Activision Case Study PDF

9-605-020 REV: JULY 18, 2005 ALAN MACCORMACK ENRICO D’ANGELO Activision: The Kelly Slater’s Pro Surfer Project Mike Ward, executive producer for the Kelly Slater’s Pro Surfer...

9-605-020 REV: JULY 18, 2005 ALAN MACCORMACK ENRICO D’ANGELO Activision: The Kelly Slater’s Pro Surfer Project Mike Ward, executive producer for the Kelly Slater’s Pro Surfer (KSPS) game, came out of Activision’s Santa Monica offices to sit in the warm sunlight. He needed to clear his head after the morning-long presentation to the Green Light committee by the KSPS development team. The meeting was the fifth and final milestone (called “alpha”) in the process that Activision used to shepherd a new game from initial concept to final product. At this meeting, in June 2002, the group had to decide when to launch KSPS. Given 60% of a game’s sales typically came in the first four months after its release, the timing of launch was a critical decision. KSPS was part of Activision’s extreme sports line, which had been founded upon the incredible success of the Tony Hawk’s Pro Skater game, released in 1999. Unfortunately, the project had had a troubled history. Initially scheduled for launch in August 2001, the original development team had hit problems and had been replaced. The new team, from a studio called Treyarch, had developed a new engine for the game with incredibly realistic waves and a compelling trick-based game play. The technology had drawn rave reviews from the Green Light committee as well as the trade press, which had played the alpha version at the industry’s biggest expo one month earlier. But the timeline for introduction had slipped yet again—it was now scheduled for September 2002. Releasing in September would allow Activision to hit the Christmas quarter, when over 50% of game sales occurred. It would ensure that Activision had a surfing game to compete against Transworld Surf and Sunny Garcia Surfing, both of which had been released months earlier; Activision’s analysis suggested KSPS was a far superior game to both. But some managers wondered if a September release was wise. Christmas was a competitive period, when many new games, including a new episode of Activision’s own Tony Hawk’s Pro Skater, were planned for launch. Perhaps it was better to delay until March 2003? Doing so would allow the marketing team to further test the concept, gauging consumer interest more accurately and thereby refining the team’s estimates of market size. Either way, the decision had to be made today. A $3.4 million marketing budget was ready to be deployed, and advertising space on TV, radio, and print outlets would have to be acquired if the decision was made to hit the Christmas quarter. Manufacturing of the game CDs and packaging materials would also have to be ramped up to ensure the channel held sufficient inventory at launch. Ward walked back to the room and fired up the plasma screen. It came to life with images of the surfing world’s best talents, all professing the virtues of KSPS. “Let the games begin,” he thought. ________________________________________________________________________________________________________________ Professor Alan MacCormack, Enrico d’Angelo (MBA 2004), and Research Associate Kerry Herman, Global Research Group, prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 605-020 Activision: The Kelly Slater's Pro Surfer Project The Video Game Industry1 From its roots in the 8-bit gaming consoles released by Nintendo and Sega in the early 1990s, the video game industry had gone from strength to strength. Increasingly sophisticated hardware consoles, such as Sony’s revolutionary 32-bit Playstation, introduced in 1995, brought more realistic graphics, sophisticated game-playing scripts, and enhanced performance. The industry experienced strong growth, even as the broader economy slowed at the turn of the century. By 2001, U.S. sales of video game hardware and software hit $9.4 billion, surpassing U.S. movie box office revenues. That year, 225 million games were sold, accounting for $6.3 billion in revenues. Of this, console-based games accounted for 141 million games and $4.6 billion.2 While video games had initially been targeted at a younger demographic, by the late 1990s they had become a mass-market phenomenon. In 1999, 61% of all game players were aged 18 and over; the average age of a game player was 28. By 2000, three in five Americans aged six or older— approximately 145 million people—routinely played video games.3 As one industry analyst proclaimed, “Video games have become a leading form of mass market entertainment as the core user has aged from teens into adulthood.”4 Sales of video game software varied dramatically across titles, with a few blockbusters carrying the industry’s many misses. In 1998, for example, only about 10% of all games released made a profit, while nearly half of them sold less than 10,000 copies.5 While over 1,000 titles were released every year, the best-sellers generated more than one-third (and the top 20 more than half) of all sales. A megahit could sell well over a million copies, returning up to 30 times its development cost (see Exhibit 1 for the top 20 games in 2001). The typical shelf life of a game was short. Over 50% of a game’s sales occurred in the first three months after its release (see Exhibit 2 for a typical life cycle). Games quickly became outdated, while buyers grew tired of playing the same title. Fortunately, a megahit typically led to a stream of highly profitable sequels. The video game industry possessed a strong seasonal cycle, with over 50% of sales occurring in the Christmas-driven fourth quarter (see Exhibit 3 for the seasonal distribution of game sales). It was also dependent on the console industry, which introduced new generations of hardware every four to six years, creating a longer-term cyclicity. Sales grew with the introduction of a new generation of hardware and subsequently declined as market penetration increased and consumers began postponing purchases in anticipation of the next generation. New consoles, outfitted with faster processors and greater memory, brought more complex technology, better quality graphics, and more realistic scenarios to each game. While games for new platforms sold at premium prices, the small installed base meant total revenues were lower at first. Sales tended to spike the year following the peak of related hardware sales. During the first few years of a new console’s release, many people still owned older systems whose games’ prices began to decline. Consequently, the industry’s overall annual revenue growth could range from as high as 40% to less than zero. 1 This section draws some data for use in the text and exhibits from Thomas Eisenmann and Justin Wong, “Electronic Arts in Online Gaming,” HBS Case No. 804-140 (Boston, MA: Harvard Business School Publishing, 2004). 2 The remaining games were sold for use with a personal computer. 3 Survey by Peter D. Hart Research Associates Inc., as quoted in “Essential Facts about the Computer and Video Game Industry,” 2002, www.isda.com. 4 Doug Lowenstein, as quoted in “Essential Facts about the Computer and Video Game Industry,” 2002, www.isda.com. 5 Peter Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107 (Boston, MA: Harvard Business School Publishing, 2000). 