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Something Ventured: May 18th

Insight For BC Technology Entrepreneurs

By Brent Holliday

A Radical Look Back

"Slowride, take it easy" - Foghat, Slowride

I'd like to tie together a couple of points that I have made in some of my previous columns. To do this I will use a local company and its industry as an example. The company is Radical Entertainment (Disclosure: BDC Venture Capital is an investor in Radical and I am on the board of directors).

A few weeks back, I argued that developing a critical mass of expertise and infrastructure for high technology in BC might require an anchor company, a billion-dollar cauldron of innovation and knowledge. I argued that the company could be Ballard Power Systems. I am pleased to share a couple of tidbits that have happened in the past week leading towards that end.

First, you may have read about Glen Clark's trip to Alabama to visit the Daimler-Benz factory there (I will restrain myself from any potentially offensive comments about him and the deep south...). He pleaded with Daimler to build its fuel-cell powered vehicles in a plant in BC. Weíll see how willing his government is to play "Let's Make A Deal" with what is now a colossus car company.

Also, a fuel cell symposium, organized by Mike Brown, was held this week to discuss the creation of the world's premier research and development area for this technology. These are positive first steps.

Let's re-visit the assumption that an anchor company is all that is needed for high tech nirvana. Could it be that a booming provincial technology economy can actually come from a group of highly competitive companies in the same industry?

What if I told you that there were over 1,000 highly trained computer programmers and artists in just two local companies, both about to go head-to-head in a booming market? The companies are Radical and Electronic Arts (Canada).

The EA division here concentrates on the hugely successful EA Sports software games for PCs, Nintendo and Sony Playstation. Radical, it was just announced in Next Generation magazine, has the exclusive right to the ESPN brand and is going to publish games in the sports genre in the same market.

Both groups are highly talented and critically acclaimed. The market is massive. There are 28 million Sony Playstations installed worldwide, 13 million Nintendo 64's and anyoneís guess as to how many of the 150 million PC's that people use for games.

The software games business is bigger than the box office movie business on a yearly basis. It could very well be that the number one and number two sports game makers in the world are here in Vancouver over the next few years (OK, Sony is actually quite a large sports publisher and Radical would be hard pressed to sell more games than they do).

These companies should grow rapidly and their thirst for talent is already drawing employees from far outside BC. VC's like me are waiting patiently to see how it shakes out and where/when the spin out opportunities start to happen.

It may be time for people in government, financial institutions and the popular press to sit up and take notice of a new opportunity to build another lasting BC industry. If the BC government wants to get high school kids pumped about staying in school to learn computer programming, physics, math etc., send the advertising film crews down to Radical or EA. Just look at how much fun these people have doing their job! Ho hum, another day, another superstar athlete pays a visit. Work hard, play hard is the mantra of these "extreme" employees.

Last week, I talked about the service company in high technology and whether this is a good area for venture capital investment. Some of you saw me talk at the IICS event in February about why funding content companies is akin to walking across hot coals for VCs.

I believe that a walk through Radicalís evolution as a company is instructive for any content or service based company looking to become a big player. Lest you misunderstand, Radical still has lots of hard work in front of it to truly succeed as a "big player", but they have done most things right to this point.

Radical was founded by Ian Wilkinson and Rory Armes about 7 years ago. Ian had experience running his own consulting outfit and was an Andersen Consulting employee in systems integration prior to that. Rory had joined on with Don Mattrick at Distinctive Software (the progenitor to EA Canada) and continued work on software games at the new EA for a few months when he decided to join Ian.

They got a bit of seed capital from a guy they met in a gym (!) and started to make their own game. As Rory puts it, ìit sucked.î They thought that they could just make a cool game and then get someone to distribute it. Simple.

The first hard lesson was learned. If you have any talent at all, make the necessary industry connections to get "for hire" work. Their failure in the first game at least got them in front of key industry people who then started to outsource development to Radical.

They were a service. Sega would call and say make me a game. Radical would get money to staff up and build it. Then they would get meager royalties from sales. But they were learning. They were learning a lot. They listened and they began to understand the dynamics of the market. Soon other publishers were calling.

Eventually, when they had enough money in the bank, they took a shot at developing their own title (at least 30% of it, enough to show the quality). Then the business model changed. They were quasi-service. They went out and sold their own concepts now and got a marketing partner to help with the development cost as an advance against what had become better royalties.

