Bernard Moon is co-founder & CEO of Vidquik, a new web conferencing and sales solution platform, and blogs at?Silicon Moon. I met the Huang brothers, Charles and Kai, a few years ago through a mutual friend over BBQs and casual poker nights, and Kai is an occasional StarCraft partner if my twin girls fall asleep at a decent time. I knew they founded RedOctane, but slowly I learned of their inspirational story that all entrepreneurs should be aware of. Their insights and learning are valuable for whatever stage or industry your company might be in.
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RedOctane was the publisher of Guitar Hero, which many consider to be one of the most influential video games of the decade. It became one of a handful of billion-dollar video game franchises in history and reached that milestone at a breakneck speed. RedOctane was acquired by Activision in 2006, but shuttered in February of 2011 when interest in music performance games declined sharply.
I spoke with Charles and Kai about the bumpy road to a billion-dollar product, and the lessons aspiring entrepreneurs can take away from their journey.
How did this all start? Kai Huang: My dad has been in business his whole life and he?s always told us, ?When you grow up, you should really do your own business. If you work for a big company, that?s fine but doing your own business is better.? So that kind of stuck with Charles and [me] our whole lives.
When did you come together to start a company?
Kai: Right around ?98. It was with a couple of other friends of ours. It was this open source, server appliance software. Back in ?98 you know, a lot of companies still hadn?t gotten on the Internet. Everyone was using dial-up AOL. So we thought there was a market for trying to get small to medium-sized businesses connected through Internet sharing.
We didn?t get much traction. We were just doing software. We were always trying to license our software out to people who could make the hardware. We did it for about 10 months or so. We ended up selling the product to another company.
The lesson we took out of that was if you don?t control the whole product, then basically you?re a half-assed company because you only control half of the final product.
"[I]f you don?t control the whole product, then basically you?re a half-assed company."
Charles Huang: That carried on through the development of RedOctane. As we progressed from hardware we realized we have to be able to do software as well as hardware because if we don?t, we?ll always be dependent on someone else to do it. Also, if they don?t share the same vision, you?re in trouble.
Right after Adux Software was when you started Red Octane?
Kai: In the middle of 1999, we sold the product off and wondered what to do next. We decided to start in online video game rentals. This was right around the time Netflix was starting with online movie rentals. We raised a million dollars from friends and family, we closed the funding round in March 2000. A month later the market bubble burst.
We quickly realized within six months the business model was way too capital-intensive. Netflix raised almost 200 million dollars before the market crashed. We raised a million, and we weren?t going to scale the business because you've got to buy the games. In the movie business, DVDs were 10 to 15 bucks. Game companies gave no discounts. We were going out and paying $40-50 per title. When the market crashed and we couldn?t raise money, we realized we needed to start generating revenue from somewhere else.
We were renting the Dance Dance Revolution game and customers were asking us if we sell or rent the dance mats. We didn?t. After three months, we decided to source and sell them. We bought them for $20 and reselling them for $30. This was our first experience into the accessories and hardware business.
We discovered there was a real niche in high-end video game accessories that nobody was doing. We thought that in video games, especially at that time, gamers had a lot of money. They?re buying consoles and games, and it?s not cheap. They want high quality products but we felt there weren?t a whole lot of people creating high quality products.
Eventually, we started to make our own dance mats. The second dance mat product that we introduced in 2002 was the RedOctane Ignition Dance Pad. It originally retailed for $100 and cost of goods was about $15. This eventually became the best-selling dance mat in the U.S. in 2003, 2004, and 2005. We were small but we were starting to build a very profitable business. So we actually broke even in our second year because of our accessories business.
Charles: There was an important lesson for us. Cash flow. We learned how to manage margins and cash flow, and how valuable it was to have a direct connection with the customer.
Kai: By 2003, we started to grow our business. We were doing about two and a half million in revenue and half a million in profits. We were making all these accessories and generating a small but healthy business.