2 Activision: The Kelly Slater's Pro Surfer Project 605-020 The video game industry comprised five key players: platform providers, content providers, developers (or “studios”), publishers, and retailers (see Exhibit 4 for relationships among players). Platform Providers Platform providers designed, manufactured, and sold games consoles. By 2002, three providers remained: Sony Computer Entertainment, Nintendo, and Microsoft. Sony had the largest installed base, with 60 million of its PlayStation 2 (PS2) consoles, introduced in 2000, selling worldwide. Microsoft’s Xbox and Nintendo’s Gamecube, introduced a year after Sony’s PS2, had each sold 10 million units. Sega, a fourth platform provider, had exited the market in 2001 after the disastrous performance of its Dreamcast console; the company now focused solely on game development. Platform providers sold their hardware consoles close to or below cost to promote adoption. Console prices typically decreased over time, reaching half (or less) of their initial price in the year before the next generation was introduced. Platform providers’ chief source of revenue came from royalties received from publishers, who paid to develop and sell games for each platform. To encourage a wide range of games, providers distributed development tools for use by publishers and independent development studios. This was important in the run-up to a new platform release—it was critical to have games available when the new hardware launched. In addition, all platform providers owned one or more internal studios and published and distributed their own games. Content Providers Many games were based upon original ideas and characters: Mario the Italian plumber was a famous Nintendo creation, while tomb raider Lara Croft emerged from a studio called Eidos. Some characters became so popular that they were licensed to movie studios and subsequently appeared in films. In general, however, the trend was for publishers to license the rights to films, famous characters, or sports personalities and base games around them. Electronic Arts, for example, bought the rights to games based upon the Lord of the Rings movies and signed stars such as Tiger Woods and John Madden to promote golf and football games. For big productions, movie studios would shoot content specifically for video games, facilitating a close tie-in between movies and games that exploited their content. By the mid-1990s, almost 40% of all games contained licensed content, for which the content owners typically received royalties of 10% of the retail price of the game.6 Developers (or Studios) Once the concept for a game was conceived, a team of developers from a studio began its creation. Studios were small in size (ranging from 10 employees for a small studio to a few hundred for a larger one) with nearly two-thirds of them employing fewer than 20 people. A team typically consisted of between five and 30 developers, each with distinct technical and/or creative competencies (e.g., graphics, game design, sound effects, etc.). The same team usually developed a game for multiple platforms and worked on sequels. Large studios had multiple teams of developers working on different games. Studios could be independent or were owned by either a publisher or a platform provider. They had strong personalities and did not consider themselves employees, even if owned by another firm. Many were started by groups of friends who shared a passion for video games and, as a result, 6 Coughlan (2001). 3 605-020 Activision: The Kelly Slater's Pro Surfer Project developed a unique culture. Because of this, even when a studio was acquired, it was rarely integrated into the other company’s structure. Typically, the studio maintained a separate identity, used its original name (which appeared in the opening titles of games), had its own Web site, and remained in a separate office away from corporate headquarters. By 2002, a typical game took a team of 10 or more developers 18–24 months to complete and cost $5 million–$10 million to develop and launch. A major game (for example, for a new movie release) could cost as much as $15 million–$20 million and require a much larger team. As a result, independent studios typically looked to publishers for financing, usually a cash advance covering their costs plus a small margin. In exchange, the publisher was granted publishing and distribution rights. As long as the title met certain volume requirements, the studio received royalties ranging from 5% to 20% of sales. Only a few independent studios could afford to finance their own games and receive the full share of a game’s profits (or losses). ID Software, for example, the creators of Doom, funded each release itself and relied on publishers such as Activision only for marketing, PR, and distribution to retailers. Publishers Publishers, like Activision, acted as venture capital funds, assessing market opportunities, financing game developments, then marketing and promoting the resulting products. Publishers typically sustained all the costs associated with a game, including development (an almost linear function of hours worked by the studio), marketing, packaging, promotion, and distribution. The latter activities could climb to as high as five times a game’s development costs, encompassing advertising (on TV and in print), packaging, launch events, and cobranding with celebrities or other firms. Most publishers attempted to manage risk with a portfolio approach, developing a number of different game types on different platforms and working with a variety of different studios. Retailers Video games were sold through many types of retailers, from specialty toy stores to electronics superstores and discounters. Large retailers such as Wal-Mart and Best Buy accounted for almost 50% of sales. Games could also be rented at outlets like Blockbuster—an important factor, given that research showed close to 70% of purchases occurred after a game had been sampled.7 The average retail price for a successful game was $40–$50, of which the retailer could expect to collect gross margins of 25%–30%. When games did not sell well, however, it was not economical to return them, given the development and marketing costs had already been sunk. Retailers therefore discounted games by up to 50% for clearance, receiving subsidies from publishers to offset their reduced margins. Activision In October 1979, four video game developers left Atari, one of the earliest home gaming platform providers, to found Activision, the first independent home video game development firm. The firm proceeded to launch a series of hit multimillion-dollar Atari titles, including the Pitfall! series, Kaboom!, HERO, and River Raid, the first vertical-scrolling shoot-’em-up game. The company also 7 Coughlan (2001). 