now entering the work force. David Shpilberg, Ernst & Young’s director of financial services consulting, finds that new hires who grew up playing videogames are more at ease with the company’s sophisticated computer programs, including business simulations, than staffers with years of experience. And discussions with the new hires reveal that they acquired a better feel for the technology from playing videogames than from working on PCs.

“Think of reengineering a company,” says Shpilberg. “The first thing you have to do is represent the obstacle course that the company is now. For instance, how a document gets from an application to an actual loan—through credit reviews, checking of income statements and balance sheets, approval from superior officers, and so on. If you think of it, it’s just like a Mario Brothers game. Our new hires understand this—that you can get through those obstacles only so fast before you have to redesign the game so that the obstacles go away.”

Far-fetched? Maybe. But isn’t it weird—and yes, somehow comforting—to think that those boys shooting car passengers in F.A.O. Schwarz may someday be reengineering your company?

A version of this article was originally published in the December 27, 1993 issue of Fortune.

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