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The game industry has gotten a lot of love from venture capitalists lately. For many years, VCs invested a small amount of money into games compared to other hot investments such as social media. But in the age of Facebook and mobile gaming, that has changed. In 2010, VentureBeat’s own analysis found that 91 game companies raised $1.05 billion in 2010, up 58 percent from a year earlier.

So it was interesting to hear what some of the top game-focused VCs thought about the state of funding for game-related companies. Sana Choudary (pictured right), co-founder of Yetizen and the San Francisco Game Developer’s Workshop, recently interviewed three game VCs — Jeremy Liew (pictured second from right) of Lightspeed Venture Partners, Tim Chang (pictured third from right) of Norwest Venture Partners, and Patrick Chung (far left) of SK Telecom Ventures. Here’s a transcript of the conversation.

Sana: Please introduce yourself.

Jeremy: My name is Jeremy Liew. I am a managing director of Lightspeed Venture Partners. I have invested in internet companies broadly including gaming companies. I have investments in Playdom, RockYou, Casual Collective, and Serious Business (which was acquired by Zynga about a year and a half ago). So that’s the sort of gaming piece of my portfolio.


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Tim: I’m Tim Chang with Norwest Venture Partners. I have investments also in Playdom with Jeremy, Ngmoco (which was acquired by DeNA in Japan), Lumos Labs, which is doing online brain training games, and then we also invested in MyYearbook, an online social games network for teens. And then one other I just invested in is called Basis, which is a gamification of health company.

Patrick: I am Patrick Cheng. I run the SK Telecom Ventures with a partner. SK Telecom is the largest wireless carrier in South Korea and we have a large social network called Cyworld, which has a big game presence. We have a game studio. We have an investment in RockYou, and we’ve invested in a small company that takes games across platforms. We also invested in a small 3D game development company that we ended up selling. That wasn’t public.

Sana: What are three words to describe the current game landscape?

Tim: I was trying to think about this. I have a top ten list.

Sana: Top ten? From your top ten, pick three.

Tim: Number 10: I got lucky. That’s me, personally. Nine: games as service. Eight: new platform land grab. Seven: Everyone is mobile now. Six: android micro transactions, finally. Five: time to flip. Four: frothy yet consolidating. Three: super copycat bandwagon. Two: distribution outweighs content. And number one: Next stop, gamification.

Sana: Jeremy?

Jeremy: I don’t have 10. Its kind of intimidating to follow. I think the landscape is terrific for game developers. I think it is always difficult to put it in three words.

Sana: Don’t worry. Tim didn’t follow instructions.

Jeremy: It’s definitely exciting. I think there is a ton of opportunity. I think we are in the third inning of a nine-inning game. We’ve seen some terrific outcomes. I think we are going to see plenty more. If you take a long view, the big idea here that allows startups to compete in gaming is that the cost of game creation has come down by a factor of 100 in some cases. That applies to social or mobile, or iPhone or Android, or other platforms. And that means startups can actually play. It’s not this intimidating, massive project. And that is exciting.

I agree that frothy is also a fair description. I think that valuations right now — not just in games but across the board — are very entrepreneur friendly. That makes it exciting too, right?

I would have to agree that distribution is more important than content. It pains me to say it, and I bet it pains you guys to hear it. And I bet a bunch of you wish it were not true. A lot of the players know nothing about a game before they decide to play it. By definition, then, the content can’t be important in making a decision about playing a game. Once they start, the quality matters. But getting them to start in the first place is hard. So distribution means different things on different platforms. But this idea that people are going to try your game before they know anything about it is a new thing. How do you get them to play? That is a new idea in gaming.

Sana: Patrick?

Patrick: Unfortunately, I will probably use the same words that Jeremy and Tim were using. We see a lot of mobile opportunities because we are the largest mobile operator in Korea. It is exciting because we see a lot of people who can have a lot of material success for themselves and their companies. They need a few developers, a great idea, that is simply well executed. As a fund, we are curious whether there are venture returns for us here. But in terms of being a developer, it is an exciting time.

