SegaSoft Networks: Multi-Player Online Gaming

Case

Author: Rashi Glazer, Mbissane Ba, Charles Frizelle, Amaresh Iyer & Rich Pearson
Online Pub Date: January 04, 2017 | Original Pub. Date: 2007
Subject: Brand Management & Strategy, Corporate Strategy, Competitive Strategy
Level: | Type: Indirect case | Length: 3699
Copyright: © 2007 Regents of the University of California
Organization: SegaSoft | Organization size: Large
Region: Northern America | State:
Industry: Computer programming, consultancy and related activities
Originally Published in:
Glazer, R. , Ba, M. , Frizelle, C. , Iyer, A. , & Perason, R. ( 2007). The Berkeley-Haas Case Series.
University of California, Berkeley. Haas School of Business.
Publisher: The Berkeley-Haas Case Series. University of California, Berkeley. Haas School of Business
DOI: https://dx.doi.org/10.4135/9781526410528 | Online ISBN: 9781526410528
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https://dx.doi.org/10.4135/9781526410528

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Abstract
SegaSoft, a software development company needed to decide whether the company should
focus on being a software development company, online gaming aggregator of third party titles,
or both. In September 1997, SegaSoft had entered into the online gaming industry. Prior to
September, SegaSoft had established itself as a software development company dedicated to
the development of interactive titles for PCs, gaming consoles, and the Internet. Students will
discuss whether SegaSoft should utilize its assets to position its online component, reinforce
its apparent core competency of software development, or attempt to support both software
development and Internet gaming. Was there an opportunity to exploit the brand identity of its
parent company, and if so, which of the above strategies would it most benefit? How could the
company maximize its online component to maximize its revenue stream in light of its current
consumer base and an unproven revenue model?

Case
Keywords: Brand management, competition, competitive advantage, corporate strategy, high technology,
gaming

In the Redwood City, CA headquarters, SegaSoft managers had just completed their annual marketing
meeting in which many issues critical to the firm’s future had been discussed. Having assessed the company’s
competitive posture, SegaSoft’s management recognized that these issues had to be ironed out quickly
before the fiscal year ‘99 business plan could be finalized. The decision most relevant to the future of
SegaSoft was whether the company should focus on being a software development company, online gaming
aggregator of third party titles, or both.

It was less than a year ago, in September 1997, that SegaSoft had entered into the online gaming industry.
Prior to September, SegaSoft had established itself as a software development company dedicated to the
development of interactive titles for PCs, gaming consoles, and the Internet. The original intention of the firm
was to configure itself with an online gaming dimension. As such, the company reapportioned its asset base
to support its online gaming site, HEAT.NET (HEAT), even though the company had been software driven
in its first two years. HEAT was not projected to turn profits for another 1-2 years, but the industry pundits
projected large growth in this category.

As Johnny Moses, product manager for HEAT, walked away from the meeting, he realized the company
was at a critical juncture. Many questions came to mind, all of which had to be answered within the next
two weeks when the company’s business plan was to be submitted. Should SegaSoft utilize its assets to
position HEAT, reinforce its apparent core competency of software development, or attempt to support both
software development and Internet gaming? Was there an opportunity to exploit the brand identity of its parent
company, and if so, which of the above strategies would it most benefit? How could HEAT maximize its
revenue stream in light of its current consumer base and an unproven revenue model?

SegaSoft History

SegaSoft Networks Inc. (SegaSoft) was established in November, 1995 as a private, independent U.S.
software development company through a joint venture of CSK Corporation and Sega of America, Inc., the
U.S. subsidiary of $4 billion Sega Enterprises Ltd. Approximately 75 of its 130 employees were transferred
from Sega – a global leader in interactive digital media – to work for the new start-up. Two factors precipitated
the venture. First, according to SegaSoft’s CEO, Nobuo Mii, the future of the consumer video game industry
could be summarized in a single word: software. Secondly, it was obvious that consumers by the millions
were taking to their home computers for news, information, social interaction, and entertainment. To exploit
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the high growth and rapid convergence of the home computing, gaming, and online experience, SegaSoft
was established to develop interactive titles for multimedia PCs, gaming consoles, and the Internet, ultimately
seeking to redefine the interactive entertainment industry.

