The Fall and Rise of Publishing (Ep. 2)

[Music] Hello and welcome to the GameCraft Podcast. I'm your host, Mitch Lasky. I'm Blake Robbins. And this is a limited series about the history of the video game business. Episode 2, The Fall and Rise of Publishing. The emergence of platform-based publishers. I'm excited for this one. This episode should cover a lot of amazing topics, but really it covers the arc of your entire career, which is going from this package-good model of publishing to what we now know as a platform-based publisher, which you've covered. I'm really excited for this episode as well, primarily because I've been seeing over the past couple of years a real shift in the way people talk about publishing. And I think many people in this younger generation of investors and people in the video game business have come to define publishing in a very narrow way as just a publisher is a company that lists other people's products for sale. We would have called a third-party publisher back in my era. But in some ways, that's come to be the only definition of publishing. And I think that's kind of unfortunate, because I think it's left us only with the word developer to cover this entire gamut from a guy in his apartment making Wordal by himself all the way to somebody who's creating a company with 850 employees like Riot or Epic, a multi-product company. And yet, we have to call both of those things developers, because we've now narrowed the definition of publisher to exclude them. Publisher in my mind, in the era that I'm in, I do view it almost like a record label or a film studio that's going and buying the rights and helping to push it out on the distribution side. But like you said, we're faced with developers. It's only term that we have left to describe a true person building a game. And in the era that you came up publishing used to mean something much bigger, right? At least my understanding is that was something much bigger. Like, what did that actually mean? That's true. It's really important for us to delve into that a little bit, because what we're going to do in this episode in some ways is reclaim the word publishing and recontextualize it for the modern era. And we're going to end up at the end of this episode talking about the new alpha predator in the video game business, which is the platform-based publisher. And in order to get there, we're really going to have to understand publishing at its essence, because there are going to be some distinctions along the way. There are things that are going to look like publishers that aren't really publishers. There are things that are going to look like developers, which are actually publishers. And so I think let's start at the beginning and go back and look at where we came from again so that we can see where we're going. So I guess even before we start talking about the package goods business and what publishing meant back in a kind of 20th century industrial business where we had manufacturing and distribution and these old classic concepts of publishing, let's talk about the word to publish itself unsurprisingly, to publish, means given how it sounds, means to make something public. And it contains really two concepts if you go and look up the definition. The first is about awareness, which is to make something generally known. So that's the way the words used typically in academia, where are you published? As is something that a professor might say, right? Are you known to the world through a piece of work that's been made generally available? You know, you also see it in libel law, right? It's like whether something was published is one of the criteria of whether or not it was available for the public to see and therefore be smurched your reputation. So that's the classic first sense, which is awareness. And the second concept that's embedded in that term is about making something available. So preparing a work for sale is a classic definition of publishing. And I think these two concepts, public awareness and availability for sale are really the essence of publishing. So let's go back and look a little bit at what happened in the package goods era and sort of apply that understanding. And then we can look forward at where we've come to today. Exactly. Based on that definition, it's clear that in the package goods era that had a very different meaning, likely tied to supply chains and actual physical manufacturing and distribution. But what was it actually like back in that era? We've alluded to it many times already and both the intro and in the previous episode. But what was it like during that time? So the publishing business back in the early days of the video game era of the package good was really an industrial process. And it was very similar probably to what book publishing was like in the 19th century, what music publishing was like throughout the 20th century, what many other industries, creative industries were like in terms of dealing with authors, dealing with creatives, taking their works and fixing them in a medium of expression, whether it was on a vinyl record or whether it was in a book form or whatever. And then managing to move those units, those packaged goods into commerce and in the way we've discussed to prepare them for sale, to get them onto store shelves. And really the role of the publisher began with a relationship with the artist and it ended when those materials, whatever they were, were delivered into commerce. So the relationship with the purchaser was a relationship that the store owner maintained. The publisher maintained a relationship with the store rather than with the end user. And so in that way, it was an industrial process and like any industrial process, it was basically an economy of scale model. I'm assuming that there were giants at that time. Are they still the same giants that we know today within the gaming industry, whether that's EA or Activision or were there other major publishers at that time? There were other major publishers, but the giants have kind of persisted. Activision was an important company in the early 80s, the era of Pitfall, if you will, in Zork. But they sort of fell on hard times. The company was taken over, revitalized, and is now probably the largest of the domestic publishers. Electronic Arts, which was founded again in the 80s, grew more steadily and more consistently, had the bedrock of their sports business, which provided kind of an underlying engine of growth for them. And they're still as relevant today as they were back at their founding. So there has been a lot of stability in that base, but there were companies that you've probably never heard of, like Interplay and Spectrum Holobite and others, who were relevant publishers in the early 90s, for example. And who really sort of fell by the wayside. And there are others who came up later in the process, Ubisoft, for example, and several others who have become more relevant over time. Just so I understand. During that era, obviously, these publishers who had real retail relationships had a lot more power than the developers themselves. And we'll say developers in this case is the people actually building the games. What were the types of deals that were being caught at that time? Was it just super favorable to the publishers or were they doing advances? What would it even look like at that time? So this was very much the same across the publishing disciplines from music to books to video games to movies. And that is the publisher was in some ways a financier. So the publisher would provide development financing in most cases to the businesses that it had chosen to do business with the authors, the bands, who they had relationships with. And the creatives would use those development funds to create their works. They would turn them over to the publisher. The publisher would generally treat those advances as advances against future royalties, which were recoupable. So essentially on the first sales of the product would