0:00

Okay, let's hear your best Sega scream impression.

0:04

Sega! Is

0:06

the emphasis more on the set? Sega! They

0:09

talk about it in console wars. Yeah, the

0:11

voice actor. And he was sick. I

0:13

think he had thrown up earlier in the day

0:15

and he was just in such a bad physical

0:17

and mental state that he could do this insane

0:20

scream. It was perfect. The cost

0:22

you pay for great art.

0:23

Who got the truth? Is

0:26

it you? Is it you? Is

0:29

it you? Is it you? Is

0:31

it you? Is it you? Sit it down. Say

0:34

it straight. Another story on the way. Who got the

0:36

truth?

0:40

Welcome to this episode of Acquired, the

0:42

podcast about great technology companies and

0:44

the stories and playbooks behind them. I'm

0:46

Ben Gilbert. I'm David Rosenthal. And

0:49

we are your hosts. Today we

0:51

have for you our first Acquired

0:54

short.

0:55

There are some stories that deserve three

0:57

or more hours to chronicle the entire

0:59

company history start to finish.

1:01

But there are also some stories or perhaps

1:04

chapters of stories that can be told

1:06

in an hour or so. Now in

1:08

Nintendo part two I asked David a question.

1:11

How exactly did Sega manage

1:13

to go from having over half

1:15

the video game console market in the US

1:18

with the Sega Genesis to abandoning

1:20

the console business entirely after

1:22

Dreamcast in a few short years?

1:25

And David, you gave us a quick short

1:27

answer, but we were both sort of looking at each other

1:30

afterwards thinking there is so

1:32

much more to this story. It really does deserve

1:34

its own episode. And frankly, it's

1:36

a nice opportunity for us here at Acquired

1:39

to take a look at a company that didn't

1:41

become hugely successful and

1:43

what the lessons we can learn from

1:45

that one are. So we bring you today

1:48

the death of Sega.

1:49

This could be really fun experiment. We

1:52

get to tell this story, right? Listeners,

1:54

let us know if you like this and we might do

1:56

more of them. Yep. Let us know

1:58

in the Slack Acquired.fm

1:59

slash Slack. It is the best place

2:02

to discuss episodes after we release them.

2:04

Tons of folks joined after the Nintendo episodes.

2:06

There's a lot of great video game discussion right

2:09

now. Check out ACQ to our

2:11

second show with interviews. The most

2:13

recent interview is with David Shue, the founder

2:15

and CEO of Retool. And

2:18

with that, the show is not investment advice.

2:20

David and I may have investments in the companies

2:22

we discuss. And this show is for informational

2:24

and entertainment purposes only.

2:26

We could technically still invest

2:29

in Sega today. Sega Sammy Holdings. Not

2:31

quite sure we'd want to, but let's get into

2:33

it. Spoilers. So we

2:36

start our story in

2:38

around call it 1992, 1993. Sega

2:43

and its Genesis, as

2:45

it was known in North America, has battled

2:48

Nintendo and the Super NES to basically

2:51

a tie in the U.S. home

2:53

console market, which

2:55

really in practice, if you go listen to our Nintendo

2:57

series, was beating the pants off of Nintendo.

3:00

Like Sega had no right to

3:02

get to 50 percent, maybe even 50 percent plus

3:05

market share, given how far behind they

3:07

came from. Imagine you're a startup and

3:09

you're fighting some big incumbent. And within three

3:11

years, you get to a basically 50 50 market

3:14

share.

3:14

It's totally nuts. The Genesis.

3:17

I mean, it was the cool console

3:19

in the 90s. It had Sonic. They've

3:21

got John Madden football. They've got great

3:23

sports franchises. They've got the Mortal

3:26

Kombat version with the blood. Oh,

3:28

the real red blood and not the Nintendo

3:30

toned down gray blood.

3:32

And they have about a 30 million total

3:35

unit install base of the Sega Genesis

3:38

around the world, the vast majority of which about 20 million

3:41

is in the United States.

3:43

Yeah. And this is basically the best video game

3:45

consoles we're doing at the time. Years later,

3:47

the PlayStation two with one hundred and fifty

3:49

million. But

3:51

no one was doing hundred million plus

3:53

units sold game systems at this point in history.

3:56

So 30 million rock solid,

3:58

huge player in the market. A great.

3:59

base to build on. Yes. Now, also

4:02

at this time and call it 1992, 1993, it has become clear that compact

4:09

discs are the

4:11

future, not just for the video game

4:13

industry, but for everything. CD album

4:16

sales and like CD players are on

4:18

their meteoric rise at this point.

4:20

It is a huge driver of business

4:22

for companies like Sony.

4:24

In the personal computer industry,

4:27

neighboring to the gaming industry, CD ROM

4:29

drives are now becoming standard in

4:31

PCs. This is how software

4:34

is shipping. This is how games are shipping

4:36

in the PC industry. And the trade off

4:39

with games is of course,

4:41

a cartridge doesn't really require loading

4:43

time.

4:44

The CD, while it has a ton more

4:46

storage,

4:47

does have trade offs where it needs to load stuff

4:49

onto the machine. Yeah. And there's

4:52

one other really big advantage of

4:54

the CD medium for the business side

4:57

of the industry,

4:58

which is that CDs are much lower

5:00

cost to produce than cartridges.

5:03

Cartridges, you got to like put silicon

5:05

in there. They have chips. CDs are

5:07

just optical discs. You can stamp these

5:09

out for a tenth, a hundredth of the cost

5:12

of a cartridge. Pennies.

5:14

So it's obvious

5:16

that the home video game console industry

5:18

is also going to move to the CD

5:20

medium as its primary distribution

5:23

technology going forward. And the

5:25

way

5:26

right now that people in the industry

5:28

are thinking that this great migration is

5:30

going to happen is not

5:33

via new consoles, but

5:35

via add on peripherals

5:38

to existing consoles. Looking

5:40

back now, this was obviously a very,

5:43

very poor path and evolutionary branch

5:45

of the gaming tree that mercifully died

5:47

off.

5:49

But at the time, everybody seemed

5:51

to be doing it. There

5:52

are other consoles like Atari's Jaguar

5:55

console came out with a CD-ROM

5:57

add on the NEC PC Engine.

5:59

in Japan in the US, it was called the Turbo Graphics

6:02

console that came out with a CD add-on.

6:05

And of course, famously, Nintendo

6:09

is working on a major partnership

6:12

that they've announced that everybody knows about with

6:14

none other than

6:16

Sony to make

6:18

a CD-ROM add-on for the

6:20

Super Nintendo that would be known as the

6:22

Play Space Station, the

6:25

Sony Play Station add-on

6:27

to the Super Nintendo. We'll

6:29

come back to that in a little bit, that doesn't go

6:31

as planned. This is now our third episode in

6:33

addition to Sony and Nintendo, where we've talked

6:35

about this. So of course, back to Sega,

6:38

they are

6:40

working on a CD-ROM add-on too

6:42

for the Genesis. And just like

6:45

with the Genesis, they had beat Nintendo

6:47

and the Super Nintendo to market with the

6:49

first 16-bit console, they want

6:51

to make sure that they beat

6:53

Nintendo and Sony to market

6:56

with the first CD-ROM add-on.

6:58

So in late 1992,

7:00

they launch the Sega CD

7:03

add-on for the Genesis

7:05

in North America. It comes out

7:07

with this game called Night Trap, which

7:10

is a full motion video game that uses

7:13

like,

7:13

it's basically a playable movie. It's

7:15

a really crappy game, but people think

7:18

that this is the future that CD-ROM technology

7:20

is going to enable. It's like a zombie slash,

7:22

like a teen horror flick that you basically play

7:25

as a video game. This is one of

7:27

the games that gets Congress all spun

7:29

up about video games are corrupting

7:31

the youth and leads to the creation

7:34

of the entertainment software ratings

7:36

board, the video game industry

7:38

version of movie ratings that comes out. Rated

7:40

E for everyone. Yeah, exactly.

7:43

So funny. You go back and look

7:45

at this stuff today and you're like, yeah, compared

7:48

to Call of Duty, you're like, this is nothing.

7:50

Seriously. Grand Theft Auto. Yep.

7:52

But ultimately, despite all this hand

7:55

wringing over

7:56

these games and everything coming out with these CD

7:59

add-ons.

7:59

There is a fundamental problem

8:03

with what

8:04

Sega is doing here,

8:05

and that is that add-on

8:08

technology for consoles is

8:10

never really a good idea because

8:13

the business model of the video

8:15

game console industry, it's a razor

8:17

and blades model.