4 Activision: The Kelly Slater's Pro Surfer Project 605-020 churned out top-notch sports games, racers, and adaptations of traditional arcade games. In 1983, the firm went public and began to pursue an aggressive growth strategy with the funds it had raised. Activision’s growth came from three main areas. First, the company developed products across a wide range of categories, including action, adventure, sports, racing, role playing, simulation and strategy, and games designed for audiences ranging from game enthusiasts and children to mass- market consumers. Second, the firm sought licensed content where possible, rather than creating new intellectual property (IP). By 2002, 60%–80% of the company’s games were based on well- known brands or names, such as Spiderman, the Star Trek franchise, or skateboarder Tony Hawk. Third, Activision increased its development capacity through the acquisition of studios, thereby expanding its IP library. Given the steady consolidation in the industry, Activision’s goal was to take advantage of scale. Smaller companies were capital constrained, had higher cash flow volatility, and had to spread their fixed costs over a smaller revenue base. By 2002, Activision had revenues of $786 million, generating income of $52 million. With a 5% share of the console game market, it was one of a number of players chasing market leader Electronic Arts (see Exhibit 5 for industry market shares). Among its games portfolio, it had one of the industry’s most successful franchises: the Tony Hawk’s Pro Skater line. Game Development at Activision By the late 1990s, developing a game had become an increasingly complex matter: whereas in the 1980s one programmer ran the whole show, newer games relied on a range of specializations and skills, requiring much larger development teams. The industry saw a huge ramp up in production costs, while facing an increasingly demanding and competitive market. Project management therefore became a much more important skill for publishing companies. In this respect, the key role belonged to a game’s “producer,” who was responsible for its timely delivery. Producers set priorities and deadlines, managed the development studio, and interfaced with marketing and branding groups to assess a game’s potential and develop a successful promotional program. As of 2002, Activision owned seven development studios (see Exhibit 6) but also used external studios, especially those with specific developer talents or IP ownership of a game. Sometimes, for example, an external studio developed a game concept and shopped it to publishers to secure funding. By contrast, when the idea for a game came from inside Activision (or from a license opportunity), the firm had to decide whether to use an internal or external studio. Using an external studio allowed Activision to supplement its internal capacity, maintain a more flexible cost structure, and assess a studio’s potential for acquisition. It also created strong incentives to deliver the project on time. As Ward noted: With an external studio there’s money attached to each milestone. If the developers don’t deliver a certain list of items within the deadline they don’t get their check. That’s the leverage we have over them. Some external studios are small, and they really depend on our funds, so there’s a big incentive for them to deliver what they promised. With an internally owned studio, it’s a bit harder. If they don’t deliver on time, their checks are still cut. Selecting the specific studio to develop a game hinged on a range of technical and artistic factors, as well as the studio’s track record and management abilities. Ward noted: The more I work in this industry the more I see that studio management is the most critical factor, even above and beyond talent. There are tons of very talented artists, programmers, and designers in the industry, but it is rare to have a team that can manage itself, that is disciplined enough to deliver a quality product on time. So you really must have a manager 5 605-020 Activision: The Kelly Slater's Pro Surfer Project within the studio organizing and orchestrating everything and pulling the talents together to make everything work. Project management is super-critical. To handle these tasks, a producer inside each studio liaised with Activision’s own producer, negotiating a game’s features and release schedule and driving these requests down to the development team. Ward explained: Activision’s producer deals directly with the producer from the studio. They, in turn, drive information down to their team. The relationship is more collaborative than hierarchical. If the studio thinks that an extra two or three months on a specific feature would have a huge payoff in terms of quality, we will discuss that. But we all understand that it’s a business and there are deadlines that have to be met. Some studios have more freedom in that respect. Take ID Software, for example, who are currently working on Doom III. They call the shots. They make great games and everybody will wait because when it comes out, it will be awesome. The “Green Light” Process By the late 1990s, the investments required to develop a game had increased dramatically, yet there was more uncertainty about each game’s chances of success. In response, Activision’s CEO Ron Doornink proposed a new “staged” approach to game development in an effort to weed out the less successful games earlier in the process. In early 1998, this new “Green Light” process was officially introduced into the company’s project management procedures. The process comprised a series of in-depth reviews at specific stages of a project, conducted by a committee that included several of the company’s most senior managers (see Exhibits 7 and 8 for the firm’s organization and Green Light process). The committee could track each project, monitoring its progress according to predefined metrics that were comparable across projects. The ultimate aim was to pull the plug on potentially unsuccessful projects before excessive investments were made (i.e., before the game entered the production stage, where over 70% of costs were incurred). The process comprised five phases: Phase One: Concept Review The concept design often comprised just a simple concept statement, with perhaps a small demo or storyboard to describe the main features, characters, and game dynamics. The source of the idea typically depended on the nature of the game. Developers, either internal or external, often proposed original ideas for games, while Activision’s marketing staff played a larger role in conceptualizing license-related games, sequels, or extensions. During concept review, the marketing team conducted an assessment of sales based on data from comparable game titles, while the development team worked up a preliminary schedule and budget for the project. With these data available, the marketing team then established a rough-cut profit and loss (P&L) forecast for the title. In 2001, the concept review phase was updated to include a concept test with potential customers. The production team would write a description of the game and actual “gamers” contacted to gauge their interest. Kathy Vrabeck, president of Activision Publishing, explained: “One of the things we do now is concept-test our ideas very thoroughly. We use quantitative market research—not just a couple of people sitting here internally judging the quality of a concept. We’ll spend $10,000 on market research. Today, most projects never get past the concept review phase because gamers tell us they’re just not that interested in the concept.” Phase Two: Assessment Typically, a game was due for assessment around three months after the concept review was approved. The deliverables included a comprehensive game design document, a technical 6 Activision: The Kelly Slater's Pro Surfer Project 605-020 demonstration showing the project’s feasibility and communicating a general idea of how