Sana: A recent VentureBeat article said social gaming is going to grow to a $5 billion industry in 2015. Is that accurate?

Jeremy: It doesn’t matter. Five billion, four billion, six billion, three billion. Who cares? It’s big. It’s plenty big to support really interesting opportunities.

Tim: I agree with Jeremy. The way I look at it, let’s assume social itself is not a market. It’s a fabric of functionality on a new distribution path that encompasses all games in all platforms. So by definition it is the entire gaming market that incorporates social features. So wherever the gaming market is now, multiplied by say another 50 percent, that is where the social gaming market will be.

What I add to that is whether that $5 billion in social game revenues is just in China. It’s a nice big number, but I actually think it would be more than that for the whole world. There are geographic boundaries due to culture and language. For U.S. developers, the question is how can you cross into those other areas. We meet a lot of developers who say they want to get into the Korean market. We face the same issues over and over again on localization. You don’t have to localize, but you should have low expectations about how well you are going to do. Does it resonate with the cultural values? If you can overcome that, $5 billion is a very low number.

Sana: Since you all mentioned distribution in your answers, what is the problem of breaking into areas where the carriers dominate? In some countries, 80 percent of the game revenue goes to the carrier and 20 percent is left for the developer. With geographic distribution, there are more obstacles there.

Patrick: That’s true. I can only speak on behalf of the Korean market. If you work with Zong or Boku or BilltoMobile, they will take their percentages. SK Telecom takes only about 5 percent since 2005. As a carrier, we are not interested in getting more money per transaction. We want a better ecosystem.

Sana: What are the five things you look for in game investments you make?

Jeremy: You are really big on these number questions.

Sana: I sent them to you ahead of time, so you should have done your homework.

Jeremy: I am going to give you one. Which is: success. I think there are a billion great game ideas and there are 150 really good game developers in this room. It’s not enough. It’s not enough because the market is so noisy and it’s so random and so stochastically unpredictable that until you see something working you can’t tell. Nobody sets out to build a bad game the same way that nobody sets out to make a bad movie. But I’ve seen so many bad movies. You just can’t tell until you see it. I will give you two things. So the first is success and the second is awareness of the importance of distribution and discoverability. I will say the teams that are focused just on the game play, I don’t get super excited about at this point in time. Given the set of opportunities that there are right now, I think that focusing only on game play has worked in the past. At this point in time, people who are deliberately ignoring distribution and discoverability are not folks I want to invest in.

Sana: Since all of you guys are institutional investors, what is the sort of minimum valuation investment you would make? I think that would weed out a lot of people in an audience like this.

Jeremy: I don’t have a minimum to my valuation threshold. (Laughs). When we invested in Playdom, we felt it was reasonable and we invested at a valuation that was above $100 million. It depends on the opportunity. For the things I look at, I am not going to do a $20,000 investment on a $500,000 pre-money valuation.

Tim: I will carry on to say that because we are a large fund that has to show a return to investors, that limits things. We can’t think about doing smaller investments because the returns we could make on that investment won’t move the needle for the larger fund’s return. That doesn’t mean that a lot of startups aren’t doing great things. They can make huge impacts for super angels or smaller funds or individual investors. But when you are talking about big funds, you have to keep that in mind. A lot of times, they are looking for massive outcomes. With that in mind, I look for these things. Number one is a good team. I’ve seen this save the day on exits. Even if the company is not working, if you have a killer team, a good company can be bought. When Playdom and Ngmoco were acquired, the acquirers fell in love with the management teams. They saw them as the next generation of management talent. Number two is traction. You have to get something out there and see how the numbers are cranking along. Number three is distribution muscle. If you talk about how you are going to build a farm game and a city game and copy that over and over, that’s not interesting. Now, if you tell me a story of how that grows distribution power over time, that’s cool because that gives you number four, which is defensibility. Namely, can Zynga copy your app tomorrow?  That’s why doing new genres and a new area of development such as geography, a new platform like tablets, or maybe a new genre like mental fitness gaming or music gaming or mid-core gaming is important. Zynga is not going to copy that tomorrow and put you out of business with its distribution.

