Acquisition vs. Innovation

Fail Often.

This article was originally published in Game Developer Magazine. It was the first in a series of business columns that I am writing for GDM.

Ask anyone over the age of 30 how many times they’ve had to “learn something the hard way.” Most people can’t count that high. Businesses are just like people in this regard: they need to experiment in order to gather the data that will enable executives to make informed decisions. And experimenting often means failing.

Despite this, most game publishers and developers are profoundly averse to experimentation and risk. “Little” mistakes, like failed prototypes, are not embraced. “Big” mistakes, like failed attempts to capitalize on new markets, are assiduously avoided until those new markets “prove” themselves, by which point it is deemed necessary to spend a fortune acquiring a successful competitor.

Dan Ariely, the author of “Predictably Irrational”, has noted that there’s plenty of research to explain this behavior. In his own words: “Experiments require short-term losses for long-term gains. Companies (and people) are notoriously bad at making those trade-offs.” Put another way: short-term risk aversion is a major psychological handicap for businesses… one worth recognizing and confronting.

The big acquisition: a misguided risk management model

Case in point: EA’s $300m to $400m acquisition of Facebook game developer Playfish. Whether EA paid a fair price for Playfish is probably irrelevant. The company had decided that it needed to get into the social gaming space, and Playfish was a good option (not to mention comparatively cheap, relative to Playdom and Zynga.) The more interesting question is: should this acquisition have been necessary?

The first social games that really took off generally cost less than $100k to initially develop. EA could have funded *ten* independent, tiny social gaming studios working on such games, empowered them to experiment with new business strategies and game designs, and it would have cost a tiny fraction of Playfish’s acquisition price. Assuming roughly $2m in cost per studio, that’s about 1/20th the price of Playfish. And don’t forget that unlike other publishers, EA already had a pool of experienced casual game developers within its Pogo group that it could have tapped to seed this initiative. So why didn’t EA do that?

Some might argue that it was impossible to know social gaming would become so popular, and thus that it was worth investing in. So let’s say that for every emergent opportunity on par with social gaming, another four that look similarly appealing turn out to be complete duds. Now the price of attempting to create the next Playfish has increased by 5x. Which, by my admittedly rough estimate, still means it would have cost 1/4th the price of acquiring Playfish.

I don’t mean to pick on EA; in many ways, it has been one of the most forward-thinking publishers in recent years. I’m trying to illustrate the fact that, contrary to popular wisdom, it may not be more cost-effective for publishers to acquire innovative companies than it is to actually innovate. And when you consider the fact that many research studies have demonstrated that somewhere between 50% to 80% of all big acquisitions end up being viewed as failures for the acquiring entity, it becomes clear that growth-by-acquisition is *not* a low-risk strategy.

The other justification I hear for M&A spending sprees is that internal innovation is simply too hard for big companies. They can’t hire the right people. They can’t adapt their development processes. And worst of all, they can’t protect innovative teams from the politics and bureaucracy that tend to doom groundbreaking projects. These are unquestionably major challenges that I don’t mean to trivialize. And yet, given the astronomical cost of recent high-profile acquisitions, and given the odds that those acquisitions will look bad in hindsight, it’s time to reevaluate the cons of organic growth.

A different approach to innovation: applying portfolio theory to concepts and development teams

So what’s the best way to encourage internal innovation? Here’s my take. (Also, note Kim Pallister’s lecture on the same subject at the IGDA Leadership Forum.)

First: given the perils of internal bureaucracy, new teams should be spun up in separate locations and treated as wholly independent studios, while still benefiting from certain shared resources like legal counsel and financial services. They should be tasked with seizing an opportunity but be given the flexibility to attack that opportunity however they wish, even if that means stumbling through a few relatively inexpensive failures. And they should be kept small, as in four to six people. It doesn’t take an army to experiment in most emerging games markets.

Second: the initiative needs protection from the top. Otherwise, the mini-studios will be cannibalized the instant a “more important” project comes along. It is not beneath a CEO or senior vice president to make this a priority… no less than deciding to greenlight a half-a-billion-dollar acquisition.

Third: the initiative needs to be overseen by a small group of people who understand that they are managing a portfolio of high-risk investments. It is not only likely, but a given that a significant percentage of those investments will not pan out. In other words, preventing failure is not the key goal. Supporting promising new experiments and helping the mini-studios share learnings with each other is the goal.

This issue is not only relevant to large companies. Indie developers may not have EA’s resources, but that doesn’t mean they can’t adopt a portfolio strategy. My studio, Spry Fox, amounts to just 18 people in total when you include partners and contractors. But as of the time of this writing, we have five F2P games in simultaneous development, with five completely independent, tiny teams working on them. Each team is experimenting with original game designs and/or new business strategies, and each team is fully aware that the experiments they are conducting may not ultimately be successful.