8:19

And the way that

8:20

video game companies like Sega, like Nintendo, like

8:22

Sony in a minute, make all of their profits

8:25

is from

8:26

the software sales, not from hardware

8:29

sales. And so you want to have as big of

8:31

an install base of consoles as possible to

8:33

amortize the software sales across. So

8:36

when you're selling an add-on console, you are

8:38

limiting the target market

8:40

to the 30 million people that already

8:42

own a Genesis. It will be smaller

8:45

by definition than the market

8:47

base that you've already created.

8:50

And this creates a huge problem because then

8:52

developers don't want to make

8:55

their best games for a limited install

8:57

base of consoles.

8:58

Consumers don't want to go buy

9:01

a platform that's only going to have a very limited

9:03

number of good games, and it quickly

9:06

becomes a death spiral.

9:08

So

9:08

the Sega CD sales, despite

9:11

starting off relatively strong,

9:14

stall out quickly. Sega only

9:16

sells about 3 million Sega

9:18

CD units versus the 30 million plus

9:20

Genesis units that they've sold. This is

9:22

a

9:23

flop for them.

9:25

Now, Nintendo, by either luck

9:27

or skill or maybe just being slow

9:29

in Nintendo, they never

9:32

actually come out with the CD add-on

9:34

for the Super Nintendo and the Sony partnership falls

9:37

apart. So they kind of avoid this

9:39

disaster that Sega stumbles into. But

9:42

after the Sony partnership fell apart, didn't

9:44

they form a new partnership with Philips

9:46

to create the Nintendo CD

9:49

thing?

9:49

They did, but that delayed

9:51

everything enough that everybody kind of

9:53

realized that this was a bad idea. And Nintendo

9:56

basically also abandoned that project

9:59

and let Philips come out with it.

9:59

with their own console, I think it was called the CDI. Nobody

10:03

supported it, it sucked. It wasn't part of the

10:05

Super Nintendo ecosystem.

10:06

Okay, so what does Sega do after

10:09

the Sega Genesis

10:11

CD add-on is abandoned?

10:14

Well, you would think, just like Nintendo

10:16

sort of did here, you would learn your lesson, console

10:19

add-ons are a bad idea, you've got all

10:21

these problems with it, it's a limited market,

10:24

you cut your losses, you move on,

10:26

you just embrace the next generation.

10:29

That's the logical thing to do here, right? Yup.

10:32

That is not what Sega does.

10:34

They decide that they are going to follow up

10:36

their failed console add-on with

10:39

another

10:40

failed console add-on.

10:43

That's right,

10:44

the infamous and infamously

10:46

terrible 32X

10:47

which

10:50

launches in the fall of 1994. This

10:54

is another hardware add-on for

10:56

the Sega Genesis system

10:58

that you plug into the top of the console and

11:00

it adds a 32-bit processor

11:03

to the Genesis. And it works sort of like

11:05

the same way a game genie worked, right, you

11:07

like put it in where your

11:09

game cartridges go and then

11:11

that

11:12

way when you put your actual

11:14

game cartridge on top, it's sort of like stacked like

11:16

a tower? Yes, exactly, this whole thing

11:19

is so hair-brained. I think it added

11:21

more colors maybe to existing

11:23

Genesis games, but then it also had its

11:26

own 32X games that you bought separately

11:29

for it. This thing was just an unmitigated

11:32

disaster. One of the worst video game industry

11:34

decisions of all time.

11:36

Huh, okay. Yeah, so

11:38

the 32X sells less than 1

11:40

million units total.

11:43

And in the meantime, almost

11:46

immediately thereafter, Sega

11:49

also rushes out a

11:51

separate brand new native 32-bit

11:54

system

11:55

to market called the Saturn.

11:57

What a nightmare. This makes no sense,

11:59

let's go.

11:59

on here. The story goes that all

12:02

of this was basically a decision handed

12:04

down from Sega in Japan.

12:06

They order Tom Kalinsky, the

12:08

CEO of Sega of America, to

12:11

launch the Saturn. Sega of

12:13

America doesn't really want to do this, but they don't have a choice.

12:15

So they spin up their patented brilliant

12:18

Sega marketing launch playbook

12:20

for the Saturn. They announced to

12:22

America

12:23

that September 2nd, 1995 is

12:26

going to be Saturn day. It is Saturday,

12:28

September 2nd, and the Sega Saturn

12:31

is going to launch on that day. But then at

12:33

E3

12:34

in May of 1995, they

12:38

shock the world. Tom Kalinsky comes

12:40

out on stage for the Sega keynote and says,

12:42

actually, I know we told all of

12:44

you that we were going to launch in September.

12:47

Well, surprise, we're launching today. The

12:49

Sega Saturn is coming out right now.

12:51

The press, the industry, the developers here, they're

12:53

all like, what?

12:55

It's like exciting, but confusing. This

12:58

makes no sense. There's

13:00

no Sonic game ready. There's

13:03

no third party games at all.

13:06

The retailers aren't prepped.

13:08

They don't know to expect this. There's been

13:10

no marketing. None of the groundwork has been

13:13

laid. In fact, everybody thinks this thing is coming out

13:15

in September.

13:17

It's really weird because it's like everyone's

13:19

sort of recent hero, the David versus

13:21

the Goliath of Nintendo,

13:23

seems like they should be firing on all cylinders.

13:25

But you have the market confusion with the 32 X

13:28

and the Sega Saturn and now Sega

13:31

Saturn sooner. What the heck's going on? Right

13:33

on top of this maybe forgivable Sega

13:35

CD thing that happened, you know, a year or two

13:37

before, like this whole thing is just weird.

13:41

So on the back of

13:43

this, the Saturn

13:44

flops. It sells just

13:47

over 9 million units compared

13:49

to the Genesis, which sold 30 million

13:52

units.

13:53

And if you read the book, console wars

13:55

by Blake Harris, he spends a lot

13:57

of time with Tom Kalinsky, the CEO of Sega of

13:59

America.

13:59

and interviews him. And Tom and

14:02

the other folks who were at Sega of America at this

14:04

time, like, they're somewhat diplomatic, but

14:06

they just kind of lambast the

14:09

Japanese management of Sega

14:11

at this point in time.

14:12

They say that they at Sega of America fought against

14:14

all of these decisions, that the

14:17

Japanese parent company was jealous

14:19

of Sega of America's success with

14:21

the Genesis. Cause the Genesis sold really

14:23

well in America, it didn't sell as well in Japan. No,

14:26

all of the Genesis's success was

14:29

in America Europe and South

14:31

America. It basically did nothing

14:33

in Japan.

14:34

And in Consul Wars, the author draws this

14:36

great analogy of Japan

14:39

as the parent and America

14:41

as the child. So shouldn't the parent

14:43

be proud of the child's success? But

14:46

in reality, the way that it actually

14:48

was going on is that Japan and

14:51

America were sort of sibling

14:53

markets. And the parents' favorite

14:55

child used to be Japan. And as the parent

14:58

showed more favoritism toward America,

15:00

the Japan leadership sort of retaliated

15:03

and found ways to

15:04

kick and scream and say, hey, you need to pay more attention

15:06

to me. Yeah. And Sega

15:09

at this point, of course, is a Japanese company

15:11

and the board is Japanese. And at the end

15:13

of the day, Japan wins

15:15

here. So Tom and

15:18

most of the rest of the team at Sega of America,

15:20

they get super frustrated.

15:22

They end up just leaving the company, including

15:25

Steve race who masterminded the whole

15:27

aggressive marketing strategy behind the Genesis,

15:30

you know, the Sega scream, the welcome to the next level.

15:32

He goes to work for Sony to

15:34

launch the PlayStation. Oh, yes. We'll

15:37

talk much more about that in one

15:39

minute. So Sega

15:42

of Japan is kind of running the ship now at

15:44

this point in time.

15:45

They decide after a couple of years

15:48

to give up on the Saturn, they launch another

15:51

new internally developed console,

15:53

the Dreamcast. The Dreamcast actually

15:56

had some real innovations to it. Like it was

15:58

the first true online.

15:59

console

16:01

that shipped with internet connectivity

16:03

built in.

16:04

It had the little slide out handheld

16:06

thing that was like a little game boy that popped out of

16:08

the controller that was super cool. Oh

16:11

yeah, the VMU, that thing was cool. And

16:13

a bunch of the design philosophy made

16:15

a lot of sense. They were using commodity components

16:17

instead of special silicon for it. Yep.

