From the March 1996 issue of CD-ROM Today
The Big Squeeze: Multimedia on the Brink
By David English
Walk into any software retailer and you'll see rows of gleaming shrink-wrapped boxes packed with the latest CD-ROMs. But if you think these titles have been carefully selected for their entertainment or educational value, you'd better think again.
"The customer looks at the things that are on the shelf and assumes that the retailer has made a good purchasing decision," says Klaus Schultheis, a partner with Dongleware, a multimedia developer in Napa, California. "The retailers get money to put it on the shelf, and they don't care what's on the shelf as long as the software companies pay them enough money."
As Schultheis explains it, just because you see 500 boxes of the same game on store shelves doesn't mean it's a good product. Many CDs are in the stores simply because their manufacturers have paid for the shelf space—a common retail practice known as "slotting." And for every title that sits on a retailer's shelf, there are 15 others waiting to take its place. Most of them never make it into the stores.
Such numbers signal tough times ahead for the multimedia industry, as both producers and consumers face The Big Squeeze. Smaller developers are being squeezed off retail shelves—and even forced out of business—by those with deeper pockets. Big-budget games are squeezing out educational and reference products. And unusual or innovative CDs may be squeezed out in favor of sequels to blockbuster titles and commercial tie-ins to movies and other media.
In some cases this process will help weed out weaker products. And alternate sources for new titles are expanding. But the ultimate result will be fewer producers of multimedia titles, and fewer choices for you.
Survival of the Richest
By most accounts, 1995 was a record year for multimedia. InfoTech, a research firm in Woodstock, Vermont, reports that just under 4,000 CD-ROM titles were introduced in 1995, nearly twice as many as in 1994. Sales continue to surge ahead. According to the Software Publishers Association, unit sales of entertainment software were up a whopping 73 percent for the third quarter of 1995 over the same quarter of 1994, and home education software was up 30 percent over the same period.
So what's the problem? According to InfoTech, fewer than one in 10 retailers stock a large number of software titles. These so-called superstores typically carry around 2,000 CD-ROMs at a time. Roughly half the stores stock only about 250 CD-ROMs titles. More importantly, these shops lack the resources to pick the best titles to sell—especially in the fourth quarter of the year when most consumer titles start shipping.
"I wish you could see some of the buyers' offices," says Ileana Seander, vice president of sales at Maxis, in Walnut Creek, California. "They have software submissions to the ceiling. They just don't have time to look at it."
The competition is especially intense in the game and edutainment categories. One national retailer reports having 1,600 edutainment titles vying for just 80 slots on the shelf. It's like a grand game of musical chairs—there are simply too many players and not enough seats at the table.
Of course, most companies also sell CDs direct to their customers. But analysts and vendors agree that the retail channel is where the action is—and where consumers are most likely to encounter new titles. Which software vendors will win out in this highly competitive environment?
"It's going to be the more established companies, the companies that already have a track record of hits, or companies that have enough money to muscle their way onto the shelves if they're new to the category," says InfoTech's chairman, Ted Pine. "It's a market that definitely favors the haves over the have nots. Smaller companies are the ones that get the squeeze."
Hits or Miss
As the well-established companies spend ever-larger amounts of money on production and promotion, the software business is increasingly becoming a hits business. And that's squeezing out titles from smaller developers. Top CD-ROM titles such as Myst, The 7th Guest, and Rebel Assault have been on the best-seller charts for several years. At the same time, the shelf-life of other programs is shorter than ever. Pine says the average consumer CD-ROM title sits on a retailer's shelf for 102 days; for competitive categories such as games the title can disappear in a matter of weeks.
In the same way that many non-mainstream movies are pulled from theaters before you have a chance to see them, many cutting-edge software titles are leaving store shelves before you have a chance to buy them. Odds are you can still see movies on either videotape or cable, but most CD-ROMs that fail at retail are gone forever. InfoTech reports that nearly 1,000 consumer titles went out of print in the U.S. last year.
Even if a CD-ROM game is starting to sell, it can be squeezed off the shelf when a new blockbuster reaches the store. Virgin's blockbuster sequel to The 7th Guest, titled The 11th Hour, shipped early last December. "How many feet [of retail shelf space] did The 11th Hour have?," asks Dan Lavin, an analyst with research firm Dataquest in San Jose. "Let's say 4 to 6 feet. The week before, when you went into the store, was there blank shelf space somewhere? No. So someone had to leave. If you're at the bottom of the pile for whatever reason, you may be moved for the later arrivals. If The 11th Hour starts seeing sales velocity, they'll give it another 4 feet. And they're going to take it out of someone's hide."
The Urge to Merge
We're already seeing the negative effects of the retail squeeze on many software companies. In the last twelve months, smaller developers such as Medio and RoundBook have gone under. Media Vision's software division, which came out with a strong group of titles in 1994, helped contribute to the red ink that eventually put the company into Chapter 11. Putnum New Media, a division of Putnum/Berkeley Publishing, folded last April—despite winning awards for its children's CD-ROM title, Big Anthony's Mixed-Up Magic. Even larger, well-respected companies, such as Accolade and Spectrum-HoloByte, have borrowed additional funds and refocused on their core strengths.
Gilman Louie, Spectrum-HoloByte's CEO, predicts that software game developers will pair off and consolidate over the next year, as they attempt to compete with Microsoft and Electronic Arts. The consolidation process is already well underway. SoftKey, for example, purchased The Learning Company, MECC, and Compton's NewMedia in the final months of 1995. As retailers and consumers increasingly turn to the established brands, software developers seek security in being large.