go toward paying off that debt, if you will, that the creative would have incurred in the creation of the work. And then as they earned out they would start to earn royalties, but in every one of those disciplines, the artists were not in a position of power because that relationship, that financing relationship made them dependent upon their publishers. And frankly, the publishers control over the distribution channel even further that dependency and made them even more reliant on the publisher for marketing and for the physical creation, the building of inventory that was going to make its way into commerce. So all those things together led to a situation where developers had very little power and publishers had a lot of power and publishers not only worked with third parties, but publishers worked with their own internal studios where they obviously had complete control, kind of like the old Hollywood studio system. They could move their own programmers, designers and artists around from project to project within their own internal studios to create games that they owned 100%. But it feels like this might actually just be where the initial world view of financiers looking at games and thinking of them as this hit driven business or much more closely to the Hollywood film business at that time. That makes sense now understanding just how that publishing model was set up. And obviously the publishers in this case, like Activision or EA, were actually the financiers. And it's logical why this business was somewhat resistant to venture capital, for example, early on, because as the venture capitalists investing in, let's say, an independent developer, that developer is going to have to go to a publisher and give up most of its economics in order to get that product into commerce. And by giving up that economics, it really diminishes the value of the overall enterprise value of the developer in that value chain. And so I think it just drives home even more how innovative it was at that time, where Ed software, which we talked about in the last episode, does the shareware model and they tried to fight against this. Obviously in an era where there wasn't really an alternative. And so they just brute force the way to do that, which is amazing. It's honestly incredible. And obviously you end up striking a publishing deal with them, which is honestly hilarious and crazy in a lot of ways because they tried really hard to resist it. But ultimately you end up striking a publishing deal with them. Yeah. In many ways, you're right. I mean, it was very much trying to buck the system. And they liked to be called the publisher of their work, even though they really weren't in the classic sense. But we sort of accepted that fiction and we called ourselves their distributor at the time rather than their publisher. But in all respects, we were the publisher. We were taking financial risk on the product. We were paying them advances. They didn't really need them because they had such enormous cash flow from their successful products that they could easily have self-financed. But we did provide them with advances against royalties. We were building units. We were putting them into commerce. We were paying for marketing. We were taking essentially financial risk. And we were putting our own imprimitor on them in addition to the boxes saying id, they also said Activision. And I think that's another important component of this concept of publishing. Because again, when we move into the modern era, you're going to see some examples where there are companies that maybe have some attributes of publisher, but really ultimately function just as marketplaces. They look more like retailers than they really look like publishers. And that absence of the imprimitor of the publisher, the publisher's mark is a very important component of that. So that was a key aspect of our deal. And yes, we did have that relationship with it. And we made them a lot of money. But in a lot of ways, we ended their dream of being an independent publisher, which would have been very difficult at the time. I imagine that they were able to strike a much better deal during that time. Just purely off of the success that they almost bootstrapped themselves for their own distribution. Do you remember what that deal looked like at that time? Absolutely. It was the richest deal in the industry. They got 40% of net receipts. And that's a remarkable number when most developers were operating in the 15 to 25% range if they were lucky. And a lot of them below that. And you think about it from a recruitment standpoint, again, like in order to fill that bucket, if you're only really recouping at a 10% royalty rate or a 20% royalty rate, the product has to basically generate sales five times the development costs in order for you to get your first dollar of royalty. So it was quite an owner's situation for the developers. And a lot of very well-known developers lived pretty hand-to-mouth generating very little royalties and access of their advances. And they really had to be clever about how they managed their development costs so that they could deliver product on the advances that they were receiving from the publishers. And there are many examples where these developers went over budget. And that opened the door for the publishers to negotiate even more owner's terms with them. I have a portfolio company that I've worked with for the last decade in Los Angeles called That Game Company, which is run by Genova Chen. And while he's now a platform-based publisher and creating a game as a service, in the old days, he was making games for the Sony PlayStation. And his most famous game for the Sony PlayStation journey was over budget and overdue. And he was forced to pay out of his own pocket to max out his own credit cards in order to finish the product because Sony was threatening to renegotiate his deal with him if he asked them for any more money. Which is remarkable. But that is the way that most developers was operated in those days. So you structure this deal with it and it's obviously very favorable for the developer. It sets a new precedent at least I can imagine what happens next. So of course, our relationship with Id was unique because they had enormous market power. They had enormous name and brand recognition. So the risk reward in the Id deal was very different than our risk reward in a situation where perhaps we were funding a new developer who had never made a game before who had no market or brand power. And where we were really putting a lot of that capital at significant risk. In this case, we were pretty sure they were going to earn out on this because their historical trends and our understanding of the quality of the game that they were producing was such that it really didn't put us at risk. But you're right. The news of this did filter out into the community in some ways and people kind of knew if they didn't know the real numbers, they knew that it was at the higher end of the acceptable scale, if you will, for publishers in that era. So it leads me to an interesting question. And one of the companies that really forms the pivot point in this because if there was one company that heard about the Id deal and kind of came back to haunt us to a certain extent, it was Valve. Tell me more about that. So Valve, I imagine here's from from it, or maybe just through the grapevine that Activision's cutting crazy deals. Do you get a call from from Gabe in the team or what what happens next? Absolutely. So in fact, oddly enough, we were introduced to Valve at Activision by Id. Wow. Because Valve had at that time licensed the Quake engine and they were going to use the Quake engine to create their first game Half-Life. So they were looking for publishers at that time and Id had recommended us because we had at that point a very good relationship with them and we were doing good work for them and it was very harmonious. We had good producers, etc. And so they recommended