We saw that Japan had all these big music games and wondered, ?How come they didn?t they bring any of them to the U.S.? We saw that these games were a lot of fun. They?re very social. We noticed they were gender-neutral and not just boys and girls but young and old people were playing these games -- something you don?t see a lot in video games, and we thought that was pretty cool. We went to all these Japanese companies and asked them to bring more of their music games over and universally they told us they didn?t think there?s a market for music games in the U.S. except for Dance Dance Revolution, which is the only one they sold.
So that?s when we decided that we better figure out how to get into the publishing business. That was in 2004.
"We learned how to manage margins and cash flow, and how valuable it was to have a direct connection with the customer."
In The Groove was our first game and [we] published [it] in the summer of 2005. We were doing about $6 million in revenues, and a couple million in profits. Cash flow was always tight, but profitability was good. We decided we wanted to take on a second project in publishing, and we called up Harmonics Music Systems. They were a game developer based in Boston. We had actually had contact with them four years before. They had developed a couple games called
FreQuency and
Amplitude. We were interested in making an accessory for their game, but nothing worked out. About a year and a half later, they released a game called
Karaoke Revolution and it didn?t have a microphone. So how can you play karaoke without a microphone? They used a headset. You gotta have a microphone. We called them up and told them that we?re interested in making a microphone accessory, but this also didn?t work out.
In 2004 we called them up again, this time it was a little different. We?re not just interested in doing hardware, but we?re actually interested in publishing a title. We shared our vision and they had a very similar vision as well. It took us about four months to convince them to work with us. They were used to working with Konami and Sony, and their response back, ?You?re a small publisher, so how do you compete against Konami and Sony if they make a similar title?? We signed them up as our developer in April 2005.
Going back to when dance pad sales were taking off, did you try to go back to the market to try and raise some capital?
Kai: We had been trying to raise money through the whole period, but we certainly did it again at that point. When you talk to Silicon Valley investors, most are not used to hardware. They said, ?Hey, your margins are great but we don?t do hardware. And this is gaming. We don?t do gaming and we don?t do hardware.?
Charles: We don?t invest in video games because it?s a hit driven business, and I?d say, ?Well, the VC business is a hit driven business.? But that didn?t convince them.
Kai: We almost went out of business three times from the beginning to when we were acquired. The first two times we said we?re never going to let this happen again, and of course it happened again. The last time was right in the middle of launching Guitar Hero. We decided we were going to launch originally with 50,000 units for that holiday season. It was 2005. We ended up signing a deal with MTV, for marketing, and when we did that we decided to bump our hardware production up to 150,000 units, which was huge for us. Very expensive. Just the hardware investment alone and the cost of goods was $3 million for a company that was doing a total of $6 million. We had tripled our production forecast, so we pretty much ran out of money. We went out to VCs and we tried to raise money and we couldn?t, and that was when Charles and I decided to mortgage our houses and borrowed as much money as we could. On top of that, we had to borrow another half a million dollars from a family friend, who happened to have the money lying around because they were remodeling their house. We used all of that to launch Guitar Hero.
When you decided to take out a second mortgage on your homes, at that point did you have a good sense that Guitar Hero would do well?
Kai: I think you never really know how a game?s going to do and we were such a small company and we were so inexperienced that we wouldn?t even know. But the one thing I think we clearly noticed was that anybody who played it and those people around it were drawn to it. You would get a small crowd of people who would stand there and watch. So we knew that the game was fun, but we had no idea how big it was going to be. Was it fun for ten people? Was it fun for a hundred thousand? Was it fun for millions? We really didn?t know.
Charles: The first store that actually launched Guitar Hero was Best Buy and the forecast from them was 30,000 units for the quarter. They called us up after the first day and told us, ?Hey, we just sold 3,000 in the first two hours, we need 80,000 units next week.?
We told them, ?No, you don?t understand, these things are built in China and they come over on a boat. We have just 5,000 for this next week and you?re going to have to split that with somebody else." The product immediately sold out. Everything.
