The video games industry is gaining ever increasing publicity, from the hype surrounding Zynga’s Farmville in 2009 to last year’s media circus surrounding Pokemon Go there has been a definite shift in the world’s attitude towards video games. Gaming has moved in the public psyche from a fringe activity to a mainstream form of entertainment, a point that truly impressed itself on me when my mother began playing Angry Birds. Yet, despite this heightened public awareness of the sector’s importance, I believe there remains significant confusion about the industry, most surprisingly amongst the venture capital community, those one would expect to be most ahead of the curve. Though, we have moved from the stage where mobile gaming is seen as a fad (it’s hard to see something as a fad when it generates the majority of the App Store and Google Play revenue) the way individual company’s within the ecosystem are characterised is not dissimilar to how the entire industry was seen previously. The lens most often used to view companies within the sector is that of the hits-driven business, this characterisation is damaging insofar as it suggests that success in the industry is for the most part random. This viewpoint proves problematic since it frames gaming companies are unsuited to the sort of discerning investment that you see in the wider venture capital space. This post aims firstly to cast doubt upon the hits-based based industry thesis and to subsequently outline a logical approach for investing in the sector.
Debunking the hits-based myth
One of the best explanations of why viewing gaming studios as hits-based is flawed was provided by Ben Holmes (a partner at Index Ventures) at Slush 2015 (link). I suggest watching the video for a fuller explanation, however, I will briefly outline the three main points below. The first line of argument essentially points to the longevity of certain games, Holmes uses King’s Candy Crush Saga and Supercell’s Clash of Clans as examples, to debunk the myth that mobile games are hits in the sense that they fated to rapidly acquire users and subsequently lose them overnight. The fact that these games, both of which were 3 years old at the time of the talk, continue to maintain strong user bases is telling. Secondly Holmes attacks the notion that games studios have a random chance of replicating their prior success in their future games, pointing to the presence of multiple games by developers such as King, and Supercell in the top 100 rankings on both the App Store and Google Play as evidence that good studios are able to consistently release successful products. And finally, Holmes challenges the idea that successfully investing in games studios is a luck based exercise, pointing to track record of firms focused on the sector such as his own success at Index (King, Supercell, Playfish) as well as London Venture Partners (Supercell, Playfish) and Initial Capital (Space Ape, Supercell, Peak). In all Holmes provides a cogent defence of strategic investment in gaming. This defence viewed in tandem with the expected growth of the sector (the industry is forecasted to be worth $120bn in 2019 having grown by $20bn since 2016), renders investment in gaming an opportunity that the wider venture capital industry ought to be looking at more closely.
Separating the wheat from the Chaff
This isn’t to say that investing in the sector is easy. There has been a veritable explosion of game developers and studios trying to create the next Clash of Clans and it is a fact of life that they can’t possibly all succeed; thus the prospective investor has their work cut out for them when seeking to discern which few companies will be ultimately be the winners. While this seems like a daunting task, the success of the firms mentioned above at consistently investing in winners suggests that frameworks exist with which such companies can consistently be identified. The logical next question is as follows: What allows Index, LVP and Initial to identify the Supercells of this world where others miss them? What is it about the structure of these firms that allows them to separate the wheat from the Chaff?
The thing that these three firms seem to have in common is the fact that they all have a genuine belief in the sector. Initial sees games as a fundamental vertical, listing it as the first of its three investment areas, Index’s partner Ben Holmes is clearly bullish on the sector and has significant expertise and passion for it leading multiple funding rounds in this area, while London Venture Partners was set up by industry professionals to invest exclusively in gaming. It emerges that none of these funds are investing opportunistically in gaming – they have clearly diverged from the industry standard ‘hits-based’ mantra and have diverted real focus to the industry. It is hypothesised that by diverging from this mantra, these firms have been able to develop the type of pattern recognition that venture capitalists regularly rave about in an industry that has been somewhat neglected by venture capital. This differentiation confers a huge advantage when identifying what will work and what won’t and developing frameworks with which to view and filter investment opportunities. Clearly the approach in the linked presentation by LVP, which essentially outlines what the trajectory and behaviours of a successful gaming start-up looks like, is preferable to the view that success is unpredictable when making investments. Moreover, since the volume of competitors within the industry has increased on the back of the success of some of the abovementioned names, I believe that frameworks such as these will become ever more important when sifting through investment prospects and that the venture funds that invest in developing the requisite pattern recognition and frameworks are the ones that will ultimately see consistent success in this sector. I mean it stands within reason that a complex, competitive industry should be approached with an equally complex understanding of its nuances and what leads to success.
A Game of Ventures 