16:20

But unfortunately, it

16:22

launches against the PlayStation 2,

16:25

which goes on to become the best selling console of

16:27

all time and completely trounces it. So

16:29

the Dreamcast sells even fewer

16:31

units than the Saturn. And it's really

16:33

sad. After just two and a half years

16:36

on the market, Sega ends

16:38

up discontinuing the Dreamcast,

16:41

announcing that they're getting out of the hardware

16:43

business entirely. They're

16:45

going to go to just being a video game developer

16:48

and publisher on other platforms,

16:51

on PlayStation, on the Xbox, et

16:53

cetera.

16:54

The company really just becomes a shadow of its

16:57

former self. It limps along. And

16:59

then finally, after a couple of

17:01

years from kind of 2001, 2002 into 2003 of Sega just

17:06

making games for other platforms,

17:09

the company gets sold off to another

17:12

Japanese public company, a company called

17:14

Sami that was a manufacturer of Pachinko

17:17

machines, which is kind of like the Japanese

17:19

equivalent of pinball machines.

17:21

This is sort of sad ending with a whimper

17:24

for this once legendary Sega

17:26

Scream company. Right.

17:29

You've got the exodus of all the talent.

17:31

You're sort of still scratching your head a little bit about

17:33

how it all fell apart so fast.

17:36

You know, I started digging into why

17:38

and how and what were the corporate

17:40

transactions that actually happened around here.

17:43

And David, I feel like there's more to this story because I

17:45

pulled up Pitchbook to look.

17:47

There are a lot more transactions around this company

17:49

than you've sort of mentioned so far. Oh,

17:52

are there? There are. Oh, if

17:54

only there were a podcast that went and did really

17:56

deep research on what actually happened here.

17:59

Well, while we're talking about PitchBook, this is

18:02

a great time to thank them as our sponsor

18:04

for this episode. And I'm going to keep this segment

18:06

very short and sweet this time because

18:08

you will be able to get a sense of all the great

18:10

info in PitchBook as a source

18:13

for this episode as we go through it

18:15

later on. And PitchBook is, of course,

18:18

the platform you can log into and get great access

18:20

to an insane amount of private and

18:23

public company data, like what companies

18:25

raised money and when, at what prices,

18:27

and number of employees in the board composition. Basically,

18:30

every VC and PE firm I know

18:33

has a PitchBook account, and it's essentially a

18:35

competitive disadvantage at this point if

18:37

you don't have one. If you want to sign up for PitchBook,

18:40

you can go to pitchbook.com slash acquired.

18:42

Just tell them that you heard about them from Ben

18:45

and David at Acquired. And our thanks to PitchBook

18:47

for powering many of the insights

18:50

and stats throughout this episode.

18:53

So David, feels like there's some big things

18:55

missing from the story here. Yeah, you like that little story that

18:57

I just told you, right? It almost

19:00

feels high gloss, apocryphal.

19:03

And if you really stare at it, you're like, I'm

19:05

not satisfied. That can't be right. This

19:08

is insufficient. Everything you say is exactly correct.

19:10

The funny thing is, though, that like listeners for you all

19:12

listening,

19:13

I bet most of you, if you knew

19:15

any version of the story of the

19:17

death of Sega,

19:19

what we just told was the version you probably know.

19:23

But while it's not wrong,

19:25

it's only one version of the story. And

19:28

the other version

19:29

is both way more charitable to Sega,

19:32

the parent company in Japan.

19:33

And also, I think way more interesting in terms of like lessons

19:36

we can take from it. So let's tell it.

19:39

If you go listen to our two

19:41

part Nintendo saga,

19:42

we talked

19:44

quite a bit about Sega along

19:46

the way. And especially in our first

19:48

Nintendo episode, when we talked about

19:50

Sega,

19:51

we talked about them as this arcade

19:54

company. And that's actually

19:57

what Sega was. The home

19:59

console.

19:59

console business, the Genesis,

20:02

the Master System before it.

20:05

These were like side project offshoots

20:08

from what

20:09

was otherwise an

20:11

enormous and very successful

20:14

arcade business based back in Japan.

20:16

Totally. It started as service

20:18

games back in the like 40s,

20:21

50s, this merger of arcade

20:24

game makers and arcade distributors.

20:26

You even had this story that you were telling. I

20:29

think we actually cut this from the Nintendo episode for Time.

20:31

But on Periscope, the Sega,

20:34

very innovative Sega game, they standardized

20:36

the unit of the quarter as what

20:38

you pay for an arcade video game

20:40

session.

20:41

Yeah, the arcade industry, it's lost

20:43

to history now because basically it doesn't exist

20:46

anymore. But it was bigger than

20:48

the home console industry and nobody

20:50

was bigger in the arcade industry

20:53

than Sega. They were the OGs. They

20:55

literally standardized the quarter, as you say. Now

20:58

that game, Periscope,

21:01

came out in the 60s. This is before video

21:03

games. This is what was called an electro-mechanical

21:05

game. So there were like mechanical

21:07

elements to this cabinet of

21:10

submarines and ships that moved around. They

21:12

were like plastic and cardboard. And then you fired

21:14

a gun that had like

21:16

torpedoes that traveled on a light bulb

21:18

path to hit the ships. I think it was pretty

21:21

cool. But it became so successful.

21:23

Sega actually gets

21:25

acquired in 1969.

21:28

Yeah, I was shocked to see this in Pitchbook. I scrolled

21:30

all the way down like I normally do when I'm looking at like private

21:32

companies who raise money to see who their seed investors

21:34

were. And the first transaction for

21:36

Sega is from 1969.

21:40

Yes. The company that acquires them is

21:42

Gulf and Western, which is a big oil company.

21:44

Oh, yeah. The U.S. So like, what the hell is going on here?

21:47

Well, turns out at the time Gulf

21:50

and Western also owned Paramount

21:53

Pictures, the movie studio. Oh,

21:56

I've always seen that at the little like,

21:58

I don't think you see it anymore.

21:59

the little title screen. Yeah, when

22:02

the movie's starting. Yup.

22:03

So they acquire Sega and

22:06

merge it into Paramount.

22:08

The operations stay separate and the like

22:11

boards of Sega and Paramount stay separate. But within

22:13

Gulf and Western, Sega is part of the Paramount

22:16

empire. So much so that

22:18

they take their two most talented

22:21

Paramount executives

22:23

and they put them on the internal

22:26

Sega board within

22:27

Gulf and Western. Do you know who those two people are? No.

22:29

Michael Eisner

22:32

and Barry Diller. What?

22:35

Right? I had no idea.

22:37

So Michael Eisner and Barry Diller are like

22:40

key parts of the Sega history. And

22:42

all of this, all we're talking about, this is before Atari, this

22:44

is before there is a home console business, this

22:47

is before there's a video game business, period.

22:50

This is how important Sega is in arcades. 20

22:52

years before Michael Eisner becomes the CEO

22:55

of Disney and long before Barry

22:57

Diller dreams up interactive Corp. Yep.

22:59

This is in the 1970s.

23:01

So we also talked on the Nintendo

23:03

series about how Atari got acquired

23:05

by Warner Brothers and this was crazy. Like Atari,

23:07

this video game company becomes part of this movie studio

23:10

and then it becomes the biggest part of this movie studio.

23:13

Warner Brothers was just copying Paramount

23:15

and what they did with Sega. Isn't

23:18

that so funny? Wild.

23:20

So part of the strategy that

23:22

Sega adopts during this time, they're

23:24

like a truly international company because the

23:26

arcade business was a truly international

23:28

business. They're thriving in the US, they're

23:31

thriving in Japan, they're thriving in Europe,

23:33

all over the world. They start not

23:35

only

23:36

building and creating these

23:38

games, these arcade cabinets,

23:40

they start building out their own arcade

23:43

centers that they operate. They're like, we're going to make

23:46

money every which way in this industry.

23:48

So they're called family fund centers in

23:50

Japan

23:51

and Sega centers in the US.

23:54

The Sega centers in the US

23:56

change hands a few times go on to get rebranded. Sega

23:58

always stays involved. These become

23:59

time out arcades, which is one of the

24:02

biggest chain of arcades in the US. Whoa,

24:04

okay. So Sega's got hundreds

24:07

of these arcades that they are just

24:08

printing cash out of, because they're

24:11

making money from selling the cabinets to their

24:13

own arcades and other arcades. And

24:15

then the arcades themselves are like hugely profitable

24:18

businesses. Yeah, I mean, there's a lot

24:20

of arcades that when you look at the side

24:22

of them have a gigantic Sega logo

24:24

plastered over it. I mean, clearly a company focused

24:27

not just on home consoles, but like making

24:30

games.

24:31

Yeah, when you say a company focused not just

24:33

on home consoles, from the parent

24:35

company's perspective, they'd rather not focus

24:37

on home consoles at all. So

24:39

now you can start to see

24:41

another perspective on things here.