Patrick: We are a $100 million fund operating at a much smaller scale than these folks. Our smallest check is about $200,000 and our biggest check is $5 million. We have invested at $100 million valuations with companies such as RockYou. I would say that, again, as we are different from what these two gentlemen said, I look at companies that are original. More importantly, I look at things that don’t have a limitation to their scale. What I mean is that you see a lot of companies that are purely mobile but you look at their game plan and you realize, this is not going to get you that much revenue. What I love seeing are people who have a mobile and web strategy that work together. I haven’t seen it done well that many times. We believe that on the web, there is no limit. There is no geographic limit. But with mobile, there is a geographic limit. We look at just the example of, look at the valuation of Ngmoco versus Zynga. Zynga’s revenue financial is much higher because they are on the web. I do believe the multiples are better on mobile, but I do think that someone is going to marry those two, and that’s the concept that I am looking for.

Sana: Gamification has made it difficult to tell the difference between an app and a game. Do you see gamification as an explosive trend, a bubble? What are your thoughts on it?

Patrick: Well, gamification is a little bit a part of life. Isn’t everything a game? Isn’t everything a negotiation? Games are part of the fabric. If we are talking about certain game mechanics, they hit a person over the head with it. Some game mechanics go into fashion and out of fashion. But fundamentally, it is just about the psychology of a person and drawing them into an activity. I don’t know if it is anything more than that.

Tim: Gamification is at the top of a hype phase and is about to enter the backlash phase. So it’s a fad in terms of the terminology they are using. That said, it is pretty much, I think, going to be meaningless in a year because it will be everywhere. Just like people thought social stuff was a separate market. Instead, I think people strive to understand social and then it is incorporated into everything. So rather than having gamification companies, you will just see game mechanics that play everywhere. Lightweight game mechanics is what has made Gilt Groupe and Groupon successful in commerce. I think we will see game mechanics entering even enterprise software, like customer support. SupportVille is not that crazy a concept, all right. We will see it entering health and wellness through startups like Basis. Nike is using it. It will be a layer of functionality that will go into everything just like social and mobile right now are part of the functionality of everything we experience.

Jeremy: I am not sure that I agree. I think that we will never see customer service that way. I think that with all of this game mechanics stuff, there is a reason that it started in games. People like to play games and so gamification helps people to do the things they like doing more. So when you talk about Gilt Groupe, for example, it turns out that people on Gilt really like to shop. So adding gamification to Gilt helps them to do more of the things that they really like to do. What gamification has not ever been successful at is getting people to do the things that they don’t like to do. I should eat less and work out more. I don’t like to eat less and I don’t like to work out more. And putting a score board against it is actually not going to get me to do even those things. So I think there are limits to the gamification. It just becomes good product management for the things that you like to do. But it also has its limitations and understanding where those limitations are is really important. It’s not this magical bullet.

Sana: Okay, so if you have some gamification platform to health startups or something else like that, don’t go to Jeremy.

Jeremy: I will also say that I am wrong way more often than I am right.

Sana: This question you guys have all touched on. Does virality still work, or should developers rely entirely on distribution channels?

Patrick: Virality went through a phase. As Facebook turned that off, I think it started dying down. But you think that there are ways to have virality, such as using Kick. They are using virality in a new way. It may cross over some lines of privacy, if you will, because I don’t think Tim wants me to see his address book. But people are starting to push the limits. I don’t think the way we saw Facebook doing virality in its early days is coming back. But I do think people are finding new ways to find virality in mobile and in other genres.

Tim: So I would say some of the spam cannon viral tactics still work on some of the other social networks, especially overseas. That allows for expansion overseas. It no longer really works on Facebook as it used to, and we’ve seen the rise of new models, like cost per install (CPI), cross-promotion layers of the world like Applifier and Tapjoy. Mobile apps never really had virality. As Facebook takes it away, the same kinds of things that people did on mobile are now moving back into Facebook.