To fulfill this mission, SegaSoft assembled the best tools, technologies, and talent in the industry through
acquisitions, alliances, and internal development. SegaSoft’s talented software developers and experienced
management team, comprised of transplants from the entertainment, video gaming, computer, and online
industries and had been responsible for producing more than $2 billion worth of interactive titles in the few
years prior SegaSoft’s conception. Complementing the human assets, as one employee stated, “We have at
our disposal the global resources, technology infrastructure, and market presence of our parent organization.”

SBUs

SegaSoft is divided into two business units. One group is dedicated solely to software development and the
other group consists of its online gaming service, HEAT.

SegaSoft’s initial manifestation of its mission occurred as a publisher of action-strategy software games
targeting PC gamers aged 18-34, and edutainment PC titles targeting females and pre-high school age
children. The Company published five retail games in both 1996 and 1997 with limited success. Its action-
strategy games comprising of “shoot-em up” and “blood and gore” games had not yet generated a popular
title. However, Cosmopolitan Virtual Makeover, a ‘97 title that allowed consumers to cut and paste new looks
onto scanned photographs, achieved hit status by selling over 200,000 units. It was anticipated that continued
sales of Virtual Makeover would provide substantial cash flow in 1998.

As a software publisher, SegaSoft is responsible for selecting a title, funding its development and bringing
it to market. The marketing tactics advertising, promotion, and distribution that SegaSoft employs were
comparable to those of other software firms. Its titles are primarily sold either direct to the reseller or indirect
through a wholesaler/distributor, as directed by the individual retailers. A small portion of sales are through
the e-commerce channel.

To address the Internet aspect of its charge, SegaSoft launched HEAT in 1997 following twelve months
of research and development. HEAT was the fourth offering in the category when it was finally launched,
six months behind schedule. HEAT is an Internet game network that allows consumers to play multi-player
games against live competition over the Internet. On HEAT, consumers could not only play SegaSoft’s
titles but other publishers’ games as well. In conjunction with HEAT’s release, SegaSoft released three free
Internet-only games that could be played exclusively on the HEAT network. While HEAT comprises 75% of
the payroll, it currently generates only 20% of SegaSoft’s revenues. HEAT has not yet turned a profit but
neither has any other online gaming site.

Industry Dynamics

Games

Games are classified into several different genres of games, namely: classic board and parlor games (i.e.
chess and card games), 3-D action (shoot ‘em up) games, role-playing games, simulations, as well as sports,
adventure and strategy games. Games can be separated into two categories based on the number of players:
single/dual player games and multi-player games.

The single/dual player category includes games played on PCs or consoles that enable players to compete
either against the computer or against another player. In 1997, console games from manufacturers such as
Nintendo, PlayStation, and Sega Systems accounted for the overwhelming majority of retail games played.

Generically, multi-player gaming consists of two or more gamers playing against each other, rather than
against the computer, using personal computers connected through a network such as a LAN or the Internet.
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In 1997, two thirds of the top 100 selling games were multi-player games. Internet game networks link game
servers and provide match-making services that allow gamers worldwide to play against each other in real
time. The Internet gaming experience periodically suffered from latency or slow play due primarily to the
speed of the Internet connection. This experience had improved immensely over the past two years due
to advances in game design and Internet technology and much of the content in development was being
designed for Internet play. 1

Consumers

Gamers

Gamers can be segmented into two categories: casual and core gamers. Casual gamers make up 86% of
the market, but are responsible for less than half of its sales, buying 3.4 games per year. Core gamers on
the other hand represent just 14% of the total gaming population, but wield the greatest spending power
buying an average of 24 games per year. They prefer adventure, action and role-playing games and spend
an average of 11 hours a week playing games. Sales to core gamers accounted for 52% of the $1.4 billion
computer games industry in 1996. 40% of core gamers currently game online and have an average of 42
games in their game library. 2