24:44

In 1981, Sega publishes

24:47

the game Frogger that Konami had

24:49

made, but Sega published it. They made hundreds

24:51

of millions of dollars on that thing.

24:53

In 1983,

24:55

right before the home video game console crash,

24:58

led by Atari, they do 214 million

25:01

in revenue,

25:02

Sega does, as a division within

25:05

Paramount. Then when

25:07

the video game crash happens at the end of

25:09

that year,

25:10

Paramount, just like Warner Brothers and

25:12

Atari,

25:13

they want out of the business. So they want

25:15

to divest Sega.

25:17

And one of the original founders from

25:19

back in the day, a guy named David Rosen,

25:22

and a Japanese entrepreneur of a company Sega

25:24

had acquired named Hayao Nakayama. They

25:27

engineer a management buyout

25:29

of Sega

25:30

for the grand total price. I don't know if this

25:33

is in pitch book of $38 million. This

25:37

is the steel of the century. Yes,

25:39

actually. There's a transaction in 1984. Looks

25:42

like the investor name is CSK Holdings.

25:45

Yes, that's it. So CSK Holdings

25:47

was a public Japanese company that

25:50

Rosen and Nakayama knew the management

25:52

of. They financed this

25:54

buyout. They were like the PE shop. They

25:56

were the sponsor of this transaction. Oh,

25:59

interesting.

26:00

And this is how Sega becomes

26:02

an actual Japanese company, even

26:05

though they were started by Americans to serve

26:07

military bases back in the day.

26:09

Right. Okay, so wholly bought

26:11

out by Gulf and Western, then wholly

26:13

spun out. Yes, they bought the whole thing

26:15

for only $38 million. Like

26:17

this is ridiculous. This company, which

26:20

is legendary in the arcade industry,

26:22

did $214 million in the year ended six months before this. Why

26:27

did they

26:28

value it so little? This is the thing.

26:31

Because of the home video game crash

26:33

in America, video games

26:36

in general just became this toxic asset

26:38

that nobody wanted to own, especially

26:40

Paramount and Warner Brothers was divesting

26:43

Atari.

26:43

So the arcade business,

26:46

yeah, it got hit by the crash, but it actually

26:48

was fine. And so this was just an amazing

26:51

deal. Management bought the dip because

26:53

they knew that they weren't actually really affected

26:55

by this. Boy, did they ever.

26:58

So then I think that was in 1984, they

27:01

would go on to take it public, I think

27:03

in 1988 on the Tokyo

27:05

stock exchange. So now it's a publicly

27:07

traded company. Yep, that makes sense because

27:10

pretty quickly after the buyout, Sega

27:12

gets back to their old tricks and they're crushing

27:15

it. They're pumping out smash arcade hits

27:17

like Outrun, people might've heard of, very

27:19

famous racing game, Shinobi,

27:22

Afterburner,

27:23

Altered Beasts, which was a kind of beat

27:26

them up brawler that we talked about on the Nintendo

27:28

episodes. That was the original pack-in game

27:30

before Sonic with the Genesis.

27:32

So they're back to making hundreds

27:35

of millions of dollars in their arcade business,

27:38

both making the games and operating them in their

27:40

own arcade centers. Nakayama,

27:42

who was one of the two guys involved in the

27:45

buyout. And Nakayama and Rosen had to get

27:47

hugely wealthy from this because

27:49

of how unbelievably little they

27:52

paid for the equity that by the time they IPO'd

27:54

it would have been very valuable. Yes, I

27:56

don't know the details, but I'm sure they did.

27:59

Nakayama?

27:59

he starts pushing the company,

28:02

he gets worried about what Nintendo's doing

28:04

and what he sees with the NES. And he says, we

28:06

should also enter the home console business.

28:09

So it's like a diversification bet.

28:10

Exactly.

28:11

Rosen, CSK, the

28:14

rest of the board, they're not that supportive

28:16

because they're like, we're doing great in arcades. Like I

28:18

don't really care that much, but sure, if you care

28:20

about this, go do this. And that's

28:22

when Nakayama goes and he

28:24

recruits Tom Kalinsky to come in and

28:26

run North America. It's kind of

28:29

like a surprising success

28:31

to everyone, the Genesis in North America.

28:35

There's the scene that we talked about

28:37

in Nintendo part two where Tom comes

28:39

over and presents his four point plan for

28:41

dethroning

28:41

Nintendo to the board

28:44

in Japan. And the Japanese

28:46

board is like, I don't know, like I don't really like

28:48

this. Now it all makes sense. They're

28:50

not dumb.

28:51

They're just like, why would we risk

28:53

pouring all this capital into the home console

28:56

business

28:57

when we're killing it in the arcades? And

28:59

on the one hand, it's an innovator's dilemma. On

29:01

the other hand, I have to imagine arcade

29:03

stayed a very good cashflow business for

29:06

a long time. It's not like that was actually

29:08

going away. Well,

29:09

let's get into it. So Nintendo

29:13

and the NES and the Super NES

29:15

and the home console business turned

29:18

out was never really a threat to

29:20

the arcade business because the

29:22

way arcade technology

29:25

and hardware worked was very

29:28

different than the console cycle and the

29:30

types of games were different.

29:31

In the arcades, it was all iterative.

29:33

It was constant iteration. Every

29:36

game that came out was its own

29:39

proprietary hardware cabinet. And

29:41

they were based on designs. They're called boards,

29:43

they're arcade boards, but you could tweak it each

29:45

time.

29:46

You think about

29:47

what sake is pushing with all their add-ons to

29:49

the home console.

29:50

Of course that would make sense to them. That's the way their

29:52

R&D team worked. They'd have like a core

29:55

base, call it the system 16,

29:58

which was Sega's kind of.

29:59

base 16-bit arcade

30:02

platform that they based the Genesis on.

30:05

Yeah, all these games I was just talking about,

30:07

Shinobi, OutRun, et cetera, they ran on

30:09

that, but each new game, they

30:11

tweaked the hardware a little bit. It was iterative. So

30:14

they didn't actually have to think

30:16

about we need to create a standard platform

30:19

for developers to target for

30:21

the next five years, because

30:23

every cabinet was its own self-contained system.

30:25

So it's not really in their DNA to do

30:28

a once every five plus year,

30:29

this is the standard thing, and we promise not

30:32

to change it, and we will create a bedrock

30:34

platform for you developers. That's not really

30:36

a thing.

30:37

Yes. And so that means a couple

30:40

of things for the market that keep the arcade market,

30:43

not just viable, but thriving.

30:45

The arcades are where

30:47

the most technologically advanced

30:50

games are during this era, because

30:52

the hardware cycle is so iterative.

30:55

The home systems, even the NES, as

30:57

amazingly groundbreaking as it was,

31:00

because the console cycles have to be designed

31:02

to last so long,

31:04

that's not where the latest cutting edge stuff

31:06

is. And so those games,

31:09

the Nintendo games that they're making, the

31:11

way Sega counter positioned against them with the Genesis,

31:14

they're slow, they're not exciting,

31:17

but that's what home console games became.

31:19

They became these long adventures, these fantasy

31:22

lands, a very different thing than you would do in the arcades.

31:25

Makes sense. So coming

31:27

out of this era and then into the early and mid

31:30

90s, Sega's arcade unit

31:32

is just killing it. They'd had

31:34

those hits in the 80s, everybody

31:36

got super wealthy,

31:38

and then

31:39

they start really pushing the envelope on

31:41

technology. There was a ton of innovation

31:43

coming out of Sega. They developed

31:47

the first real modern, great

31:49

3D games. We

31:51

all think now of Super Mario 64 as

31:54

being the first 3D video

31:56

game that consumers used and loved.

31:59

Actually years. before,

32:01

Sega put out the Virtua

32:03

series in the arcades. So this was

32:05

Virtua Racing, Virtua Cop,

32:08

and most importantly, Virtua

32:11

Fighter. Now this game, Virtua Fighter,

32:13

which was a fighting game,

32:14

it used 3D polygonal

32:17

technology. If you think back to 16-bit

32:19

Super Nintendo games, they're flat, they're 2D. 3D

32:22

games like Think Mario 64, you're running

32:25

around in a 3D world, all

32:27

of the environments and characters

32:29

are built using

32:31

polygonal math. We talked about this a

32:33

lot on the Nvidia episode. Right, triangles.

32:35

Triangles, this is new. Sega

32:38

is the one that actually brought really

32:40

good games to market with this, and

32:42

it was all in the arcades.