us. And so at that, the CEO of Activision, Bobby Codic and I got on a plane and we flew up to Washington State, we flew up to Seattle, and we went to visit Valve at their new offices. They were a brand new company just outside of Seattle and started to have some conversations with them about potentially publishing Half-Life. And for people that aren't familiar with Valve, obviously, now we know what Valve is, you and I, like what's the timeframe of this? What year is this, do you know? So this was 1996 and they were long time so you you had Gabe Newell who was still the CEO and founder and Mike Harrington, who was his partner and they had a third partner at the time and the three of them were very early Microsoft executives. So they had been, I think Gabe had been at Microsoft for a dozen years at the time he had left to form Valve. So you know, you do the math. He was there really at the dawn of the PC era and you know, as a result, he and his co-founders had made quite a bit of coin. Just riding the stock as Microsoft became one of the most important companies in the world during that decade. So you know, they had some startup capital, shall we say, and they were starting a new company. They really wanted to make games. That was their passion. And I'm not sure if they knew exactly what our deal was with Id, but they certainly knew enough that they drove a hard bargain. I can imagine that at the time, you end up in this meeting with Bobby and it's like, okay, these people seem accomplished. I imagine they haven't built a game before at this point. And so they're saying, hey, we're building a new game. They're already independently successful. You're sitting there and you're like, okay, what are they actually asking for? What's the ask do you remember that they end up asking for? It was nearly the ideal. Maybe not in terms of advances, but certainly in terms of royalties. And this was for Half-Life at the time, right? So Bobby and I heard the pitch, the game looked really interesting and they were clearly passionate about making it. And it checked a lot of those boxes for us as the potential publisher. But at the other hand, these were some ex-Microsoft employees who'd never made a game before. And in our line of work, we came across a lot of people who we viewed as tourists, if you will, people who were really intrigued by the video game business, but who we weren't sure were committed for the long haul. So unwisely in retrospect, we said no. And as did almost every other major publisher who they pitched Half-Life to at that time, they ended up, I think, doing the deal with the third tier publisher called Sierra Online that was willing to take it on. For people who aren't familiar with Half-Life, what ends up happening in that story? Because I can assume that it blows up. I know Half-Life almost through like lore of just knowing the industry, how big of a deal was it when Half-Life launches? Half-Life was a juggernaut. It came out for Christmas 1998 and it just blew up. I think it sold a couple of million units in its first four months and on the market, which, you know, in those days was considerable. I think it generated maybe 250 to 300 million in gross revenue over its life, as it got ported out across various platforms and refreshed with mission packs and other things over the years. It was an incredibly important game. They seem inspired by it at that time. And they're using the Quake engine. Were there any other lessons that you think they took from it at that time? Well, by licensing the Quake engine, they opened themselves up to some of the things that made id and their products so successful. And one of those things was the modding engine. So Quake was the Quake engine and the Doom engine before it were always highly modable. And people people were creating their own content on top of it. In fact, as we discussed in the last episode, one of my introductions to the publishing business with Id was publishing Doom and Quake Mission Packs, which were being created a lot of times by Amateurs. And Id had a relationship with their community and they would point us in the direction of some of the best modders. And we would then professionalize their output into an official Mission Packs and then release it under Id's imprimitor. And so that was a thing and Half-Life kind of inherited that with the Quake Engine. But they ran with it. With Half-Life out in 1998 and a huge hit, they opened up their product to the modding community. And in 1999, on top of the Half-Life version of the Quake Engine, they got Counter-Strike. - Josh. - So not only did Counter-Strike become a hit and drive another wave of revenue and sales for Half-Life because you needed Half-Life to play it, you had to run it on top of Half-Life. So it reinvigorated Half-Life, but it sort of established itself as a brand on its own. It was so successful that in 2000 Valve acquired it and they bought the team and the IP and brought it in-house and relaunched it as an official Valve product. - It's super interesting because it hadn't occurred to me until you just mentioned it, but at that time, Half-Life and Counter-Strike were still package goods. Like they were still in this package goods era. And so you didn't have to free to play a mechanic. And so you really did need to own Half-Life to even play Counter-Strike at that time. And then I imagine they re-release is that what happens with Counter-Strike? Like they push out Counter-Strike as its own package goods and stores then? - Yeah, they did. And ultimately, because we know the end of the story, it migrates online and it becomes one of the most important games probably ever. Wouldn't be hyperbole to call that acquisition in 2000 of the team and the IP, one of the great acquisitions in the history of the video game business. Again, it's most recent incarnation as CSGO or Counter-Strike global operations. It continues to be one of the most popular games in the world 20 years later. - I have over 2000 hours on CSGO. So you're preaching to the choir here. - So you brought up the idea of Counter-Strike as a package good as a companion to Half-Life, which was out on the market at the time. And that's absolutely right. They, by acquiring that team and acquiring the IP, they had to now sort of press that as an independent package good and put it out into commerce. That led to some really interesting phenomenon that grew up around those games because in particular with Counter-Strike, Counter-Strike was a competitive game, right? It was more in the vein of a Quake III arena or an unreal tournament. And because it was a competitive game, it raised an enormous number of sort of post-launch issues with regard to balance, with regard to exploits, with regard to cheating and other things like that. And at the same time, Valve was internally working on the sequel to Half-Life, Half-Life II, which was gonna be even bigger and even more expansive than the previous version. You know, it's hard to remember what this was like in a kind of pre-internet era, but having a game like Counter-Strike, a competitive game out on the market, it had to be constantly patched. And you needed to constantly get your users online to download software so that they could make it work. And you had to lock people out of playing competitively if they hadn't downloaded the patches because they were capable of exploiting the game of cheating, of doing the things that you were really trying to avoid getting them to do. And even in the benign cases, there were bugs. Software's always got bugs. And so you really needed to get people back online in order to patch those even single-player products so that they could be bug-free and play as intended. Yeah, I can't even imagine at that time. Like I play a lot of Counter-Strike still. I play a lot of League of Legends. And those games are balanced and updated quite a bit. And so I can't imagine that era, especially with how buggy the games must have been, just how broken they were. And actually