Acquisition vs. Innovation

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

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

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

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

The big acquisition: a misguided risk management model

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

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

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

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

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

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

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

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

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

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

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

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

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