32:44

So Virtua Fighter, when it comes out in 1993,

32:47

is so popular, Sega sells

32:50

over 40,000 Virtua Fighter cabinets

32:53

worldwide

32:54

at a price of like $10,000 plus per

32:58

cabinet. So that's half a billion dollars

33:00

in revenue on Virtua Fighter. Wow.

33:03

So it's a huge win financially for the company.

33:06

Even more so though, it's

33:08

so impactful on the video game industry.

33:10

Once Virtua Fighter comes out, everybody

33:13

realizes,

33:14

hey, 3D polygonal games

33:17

are the future. And what year was this? This

33:19

was 1993, right as Ken Kudoragi

33:24

and the team over at Sony

33:26

are working on

33:28

their standalone PlayStation.

33:30

They've broken up with Nintendo, they're

33:32

gonna come to market with their own console. And

33:35

this is pivotal. So

33:38

I wanna read now from the Wikipedia page

33:41

for the PlayStation 1 console.

33:43

After Sony witnessed the success

33:45

of Sega's Virtua Fighter in 1993 in Japanese

33:47

arcades,

33:50

the direction of the PlayStation became

33:52

quote, instantly clear and

33:55

3D polygon graphics became the console's

33:57

primary focus.

33:59

Sony Computer Entertainment.

33:59

president expressed gratitude

34:02

for Sega's timely release of Virtua

34:04

Fighter as it proved, quote,

34:06

just at the right time that making

34:09

games with 3D imagery was possible

34:11

and that this was the direction the

34:13

PlayStation should focus.

34:15

So the impact of

34:18

this is huge.

34:21

Arcades remained viable

34:23

through the 90s because they

34:25

had the technological edge.

34:29

But now Sony is going

34:31

to come enter the market and they don't care about arcades.

34:34

They're going to bring their technology and

34:36

financial firepower all

34:39

to the home market and their goal now

34:42

is to make a machine that can rival

34:45

the arcade technology in the home

34:47

market.

34:48

And they have the balance sheet to subsidize it

34:50

so they can take a strategy of

34:52

coming into the home with very, very

34:54

good technology at a price point that

34:56

consumers could afford.

34:58

Yep. So here we are now,

34:59

the end of 1993 into 1994. Sony has announced that they're coming

35:04

out with the PlayStation. They're all in on entering

35:06

the video game market.

35:08

They start going around and talking

35:10

to all of the non-Sega arcade

35:13

manufacturers. Namco,

35:16

Midway in the US, Konami,

35:18

and they start

35:19

convincing them to bring all of their new

35:22

arcade games directly to

35:25

the PlayStation. When it first

35:27

comes out in end of 1994 in Japan and then 1995

35:29

in the US, it's an arcade killer. That's what

35:32

it

35:35

is billed as. It becomes so

35:37

much more than that over time. It's Grand Theft

35:39

Auto, it's Final Fantasy, it's all that. But

35:41

in the beginning,

35:42

the vision for the PlayStation was we're

35:45

going to take the technological firepower

35:48

of the arcades and we are going to bring

35:50

that in a way that Nintendo can't and

35:53

Sega won't into

35:55

the home

35:56

market. And of course, all the other arcade

35:58

manufacturers love that. this strategy. Right.

36:01

We can benefit from writing the Sony platform

36:04

into the living room, but Sega is going

36:06

to get caught in the wind here. Because

36:09

they have a home console that's making

36:11

it so that they can't go align with another

36:13

home console. Namco doesn't have a home console.

36:15

Konami doesn't have a home console. Midway

36:18

doesn't have a home console.

36:19

So before the PlayStation

36:22

launched, the arcade industry

36:26

was back up to about seven billion

36:28

dollars a year globally, and a huge

36:30

portion of that was controlled by Sega.

36:33

After the PlayStation launches, by

36:36

the end of the decade, it's down to two billion

36:38

dollars. So it drops

36:40

by 60 percent in just

36:42

a few short years, and it's all due to the PlayStation.

36:45

So the PlayStation basically killed Sega's

36:48

arcade business and their

36:50

console business. Yep. That's

36:52

what happened. Wow. So now

36:54

let's go look at this kind of original

36:57

console wars book type narrative about what happened.

36:59

We have a whole different perspective now. All

37:02

this crazy hardware, schizophrenic

37:04

add ons.

37:05

These are like panicked responses to

37:08

the coming tsunami of

37:11

Sony. Not just worrying about the home

37:13

market, but worried about their arcade dominance

37:16

as well.

37:17

Huh.

37:17

And I have to imagine at some point,

37:20

Sega of Japan lost their

37:22

desire to make a great competitive

37:25

home console because that

37:27

was the thing that was preventing them from being able

37:30

to be in business with Sony.

37:31

Now, it doesn't mean that they're going to stop making

37:34

consoles right away, but it does sort of plant

37:36

this seed of, huh, we have a

37:38

little bit of a strategy conflict here where

37:41

we either have to be all in and

37:44

winning in consoles or we

37:46

just need to make games. Yes. But

37:48

we can't really be on a seesaw kind

37:50

of trying to do both and have a foot in both worlds.

37:53

So here's what happens in September,

37:57

1994, right before this crazy 32 X thing. comes

38:00

out, Sony and

38:02

Namco, when now Namco was

38:04

Sega's biggest rival in the arcade business,

38:07

they come out with a pretty huge industry

38:09

changing announcement. They're

38:12

gonna partner together to

38:14

release a, quote unquote, Virtua

38:16

Fighter Killer arcade game

38:19

called Tekken. Folks might recognize

38:21

the Tekken series.

38:23

Well, I had no idea. Tekken is so much more than

38:25

Tekken.

38:26

The game is gonna come to the PlayStation when

38:28

it launches. It's not out yet, but yeah, like great.

38:31

Okay, we all remember Tekken. You played on the PlayStation.

38:33

I think it was an exclusive, et cetera.

38:35

But it's also

38:37

coming out right now in

38:39

September 1994 in the arcades. And

38:42

in fact, it's gonna be running on

38:45

Namco's awesome new System 11

38:48

arcade board platform that

38:50

they have developed together with Sony.

38:54

And guess what? Further surprise,

38:56

this System 11 arcade board developed

38:58

with Sony

38:59

is the PlayStation.

39:02

Whoa. So this is just

39:04

the ultimate knife in Sega's

39:06

back. They're just basically shipping

39:08

PlayStations inside of these arcade cabinets?

39:11

Yeah, it was the PlayStation hardware. Like there was some buffs

39:13

to it and whatnot, but Namco

39:15

and now Freddy soon, all the other arcade guys,

39:18

they're gonna be like, oh great. We're moving all

39:20

of our development platform for the arcade

39:22

industry to the PlayStation

39:24

platform.

39:26

The technological bleeding edge is now gonna be,

39:29

yeah, also in the arcades, powered by the PlayStation, but

39:31

in the home,

39:32

powered by the PlayStation. Wow,

39:35

what a Trojan horse.

39:38

So now, Sega is like,

39:39

oh shoot. We

39:42

are screwed. We

39:45

need to scramble the jets and just do anything

39:47

we can

39:49

to try and stave off this apocalypse.

39:52

So

39:53

they launched the 32X. Seems

39:55

really dumb, but they gotta do something. Okay,

39:58

we need to get into market right now.

40:00

with a 32-bit system to just try

40:02

and preempt

40:04

Sony here and the PlayStation launch, then

40:06

they massively accelerate

40:09

the Saturn launch. Why did they do that? The

40:11

same thing. They're just trying to do anything they

40:13

can think of to steal some of Sony's

40:15

thunder here.

40:17

Yeah, makes sense. The Barbarian is

40:19

already through the gates on the arcade

40:21

side of the business because Namco's

40:23

shipping these System 11 arcade

40:25

cabinets today and it's

40:28

right at the gates coming next

40:30

year with the PlayStation. It's funny how

40:32

much in our Nintendo episode the

40:34

conflict was Sega versus Nintendo,

40:38

but

40:38

the death of Sega really is

40:40

against

40:40

Sony. Yes,

40:42

so that brings us

40:44

to the

40:45

very famous

40:47

E3 conference in May

40:49

of 1995. And this is maybe

40:52

the most incredible video

40:54

game industry event of all time. We

40:57

referenced it earlier in the show,

40:59

but we're heading into the conference.

41:00

Sony is expected to announce the

41:03

US release date and pricing of

41:05

the PlayStation at this conference.

41:07

People expect it's gonna be in the fall. You don't kind

41:09

of know what's gonna happen.

41:11

Sega, they need to do something.

41:13

And so this is when Sega of Japan tells

41:16

Kalinsky and Sega of America, do

41:18

the surprise launch. Get up there, announce

41:20

the Saturn. Just do it.