getting the ability to update it must have been a true hassle. - It was a true hassle, but it led to an incredible innovation. Gabe Newell, who we've discussed the CEO valve and his partner Mike Carrington, these guys had come out of Microsoft. They had worked on the Windows team. They had worked on the Windows NT team at Microsoft Prior to Starting Valve. And by 2002, while they were getting ready to bring Half-Life 2 to market and had already had a couple of years of Counter-Strike under their belt, they began thinking about building this software tool that they could use to automatically update these games. So not only would it be really convenient for users who could get the latest and greatest and make sure that their products were bug free, but it was also a way to keep the games competitively pure, to force patches and updates that would limit the exploitability of these multiplayer games. And so it was a really high priority for Valve to kind of get this right because they had a lot riding on these products. So they sought some input from third parties. In fact, they actually went back to their old bosses at Microsoft and it tried to get them to help them out in building this tool. But nobody bit and they ended up building it themselves. So they built their own standalone app, which they launched in 2003 just on the eve of Half-Life 2 launch. In order to get when Half-Life 2 was finally on the market, in order to install Half-Life 2, you had to install this bit of software that allowed for the updating and patching. That app turned out to be steam. - Oh my gosh. And at that time, I'm assuming Half-Life 2 was still a package good. It was more that you put in the disk and Steam was a downloadable program that you needed to actually run the game. - Steam was on the disk. - And you ran it in parallel with Half-Life, the package, you're good. And it reached out to the internet and helped download patches, auto install, made sure you were up to date, et cetera, et cetera. It was basically an updater for Valve's products. And from those humble beginnings, one of the most important companies in the entire video game business and the history of the video game business got started. - Yeah, Steam, to this day, is truly the giants of the video game industry. And I have probably 150 games on Steam. But for people who aren't familiar with what Steam has today, maybe it'd be helpful if we just talked or what Steam actually looks like today. - I think it could be argued that Steam was really the first game service to take advantage of the disruptive power of the internet. It's fundamentally changed the way games have been marketed, sold, and even played since it came out on the market. It was released, as we said, back in 2003, and really came to the fore in 2004 when Half-Life 2 came out. And since that release, it's grown to over 100 million monthly active gamers. And those gamers use Steam, they discover games there, they buy them, they manage their licenses and libraries of games, they participate in a huge community of gamers who come to the site on a daily or monthly basis in order to check out what's new and to log and play their games. That was very secretive about their numbers. They remain a private company to this day, something we'll talk a little bit about later on. But it's estimated that they generate more than $5 billion a year in revenue. And that represents a substantial fraction of video game revenues. It's just staggering how successful Steam has been and how important it's been. - Steam today is now almost the defective places where you launch your game digitally. Because Steam essentially collapses. It plays this critical role in collapsing what the package good model was. And it turns it into digital distribution. Do you happen to know when that shift finally happens? Like when they start releasing games through Steam? - It took a couple of years before Steam went fully online and before the marketplace really came to the fore. I mean, you think about it on launch, it really just served two functions, right? First was license validation. So were you the legit owner of the game? And this was kind of something we talked about in the last episode when we talked about piracy that license validation and copy protection were still really important concerns in 2004 because of the nature of the package goods business. So that was one thing that Steam did when it first came out. And then the second was that it was a hosting and downloading facility, but primarily for mods. It wasn't really a place where you would go to buy a packaged good, a fully featured $60 version of the game. It was more a place where you would go to download peripheral content, if you will, content that was a pertinent to the main skew that was going to enhance your experience. It was really more of a kind of enthusiast community in those days than it really was a commercial marketplace. But that evolved. And over time, they made a couple of game changing moves. So first they bought the online community network, the World Opponent Network, that really they had kind of helped build with their publisher, Sierra Online. I think they bought that in the mid 2000s, 2004, 2005 era. And it sort of gave them a community and matchmaking service that they could bolt on to their products on the one hand. They shut it down. They shut down the branding of the old World Opponent Network and they just rolled it into Steam. And it just became the Steam community at that point, right? So they now had their own audience that they were aggregating on this online platform. And then in 2005, they opened up the Steam store, the mod store we discussed earlier, to third party publishers. So for the first time, developers and publishers who wanted to sell their games as digital downloads could do so. And they could leverage the fact that Steam had this enormous audience of users with accounts online. Yeah, it did some. I take it for granted today, but when I look at Steam, it's just like, okay, this is my default gaming app. I have all of my friends on there. I have my community. I have all of my mods, everything in there, even my in-game virtual goods. And so it's fascinating that that moment in time, I don't even know if they understood that what they were about to unleash, but obviously opening up this digital goods marketplace or just the marketplace of digital game downloads completely changes the industry, I imagine. - It did, and it had really two principal radical transformative changes, really. So you think about it. The first one was it eliminated the package from package goods. And by eliminating the package from package goods and by that, I mean the box, the disk, and frankly, the retail shelf, it completely changed the relationship between publishers and developers because suddenly a lot of the justification for publishing, which was, hey, we're the ones with access to the shelf space in Best Buy. And if you really wanna get your end cap for Christmas, you need to come through us because we control those end caps in Best Buy. That was no longer relevant because we were no longer putting a package into commerce. We were simply downloading bits onto your computer, which you could then run locally. So that transformation, that elimination of the package from package goods is a really underappreciated power move here because it invalidated a lot of what made the existing incumbent publishers powerful in the first place. To put it even more bluntly, like instead of having to build millions of dollars worth of package goods inventory for a launch, a developer could just upload a single digital copy of their game to the steam store, incurring zero marginal costs. And for each subsequent unit sold, there was no cost of goods anymore. That was an absolutely radical and transformative moment in the video game business. And it shifted the power structure of the video game business fundamentally would have lasting effects. But kind of more important in some