the game would work, and a marketing assessment of the game’s likely positioning. Ward explained: We have a detailed design document that is scrutinized thoroughly in this phase. There are technical people who evaluate if the technology will support the design. Artwork is also established in terms of the look of the game. We might not have a lot to show running on the system—we might have barely one level with a guy running among some geometric shapes. It’s really minimal, but it’s enough to get the point across. Deanna Natzke, Activision’s global brand manager, explained the role of positioning: We conduct research to gauge consumers’ interest and to develop a positioning for the game. We look at the competitive environment to understand how we fit in and where we can take advantage of the new concept. We work with production, taking the game that’s being made and translating it into an appealing and understandable form for retailers and consumers. We can also ask for modifications if we think the game is likely to miss the mark. Phase Three: Prototype The prototype review was typically reached three months after assessment. The main deliverable was a small version of the game that was representative of its final features, giving an impression of how it would look and feel. The prototype rarely demonstrated all the planned graphics or sound effects of a game, but the controls had to be defined and implemented in a way that provided something close to the feel of the game-play experience. Ward explained: We start work on the prototype right after concept review. The assessment is midway through this work, but the prototype is really where things get nailed down. We call the period from concept review to prototype “preproduction.” At the end of it, developers have all the game elements and technology in place. They know how long it will take to build a level [games typically comprised multiple levels of increasing difficulty] and how many polygons8 every element on a screen is to have. They have all the bricks and the overall blueprint. That is what a prototype is all about: to give people an impression of what you can do when the components are applied to the whole game. Alongside the prototype, a preliminary marketing plan and creative strategy were developed to give the committee a sense of how the game would be promoted and who the potential launch partners might be. This plan was expected to evolve as development progressed. Ward explained: Once we pass the prototype review, the production, marketing, and brand management teams meet weekly. We all need to know where the game is headed, because we all impact each other. There have been games where the marketing assessment was modest at the beginning, so the marketing choices, in terms of where and how much to advertise, were made accordingly. But in the end, the game came together so well that the potential appeal was greater, so the marketing strategy changed, and the budget for promotions increased. Assuming the Green Light committee approved the prototype, the game moved into production, when most of the development expenditure would occur. The nature of Green Light committee meetings often changed past this point. Ward explained: 8 In order to generate three-dimensional graphics, every object is decomposed into basic geometrical shapes, called polygons. These polygons are then “painted” with images, called “texture maps,” to create the impression of different materials. 7 605-020 Activision: The Kelly Slater's Pro Surfer Project Once you get beyond prototype, it’s hard to see a project cancelled. Production is where 70% of the development costs are spent, so canceling means you are going to lose a lot of money. The assets have already been built. Given this dynamic, the committee’s role changes slightly after the prototype review. It’s not “do we continue or not,” it’s more an update on progress. A lot of the discussions revolve around marketing, promotion, and the trade’s response, rather than being focused on changing the core of the game itself. Phase Four: First Playable The next review, typically three to six months after prototype, examined the first playable version of the game. Whereas in the prototype things were put together temporarily to demo the underlying technology and game-play experience, the first playable was a fully working game that, although not complete, allowed a player to play through one or more levels completely. At this review, the marketing and brand management teams had to present the final marketing plan and an overview of the packaging and advertising concepts that would be used for promotion. This involved working with agencies to test-market potential advertising concepts with focus groups. Advertising was one of the biggest costs in a project, so this type of feedback was critically important. Phase Five: Alpha Ideally, six months before a game was scheduled to ship, the alpha version was shown to the Green Light committee. This was the full version of the game with every feature implemented, although it was typically not yet fully tested so had bugs remaining in the software. At this milestone, the actual packaging and advertising concepts (in real or storyboard format) to be used in marketing the game were presented and the trade promotion package finalized. The committee was briefed on any game-play tests with consumers, and an updated P&L for the project was delivered. A separate “beta” phase was conducted three months prior to launch, using a number of testers who were asked to push the game to the limits. The sole aim of beta was to uncover any remaining bugs prior to launch. Hence, beta was not considered a part of the Green Light process. Ward noted that not all projects went through Green Light in exactly the same way: Not all projects face the same uncertainty. For example, the sequel of a successful game requires less market analysis or basic game-play testing, since it has a proven concept, game structure, and game engine9 in place. The uncertainty comes from newer parts of the game. In other cases, we might reuse an engine from one game in a different setting. This lowers cost and limits our technology risk. By contrast, developing original games is much riskier, since the game play, the characters, and sometimes the technology have to be built from scratch. Ward reflected on the aims of Green Light: Green Light ensures that the developers are doing their job and that the production team is on top of the project. It forces coordination between production, brand management, marketing, and finance. It allows upper management to get a deeper understanding of each project and provides an opportunity for constructive feedback from a big-picture perspective— something that is not always easy when you're in the midst of development. Ultimately, the process is designed to catch projects we don’t want to do and kill them in the first three phases, before the big money is spent. Ninety percent of projects are cancelled in 9 An engine is the piece of middleware software in charge of moving all of the objects in a game’s “world,” controlling all the interactions between them. Programmers can therefore work on objects (say a person) and the engine independently. 