41:22

Even though the ecosystem isn't ready, the hardware

41:24

is ready, so we're shipping it. We're shipping it.

41:27

So Tom does that. As he dutifully goes

41:29

up, he announces, oh,

41:31

forget Saturn day, you can buy the console

41:33

now. It's in limited quantities

41:35

at select retailers for a price of 399.

41:39

And he's basically doing this because Japan has said,

41:41

either you are doing this or we will find a new CEO

41:44

for Sega of America who

41:46

can do this. Yes.

41:48

399, that is the Sega Saturn

41:50

price point. Available today, May

41:53

11th, 1995.

41:56

So Kalinsky finishes his speech.

41:59

He walks off stage.

41:59

They usher everybody out of the room.

42:02

They turn it over. They get ready for the next keynote

42:04

of the day, which is going to be Sony.

42:07

Sony keynote starts a couple hours later.

42:10

Olaf Olafsson, who's the president and

42:12

head of all of Sony America, so like not

42:14

just the PlayStation, all of Sony's businesses,

42:17

he gets on stage. He starts giving his presentation.

42:20

He says that the PlayStation will

42:22

release in the US on September

42:24

9th, 1995. So Sega's

42:27

like, whew, great. They're not moving it up. We're

42:29

going to beat them to the punch. We're live today.

42:32

We got a four month head start. Let's

42:34

go. And then Olaf

42:38

invites the new head

42:40

of Sony Computer Entertainment

42:42

America, one Steve Race,

42:45

formerly of Sega of America, up

42:48

to the podium to give a quote unquote,

42:51

brief presentation.

42:52

He walks slowly up to the podium.

42:55

He's got a large stack of notes. He

42:58

places them down on the lectern.

43:00

He shuffles them around. He waits

43:02

a beat. He's ready to give his big speech. He

43:05

looks up, he looks at the audience and

43:08

he says, $2.99.

43:10

And then

43:12

he picks up his notes and he walks off

43:14

stage. And

43:16

this is, I think most people in the industry, I

43:18

think would agree that this is the greatest

43:21

moment in all of video game industry

43:24

history. Right. Of industry announcement

43:26

type things. Yes.

43:28

All right. So that Sony PlayStation one to

43:30

ninety nine for by far the

43:32

most sophisticated system on the

43:34

market. We will link to the video of this

43:37

in the show notes. It's on YouTube. I mean,

43:39

people still watch this to this day. The

43:41

reaction is amazing. At first, there's

43:43

silence because people are like, what did he just say? What does this

43:45

mean? What's going on? And then the crowd

43:48

starts cheering.

43:49

And then you can hear after about like 20 seconds

43:51

or so when this really sinks in of what

43:53

this means,

43:55

people go nuts. There's like another wave

43:58

of cheering. It's unbelievable.

43:59

Unbelievable. It's like that last wave

44:02

is all the developers realizing. Oh my

44:04

god We are going to print money

44:06

because there's gonna be so many people buying this thing

44:08

this

44:09

exact moment

44:12

in the afternoon of May 11th 1995 is

44:14

the death of Sega Because

44:18

let's go back and think about the three

44:21

key constituencies in the video game

44:24

home console Business kind of flywheel

44:27

you've got the consumers

44:28

Why on earth would any

44:30

consumer go buy a Sega Saturn

44:33

today on May 11th on its launch

44:36

day?

44:36

That has no sonic game

44:38

has only six games total and it costs 399

44:42

When you now know that the PlayStation which

44:44

is far superior is gonna

44:46

come out

44:47

just four months later They're gonna have

44:50

perfect ports of all the

44:52

latest and greatest Arcade technology

44:55

video games and it's gonna cost

44:57

less Wow, you're not gonna buy a Saturn

45:00

So that's the consumers

45:02

then the retailers

45:03

The retailers are so mad

45:06

at Sega Sega just completely

45:09

ruined all of their holiday season planning

45:12

because for retailers Q4

45:15

is everything and why are these consoles

45:17

launching in the fall in the US so that it

45:19

can be ready for the holidays? Sega just screwed

45:21

all this up

45:23

and now more importantly They've

45:25

got units on trucks en route

45:27

to their stores that they know they're not gonna

45:29

be able to sell now So they are so

45:31

mad at Sega I think it was KB toys

45:34

which then was a big franchise in America.

45:37

They drop Sega entirely They're like we're not

45:39

carrying your stuff anymore. Goodbye. You're gone. And

45:41

then

45:42

you've got the most important piece

45:45

the developers All the third-party

45:47

developers who are sitting there at e3 watching

45:49

these keynotes They're like wow

45:51

We're gonna make a ton of money on Sony

45:53

and Saturn has no chance of

45:56

building a meaningful install base So

45:58

like if I was planning on

46:00

developing games for the Saturn, I am now canceling

46:03

those plans.

46:04

This is just the worst thing that could

46:06

possibly happen to Sega

46:08

and the Saturn and the arcade business.

46:11

Now, listeners, as you can imagine, there is a tough

46:13

path that they have to now traverse to

46:16

get to the 2023 Sega

46:18

that we're going to talk about and what they

46:20

look like as a games business today. David,

46:22

I have a couple of stories that I

46:24

don't think you know about

46:26

how they made that transition. I'm curious

46:29

to know if I will stump you with that or not.

46:31

But first, we want to thank our other

46:33

sponsor, this episode. It's our

46:35

good friends at Vouche, the

46:38

insurance of tech.

46:40

Vouche, as you know from previous years, is the

46:42

best way to ensure your startup as you're getting

46:44

started,

46:45

but they have really grown into a fantastic

46:48

way to ensure your company, even as you

46:50

scale much larger. So this

46:52

season, we're talking about real life

46:54

examples of startups buying insurance.

46:57

So we're going to meet Josh, the founder of Inspectify.

47:00

Inspectify is digitizing the entire home

47:03

inspection process. Traditional

47:05

home inspections are old school, fragmented,

47:07

it's phone calls, paper forms.

47:10

It's a mess. Josh envisioned a world where

47:12

customers could order an inspection on

47:14

any property anywhere with a click of

47:17

a button. Funny story that the Vouche folks

47:19

don't know. I am an Inspectify

47:21

customer myself. Oh, no way.

47:23

That's awesome. I've actually used this service

47:26

when I bought my house. So Inspectify went

47:28

through YC in summer 2020. They quickly

47:30

built the world's largest network of inspectors.

47:33

They at this point realized we need business insurance

47:35

to meet many of the requirements spelled out in the contracts

47:38

they were signing. So they turned to Vouche,

47:40

as many YC startups do because

47:42

Vouche is a fellow YC company. So Inspectify

47:45

went to vouch.us. They cruised

47:47

through the application. They bought a Euro basic coverage.

47:49

They did the lightning fast thing when you're trying

47:51

to get a company off the ground. In 2021,

47:54

as many of you know, in the real estate industry, things

47:57

really took off. Inspectify achieved product

47:59

market fit. with big institutional

48:01

real estate buyers like REITs

48:03

who need to run a ton of inspections.

48:06

And so as many of you running startups

48:08

know, when your vision expands and you're scaling

48:11

a company, a lot of the things that you started

48:14

with aren't necessarily the way that you continue.

48:16

Vouche is the complete opposite of this. They

48:19

are awesome as you are scaling. They're

48:21

cranking out certificates of insurance for

48:24

InSpecify in 40 plus states to

48:26

onboard all these inspectors. There's a great client

48:28

services team who's anticipating

48:31

risks and helping them put together a really robust

48:34

program that will support them as

48:36

they grow. So obviously, if you

48:38

are looking for insurance today for your

48:40

startup, you can go to vouch.us slash

48:43

acquired, save 10% on your

48:45

first policy when you come in through

48:48

the acquired channel. And also

48:50

email josh at inspectify.com. If

48:52

you are interested in InSpecify

48:54

either as a real estate professional

48:55

or as a potential employee

48:59

or frankly, as a customer, I can vouch.

49:01

See what I did there, David? Haha,

49:03

there you go. That it was a great, great

49:05

experience. So our thanks to vouch.

49:07

Thank you, vouch.

49:08

Okay, so David, here are a few

49:11

things that I was curious if you knew about. So

49:13

I planted the seed earlier

49:15

with the idea that

49:16

some people personally accumulated

49:19

a lot of wealth through Sega.

49:20

One of these people was Aiseyo

49:23

Okawa.

49:24

Yes, the chairman of

49:26

CSK, right? Yes, exactly. And

49:28

then ultimately became the chairman of Sega.