ways was what they were able to do on the audience side. What they provided to these developers and publishers who were willing to list their products on the steam store was access to this huge and super high qualified 'cause they were already gamers. This high qualified audience of gamers as we said, over 150 million accounts with credit cards on file. And this really changed the way that a game company could do customer acquisition, right? In the old days, you had to go run magazine ads and television ads where you were casting this enormously leaky net out into the sea. And you were coming back with some gamers and we used to laugh because comedy central after 10 pm was like the best place to find gamers back in that era because we knew that that was likely the people that were watching TV. But that's how imprecise the idea of targeting was in those days. We really had to cast an incredibly wide net in order to get the few gamers who we could to show up at the party. Here, we knew that if we put our game up on steam, we were getting access to gamers and only gamers because that's who was on steam. And so again, that was massively disruptive because again, it changed the nature of customer acquisition in the video game business. - Yeah, I think just to reiterate, it's hard to overstate the impact that steam had and continues to have on the industry where it really did change the way that games were marketed and sold and distributed. And then even just played, like having that built in friend's list that today is sort of the bedrock of my social network on games is honestly remarkable. Like it's hard to imagine that games ever existed or would distributed not in this way. And obviously I bought package goods back in the day, but when you first use steam, it just becomes this magical experience. - By delivering an experience, that was that compelling to the end user that provided so much value to the end user. They really did earn their right to disrupt the video game business in a fundamental way. I think not only were they disruptive and transformative in a commercial way, but they actually made the experience of being a video gamer better. And in so doing, I think they still have tremendous goodwill from their community. And to this day, they're still a risk of not putting your game up on steam because steam continues to be a place that gamers want to use to manage their licenses to manage their libraries. - Exactly. And just so we clarify, like steam, do you know what their take rate is? At that time, they're taking revenue still, I imagine, on the digital downloads that are happening. And they're taking it on a digital download basis versus what you have in package goods model where you have the supply chain collapse. Or in this case, you actually have a digital distribution. Take rate. - Yeah, it flipped the model. So rather than a 70/30, if you will, relationship between the high end developer and the publisher where the publisher was taken 70 and the developer was taken 30, steam was taking an roughly equivalent amount to the royalty and passing along the rest of that cash to the developer, the publisher, who was putting their game up in the first place. And they had to in a lot of ways because those third parties were taking risk. Those third parties were primarily self-financing. The reason I consider Valve a publisher in their own right is because they themselves were taking inventory risk and financing risk and marketing risk on their own products, right? CSGO, Half-Life, ultimately team fortress, portal, the list goes on and on of games that Valve put up on their own that were financed by them, developed by them. And therefore, I think they really deserve to be considered a publisher in their own regard. They did, however, publish their party product and they published it on kind of an arms length basis. And in so doing, they flipped the economics. They were able to do so because they had eliminated the package because they had eliminated the need for access to shelf space. They had infinite shelf space. There was no marginal cost to putting another game up on the list as there was marginal cost to building another video game shelf at Best Buy. It's fascinating because obviously that 70, 30 split is now almost a contested thing within the industry. But at that time, it was so much better in theory than the publisher deals that they were taking. They might have had some advances in some cases. But for the most part, this opens up an entirely new type of developer and access that they would have never had before. And it did shift some of the burden to these independent developers because now you were in a position where you would have to seek financing. That's not always a comfortable place for developers to be. But to back to your original question, the beginning of this episode where we talked about the "financeability of video games and video games as an investment," Steam was really a catalyst for bringing independent investors into the video game business because really for the first time now, you could move from a developer who was building their own game with money provided by an investor from outside of the video game business and actually receive enough revenue from the sale of that game to justify the investment. And you touched on something there before, which is the internet plays this really critical role here. And Steam sort of flips the economics. Obviously, we've seen this with other companies, whether that's Amazon or Uber or Airbnb. What actually happens in this case? Because Steam plays such a critical role in flipping everything. So I think to understand this move, and you're right to put it into that same category with Amazon and others, you really need to understand this concept of aggregation theory. Let's take a minute and unpack that a little bit because I think it's so important to understanding why this is such a powerful concept in the game's business and why it was so transformative. So in the old days, in the pre-Internet era, as we've discussed again and again, you have this relationship where there are retailers and there are publishers and there are developers. And for the publisher, in order to guarantee that they're going to have adequate access to demand, adequate access to the end user, they have to bring enough useful and interesting content to the retailer. So they have to get the supply side organized so that they can control enough hit supply to provide to that retailer so that that retailer can basically generate enough demand in their stores can get the butts in the seats, if you will, in order to move units so that that revenue can flow back to the publisher. So really, the relationship was in order to control distribution, in order to control demand, in order to influence demand, you really looked back at your own supply and tried to control supply. And so you saw intellectual property licensing, right? Electronic Arts invested extremely heavily in sports brands, because that was something that the retailers wanted and that they knew would drive demand at the retail level. And that happened throughout the industry, right? And that was the general order of things. When Steam came into the market, and suddenly you had this new model, Steam wasn't aggregating supply. They were aggregating demand. They had their own 150 million users with their own credit cards on the platform. And by aggregating demand, the supply side of the business collapsed, because now the supply side no longer really had to worry about the middle man of the publisher to get into commerce, the supply side could go straight to the end user through the Steam marketplace. That is a transformation that Ben Thompson's written about extensively on his Stratekery site under the moniker of Aggregation Theory. And it's vital to understand What? that entailed when what that meant for the business when that happened because it absolutely shifted the floor underneath everyone's feet. And we are still