8 Activision: The Kelly Slater's Pro Surfer Project 605-020 the first three phases, and 80% of those are cut in the first two. Cancellation is a decision that every publisher faces, and sometimes, it’s absolutely the right decision. A game might have been exciting nine months before, but now the market data says it isn’t anymore. That said, the struggle between market data and personal belief is undeniable. Back in the old days, there were two people in a garage pitted against the establishment and working on a project that they firmly believed would be a huge success. Things have changed now. This is a huge industry, so we have processes to help mitigate risk and make sure we have a better chance of success. Yet on the development side, there’s still an attitude that challenges marketing and analysis with the firm belief in an idea. I don’t know what the marketing research said for Tony Hawk, but I’m sure they didn’t describe it as the huge hit it turned out to be. Or take Mechwarrior 2, one of our biggest titles ever. That project was completed by a miracle. Management cancelled it, but a couple of guys on the team worked through a long weekend, burning the midnight oil to turn the game into the form they thought it should take. They presented it the next week, and everyone was back on board. So marketing plays an important role, but we don’t want to design games based on focus groups or market research. Activision’s Extreme Sports Line In the fall of 1999 Activision launched Tony Hawk’s Pro Skater (THPS), the first episode of what would become one of the biggest franchises in the video game industry. THPS featured an innovative trick system that allowed the player to perform acrobatic movements comfortably and naturally—points were awarded for the complexity of the tricks attempted. As Tony Hawk, or one of nine other skateboard professionals, the player could skate through a course full of half-pipes or, alternatively, ride through the streets of cities ranging from San Francisco to Chicago, where a full range of urban obstacles such as railings, stairs, and loading ramps were encountered. By 2002, THPS and its two sequels had shipped more than 3.5 million units worldwide. The game had been a top 10 PlayStation title since launch.10 After the huge success of THPS, Activision began thinking of how to transform the stand-alone title into a big franchise with multiple games. Electronic Arts had pursued a similar approach very successfully; its EA Sports line had a cohesive strategy centered on licenses with the National Football League and the National Basketball Association and famous athletes such as John Madden and Tiger Woods. Vrabeck explained, “Marrying a pro athlete with an action sport seemed a good strategy. The game play was to be similar to THPS, very individual and trick based, as opposed to a racing game or team sport.” Several titles were proposed, including Mat Hoffman’s Pro BMX, Shaun Palmer’s Pro Snowboarder, and Kelly Slater’s Pro Surfer. The line would follow consistent naming and packaging formats in order to make it recognizable. Kelly Slater’s Pro Surfer Kelly Slater’s Pro Surfer seemed like a good fit for Activision’s new line. By 2000, surfing had an increasingly “cool” image, and Slater’s sporting achievements had begun to penetrate mass consumer consciousness beyond just the surfing community11 (see Exhibit 9 for data on Kelly Slater). The surfer community was sizable and growing, plus research showed a tight link between surfers and 10 NPD Funworld. 11 In 2001, Slater was rated third among “trendsetting young men,” behind basketball stars Michael Jordan and Kobe Bryant. 9 605-020 Activision: The Kelly Slater's Pro Surfer Project gamers; the majority of surfers owned a PlayStation (see Exhibit 10 for data on surfing). Given these dynamics, the concept review for KSPS was quickly approved in the spring of 2000. Vrabeck recalled: “Back then, we weren’t concept-testing to the extent we do now. We approved KSPS based on comparisons with Tony Hawk. With a ‘trick-style’ game play, new wave-riding technology, and a star athlete, we were confident it would be a best-seller. Besides, all the guys who work in marketing here are surfers—and they thought the concept was really cool.” At the same time as the KSPS concept was being assessed, a studio called IRC approached Activision with an impressive demo of a wave-riding technology. IRC was immediately signed to develop the game and by September 2000 had refined the software enough to present to the Green Light committee for assessment. The technology looked a generation ahead of anything else on the market (see Exhibit 11 for a description of existing surfing titles in 2000). The first version of KSPS was promptly scheduled for release in August 2001. In November 2000, IRC presented its prototype to the Green Light committee showing a surfer actually riding waves. The feedback was very disappointing. Despite the “cool” appearance of the waves, the game play itself was not thought compelling. The committee asked IRC to redo the prototype. Over the next few months, however, it became clear that IRC was stuck: it had pieces of working technology but could not figure out how to build a game from them. In April 2001, having spent almost $2 million, Activision cut ties with IRC and began looking for another studio. Starting Over Activision chose a large independent studio called Treyarch to take over KSPS; Treyarch had been working with them on the Spiderman—The Movie game. Ward, who had just joined Activision, was asked to oversee the game’s development. The game was given a new target ship date of March 31, 2002. Ward recalled: The concept had been already agreed upon, so we didn’t review it. But everything else had to be redone, especially the game design. I was a game designer before being a project manager, and this skill is often overlooked. A lot of games don’t have a real design. What we had was a rough idea of a game: a trick-based surfing game, a sort of Tony Hawk on a wave, which would incorporate the lifestyle and mentality of the surfer community. But there was no real design. Nobody knew how the game would work, how the player would score, how tricks would be linked together in combinations, or how the level progressions would happen. The development team focused first on a new engine for wave generation. At the assessment review in June 2001, everyone was impressed with the progress. Ward recalled: The programmers had created a wave that looked good and behaved dynamically like a real wave but was also fun to play with. A physically very realistic model is usually not a lot of fun. So we started from real-world physics and then tweaked it, asking ourselves what was going to be fun while keeping the “real water” feeling. The team created a new technology, called a “standing wave,” that gave a player the illusion of movement while at the same time confining her character to a relatively small section of the overall game “world.” By August 2001, the team had reached the prototype review. The prototype showed a surfer interacting with waves and performing a series of tricks. It was the first time that the Green Light committee could fully grasp the potential of the game. Ward recalled: We discovered the standing-wave technology wouldn’t support the game play we wanted. So we had to keep working on a better engine. Eventually, we built the wave in sections, so 10 Activision: The Kelly Slater's Pro Surfer Project 605-020 