49:31

So in 1999, he had loaned Sega $500 million. I

49:36

believe personally, in 2001, the writing

49:38

was on the wall, he was coming to the end

49:41

of his life. He actually forgave

49:44

Sega's debts to him ahead of

49:46

his death and returned $695

49:48

million worth of

49:51

Sega and CSK stock, which

49:54

basically was the bridge that Sega needed

49:56

to transition

49:58

a massive shift.

49:59

from the Sega that we've been talking about

50:02

this whole episode to just being

50:04

the game creator that they are today.

50:06

Yeah, because all

50:08

of this R&D that was required to

50:11

go into these new consoles, the Saturn,

50:13

and then we just talked about how the Saturn basically

50:16

got the floor wiped with it by Sony and the PlayStation 1,

50:19

Sega would then turn around and pour a bunch

50:21

of effort into the Dreamcast. The

50:24

same story would happen, but even

50:26

worse, the Dreamcast sold less than the Saturn

50:28

and the PS2 of course goes on to become

50:31

the best selling console of all time. It

50:33

takes hundreds of millions, if not billions of dollars in

50:35

R&D to create these consoles. Right, they're

50:37

just destroying their cash reserves. Yeah,

50:40

you would think

50:42

when the PlayStation comes out and

50:44

basically creates a giant sucking

50:46

sound that takes all of the business

50:49

and players in the arcade industry and brings

50:51

them into the home console with the PlayStation,

50:54

that

50:54

Sega would also get decimated in

50:57

the arcade side of their business, which was the Golden Goose.

51:00

They do,

51:01

but they kind of get a stay of execution for

51:03

a couple of years. Thanks to

51:06

this partnership that they do with the Japanese

51:09

developer Altus to launch Purikura

51:12

machines.

51:13

So yes, the core gaming experience

51:16

of the arcades does get totally

51:18

gutted and Sega along with it.

51:20

But almost like Nintendo and Pokemon, this

51:23

Purikura thing,

51:25

these are photo booth, like

51:27

selfie booths. Oh, I did

51:29

read about this. I just didn't know what it was called. Yeah,

51:32

this kind of becomes sort of the origin of the

51:34

selfie phenomenon that of course started

51:36

in Asia and then like moved to the rest of

51:38

the world. Sega was right there

51:40

at the beginning of this. So the

51:42

photo booths in the late 90s make

51:46

over a billion dollars in revenue that

51:48

Sega plugs into their quote

51:50

unquote arcade business division. Now this

51:52

is not the arcades by any stretch of the imagination.

51:55

It makes sense though. It's the same distribution

51:57

channel. It's kind of the same locations as arcades.

51:59

Exactly, but unlike

52:02

cutting-edge technology in

52:05

the arcade video game business, there

52:07

is nothing defensible about this. It's a one-time

52:09

cash grab. Exactly. So,

52:12

once both the fad subsides and

52:14

competition springs up,

52:16

by the end of the decade, Sega

52:19

no longer can continue in the

52:21

hardware business on any front. So

52:23

what do they become? Well, they

52:26

become a games publisher. You can

52:28

get Sonic on Nintendo platforms

52:30

and on the PlayStation and on Xbox,

52:32

and

52:33

that's great.

52:34

They make mobile games. I remember

52:36

in 2008, the very first iPhone game that I had was

52:38

Super Monkey Ball, which was a Sega

52:40

game. Yep, actually a really good game. Super

52:43

fun puzzle game. Yeah, and it was perfect for

52:46

the iPhone handheld device with accelerometers.

52:48

Like it was this natural fit on mobile as

52:50

people were trying to explore that form factor and figure

52:52

out what it should be. In fact, it was, I

52:55

believe, in one of the original Apple

52:58

iPhone OS app store keynotes

53:00

to show off what games you could

53:02

make, what types of experiences you could do on this device.

53:05

And so we keep talking about the Sami. What

53:07

was the Sami transaction and what was Sami before

53:10

Sega Sami?

53:11

Yeah, so Sami was and is a pachinko

53:14

machine manufacturer and operator in

53:16

Japan beyond the scope of this episode,

53:19

but pachinko is kind of like pinball

53:21

used to be in the US. It's like gambling meets

53:23

pinball and it's like much smaller

53:25

than pinball. It's like a small vertical type

53:28

thing.

53:28

Yeah, you know, on the one hand, it's sort of

53:30

gaming-esque. On the other hand,

53:33

it's also like a slot machine just like pinball

53:35

was back in the day in the US. So

53:37

that's what Sami was. They had made some

53:40

video games in the past. They had

53:42

a small video game division. And so they acquire Sega

53:44

and merge that into

53:46

their video game division.

53:48

And it's fine. It's still a public company. You

53:50

could say maybe at the bottom end of the majors or

53:52

the top end of this sort of like mid-level

53:55

game publishers out there. It's

53:58

fine. Yeah. And Pitchbook's got

54:00

this around 2003 for

54:02

the Sega and Sammy merger and they've

54:04

just been Sega Sammy publicly

54:06

traded ever since.

54:08

More stats from Pitchbook today, they're a $4.3

54:11

billion market cap company.

54:13

If you back out their cash, they have an enterprise

54:16

value of about 3.6 billion. Last

54:18

year they did 2.7 billion in revenue. So

54:22

clearly the market doesn't think much of them

54:24

with a revenue multiple of 1.3.

54:27

It's a little bit of like a zombie company.

54:30

Yeah. You know, this is a good spot

54:32

to transition to analysis here. I think there's

54:34

a couple of interesting things to talk about

54:37

in playbook. And then we have a fun sort

54:39

of way to end the episode.

54:40

One of the things I want to talk about is

54:43

despite all of these

54:46

machinations and mistakes, they

54:48

do have some pretty great IP in

54:51

the company.

54:52

The Sonic movie, it's no Mario movie,

54:54

but it did pretty well. People still

54:56

love Sonic the Hedgehog. The Acusa

54:58

franchise is strong. There's lots of other

55:00

franchises within Sega.

55:03

Is there almost, I'm wondering, like

55:05

a LVMH Bernard Arnaud style

55:08

take over opportunity here, like could you come

55:10

and acquire either the whole Sega

55:12

Sammy company or the Sega IP out

55:15

of it

55:15

and like do it right? You know, there's so

55:18

much more that could be done with this stuff. I don't

55:20

think so. I mean, my take on this whole thing

55:22

is that

55:23

Sonic was a one trick pony.

55:25

And that they never really found an

55:27

effective way to expand the franchise. They came

55:29

out with a bunch more stuff that had Sonic on

55:32

it, but I never wanted to play

55:34

3D Sonic the way that I wanted to play the original

55:37

Sonic the Hedgehog side scroller

55:39

game.

55:40

It feels to me like there's a

55:42

lot of nostalgia to play with,

55:44

but it didn't really create any durable,

55:47

extensible IP or a gameplay,

55:49

frankly.

55:50

Well, right back to the difference between Sega

55:52

and Nintendo and the games and

55:55

the difference between Miyamoto and Sonic

55:57

Team,

55:58

you know, Sega's DNA.

55:59

This is the whole point of this episode. It was the arcades.

56:02

The type of game you make for an arcade

56:05

is very different than the type of

56:07

game you make for a $60 packaged

56:10

good

56:10

home console. Sonic

56:13

was the perfect arcade style

56:15

game. That first level in the first

56:18

Sonic

56:18

was so good. And even the subsequent 3D stuff

56:20

like Sonic Adventure and beyond, the

56:23

first level of Sonic Adventure for the Dreamcast

56:26

is so good. It really is

56:28

like you play it and you're like, wow, this is

56:30

3D Sonic. This is everything I remember. The

56:33

first level is in like a island setting

56:35

and you're like chasing a whale, like running

56:37

around at Sonic speed and doing 3D loop-de-loops.

56:40

It's super fun.

56:41

But the problem with these games and with

56:43

Sonic is it's super fun

56:45

for five minutes. And then you're like,

56:48

okay. I'm done. Whereas Mario

56:50

and Zelda, it's not as fun

56:52

in the first five minutes, but you

56:54

can play it for 50 hours and

56:57

lose yourself in it.

56:58

Since we did most of the kind of analysis

57:00

commentary in the story, let's

57:02

just ask the question, what could have saved Sega?

57:05

And

57:06

this is where it's probably worth sharing

57:09

the Jim Clark story.

57:10

Yes.

57:11

So this is a great excerpt from Console

57:14

Wars and I

57:16

had no idea. I mean, we have

57:18

talked a few times about

57:20

Netscape and Jim Clark and SGI

57:22

and how the internet almost happened on N64s with

57:25

Mark Andreessen and Jim Clark together.

57:28

And you may know that the N64

57:30

was based

57:33

on SGI's architecture. You needed an expensive

57:35

SGI workstation to create

57:37

the amazing graphics games.