living in that world today, the world that was created from that move, from aggregating supply to aggregating demand. Yeah, I think that the aggregating demand here, there's no clear point of how valuable it is to the point where you actually have, yay, an exhibition games on steam. If you told any of those company execs 20 years ago that they would be listed on another platform and they wouldn't be the ones traditionally publishing it or they'd be giving up 30% of net sales to steam, that I imagine that would have been a crazy concept. Absolutely insane. Like, you'd never have really imagined it, right, in those days. And what I find so fascinating is that they didn't respond immediately. Electronic arts, Activision, many of the other large publishers of the day, the console publishers as well, not just the console owners like Microsoft and Sony and Nintendo, but even the major publishers who were publishing to those platforms. None of them really got it. None of them really understood what was happening. And it's remarkable because they themselves had large audiences who had affinity with their brands. They could have done this. They could have aggregated audiences on their own. They could have put up their own alternatives. But they delayed and they waited and their innovators dilemma that they were burdened with in their inability to bite the hand that was feeding them at retail, if you will, really became problematic for them as this went on because steam just continued to aggregate power and influence in the video game business and had access to all of the best content. Yeah, the amazing thing is, from my perspective, I would have assumed the shift would have happened because of free to play, but it's important to note that like during this time, they're still the package goods. They're just digital package goods, right? Like, you don't have the full shift of games on steam being free to play games. And even to this day, a lot of games on steam are still package goods. And I think that's just so fascinating that it wasn't free to play that actually caused this shift of the aggregation theory to kick in. It was just digital downloads in the internet. It was platform. And that's really the important concept that we need to talk about because what we're going to move from is a 20th century, you could even say 19th century industrial publishing model to what I've dubbed platform based publishing. And in order to really understand that, you have to understand what I mean by platform here, right? Because we've already talked about publishing, making things available for sale, generating awareness. So a platform in this context is a business model that creates value by facilitating exchanges between customers and producers. So in our case, that's an exchange between, let's say, a game player and a game creator. You have a platform that's facilitating the exchange between those two. In this case, art is moving in the direction of the end user and money is moving from the end user in the direction of the creator. And so in order to make these exchanges happen, the platform creates large scalable networks of users and large scalable networks of products and makes those available on demand both ways. So that the supply side, the creative side has access to customers and the customers have access to product. And it's really important to understand that it's a two way street by combining then this idea of platform, this facilitation of exchange between creators and consumers on the one hand. And the concept of publisher that we've talked about before, where you've got a generator of awareness and an enabler of sale. You get this new hybrid entity, this thing that I call a platform based publisher. And so it combines these two ideas, right? Platform on the one hand and publisher on the other. And it stands between producers and consumers, so facilitating awareness of new games and also streamlining the purchase of those games. And I think those, to me, are the key components of a platform based publisher. I want to draw a little bit of a distinction here between a platform based publisher and a platform. Because a lot of times when people hear this, there are marketplaces which function purely as platforms. So I would argue the iOS app store, for example, they don't take any risk with any of their products. They don't have any creative contribution to their own store, if you will, at least in the game's context. They do in the application software realm, but not in games. And therefore, they're really functioning just as an online retailer of games, right? They're not taking marketing risk. They're not taking product inventory risk or creative risk, if you will. And therefore, I consider them a platform, but not a publisher or a platform based publisher. On the other hand, you have things like Epic or Riot even, which I do consider platform based publishers. I mean, Riot's audience is all aggregated online. For a long time, they really function kind of as an online super developer. They were the publisher of League of Legends, but that was about it. And so their platform was useful as it supplied users and content to League of Legends, but not really beyond that. But then, after a decade or so in business, they decided to branch out and start releasing new product and valorant a very successful product came to the market, leveraging that platform because they already aggregated the audience and they were able to market valorant directly to that audience, provide them with the download from their own platform and facilitate that commercial relationship. So I think you could argue that very successfully, in my opinion, that Riot and Epic are prime examples of modern platform based publishers. I think you could even take it further and suggest that Tencent, which has grown to become the largest video game publisher in the world, to Chinese company that started out in the messaging business with a product called QQ and WeChat, which frankly at this point have aggregated a billion users in China and other countries onto this platform. They decided that they wanted to be in the games business in a big way and they started to acquire developers to build product in their own internal studios and make their platform available to third parties in a steam-like way. And they've grown to be the largest publisher in the world on that basis. But they're clearly a publisher because they're taking creative development and marketing risk across a broad portfolio of product. And they've really become the alpha predator of the modern video game business. Yeah. I think in this case, it all ties back to their building great games. They're aggregating demand and they're in a steam case, you're choosing to open that up to everyone or an epic case, you're choosing to open up to marketplace and leverage that demand to build not the entire ecosystem. In Riot's case, you're actually saying, hey, we're going to use this demand to publish our other games so when they were going to build. And then obviously in the Tencent case, you have acquired a bunch of studios and companies like Riot and even Epic to some extent where they can aggregate that demand and push it back out into their ecosystem. And given the commercial success and valuation success, if you will, enterprise value success of the epics of the riots and particularly of the Tencent which has grown to become one of the most valuable companies in the world, it's really interesting to go back and revisit what happened to Valve because Valve as a company was a pretty curious case. I mean, Valve is to this day one of the most interesting companies in all of gaming, but it's still private. No one actually knows the numbers. That to me actually is this indicator of maybe the financiers of this world or maybe the venture capitalists aren't even still aware of Valve. Maybe they don't even understand how great of a business this actually is. Well certainly to the extent that investors are really only