Jeremy: I think they would be able to distinguish between kind of word-of-mouth virality and manufactured virality. Word-of-mouth virality is anything where people actually want to show another person how awesome something is. That’s ideally mostly about some product development. You look at something like Talking Tom Cat, it has rocketed to millions of installs in a short period of time. People say, ‘hey man, come check this out!’ That is virality. It’s not manufactured. You can use channels like Facebook or email to propagate a viral message. This word-of-mouth is genuine virality. It’s fun to do with other people. Then there is manufactured virality. That is hacking the system. There are loopholes in the system that, when you hack them, you can use those channels to propagate something in a viral fashion. There were plenty back in the day on Facebook, and there were plenty of loopholes in email. If you put a good enough set of hackers against a system, they will figure out how to hack it. That has happened with every new communications system. And from that point of view, manufactured virality will never be dead. You have to keep looking because the environment has changed.

Sana: What platforms are saturated, and what emerging platforms are you looking towards next?

Tim: Facebook, online, social gaming. I think Zynga pwned us all. The iOS is pretty noisy as well. Building niches can still get companies billion dollar outcomes. Android is still wide open, especially now they finally turned on in-app purchases. I’m hoping the billing mechanisms will work there but that remains to be seen. Tablets, I think, will engender whole new genres. I would like to see the next Riot Games come out of tablet, or the next Club Penguin be a tablet-based experience. I think the web is still a good platform, especially for mid-core and especially to the degree it can be browser-based and not a client download. And so-called cloud gaming like the Gaikai’s of the world — where you stream the game to the user — could be very interesting, whether you leverage a Unity Technologies-style engine or do it Citrix-style in the cloud.

Patrick: I especially like Android. The iOS system, while great, is still curated by Apple. We were an Android shop from the start as a partner with Google. Now we are selling the iPhone as well. We started selling it about a month ago. We realized we have, as a carrier, nothing to offer the developers. As a carrier, we have 51 percent market share. We can’t help them. We can’t market for the developers. We can’t push any apps. That kind of stinks, because we think we can be a great partner for developers.

With respect to games and where they are, I am leaning more to the [browser-based] Citrix model. There are cross-platform development systems that are the Ngmocos of the world with iOS and Android systems. I don’t think people care what platform they use. What people want is to see a screen and a game. They have an input and an output. That’s all they care about. If a great game can be outputted through a virtualization system, that’s great. Then it can be played on multiple platforms. That increases the likelihood of success. I don’t think any particular OS has to be the one that wins.

Jeremy: I don’t think anything is saturated. I think there are opportunities everywhere. I think the key question, though, is whether or not you can afford it as a startup to pursue those opportunities. There are certain platforms that support relatively low-cost development. You get more shots on goal that way. Mobile, tablet and so forth, will be consistent with that. Then there are platforms like the consoles, where you can still see multi-hundred-million dollar games. But because you need $50 million to make that game, only a few companies can do that. That doesn’t mean there are no opportunities there. It just means you have to do something that matches the size of your company and your aspirations. I would say that social is somewhat saturated.

Will someone beat Zynga? Probably not. But can you build a business that can be worth hundreds of millions of dollars on Facebook gaming today — I think you still probably can. I think Kabam just recently closed a round (not actually announced) valued at a few hundred million dollars. Obviously, there are people who believe there is going to be upside from that. Given their level of business, that’s not so unreasonable.

I would say that you should be worried about Zynga if you get to play in that space. But you can’t be paralyzed by it. It used to be that everybody worried about whether Microsoft could copy what I’m doing. It turns out that they could but they didn’t because the company was doing too many things. Any company can only do about three things at once. Microsoft may have to worry about Google and Facebook and Zynga. If you pick something that is not a top three target for them, you can do well. Your top priority will be executed better than their eighth priority every time.