57:40

A big reason why the best N64

57:42

games were first party and there weren't a lot of third party

57:44

games. Right.

57:46

But the way that that came about

57:49

is crazy. It was actually

57:52

Tom Kalinsky,

57:54

the CEO of Sega America,

57:57

who wanted to do the partnership

57:59

with... SGI.

58:01

He saw the potential in the cutting

58:03

edge chips.

58:04

And after the potential

58:06

Sony partnership that we referenced earlier fell

58:09

apart between Sega and Sony,

58:11

he came back to Sega of Japan with

58:13

a pitch saying, I just met with Jim Clark.

58:16

I really think we should do something with

58:18

SGI. I think our next generation

58:21

console should be powered by SGI.

58:24

And Sega of Japan got back to

58:26

Kalinsky and said, no. And

58:28

when Kalinsky pressed them and said, why it's

58:30

a no brainer, they said, the chip is

58:33

too big.

58:34

And Kalinsky was like, what? This doesn't

58:36

make any sense. And they were like, that's our decision.

58:39

And so he had to have this really hard

58:41

phone call with Jim Clark saying,

58:43

I'm sorry, man, I actually don't have a deal

58:45

for you here. Japan is against

58:47

it.

58:48

And so Jim Clark goes, well, what am I supposed

58:50

to do now?

58:51

And Kalinsky in this incredible moment

58:53

of frustration where he seems half a foot

58:55

out the door,

58:57

looks in the phone book, looks

58:59

up Howard Lincoln's phone number and says,

59:01

you should call Nintendo of America, which

59:04

I can't believe that actually

59:06

happened. I know. It's so

59:08

crazy. But again, you

59:11

know, understanding what we know now

59:13

from the Sega story,

59:15

it's not just that

59:17

Sega of Japan was being really dumb

59:19

and arrogant here. Right. That was a reasonable

59:21

business decision.

59:23

Because at that very same time that Tom

59:25

was calling up Japan and being like, oh, we're

59:27

going to do this thing with SGI.

59:29

The Sony

59:30

apocalypse was coming in the arcade business

59:33

with the system 11 and Namco and the PlayStation.

59:36

And I can totally understand Sega of Japan being like,

59:39

look, doing this SGI thing. That's not

59:41

what we have time for right now. Yeah.

59:44

I also think there was probably some kind of like

59:46

not invented here sentiment where it

59:48

has to happen in Japan within

59:51

Sega's walls in order to be

59:53

a viable strategy. It

59:55

is a little weird. You know, it's not like

59:57

they already were thinking we should just be a software

59:59

business because they did. have the Dreamcast after

1:00:01

this, to me it feels more

1:00:04

like a lack of willing to

1:00:06

partner than it does

1:00:08

a sort of business model conflict. Had it happened a

1:00:10

couple years later, you would have been like, okay,

1:00:13

clearly you should get out of the console business and so

1:00:15

don't invest in new hardware partnerships. But

1:00:17

I think this is just a,

1:00:19

we don't know those guys, we don't trust those

1:00:21

guys, so we're not working with them thing.

1:00:24

Who knows if it could have saved Sega, but maybe.

1:00:27

That's probably the closest thing that

1:00:29

I can think of too. Like had that happened,

1:00:32

probably still wouldn't have saved Sega,

1:00:34

but at least the Dreamcast might have had more

1:00:36

of a chance of success. Maybe.

1:00:38

We'll never know.

1:00:40

Carve-outs. Carve-outs. Let's

1:00:42

do quick carve-outs. I have one funny story

1:00:44

before giving my carve-out.

1:00:46

This is a thing that also got cut from

1:00:48

both last episode and I'm not letting it get cut from

1:00:50

this episode. Sonic Origin's

1:00:52

story is hilarious. In an interview

1:00:55

years later, Naoto Oshima,

1:00:57

who is one of the creators, I think he was the designer

1:00:59

of Sonic, he was asked, how

1:01:02

did you come up with Sonic? This blue

1:01:04

hedgehog, why does he look like that?

1:01:06

And his answer, he just says, well,

1:01:08

I put Felix the cat on the body of Mickey

1:01:10

Mouse.

1:01:11

That's right. And I was reading

1:01:14

that, I couldn't believe it. And you look it up and

1:01:16

you're looking at Felix the cat and you're looking at his eyes and

1:01:18

his head shape. Like, oh my God, it's

1:01:20

Felix on Mickey dyed blue with

1:01:22

sneakers. It's ridiculous.

1:01:27

To your point about

1:01:28

Sonic while being beloved, isn't

1:01:30

really like the super deep IP. No.

1:01:34

Kalinsky and team gave it a good run,

1:01:36

but man, it was thin all the way around. It

1:01:39

was.

1:01:40

All right. What do you got on carve-outs?

1:01:42

My carve-out, I want to re-carve-out. I'm

1:01:44

going to re-carve-out from a couple episodes of Daryl

1:01:46

Morey on Invest Like the Best. I

1:01:49

listened to it after you recommended it. Daryl,

1:01:51

now the GM and president of basketball operations

1:01:54

at the Sixers, formerly the GM of the

1:01:56

Houston Rockets.

1:01:57

He's just brilliant and so fun to listen

1:01:59

to.

1:01:59

whether you care about basketball or sports at

1:02:02

all. I mean, he was a computer science major.

1:02:04

Like, he's very, very interesting.

1:02:06

And Patrick is just such a good interviewer.

1:02:09

It really is a masterclass in how

1:02:11

to conduct a truly

1:02:14

interesting explorative

1:02:16

discovery-based interview. And I

1:02:18

learned so much from it. I really enjoyed it. Yeah,

1:02:21

so good. Okay, I have three. They're gonna

1:02:23

be fast. One is, my God, if

1:02:26

you are not watching this season of Succession, it's the

1:02:28

best television I've ever seen. Just remarkable

1:02:30

storytelling.

1:02:31

Two, I'm

1:02:33

keeping a close eye, and I suspect many of

1:02:35

you are as well. In the next month, Starship

1:02:37

is scheduled to launch. And so,

1:02:41

SpaceX launches always sort of our, who

1:02:44

knows on the date and Elon things always

1:02:46

slip, but it is on the launch pad. They're

1:02:48

doing lots of pre-launch inspections

1:02:50

and tests, and it is gonna be so

1:02:52

freaking cool to watch that thing do its first launch.

1:02:55

And then three, I

1:02:56

said this to David. I don't know, David, have you watched

1:02:59

it yet? Six Days to Air? I

1:03:01

haven't yet. All right, if you like this

1:03:04

and you like South Park, you will

1:03:06

love that. If you like this and

1:03:09

you like watching creativity in

1:03:11

action, but you're not so sure

1:03:13

on South Park, you may still love it. It

1:03:15

is a documentary about the process

1:03:18

of conceiving of a South Park episode

1:03:20

idea on a Thursday and then having

1:03:23

it air the following Wednesday. And

1:03:25

the unbelievable six-day turnaround.

1:03:28

There's just nothing more special than watching creativity

1:03:30

in action. I think the documentary is like 10

1:03:32

years old at this point, but a pretty special view into their

1:03:34

process.

1:03:35

Nice. We could learn some stuff for Acquired.

1:03:38

A lot we can learn. All right, listeners, that's

1:03:40

it.

1:03:41

Thank you so much for joining. Our huge thanks to

1:03:43

Pitchbook and Vouch. You can click the

1:03:45

link in the show notes to learn

1:03:48

more.

1:03:48

You can become a deeper part of what we do here

1:03:50

at Acquired by becoming an LP. You

1:03:53

will gain access to our LP-only

1:03:56

Zoom calls every couple months or so, and

1:03:58

you will help us pick at... at least one episode

1:04:01

per season. Our next episode is

1:04:03

actually LP selected. So if

1:04:05

you join now, you will get in

1:04:08

on the next one. You can join at acquired.fm

1:04:10

slash LP. Check out our interview

1:04:12

show ACQ2, available in

1:04:14

the podcast player of your choice, free

1:04:17

and public. Join the Slack. The

1:04:19

Slack has been a critical part of our

1:04:21

research recently, since many of you

1:04:23

are experts in the topics that we are covering. So

1:04:26

lots of great gaming discussion going on there. And

1:04:28

if we missed anything in this episode,

1:04:29

let us know acquired.fm

1:04:32

slash Slack. And with that

1:04:34

listeners, we will see you next time.

1:04:37

We'll see you next time.

1:04:38

Who got the truth? Is it you? Is

1:04:40

it you? Is it you? Who

1:04:42

got the truth?