It took Radical 4 years to build up enough credibility to be a developer of its own games. Even still, the company was not a publisher. They were not "big time" like their friends at EA. Over the past two years the company has taken huge risks to ramp up their development effort of original content while looking for a brand and distribution partner.

Finally, last year, Disney agreed to be both brand and distribution partner (Disney owns ESPN and Capital Cities/ABC). Now the company was in the big leagues and was able to attract top American management talent in CEO Mike Ribero and VP, Marketing, Tim Dunley. It will be fun at E3, the big software games conference at the end of May in Atlanta.
Radical is the new kid on the block, but they have some heavyweight support. Weíll see how they do.

To sum up, a content player looking to have a huge hit as a start-up is against incredible odds. It's probably wiser to chart a course like Radical and convince investors that you can take your time and do it right.

Would I have invested in Radical 6 years ago? I would have had to be convinced that Rory and Ian had the management skills and talent to fulfill the vision. It's still a tough call. The service-based ìfor hireî model has to generate the necessary experience and cash flow to get the company to its product stage. But I think it's the best chance that anyone in a similar situation has.

What do you think?
Responses from Last Week:

I guess my first point is that venture capital companies are essentially service companies. How do you maintain a sustainable competitive advantage?

You stated:

"I have not spent a lot of time looking at systems integrators and other technology services companies because I was under the impression that, like any service-based company, you could only sell your time. And how much is that really worth?"

The business model of a service business of a successful service business includes the following (which may be considered valauble assets):

1. economies of scale - leverage infrastructure and expertise across many clients (often selling one consultant's time to many customers - ie. like a research report)

2. proprietary business practices - using highly refined processes and proven management methodologies, create operation efficiencies and service quality that few can match

3. valued customer base - competitor would have to spend much to get the same customers, and customers invest much in allowing the services company to understand their own business

4. annuity sales - customers continue to buy more without much sales effort (note : these are the same qualities that make utility and phone companies valuable)

" . . . the fact remains that service-based companies have a fundamental problem. They do not have a sustainable competitive advantage. "

In fact, if they can combine economies of scale and the right proprietary business practices along with the right 'people' assets, they can create a sustainable competitive advantage. For example, in the emerging 'knowledge management' are, Ernst&Young and Arthur Andersen have a pretty dominant position as service providers by combining their size, knowledge base and customer base.

Given the amount of change in technology, it could be argued that services are much more sustainable than products.

"It may look attractive to have a hybrid company that is bringing in revenue from services and can then sell their product to their client base. But building a product and selling it are monumental tasks for any management team, let alone one that is also running a service business. "

I think this is very traditional thinking, but I don't think this applies to the non-traditional nature of emerging information technologies. The Internet sector is particularly indicative of this with Hotmail and Yahoo being among the best examples of service/product hybrids.

From a sales perspective, managing product sales and service sales in today's complex business sales processes is not very different. The success of Digital (DEC) in recent years, can be attributed to their combination of service and product sales - often seling their competitors products in order to maintain service quality.

From a product management perspective, knowing the customers needs and having the ability to 'right-size' a product for a given market is a tremendous challenge. Most product companies fail with their initial product releases and must right-size the product over many generations of development.

A product developer who is offering services to those same companies has a unique advantage in creating feedback loops into the development process. SAP is a great example of a company who leveraged customer intimacy at a service level into great products.

"De-coupling product from service is usually a wise choice. "

I believe that for some technology areas, such decoupling may equate to suicide. Particularly in the enterpise product area, too many companies are building enterprise products without any first hand knowledge of the true needs and requirements of enterprise customers.

Ask any young JAVA or Intranet startup who their market is and most will answer 'Fortune 500" or 'Enterprise'. If you ask these same developers how many of their staff have worked inside one of these companies or how many of their staff have serviced one of these companies, the answer is usually 'none'.

Geoffrey Hansen

-- OK smart ass, VC's do develop advantages through reputation and credibility as well as economies of scope and scale. You make excellent points about the service based company key success factors. But I disagree on the sustainability issue. These companies do create methodologies that win them customers, but they cannot build in serious switching costs.

Consultant turnover is quite rampant in IT, despite (or maybe becasue of) the complexity in computer systems today. And, by the way, there is still nothing stopping a company from taking another VC's money.

On the issue of hybrid companies, I want to emphasize that start-ups don't have the resources that DEC does. Of course large companies can do both services and products. Start-ups don't have the resources. As always, I appreciate your point of view, Geoff.

What Do You Think? Talk Back To Brent Holliday

Something Ventured is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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