looking at public companies, that would be the case. But I think most people are appreciating the fact that Valve is an incredibly important company. But I think more interestingly is why. And I don't think anyone really knows what the answer to that question is. I mean, you think about the progression post the launch of steam. So by the end of the first decade of the 21st century, by around 2010 or thereabouts, they moved into free to play. They made the changes to their commercial platform that permitted free to play so they could still get their cut and allow developers to provide virtual goods and others. They had moved some of their own games to virtual goods. So team fortress, great example. I mean, what's the hats? Yeah, the hats and then Counter Strike, I think, was a couple of years later where they introduced all the Counter Strike skins for every gun. And I mean, that's completely revitalized second. So as we discussed, this was CartWider, right? I mean, these kinds of cosmetic upgrades to a free game, very reminiscent of the things we were seeing coming out of Korea five years earlier. So they are not lagging behind the times. They are not stuck in the package goods era, just simply putting an internet veneer on top. They are really continuing to innovate and continuing to move the platform in the direction that the puck is going, if you will. And so I think that's really important. They opened virtual goods monetization for their partners in 2015 after having kept it proprietary to their own games for a couple of years. So here you have this first really important commercial platform on the internet for games. It's growing like crazy. It's generating billions of dollars in revenue. And it's by all accounts ridiculously profitable. And it just seemed inevitable to all of us in the video game business at the time that Valve was going to take it public, was going to make a huge splash. This was going to be a worth tens of billions of dollars in the public market and that they were going to use that treasury, that enormous balance sheet to go out and just really become a rival of EA and Activision and others in sort of directing the future of the video game business. And it didn't happen. I mean, you obviously know Gabe or you've met Gabe. like, "Why do you think that happens?" Like you said, they could have went and tried to be the Netflix or they could have went and really swing for the fences, but instead they went different out. - They could have demolished brick and mortar retail if they wanted to, right? They could have put an end to it once and for all if they had been super ambitious in that regard and had been willing to maybe make some moves that might have been a little uncomfortable for them, but they just never seemed to really have the appetite for it. I don't think Gabe was really ever tempted. He still runs Valve as a private company to this day. Obviously, he's rich beyond anyone's imagination, given what the incredible cash flows have been like for Steam. He's never really had to take on outside investment. He's always kind of bankrupted originally from that Microsoft equity that he started with, but really the business has been so cash-generative that he's never really had to deal with an outside board or outside investors who might have pressured him into the public markets. Unlike Bezos, for example, who's across town running Amazon pretty much through this same period, Bezos has pushed the boundaries of kind of every commercial opportunity that his platform created. He's delivering dial tone to the internet through AWS and he's in the movie production business and he's pushing the boundaries across the board of what it means to be an e-commerce platform. And at the same time, Valve's sort of capital appreciation, if you will, looking at it purely as an investor, is still kind of unrealized. - It's almost stealthy, right? Like you don't fully understand or appreciate how successful they have been, right? Like you know that there's millions of games, there's millions of players, but you still don't have any of the real numbers. And obviously we've seen some attempts of them to try and evolve, but what does that even look like? They don't just stay building the platform, they try and swing for some things, but none of them really seem to land. - It is curious, and you're right, there are four A's outside of their core business have been kind of strange if you think about it. I mean, on the one hand, they've done an operating system, a Linux-based operating system for gaming. They've done a game console, or they're at least trending in the direction of delivering a game console. And they built in conjunction with HTC virtual reality headset. So those are the three big swings, if you will, like operating system game console and virtual reality headset. What does that sound like? (laughs) - I mean, it sounds a little bit like Microsoft. - And that's really the case. I mean, I agree 100%. It sounds like Microsoft. It sounds a little bit like fighting the last war. You've got Microsoft really obviously built-on operating systems, Windows 95 and DirectX were incredibly important in the neighbors of the games business in their day. They built a game console, the Xbox, which they launched in 2000, and is now one of the two or three dominant platforms in console. And they built peripherals and including their own virtual reality headset. So yeah, it sounds a bit Microsofty in a weird way. And as much as I admire Gabe and admire what Valve has done and recognize its absolute importance to the video game business that we all operate in, you can't but be a little bit disappointed by where they've decided to take that market power. - I think that's right. And I think even as a user, if you load up steam, you might look at it and you're like, what, like if it's your first time using it, it almost still looks like it's in the 2000s, or like 2000s products and you look at the community tabs, or you look at their attempts and trying to do things around social. And they feel so close to actually nailing it, but it leaves room for the discords and these other products to emerge. - It is really interesting. And really ironically to your point about them feeling a little bit Microsofty in terms of what they're doing, when you look at what's happening across town at Microsoft down in Redmond, Microsoft has really learned the lessons that Valve was trying to teach and has completely transformed their game business under Phil Spencer into something that looks a lot more like a platform based publisher than ever before. So while Valve is kind of looking back at Microsoft, I think Microsoft is looking at Valve and saying, we want to look more like that. - And by that, I'm assuming you're referring to Game Pass? - Yeah, to Game Pass broadly, right? Game Pass I think is a component of this strategy that they've clearly been working on for several years to transform the Xbox brand from simply being a hardware platform, a hardware appliance, if you will, into something more platform-like. So today when you go on Windows and you launch something that's called Xbox, right? And it is a steam-like locus of your gaming and I think Game Pass is an important component to that. Game Pass is a subscription service, Netflix-like and annual, or I'm sorry, a monthly subscription that you pay and it enables you to access a number of games under that single subscription. But again, there's a strong component in there of license aggregation, of community, et cetera. And Xbox was always a pioneer in that regard with Xbox Live going back to the console days and Halo and stuff you probably grew up with. - Yeah, yeah, I'd be curious to get your perspective just because you obviously were in the industry during this time. I imagine that Microsoft at some point was like, hey, Valve is taking off and Steam is taking off. We clearly missed this opportunity. Do you think there were sooner conversations of how do we try and take on Steam