Tim: I look at the Kabam example. What I think will happen is that, instead of playing a game in Facebook, Facebook becomes the new retail store front. You find the users on Facebook and play the games offsite at your own destination where you have more control over the application and the experience. You acquire users on Facebook and then monetize them across many platforms. Facebook is sort of like the new bar in many ways.

Jeremy: Well, Kabam is doing pretty well on Facebook right?

Tim: Yeah, the entire plan is to be able to control their destiny on

Jeremy: Be that as it may, their current success has been entirely on Facebook.

Tim: Right, driven primarily by the success of one type of game.

Jeremy: Absolutely. It only takes one. To build a company, you can’t rely on one title. You’ve got to have one hit. This is not about building hit games. It’s about building hit factories. The hit factories have to start with one hit. Once you’ve got that hit, you can afford to invest in all the rest of it. But focusing on all the rest before you have the hit is putting the cart before the horse.

Tim: Right. You could have the distribution muscle without the content debate.

Jeremy: Exactly.

Tim: And so we will see if any people try to come at it from both sides. You could aggregate a long-tail audience and build something like Applifier. Or you can try to build a network once you have a hit.

Jeremy: That’s right.

There isn’t enough controversy if you guys decide to agree.

Tim: Here’s my question: How many companies are going to keep innovating as opposed to just re-skinning their first hit game. Because what we see a lot of out there are companies that will have one mechanic or engine and they quickly do re-skins. That makes sense. But you may re-skin that game five or six times and then you are going to lose the audience. You can raise lots of money from VCs and then go find a new thing.

Jeremy: I also think there are a lot of times that you can re-skin the same game with a slightly new dynamic. People who have a hit game and are not re-skinning it are leaving money on the table. They are walking past $100 bills lying on the ground because they don’t want to stoop and pick them up. You have to do it. Not doing it on ideological grounds is wrong.

Sana: If you were to develop a game today, which monetization model would you guys follow? Freemium versus paid games?

Tim: Freemium. If you’ve got strong intellectual property, then paid models will win because you can justify spending money to develop a game that people will pay for. PlayFirst has a great brand in Diner Dash and if they were to move to freemium, they would cannibalize their business because there are a lot of people who were willing to pay upfront. If you are breaking out with a new product, then freemium absolutely makes sense because you have to reduce friction. You want people at the top of the funnel to try out the game and get addicted. People try it and they come back. If you have a great brand that comes from that, like Angry Birds, you can start to charge more and move in the direction of paid and microtransactions on top of that too.

Patrick: I like that answer too. I mean premium was really started by companies trying to escape piracy. It has worked as a model for the past ten years and so I don’t see why we won’t continue to use it for new genres and platforms.

Sana: What disruptions do you predict we are going to have in the game business this year?

Jeremy: I think Tim already mentioned that being able to do in-app purchases in the Android Market is going to change the game. We are going to see new players emerge.

Tim: I’m hoping some big new companies will pop up on the tablet side. I do think that the bigger screen is fundamentally a better experience. So I am really hoping that someone will do a better Club Penguin on a tablet. Tablets are really good devices for kids because they are the ultimate pacifiers. I have seen parents that pass them to the kids and it just delights them and shuts them up for the rest of the night.

Another disruption in the market is that you may see bigger VC funding dry up for classical social game 1.0 companies, online and mobile. If people are going after Zynga with a copycat strategy, that jig is already up. But there are lots of new areas to attack. So I hope one of the disruptions is that more sub-genres will emerge, which will lead to multi-hundred million businesses.

Patrick: The thing I hope to see is a shift in demographics on social games. There are all of these women 25 on up playing games on Facebook. I want to see it swing back into balance where there are more hardcore games out there on Facebook. If we can unlock that, it will bring in a lot more revenue inside the Facebook ecosystem.

Jeremy: That’s Kabam.

That’ just one. There could be many more.

Sana: And finally, what tips do you give to small and new game developers to help them survive in the ecosystem, starting with Tim?