It is possible that all our projects will fail. But if we succeed, we’ll have accomplished what very few large companies in our industry have been able to accomplish: a true portfolio process for developing innovative, original IP within new markets. I look forward to sharing the results of our efforts, be they successful or not, in my upcoming columns.

In the meantime, I invite you to ask yourself a question the next time you’re weighing the pros/cons of conducting a business or game design experiment: are you focused on all the ways the experiment could go wrong, or are you focused on how to make the experiment as efficient and educational as possible?

10 responses to “Acquisition vs. Innovation

  1. How does branding fit into this? If I’m a big name like EA, I don’t want to attach my name to these tiny studios, because when (not if) they fail in their inexpensive way, they’ll do so with the EA name attached. LucasArts got a fair bit of heat for Lucidity, which was arguably an example of them doing exactly what you propose (though I’m not very familiar with Lucidity’s development model, so I might be wrong). But you can’t attach your giant corporate brand to these endeavors. So they should have their own names and branding, but then if they succeed do you swap in the big corporate name? At what point does this it just boil down to venture capital by another name (not that there’s anything wrong with that)?

  2. Actually, how does the portfolio strategy differ from the standard publisher model? In it, a publisher provides certain services (marketing and distribution), and seeds money to a collection of completely independent studios, which is called a “portfolio”. Kinda the same thing, no?

  3. I should add that I think you’re right on about tolerating and even shooting for failure, but I wonder whether the portfolio model you’re describing here is perhaps obscuring a deeper point. No matter how your company is structured you should be able to tune things to be more friendly to experimentation.

  4. Actually, Lucidity is a very good example of precisely why the model I propose would be useful to big publishers. Normally, they do exactly what LucasArts did — invest in a single project or two, then freak out when it doesn’t go the way they hoped and cancel the entire initiative. (Most companies also dramatically increase the odds that the first project or two will fail by messing with the development team in a variety of ways.)

    As for branding, it’s actually pretty common outside the video game space for companies to spin up separate brands precisely for the purpose of safely experimenting. For example, a company might want to protect a luxury brand (i.e. you want to release a lower-priced product, but you don’t want to tarnish your brand, so you release under a new brand name. Super-common in the fashion space but also even in common household products.) Interestingly, Popcap announced that they were adopting this “protect the brand with an experimental brand” strategy just a few days ago, when they launched 4th and Battery. Rocky start for them so far; we’ll see how it goes longterm.

    Anyway, if you’re interested in this topic, you should watch Kim Pallister’s lecture and check out some of the other online resources on the subject of innovation within big companies. This is a very active topic of research in debate in the business world, and given the huge percentage of big companies that struggle to innovate, I think it’s a bit idealistic to think you can ignore structural elements of the problem…

  5. Oh, as for how this differs from the standard publishing model: a few different ways, but primarily charter and scope. Publishers tend to view risk management as something you accomplish via acquisition of proven IP or development of sequels to proven IP. They don’t tend to view it as the product of ten small, independently and concurrently developed experiments, eight or nine of which can fail to achieve mega-hit status without the entire initiative being deemed a failure, even though this is precisely how (for example) a VC looks at the process of investing in startups.

    It’s also not clear that the traditional publishing model (i.e. get pitched by developers; pick the best things you’re pitched; negotiate an arrangement; etc) is necessarily as efficient as you might think. You want relatively tiny teams for this to work, but most tiny development teams aren’t terribly good at pitching themselves; its the bigger studios who know how to convince a publisher to fund them, and they usually need to spend lots of time and money creating the pitch materials that get them funded.

  6. You can’t start a restaurant without a dishwasher. I think that the need you’re addressing here is for good clean conceptual ways to detect and to move past failures. Those are the first concerns of someone whom you’re trying to convince to be more innovative.

    The portfolio/VC structure has good answers: you detect failure by profitability, and you move past failed experiments by just working on new ones (the Bay Area buzzword is “pivoting”).

    The current publisher system doesn’t work very well, we both agree, but I think that it’s only historically so, and there’s no structural reason that it couldn’t shift over to a more innovation-friendly paradigm. (The music industry is a prime example of dinosaurs mightily machine-gunning themselves in the feet for no good reason except “tradition”.) And I hope the publishers do start to take risks on smaller projects and teams, earlier on. They sort of are, in that they seem to be more interested in retaining teams of talented people than before, and they’re creating smaller groups internally with more autonomy, etc etc. It’s only microscopically better at the moment, but maybe there’s a trend in motion. I think the barriers are mostly psychological, not structural.

  7. > I think the barriers are mostly psychological, not structural.

    This is a meaningless statement. What is “psychology” in the context of a big company? It is part cultural (i.e., what are the values of the company’s many employees?), part political and part structural (i.e., is the company public or private? How is its existing R&D group structured? What existing stakeholders are potentially threatened or bolstered by a given new initiative? Etc.) Big corporations of all types have been struggling with this specific innovation problem for a very long time, which is why there are so many books on the subject and why business schools focus on it so heavily.