designers could manipulate them endlessly. Just like Lego, you could mold the waves to do what you wanted. The player would never ride the same wave twice. The beaches also looked great. The programmers had researched real beaches—Tahiti and Hawaii looked like the real thing. From an art and technology standpoint, we were doing a great job. By the time of the prototype review, the marketing team had developed a draft creative strategy, detailing the tactics that would be used for launch (see Exhibit 12). Activision partnered with surfwear and skatewear manufacturer Quicksilver to cross-promote Activision’s Tony Hawk’s Pro Skater and Kelly Slater’s Pro Surfer franchises through retail, clothing, promotional, and in-game sponsorships. The PR team had begun to ramp up Slater’s media presence. PR team member Ryh- Ming Poon recalled: He actually retired for part of that year, so his name wasn’t out there. I was trying to get his name back to the forefront, but he was training a lot, focusing on competing and trying to get back into the sport. He didn’t do a lot of interviews or TV appearances like we had hoped. MTV didn’t want him on just to promote a video game, it had to be something else—Hawk goes on MTV, for example, to promote his national tour. For the soundtrack, songs were licensed from famous artists from the surfing scene, including Pearl Jam and Jack Johnson. Instead of rap, rock, and pop, the music aimed for a laid-back international sound, lending the game a tribal and spiritual feel. Activision also commissioned a one- hour video called Pipeline Sessions, featuring famous surfers chilling in Hawaii and talking about the game. The plan was to bundle this with KSPS in big retailers like Best Buy. In October 2001, Activision acquired Treyarch, making it the company’s third internal studio (after Neversoft and Raven). A month later, the KSPS team reached first playable. At this point, the athletes, locations, and game controls were finalized. The marketing department also had feedback from the test of a TV advertisement with gamers in Chicago, but results were lukewarm. The report stated: Pro surfing seems to be a very viable extreme sport gaming concept, even amongst kids who do not live in close proximity to a surfing culture... [but] kids do have some doubts about how inherently exciting a surfing game can be over time. It will be important to build as much unpredictability and evolving challenge into the game as possible, and to tout this in advertising to create a sense of real replay value.12 The committee was worried. While people liked the concept, they did not seem convinced about the game’s playability. There was a chance that they would find it boring—a fate worse than death. The committee asked the team to come back in December for another review. But two months later, there was still little news from the Treyarch team. It became clear that the game would not ship on time. By February 2002, Ward had to step in and take a more directive role. He recalled: The game design was still driven by technology—it wasn’t fun. One of the problems was that we had always assumed the game was going to be patterned after the Tony Hawk style of game, so not much attention had been paid to core design fundamentals (how to score, how to link tricks, etc.). So we set ourselves a six-week deadline to come up with a new design. The first question we asked was, what could you do on a wave? What do surfers do? They leap in the air, do tricks in the air, surf on the surface, and surf in the tube. And they have “floaters,” where they skate on top of a wave that is sectioning out in the same way that 12 Source: Activision market research on TV spot for Kelly Slater’s Pro Surfer game. 11 605-020 Activision: The Kelly Slater's Pro Surfer Project skateboarders “grind.” So we divided the tricks into categories: face tricks, floater tricks, air tricks, and tube tricks and came up with a way to combine them. We also tried to address the game’s repetitiveness by adding unusual elements, such as the ability to challenge other human players and placing other computer-generated surfers in the sea. By the beginning of April, the team was convinced it had got the game design right. They were also confident that they could hit a September 2002 launch date. A month later, all the game-play elements were in place and the team was left only with fine-tuning. In late May, the team took an almost complete version of the game to the Electronic Entertainment Expo (E3),13 where reviewers were allowed to play it for the first time. Douglass C. Perry, an editor from the influential video game Web site ign.com, tried the game during the show: We finally got our hands on Kelly Slater's Pro Surfer today, which is a very good looking game and a very different surfing game from any surfer that we have seen before.... Unlike in TransWorld, Kelly Slater is a very, very fast moving and fluid-moving game that requires a little more skill in the tube and a lot more management.... Unlike any game before it, the surfer is able to interact with the wave in ways that surfers do in real life. They can ride down the curl of the wave, duck their heads into the wave, actually break through the curling lip of the wave and enter into the barrel forcefully, and they can shred, rail and slide all over the wave surface.... The other striking thing about the game is its looks. The deep hues and excellent use of color are unlike any water we've seen in any water-based games before. The water is deep with blues and greens, and from what I can tell it's the best re-creation of ocean water I have ever seen in a video game.14 KSPS was awarded a prize for the most technologically impressive game at the show, beating out fierce competition. The team was full of confidence heading into the next Green Light review. The Alpha Review During the morning-long presentation at the alpha review, Treyarch presented the final polished game to the committee. The marketing team detailed the creative strategy, presenting the specific packaging and promotional materials that were to be used for the launch. They also provided a revised forecast of the game’s P&L, one that was substantially below the estimate given at the time the KSPS concept had first been proposed (see Exhibit 13). In response to questions about the decline in expectations, the marketing team cited three factors as having a relevant impact. The first was that a September launch meant KSPS would be selling in the competitive Christmas season. All publishers launched their most anticipated blockbusters at Christmas. On Activision’s slate were sure hits like Tony Hawk’s Pro Skater 4, X-Men: Wolverine’s Revenge, and True Crime: Streets of LA, while Nintendo’s new Legend of Zelda and UbiSoft’s Splinter Cell were among other popular games ready for launch. The second factor was that neither Mat Hoffman’s Pro BMX nor Shaun Palmer’s Pro Snowboarder, released months earlier, had performed up to expectations, with revenues significantly lower than those projected at alpha. This had prompted the marketing team to revise expectations downwards for the entire extreme sports line. Finally, competitive surfing games had not been selling well: Sunny Garcia Surfing and Transworld Surf (see Exhibit 14 for comparisons with KSPS) had both launched months earlier, yet sales to date had been disappointing. 