Over 35% of U.S. adult Internet users spend time playing games on-line, making it one of the top ten Internet
activities. 3 In fact, 77% of the current two million online gamers are adults and 16% are college students.
Internet gameplay is expected to have the highest penetration among teens and college students who are
projected to make up 79% of the total online gaming population in 2002. 4

Market Size

Internet gaming is an emerging market that is estimated to grow from the current market value of $40 million
to $1.1 billion by 2002 (see exhibit 1). Although software sales are projected to continue at a high growth rate,
it pales in comparison to Internet gaming forecasts. Based on registration and subscription levels, the number
of online gamers in 1997 is estimated at approximately two million and is expected to grow to nearly 27 million
in 2002 (see exhibit 2). 5

Although profits remained scarce through the end of 1997, the forecasted growth of Internet gaming has
created many competitors contending for various segments and niches. In less than one year, multi-player
gaming has grown from no online services to over ten well established competitors, and another twenty or so
attempting to cash in on future opportunities.

Online Gaming Industry Structure

The online multi-player game industry is made up of developers who write the game software, publishers
who fund and market the games, and aggregators who distribute third party games via an online service.
Developers create the game content that is generally licensed to publishers. Publishers distribute games to
retailers, license the games to gaming aggregators, or both.

Publisher Sites

There are several online game services set up by game publishers as an extension of their retail products.
Offering online play is generally believed to increase a title’s sales by 10-15%. Publishers typically set up an
online service to support its hit retail titles, often including a few of its retail successes in the same genre. Their
online services provide matchmaking services only, meaning that players can arrive at the website and look
for other interested players and choose the game server that offers the best online game play. Publishers are
able to minimize the substantial costs of running a site by providing very few features other than matchmaking
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and little customer support. Publishers also take advantage of the underground nature of the Internet by using
their own consumers as unpaid volunteers, wherever possible, to set up servers and maintain the online sites.

Because publishers view their sites as a necessary element to increase sales at the retail channel, services
are offered free of charge. While some sell banner advertising on the sites, all gameplay is free with little to
no focus on the online service as a profit contributor.

Aggregator Sites

Aggregator sites concentrate on acquiring titles and optimizing gameplay over their networks. The goal of an
aggregator site is to provide a large selection of titles to drive consumers to the site. The market for third-party
titles has been dynamic; the initial power was held by the publishers with rates of up to $2 million paid for hit
titles in 1997, but the power is beginning to shift to the distributor. Aggregators now typically pay publishers
for distribution rights, paying $50-100 k for non-exclusive game rights to hit titles and $150-250 k for exclusive
rights. These sites offer more robust features such as chat, paging, e-mail, and tournaments, all in an attempt
to build the online community into a total entertainment site.

Advertising/sponsorship and subscriptions are the primary revenue sources for these sites. Companies
offering free online gaming services largely depend on advertising and premium level sponsorship for its
revenues. Firms that offer pay-to-play services currently have much smaller user bases, and thus are unable
to command significant advertising revenue.

Aggregator sites require a different skill set than the publisher sites. While not focused on making games,
technical resources are needed to “enable” games for online gameplay. In some cases, the publishers provide
the enablement, but for most titles, the aggregator does it internally in order to ensure the game is available
on site as close to the release date as possible. Additional technical resources are necessary to build
the community-building features and maintain the network’s servers. In addition, sales force and business
development resources are needed to sell advertising, establish e-commerce partners, and acquire third party
games. Finally, aggregators need a customer service infrastructure to meet he demands of paying members.
In the current competitive environment, subscription revenues have not offset these costs.

Publisher and Aggregator

SegaSoft and Microsoft are the only competitors that publish their own first party titles while aggregating third
party titles. This strategy requires a compelling online feature set to compete with the aggregators and quality
games that can sell in an intensely competitive retail environment.

In trying to compete on both fronts, firms risk mediocrity from lack of focus. This strategy requires substantial
financial support because advance commitments of several million dollars are required to publish an AAA title
with no guarantee of success. On average, one in 25 titles break even, but a hit title can reap several years
of rewards as sequels and add-on packs extend the revenue stream.