or how are people within the industry thinking about that? - Oh, absolutely. In fact, when I was at Electronic Arts on the senior management team there in the 2006, 2007 timeline, we were very seriously considering trying to make a bid for Valve with an offer in the billions of dollars. I don't think Gabe would have taken it. - Yeah, I don't think he would have. - So yes, everyone in the video game business at this point, by the end of the first decade of the 21st century, by 2010, everyone was well aware of how powerful and disruptive Valve was to the potential future of the business. I think what's interesting to me is that Microsoft of all companies was one of the only companies to really respond from that era of incumbents. You don't really see a similar kind of move coming from EA or from Activision. You saw it coming from Microsoft and I think it's a real testament to the genius of Phil Spencer who's currently running the Microsoft games operations. He is, in my opinion, one of the most clever and intelligent executives who's currently operating in the video game business. And to be able to engender that kind of a transformation at a company like Microsoft, and with all due respect, I think Microsoft under Satya is a very different organization than it's ever been, but that notwithstanding. It's like steering a super taker. And the visibility to have pulled this off inside of Microsoft, I think, is underappreciated. - Obviously now they're trying to close on the Activision deal. How do you think that plays into all of this? - Well, it's so interesting because it really positions his move into platform based publishing in a lot of ways, right? I remember he was interviewed back in 2019 and he said something that always stuck with me and really made me understand how he was thinking about it and how he was thinking about it just like you or I would be thinking about it. He said something like, "The business isn't how many consoles you sell, the business is how many players are playing the games that they buy and how they're playing them." And when you think about that, that is really the essence of platform based publishing. It's a concentration on the demand side of the business, the users, what games are they playing and how are they playing them rather than on the supply side how many consoles you're selling or how many units of package goods you're putting on the shelves at Best Buy or Target. So I think Phil gets it. And I think he really fundamentally has migrated Microsoft into this era of platform based publishing in a major way. And I think that's gonna be really interesting to watch as the industry goes forward because if anything, it's even more radical than Steam with this Game Pass subscription, bringing a Netflix-like experience to video gaming really for the first time. Obviously getting Activision within the Microsoft brand, it jump starts to distribution to a different level than they previously were at. - Sure, because looking at the Netflix model and all the other streaming video models, really, it's all about having that content that's gonna keep someone subscribed. So by bringing those great Activision brands, the Call of Duty's, the Tony Hawk's Pro Skaters, the World of Warcraft, Overwatch, et cetera, under the banner of Microsoft, he ensures that he has a consistent supply of product that he can supply to his own platform that will keep people subscribed and keep people engaged. Because again, we've now moved the model from, is this sufficient this product to get somebody into a store to buy a package good? Then we went to, is this product sufficient to get someone to download and invest in the learning curve that might get them on a free-to-play basis to start buying things like cosmetics or upgrades. And now we're at the point where, is there enough content on this platform to guarantee that my $5 or $10 a month is gonna get me stuff that I'm gonna be willing to play? And as we've moved along that curve, having access to that premium content has become important again. - It's super interesting. And I just can't help but feel like I'm just constantly reminded in these conversations how much of this industry is actually impacted by the business decisions. Like it continues to be this thing where if you are just looking at the industry from a purely gamer perspective, you look at Steam and you don't think of like, oh, that actually caused all these ripple effects on the business side. But it fundamentally shapes what games are even being played and what the power that developers now have versus the incumbents in that time. - I think it's entirely true and it is one of the most fascinating aspects of how their business is transformed. So I think just to sum it up for today, you know, we've, really tried to walk through this process whereby the industry transformed from its early roots as a package goods business with very strong retail presence and power and with these big publishers who were really in a central position in the business in terms of controlling content and getting that content onto store shelves and how that affected the whole ecosystem of developers and retailers and even end users. And with the introduction first of steam and then later with these newer versions of platform-based publishers, we've really migrated to an internet model where the relationship between all of those parties has been fundamentally changed. The publishers have lost a lot of power, the traditional incumbent publishers and a lot of that power has been transferred to these platform-based publishers who are the ones who are controlling demand now. It's at the same time really empowered the independent development community and I think we're in a golden age of independent game development, both with mobile and with what's available on the PC through steam and through other platform-based publishers. And so again, I think it's been an overall great benefit to the industry that we've gone through this transformation. I think it's opened up some choke points that had historically been limiting the kinds of products that were being made available to end users and as a gamer, I think this is a great transformation. At the same time, it's created some new power aggregations in the video game business companies like steam. It's reinvigorated, Microsoft is a publisher. I think you've got now other alternatives out there from Epic and from Riot and others who are going to grow in power and are going to start throwing their weight around and we'll see how that turns out. But for now, I think that this move has been overall greatly beneficial to the industry and really has allowed for an enormous amount of value to be generated in the industry. Valve not being public, not with standing. We've still seen enormous value accrued to those platform-based publishers because they look like SaaS companies. They look like software as a services companies, marketplace companies, e-commerce companies, models that are well understood by investors. And so when they make their way public or into the hands of larger companies as acquisitions, their value is well understood. And I think having this lens that everyone is most game developers outside of, let's say the independence, are trying to battle to be the best platform-based publisher, I think that lens will really help as we continue to go through this entire podcast. Absolutely. We're going to move in the next episode to talking about the casual games business and how it evolved onto mobile where it found it's really it's real home. And that's one of the most interesting topics that's ever really occurred in the video game business. It's been something where we've gone from mobile being this tiny sliver of the business when I was first involved with it to now being the dominant platform in the entire industry. And that is really not going to be comprehensible without really understanding first, free to play second the concept of platform. Well, I'm looking forward to it.