Buyouts also keep quiet the industry's dirty little secret—most software companies are losing money on their commercial titles. Gistics, a research firm in Larkspur, California, shocked the industry last year when it released a study of 912 multimedia developers. The study claimed that only 4 percent of the production units of these companies were making money. Michael Moon, an analyst with Gistics, says that the study was widely misquoted: While the production units of most developers are losing money, the companies are subsidizing their title development with other income. Like aspiring actors who drive cabs and wait tables to make ends meet, CD-ROM developers sell multimedia services, create corporate CD-ROMs, and train others in multimedia development to pay their expenses until they have a hit title.
Many developers use buyouts and stock offerings to pay for their next projects. As Lavin explains it, a company might spend $3 million developing three CD-ROM titles, which generate only $1 million in sales. No problem. Investors are valuing multimedia companies at ten times earnings, so when the company goes public, its stock is worth $10 million. The stock offering generates an additional $8 million for title development—even though the company has failed to turn a profit. Many financial analysts feel that multimedia companies are ridiculously overvalued, but until the bottom falls out of the CD-ROM market, it's someone else's problem.
Just Like in the Movies
One major reason for the lack of profits is a huge increase in production and promotion costs. Games that depend heavily on video and 3-D graphics are getting the kind of budgets usually associated with television movies and grade-B Hollywood films. Much as the producers of Waterworld played up the extraordinary costs of its production, Sierra, Origin, and Interplay have reaped a lot of mileage from revealing the $3, $4, and $5 million budgets required to produce Phantasmagoria, Wing Commander III, and Stonekeep, respectively.
Are these budgets reasonable? According to Pine, once you factor in licensing costs and money paid to retailers to guarantee shelf space, "then you're looking at hitting a break-even point of 200,000 to 250,000 units on those multimillion dollar titles." The top-selling titles can sell that many units, but the market isn't big enough to support more than a few mega-hits at a time. For companies that spend millions on a project, only to have it fail in a matter of weeks, these budgets can spell disaster.
"The total size of the market is incompatible with million-dollar products," says Lavin. "It would work [only] if the market were 10 times the size." This situation strongly favors the media conglomerates, such as Disney, Sony, Time Warner, and Viacom. They can extend an established property over several media, and thus spread their costs over a number of related projects.
Yet smaller companies continue to spend enormous amounts of money hoping to create the next Wing Commander or The 7th Guest. Their goal is to establish an ongoing series that can pay big dividends in the years to come. Sequels are where the real money is made, but it's harder than ever for a small developer to do what Sierra did with King's Quest, Maxis did with SimCity, and Spectrum-HoloByte did with its Falcon series. To reach a broader audience, developers are focusing more on creating Hollywood-caliber productions than providing the best in quality game play.
"For a small company to think that it's going to be able to do what an Acclaim, Capcom, or EA does is crazy," says Gary Schultz, an analyst with Multimedia Research Group in Sunnyvale, California. "They bring in the top stars, pay them a lot of money, have five or ten products that come out at the same time, and spend millions to promote them."
Schultz says that there was a similar gold rush in the video business in the early 1980s. "Time Warner thought it was going to make many billions of dollars just publishing video titles." The video companies soon learned what many of the software developers are learning today—unless a company has a high-quality product and a good distribution system, it will have trouble competing in an overcrowded market.
Finding a Niche
The small companies that are successful generally find a market niche, create high-quality products to fill a void, and build a brand name that consumers come to respect. Pine likens the strategy to that of the small record labels, such as Rounder and Windham Hill, that have established a reputation for quality music in a particular area. By filling a niche, they're able to compete in an industry dominated by a handful of large diversified record companies.
"When you're big, you have enough clout and muscle that diversification works really well, but if you're small, diversification can bring problems," says Pine. He cites Access, Grolier, and Maxis as examples of small software companies that understand their particular market niches.
Dongleware has also gotten excellent reviews for three of its computer games—Bolo, Oxyd, and Oxyd Magnum—but has been burned so badly by the retail channel that it has spent the last two years moving out of the stores. "It took us almost nine months to get our money from the retailers," says Schultheis. "If you have to run after your money, you're going to be so angry with people that you can't be creative anymore."
If CD-ROM titles can get excellent reviews in the magazines, but are unable to find a place at retail, then something is clearly wrong with the current distribution system. The bottom line: A growing number of outstanding titles never make it to the stores, because a growing number of mediocre titles are buying their way in.
Some analysts believe the squeeze for shelf space will loosen as the superstores increase their share of the market. But the question remains are to whether they'll be willing to offer the space to promising titles from unknown developers. Will the next Myst get a chance if it doesn't carry a logo as familiar as Brøderbund's?
Others argue that the Internet will ultimately offer a level playing field for program demos and distribution. Instead of strolling the retail aisles, you'd surf the Net, then download the programs you want to buy. In this scenario, Microsoft's applications would have no advantage over a killer app from Joe down the street—but current bandwidth limitations put this possibility at least four or five years away.
Some claim that the marketplace will sort it all out, and that developers will voluntarily cut back on their production plans, realizing that their chance of creating the next Doom or SimCity is pretty remote. Don't count on this scenario anytime soon. According to InfoTech, CD-ROM publishers plan to release 42 percent more new titles in 1996 than they did in 1995, while the retail channel will grow at about half that rate. It seems that for the present, The Big Squeeze will continue its grip on the industry, and your ability to find great CD-ROM titles.
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