Competition

SegaSoft was the fourth company to enter the Internet gaming market behind Microsoft, Mpath and TEN.
SegaSoft’s on-line aggregator site HEAT now competes against several other game networks. A review of the
main competitors is given below and an overview of the competition is presented in exhibit 3.

Mplayer (Mpath)

Mpath, which claims 500,000 registered users, offers over 60 games spread across all categories with both
Premium and Free-Play options. Premium benefits at $29.99 per year or $49.90 for 2 years provide members

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with unlimited access to “plus only games”, previews, and exclusive tournaments. The network also offers
general community features like chat, newsletters and e-commerce.

The Internet Gaming Zone (Microsoft Corp.)

Microsoft’s dominant position in the software industry allows easy access to potential consumers through the
Microsoft Network (MSN) and the Internet Explorer browser. The Zone reports over 1.1 million registered
users with a peak of 6,500 simultaneous users. The Zone offers “Free-Play” with select “Pay for Play” games
at $1.95 per day or $19.95 per month.

Battle.net (Blizzard Entertainment)

Blizzard Entertainment is a games developer/publisher who uses their online game service, Battle.net,
to promote its role-playing/action games Diablo and Strarcraft which retail for $40-50. Battle.net offers
“Free-Play” with a claim of 1.5 million registered users making it the largest competitor. The site focuses
on matchmaking services and has an extremely user-friendly interface that makes it very attractive to
newcomers.

WorldPlay (America OnLine)

WorldPlay offers users easy access to over 20 games through the AOL portal site which means users do not
have to download the game in order to play. Most games, with the exception of card games, are developed
by third party publishers or developers. Approximately 1.5 million AOL subscribers visit WorldPlay monthly
where gaming is free with the AOL flat rate and premium service is available for $1.99 per hour.

HEAT

Differentiation

SegaSoft’s HEAT differentiates itself from competitors in four main ways: content, loyalty program, network
E-mail, and Ripx technology.

Content

Unlike other networks that also offer card and board games, HEAT focuses on the genres popular with core
gamers – action, strategy, role-playing, and sports (limited). HEAT offers SegaSoft-published multi-player
titles as exclusives as well as the most popular multi-player games from other publishers. Two of SegaSoft’s
upcoming exclusive retail titles are designed as games that only allow online play.

Loyalty Program

HEAT is the only network to have a loyalty program in which players earned points (Degrees) for spending
time on the network and clicking on banner ads that appear on the network. Similar to frequent flyer miles,
Degrees are redeemable for free games and discounts on other computer peripherals and could also be
wagered against other members in challenge matches.

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Network E-mail

HEAT mail allowed its members to communicate with other users and provide a communication means for
SegaSoft and its advertisers to reach the HEAT audience

Ripx Technology

To make a game playable over a game network, the game’s server code had to be modified and tested for
Internet play, a task that was usually performed by game network engineers. HEAT has a Ripx proprietary
technology that made virtually any multi-player game playable on HEAT with few modifications to the game
code. This technology allowed HEAT to offer games that were supposed to be exclusives on other networks.
6

Business Model

SegaSoft’s business model relies on revenue streams from its publishing efforts and the HEAT network. HEAT
generates revenues from the following:

E-Commerce

HEAT operates a proprietary store within its site, offering a large selection of games and computer peripherals
available for purchase with a credit card. In FY99, it is anticipated to generate 45% of HEAT’s revenues.

Advertising

HEAT contracts with an external sales force to sell banner ads and interstertials on its site. This is projected
to produce 25% of HEAT’s revenue in FY99.

Subscriptions

Consumers can play most games on HEAT for free, but several of its upcoming SegaSoft exclusive games
will require Premium Membership. In addition, only Premium Members can redeem their degrees in the HEAT
store and wager their degrees against other members. Premium Members were forecasted to contribute 30%
to HEAT FY99 revenues.