Kai: We shipped in 120,000 by the holidays, and it all sold out. Which is great, but in the scheme of things, 120,000 units to big publishers was a total flop. They need to sell millions and millions. When you?re dealing with hardware, you know we can?t call in the products immediately in three days like you can with software. We were calling, but in November and December, so we wouldn?t get product until March. We were also concerned that if we called in a giant order now, and thought, ?What if demand dies right after Christmas??
So how many did you sell the next quarter or two quarters?
Kai: So that was the interesting thing with Guitar Hero, and why it garnered so much interest was that it was a video game that was on a very unusual sales curve. We were selling more every single subsequent month for the following ten months. So most video games launch, and then the next month they sell half, then the next month after that, half of the previous month?s, and so on. But [with] Guitar Hero, every month our sales numbers kept going up and up and up until September of the following year, which is when we sold the most units. We sold 80,000 units that month.
"We almost went out of business three times ... The first two times we said we?re never going to let this happen again, and of course it happened again."
We?d heard that people at Nintendo were playing the game and that they loved the game. We had only released the game on Sony?s platform, so for a Sony game being played at Nintendo, we knew they must have really loved it.
Charles: Activision?s CEO, when he first visited us, joked that half their [quality assurance] department was playing our game on a full time basis.
Kai: We finally then ramped up once again, for the 100th time, a road show for the VCs. We were finally able to get interest from venture capitalists. We got term sheets to close about $20 million dollars from VCs. Well, they were mainly private equity firms. We didn?t really need the money at the time, but we were planning to raise the money and taking the company public within a couple years.
Charles: Then Activision came in and said hey, we?d like to talk to you guys.
Kai: Activision called us at the beginning of the year and told us that it?s not just about distribution, but they were interested in potential acquisition of the company. We weren?t interested in selling because we were looking at growing and going public, but the conversation kept going and going until ultimately in April we decided to sell.
We signed the term sheet in April and the deal was announced in June of 2006.
How about taking a step back. As entrepreneurs, did you guys have any concerns about working together as brothers?
Kai: I think for me I always had concerns, but it was never anything like I had to sit there and pull my hair out [wondering if] this is what I want to do or not.
Charles: I think there were a couple big pros and cons. One of the biggest pros was that you have familiarity and trust that has been going on for a lifetime. You don?t have to learn what are the strengths and weaknesses of your partner, and that?s one of the most important things of any startup.
So you guys want to talk about the next thing you?re working on?
Kai: I?m OK with talking about it. One of the things that always interested us has been health and fitness, and it stems from our first experience with Dance Dance Revolution. We did a lot of marketing for that game and we took the spin that video games are getting a bad rap. There was a lot of violence in video games, but these [other] games are fun. They?re music games and you can actually lose weight. We found a great example of this young girl. She lost 90 lbs. playing this game. She was shy, reclusive, and didn?t have a lot of friends. She ended up making a lot of friends, lost all this weight, and totally changed her life. She graduated from college and went to work at Microsoft.
We loved this story. We basically took that story and used her as an indirect spokesperson. We ended up getting her on CNN, The Today Show and various magazines. So this whole concept of exercise, and health and fitness with gaming layered on top of it has always interested us. When Guitar Hero took off, we didn?t have time to think about anything else. We always thought that [there was] a billion dollar market opportunity in music games, and a billion dollar opportunity in fitness games. Well, it turned out that music was a billion dollar opportunity not just for the category, but for a single game like Guitar Hero 3. Amazingly, when Wii Fit came out, it became the fourth product that became a billion dollar product. There was World of Warcraft, Call of Duty, Guitar Hero 3 and then Wii Fit.
We want to figure out ways to get people healthier -- more active and fit, ultimately leading them to a healthier lifestyle by leveraging gaming some how.
Awesome. Can?t wait to see it.
Kai: Me too.
This story originally published on Mashable here.
Source: http://us.rd.yahoo.com/dailynews/rss/internet/*http%3A//news.yahoo.com/s/mashable/20111122/tc_mashable/billion_dollar_brothers_entrepreneurial_lessons_from_the_duo_behind_guitar_hero
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Public release date: 21-Nov-2011
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