    Disregarding structural solutions to the problem because it seems like “a psychological issue” is basically condemning companies to continue failing, because even when a high-powered executive at a big company “gets it”, systemic issues hamstring them so badly that nothing gets done.

  8. Reading your suggestion for simultaneous development of titles by smaller, protected teams immediately brought something to mind that I’ve participated in several times over the last few years. The Global Game Jam is an event for developers both casual and professional around that world that are encouraged to make a complete game in 48 hours, with but a simple theme to guide each team. No other expectations or restrictions are attached: just to create what you can with the people and time that you have. In the course of a weekend over 1500 games were created around the world, with fantastic range.

    I’m afraid I don’t know much about business models and can’t contribute much on the topic of Acquisition vs. Innovation, I think events such as this Game Jam share the same vision as your suggestion: the freedom and support to experiment for the sake of new ideas. While it would be hard to implement in large companies – and even smaller indie studios – I think it’s encouraging that such events exist for aspiring game developers. They can learn to quickly generate ideas and move forward without dwelling on the consequences, knowing that they can learn from failed prototypes as well as the achievements of their fellow participants.

  9. Yeah, you’re right, man, I didn’t mean psychological in the sense of “if only you’d see a therapist and think about your father, things would get better.” ๐Ÿ™‚ What I meant is probably better described as “culture”. That better reflects politics, tradition, stakeholders, etc etc, right? Lemme know if there’s a better term. I am not up on the hip lingo.

    Assuming the term is good, how separable is culture from the structure of a company? It seems those two things are two sides of the same coin. It seems to me that you can no more fix an uninnovative company through restructuring than you could by trying to change the culture. If EA tries creating some independent teams, aren’t all the people whose positions become uncertain in the portfolio model going to fight against such a change and try to sabotage it so it doesn’t take over? Aren’t they likely to be powerful people? If the company suffers a downturn, isn’t the first neck on the chopping block going to be the innovative independent remote teams? I’m not an industry old hand by any means, but I’ve seen it happen in companies that had the strongest possible support at all levels of management, except for the one whose hand was on the axe.

    Maybe I’m just cynical, but I think that existing companies are largely stuck; I think the effort required to fix them is simply greater than the effort required to beat them. I’ll be as happy and surprised as anyone if they do successfully turn it around — the industry really needs more innovation — but I ain’t waiting for it. I don’t mean to sound like I’m arguing against your thesis; I think it’s good advice, but if big companies were gonna listen, they would have already listened.

    Also, just thought of an interesting notion: Valve is pretty good at internal innovation, and they also seem to be pretty good at acquiring innovators. Perhaps once you’ve got a culture/structure that supports innovation, it doesn’t matter as much whether it’s homegrown or imported?

    Cody’s totally right about the Game Jam being there for the indie community (sad I missed it this year). That’s a really good source of strength for the form, and if we keep nurturing it, it’ll only get stronger. The meetups we have in San Francisco are another, though more for social and business purposes than innovation. I think it’s very worthwhile to shine a light on existing sources of innovation.

  10. @Cody, @breath – Yup, the GGJ is very cool and I expect it will be dramatically cooler ten years from now. ๐Ÿ™‚

    @breath – two thoughts. 1) It is definitely true that if the culture of a company is inhospitable to innovation, you’re always going to have a *very* hard time with any innovative initiative. Cultures are very hard to change. 2) Structural solutions (with the direct support of the CEO) are probably the *only* viable solution in such a scenario. Otherwise, as you wisely noted, an axe-man could come from anywhere.

    (All that said, if I felt I was working for a company with a culture truly opposed to innovation, I would probably just quit. Why fight that headwind? I’m not sure we can slap the “anti-innovation culture” label on EA, however. After all, this is the company that brought us The Sims, Boom Blox, Dead Space, etc. And it was willing to invest a fortune in Spore, even if that didn’t work out for the company…)

    The conversation about the difference between politics, culture and structure is a long one, best had over several beers. ๐Ÿ™‚

    RE: Valve – tell me if I’m wrong, but they generally don’t acquire large (or even mid-sized) companies. I was under the impression that they scoop up relatively small, promising development teams and carefully foster the interesting work they were doing (i.e. Portal.) Pretty close to opposite of what EA did with Playfish (giant acquisition, driven partially by a desire to foist EA’s brands onto Playfish’s dev teams) or what Disney did with Playdom (same story.) In general, small, talent-inspired acquisitions are much less challenging to perform successfully than giant acquisitions. In the case of the former, it’s expected that the acquired group will be integrated into the acquiring company’s culture. In the case of the latter, the cultures of the two companies often end up conflicting in some way.

    I will definitely agree with you on one point in particular — it is hard for these behemoths to change, and that’s partially why I work for a startup.

Leave a Reply

Your email address will not be published.