Tim: Small new game developers should go dominate a new category like these new sub-genres or things that aren’t well suited for social gaming 1.0 companies like Zynga to copy quickly. That can mean going into tablets or Android or dominating a new territory like Brazil. And the second is, you should know up front what you are trying to do. Are you really trying to raise big VC money and go big, or are you happy with just kind of, you know, selling out to a Zynga so you can put $20 million in your pocket quickly. There is a different type of outcome, a different type of road to get there depending on your goal. There is a different risk profile.

Another trick is the team. If you have trouble getting a great team in the U.S., look overseas. A friend of mine built a great team in China. They flipped it for a really nice number to Zynga, which needed those development resources to keep its costs low. Always engineer your team to have very high human resource quality.

Patrick: So my advice to you developers would be, try to control your future. Find a business model that works for yourself and your team and try to show success. I mean VCs love to find things that are on fire, that are just growing so fast and they can’t keep the servers on, they can’t get enough of them. There comes a point when you have to decide if want to take more money to do extra work. But fundamentally, you have to control your future. The worst time to raise money is when you need it. Like when you are out of cash. The better time to raise money is when you least need it. If your servers are overloaded, that’s a great time to raise money because people will be stuffing your pockets with money.

Jeremy: I have three suggestions. The first is eat ramen. Keep your costs low. The second one is cut corners. Get the product into the market; see what is working or not and change it. The third one is quit early. The pattern we have seen is that successes happen quickly. If it’s not working, stop pushing the rock uphill. Try something different. Now is such a great environment that there is a real safety net. If it doesn’t work out, Zynga or Playdom or Playfish will hire you in a heartbeat.

Sana: What are you more interested in investing in: platforms, tools or game studios?

Patrick: Okay, I wish I could invest in game studios because that is where the biggest value creation is. But in terms of our fund, we tend to gravitate to platforms.

Jeremy: I will never invest in a tool company. It’s a really difficult way to make a living. If you are selling to developers, that’s a problem. Developers have no money. That’s why I don’t like tool companies.  … I’m wrong more often than I am right.

Platforms when they are successful are wildly successful. But it is hard to be a successful platform from the get go. Usually you start off as an application and then you extend the platform piece. People always buy the big platform from the get go, so it’s hard to be the small platform. So that leads us to applications and game studios. That is where I have made all four of my investments.

Tim: The end game should be, of course, hopefully a platform, but ultimately have some true distribution muscle. You can get there different ways. So I would say Unity started life as a tool company, but with the way they are thinking, the vision is to become more and more of a platform over time. They are starting to prove it. Angry Birds comes from a game studio. If you have a hit, you can use cross-promotion to get more distribution muscle. It is generally true if you start a platform, you probably need to build your own first killer app. No third-party will invest unless you have a killer app on your platform, and no one knows your platform like you do.

Audience: So Tim and Jeremy mentioned that things are a little frothy now. I just wonder what the consequence of that is and what actions startups should take because of that. If we look back at 1999, one of the good moves was to raise as much money as you could and then sort of use that as a war chest to survive on for the next few years. So how would things be different now, and what is the course of action?

Jeremy: I think one of the consequences is to raise funds. I think that is really smart. But you know one of my partners says if they are passing hors d’oeuvres, it is a good time to eat. People are passing hors d’oeuvres right now so eat and don’t just eat for now. Put some in your pocket and take them home. If you are trying to raising money now, then raise a lot at an attractive valuation. You should do that, and I am advising all companies to do.

Tim: And then be careful how you spend it. That is the smartest thing Slide did. They raised a lot of money and didn’t spend it. They would have been toast if they’d spent it. They got a good exit because they had a great team. Make sure there is gas in the tank to get to your next milestone. Remember too that whenever you raise money, it sets the high jump hurdle higher for yourself. It can be a double-edged sword if you raise money. Just don’t run out of gas.  It is frothy. In that environment, the market behaves on a greater fool principle. Can you find a greater fool than your current investors to put money in at a higher valuation? It goes on and on until it crashes down and repeats every ten years. Just be aware of where you are in the cycle and play that game well.


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