13 E3 is the most important video game show of the year, where publishers showcase new titles and products in development. 14 www.ign.com, accessed on November 3, 2003. 12 Activision: The Kelly Slater's Pro Surfer Project 605-020 Treyarch’s developers thought the poor showing of Activision’s other extreme sports games and competitive surfing titles was due to game design—the area they had finally cracked. Kelly Slater had some very unique features, including a completely new wave-generating engine and a game-play system that had proven successful in Tony Hawk’s Pro Skater. The game’s attraction was evident in the enthusiastic response from reviewers at E3. As one team member reflected, “We have a great game, and that’s what makes a title sell. Tony Hawk’s Pro Skater was not predicted to be big, yet it led to a completely new line. So why worry about the projections—this stuff is unpredictable anyway.” Surf’s Up, Dude: Time for a Decision As the Green Light committee huddled around the conference table, the discussion quickly moved to the question of the optimal timing for the launch of KSPS. The Treyarch contingent and the marketing team were strongly in favor of a September release, given that 50% of all video game sales came in the Christmas quarter. The game itself had proven its merit at E3, and the marketing team’s competitive analysis suggested that it was superior to Transworld Surf and Sunny Garcia Surfing. While it was true that development costs had far exceeded the forecasts made at concept review, these costs had already been sunk and therefore had no bearing on the launch decision. Not all the Green Light committee members were convinced, however, that the decision was so simple. Christmas was a very competitive season when many games would be competing for attention. In addition to this competition for the consumer’s wallet, prices for TV spots and space in gaming magazines would both be at a significant premium. Delaying the launch till March might allow Activision to spend significantly less on marketing and promotion while achieving the same overall impact. Even if sales were lower, the reduced marketing expenditures might warrant a delay. At least one member of the committee wanted to delay until March for a different reason. She was worried about the attractiveness of the overall game concept, especially given the response from tests of the TV spot in Chicago. “Perhaps we should give ourselves more time to do a round of game-play testing with potential customers,” she argued. “With a more accurate assessment of market size, we will be better placed to optimize our marketing spend and forecast how much inventory to build for the channel. The last thing we need is a supply chain full of a whole quarter’s inventory that we have to discount by 30% just to get them off the shelves.” 13 605-020 Activision: The Kelly Slater's Pro Surfer Project Exhibit 1 Top 20 Games in 2001 Title Genre Publisher Units 1 MADDEN NFL 2002 Sport ELECTRONIC ARTS 2,186,323 2 GRAND THEFT AUTO 3 Action TAKE 2 INTERACTIVE 1,965,832 3 METAL GEAR SOLID 2 Action KONAMI OF AMERICA 1,231,303 4 GRAN TURISMO 3: A-SPEC Sport SONY 1,172,322 5 SUPER MARIO ADVANCE Action NINTENDO OF AMERICA 1,133,630 6 TONY HAWKS PRO SKATR3 Sport ACTIVISION 1,044,738 7 MARIO KART: CIRCUIT Action NINTENDO OF AMERICA 830,363 8 HALO Action MICROSOFT 783,165 9 FINAL FANTASY X Role Playing SQUARE EA 746,632 10 NBA LIVE 2002 Sport ELECTRONIC ARTS 720,818 11 SUPER SMASH BRO MELEE Action NINTENDO OF AMERICA 643,996 12 LUIGI'S MANSION Action NINTENDO OF AMERICA 602,835 13 NBA STREET Sport ELECTRONIC ARTS 574,055 14 BOND: AGENT UNDER FIRE Action ELECTRONIC ARTS 567,469 15 NCAA FOOTBALL 2002 Sport ELECTRONIC ARTS 548,147 16 TONY HAWKS PRO SKATR2 Sport ACTIVISION 515,676 17 SW: ROGUE SQUADRON II Action LUCASARTS ENTERTAINMENT 487,810 18 PROJECT GOTHAM RACER Sport MICROSOFT 454,356 19 DEAD OR ALIVE 3 Action TECMO 399,775 20 HARRY POTTER: SORCERER Action ELECTRONIC ARTS 390,566 Source: Activision. 14 Activision: The Kelly Slater's Pro Surfer Project 605-020 Exhibit 2 Typical Game Software Sales Curve Source: Peter Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107 (Boston: Harvard Business School Publishing, 2000). Exhibit 3 Typical Distribution of Video Game Sales Throughout a Year 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Source: Casewriter analysis; data provided by Activision. 15 605-020 Activision: The Kelly Slater's Pro Surfer Project Exhibit 4 Relationship among Video Game Industry Participants Source: Peter Coughlan, “Note on Home Video Game Technology and Industry Structure,” HBS Case No. 700-107. Exhibit 5 Console Software Market Share Rank Publisher 2003 Share 1 Electronic Arts 20.0% 2 Nintendo of America 11.8% 3 Sony 6.9% 4 Atari 6.2% 5 THQ 6.0% 6 Activision 4.6% 7 Take 2 Interactive 4.5% 8 Konami of America 4.4% 9 Namco 4.0% 10 Ubisoft 4.0% 11 Sega of America 3.1% 12 Vivendi Universal 2.9% 13 Capcom USA 2.9% 14 Microsoft 2.6% 15 Acclaim Entertainment 2.0% Source: Thomas Eisenmann and Justin Wong, “Electronic Arts in Online Gaming,” HBS Case No. 804-140 (Boston: Harvard Business School Publishing, 2004). 16 Activision: The Kelly Slater's Pro Surfer Project 605-020 Exhibit 6 Activision’s Internal Studios Gray Matter Studios Gray Matter Studios is responsible for such games as Return to Castle Wolfenstein. Gray Matter Studios, Inc. rose from the ashes of Xatrix Entertainment, Inc. with the help of Activision, Inc. Gray Matter Studios is located in sunny southern California on the west side of Los Angeles, just a few blocks from the beach. Infinity Ward Infinity Ward is an accomplished team of game makers focused on creating games that are fun, exciting, immersive, and the best anyone can imagine. Infinity Ward's games have a quality of animation not often seen in PC games and include Call of Duty™. Infinity Ward is located in Encino, CA. Luxoflux Corp. Located in Santa Monica, CA, Luxoflux Corp. produces games like True Crime™: Streets of L.A.™ , the Vigilante 8 series, and Shrek2TM. Luxoflux develops cutting-edge technology, addictive game play, and captivating storylines for today's top consoles. It's a great place to work, and play! Neversoft Entertainment Famous for being the talent behind the Tony Hawk's Pro Skater franchise and other successful games, Neversoft continues to pursue their goal of kicking everyone's ass at making video games. Neversoft is located in Woodland Hills, CA. Raven Software Raven Software is an award-winning computer game software developer based in Madison, Wisconsin. With a focus on graphic excellence and high-level, intense playability, Raven has produced hit games including the Soldier of Fortune series and various Star Wars titles. Shaba Games Their mission: to make the best damn games in the world. Located in San Francisco, CA, Shaba Games has produced such critically acclaimed, high-selling games as Wipeout, Alien Trilogy, Frank Thomas Big Hurt Baseball, Magic: The Gathering, Soul Reaver: Legacy of Kain, and the Pandemonium series. Treyarch Located in Santa Monica, CA, Treyarch is a leader in entertainment software development with titles like Tony Hawk’s Pro Skater 2X, Spider-Man: the Movie, Spider-Man 2™, and Minority Report. Z-axis Headquartered in Hayward, CA and acquired by Activision in May 2002, Z-axis is the award-winning creative studio behind the million- unit selling franchise Dave Mirra Freestyle BMX and the Aggressive Inline series. Source: http://www.activision.com/en_US/studios/studios.html. 17  605-020 -18- Exhibit 7 Organization at Activision PRELIMINARY Activision Green Light committee Executive Executive Marketing Finance and Strategic budget Trade Producer Producer & Brand Administration Alliances Marketing A B Mgmt budget Activision Activision Activision Activision PR Producer 1 Producer 2 Producer 3 Producer 4 Studio X Studio Y Studio Z Studio K Retailers Producer Producer Producer Producer Studio X Studio Y Studio Z Studio K Assistant Assistant Assistant Assistant Producer Producer Producer Producer Studio X Studio Y Studio Z Studio K Developers Developers Developers Developers Source: Activision; casewriter analysis.  