Marketing and Distribution

HEAT’s marketing and distribution efforts were focused on its target audience of core gamers. HEAT
primarily reached this audience through online and print advertising, distribution through SegaSoft and other
publishers’ PC games, and OEM deals with hardware and software manufacturers (see exhibit 4).

Current Situation

The costs to operate, manage and market the network far exceeded the revenue projections for the next two
years. While the network had grown quickly, reaching 225,000 registered users six months after launch, its
revenue streams are still unproven. The network’s user base is young, with over 40% under the age of 18
and without convenient access to a credit card, the primary means of payment over the Internet.

The release date of three of SegaSoft’s most promising games had been delayed over six months, forcing
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HEAT to acquire two exclusive games from another publisher in an effort to boost membership. The category
continued to grow, but the numerous free play options on other networks was further hindering premium
membership growth. Furthermore, dependency on a licensed technology from Mpath has forced HEAT to
remain 2-3 months behind one of its biggest network competitors. SegaSoft’s technology group hoped to rid
itself of the Mpath dependency by having its proprietary technology in place by November 1998.

Johnny felt that HEAT’s consumer base provided a few advantages for SegaSoft’s publishing efforts. First,
it had a captive audience to boost awareness of its titles through on-line marketing efforts. Second, HEAT’s
users provide a free testing ground from which to gain feedback in early versions of products.

Johnny believed that the revenue from SegaSoft’s publishing efforts would have to support HEAT for a few
years until there was an industry shake-out. He also thought that HEAT would benefit greatly from a exclusive
hit title, potentially driving a lot of traffic on the HEAT site.

Sega Relationship

HEAT was launched as a separate service to minimize potential harm to the Sega Brand. Recently however,
Sega’s prominence had slipped dramatically with Sony’s PlayStation and Nintendo’s N64 system achieving
dominant market share position. Sega was now interested in a more formal relationship especially since
a larger percentage of console gamers were gaining access to the Internet and playing games on both
platforms.

Johnny wasn’t sure how he could exploit the relationship with Sega, especially after SegaSoft had already
spent significant resources building the HEAT brand.

Content—Niche or Mass Market?

The Internet market was still evolving, and many of the popular genres available in the console market (sports,
fast action, fighting etc) were not yet playable over the Internet due to bandwidth and latency issues.

The Internet’s ability to provide a live competitor has made several genres of games (cards, chess, board
games) more popular than the stand-alone version with appeal to a broader market. The demographic that is
attracted to these games is older and more affluent than the users of some of the action-strategy games and
therefore more appealing to potential advertisers and sponsors. As a result, several of the aggregator sites
have expanded their content from action strategy games to the more traditional games mentioned above in
order to reach a broader audience. Although HEAT is capable of providing board/card games, Johnny had
chosen not to do so because he felt that HEAT’s online community of action-strategy gamers would clash with
the card-playing demographic.

HEAT’s game content focus did not appeal to mainstream companies, ultimately diminishing their willingness
to advertise and sponsor through HEAT

The Decision

SegaSoft was well positioned to maintain its presence in software publishing but online gaming seemed to
be a “can’t miss” opportunity. Young adults were flocking to online gaming networks in mass and HEAT had a
loyal following of young action-strategy enthusiasts with the potential to broaden its content.

Johnny, reflecting on his long day, thought about the company’s mission to be “the definitive provider of
interactive gaming experiences.” As such, what should the company’s long term strategy be – publisher,
aggregator, or both? If SegaSoft were to become a pure aggregator, what impact would this have on the
company? If it were to remain a publisher, would the absence of HEAT be felt? Johnny recognized that issues
involving HEAT’s current revenue model, content, and user base had to be resolved. Lastly, Johnny pondered

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his job and large stock option package, unsure of the company’s short or long-term future.

Notes

1. For best results, a minimum speed of 28.8 kbps is required.

2. Computer Gaming in America, January, 1998

3. Find SVP American Internet User Survey, April 1997

4. Jupiter Communications, “Internet Games: Five Year Outlook”, 1998

5. Ibid.

6. Publishers have questioned the legality of the use of this technology, but it had not yet been formally
challenged.

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