605-020 -19- Exhibit 8 The Green Light Processa Preproduction Production Concept First Assessment Prototype Alpha Review Playable Is the game Does the game’s Based on the Is production Is the game Purpose concept valid design proves development of progressing being completed and the concept’s a prototype, according to in a timely marketable? validity, should the game budget, manner, marketability be approved for schedule and consistent with and technical production? quality? creative and feasibility technical goals? Game concept/ Game design Working prototype First playable Alpha version of the Deliverables treatment overview version of the game game Preliminary Team identification First on-screen marketing plan and Final marketing Trade marketing view creative strategy plan summary Preliminary Recommended Final Packaged concept/ Final packaging/ Budget & marketing Advertising concept rough TV boards schedule Game design positioning Revised Revised product Product P&L Production Updated P&L budget & schedule Production Budget & budget Consumer play test Product P&L schedule results Product P&L Product P&L Source: Activision. aThe beta and launch phases are not described since they are external to the Green Light process. 605-020 Activision: The Kelly Slater's Pro Surfer Project Exhibit 9 Information on Kelly Slater 6 Time World Champion Surfer Going for his 7th World Championship win in 2002 Just won the Quiksilver Big Wave competition in Waimea, Hawaii! Has won more World Champion titles than any other surfer Has been called “the Michael Jordan of surfing” The Greatest Hero to surfers 42% of surfers named Kelly Slater as their hero Has appeal beyond surf niche: Rates #3 in appeal among “trendsetting young men” behind Jordan, Kobe Bryant and tied with Allen Iverson Recognized for his appearance as a character on one season of “Baywatch” Quiksilver’s Board Riding stores – Universal City Walk store is the Kelly Slater Board Riding store and is #1 for all Board Riding stores in terms of sales. – Opening 4 more Kelly Slater Board Riding stores in 2002. Slater is a cornerstone of Quiksilver’s marketing campaign, which extends into mainstream consumer publications like Spin, Rolling Stone, and Maxim. Kelly’s autobiography will be released fall 2002 by Harper Collins. There are currently 14 Kelly Slater licensed products on the market: – Finger boards – Remote control toy (Radio Shack and other key accounts) Source: Activision marketing documents. Exhibit 10 Surf Industry Data from Activision Sport of Surfing 2.2MM kids surf in the US (25.6% participation growth in past year) 75% of kids who read Surfing Magazine are 24 and under Crossover to video game industry 74% surfers (who read Surfing Magazine) said they owned a PlayStation 37% said they owned a GameBoy 79% said they had Internet access Source: Activision marketing documents. 20  605-020 -21- Exhibit 11 Competitive Environment (surfing titles released in 2000) Source: Activision. 605-020 Activision: The Kelly Slater's Pro Surfer Project Exhibit 12 KSPS Planned Marketing Tactics KSPS TV Ad: – :30 and :15 spots at launch KSPS Surf Trip on ESPN2: – Airing on ESPN2 to build awareness prior to launch Print Ads: – 4-month print ad campaign targeting gamers, surf and broad consumers prior to and through launch Online—Web site and Ads: – Enormous, dedicated KSPS community Web site with updates and information about the game and surf lifestyle – Banner ads, eyeblasters, interstitials and online viral marketing targeting core gamers and surf enthusiasts at launch Demos/Comarketing – In-game video released on SPPS PS2, cross-sell ad on THPS3 Xbox manual, trailer on MHPB2 PS2 and cross-sell ad on MHPB2 PS2, Xbox and AGB PR – Comprehensive 12-month campaign. Generate awareness in gaming and surf publications prior to and during launch. Consumer Promotions – Consumer promotions designed to drive awareness and communicate key benefit of game to target consumer prior to launch. – Surfer/ Surfing Magazine National Sweepstakes, National print/contest promotion in key gaming pubs, stickers and online. – Quiksilver: in-store promotions (stickers, posters, etc.), national promotion. Event Marketing – Leverage connection with action sports industry through lifestyle events – ASP- and Quik-sponsored surf events ATVI Comarketing – Activision O2 [extreme sports line] efforts – Ads in Activision O2 game manuals – THPS3 Xbox, MHPB2 PS2, Xbox and AGB – Video trailers on SPPS PS2 and MHPB2 PS2 – Kelly Slater is secret character in TH3 Retail – In-store consumer promotions and strong ATVI O2 presence to gain incremental sales, account-specific promotions and POP Source: Activision trade marketing presentation. 22 Activision: The Kelly Slater's Pro Surfer Project 605-020 Exhibit 13 Financial Projections for Kelly Slater’s Pro Surfer at Different Project Phasesa Concept First Playable Alpha Net Units 930,000 850,000 800,000 Assumed Net Revenue/Unit $32 $32 $30 Net Revenues $29,760,000 $27,200,000 $24,000,000 Cost of Goods Sold Manufacturing and Distributionb 40% $11,904,000 $10,880,000 $9,600,000 External Royalties (Surfers, Consoles)c 5% $1,488,000 $1,360,000 $1,200,000 Studio Royalties (Treyarch)c 8% $2,380,800 $2,176,000 $1,920,000 Gross Profit $13,987,200 $12,784,000 $11,280,000 Product Development and Launch Costs Studio Game Development $1,000,000 $2,400,000 $2,400,000 Central Development/Localization/Other $900,000 $900,000 $900,000 Sales Marketing and Promotion (Launch) Costs $3,500,000 $2,800,000 $3,400,000 Contribution Margin $8,587,200 $6,684,000 $4,580,000 Selling, General, and Administrative Costsd 9% ($2,678,400) ($2,448,000) ($2,160,000) Income (Loss) before Write-Off $5,908,800 $4,236,000 $2,420,000 Write-off from Original Developer (IRC) ($2,000,000) ($2,000,000) Operating Income (Loss) $5,908,800 $2,236,000 $420,000 Source: Activision, casewriter analysis. a Financial figures have been simplified and adjusted to aid analysis. b Manufacturing and distribution (M&D) costs are estimated to account for 40% of revenues. Once in production, however, these costs are incurred on a per-unit basis. Consequently, if a game’s price is discounted (e.g., to clear excess inventory), the proportion of revenues accounted for by these costs would increase. c External royalties and studio royalties are paid as a proportion of net revenues. d Selling, general, and administrative overhead costs are allocated to projects proportionately on the basis of a game’s net revenues. 23  605-020 -24- Exhibit 14 Comparisons with Competitive Surfing Titles as of Summer 2002 Source: Activision.