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The yahoo of games is on its way?

Nice article on Forbes on Valve founder Gabe Newell and his growing online games venture.

It's A Mod, Mod Underworld
Victoria Barret, 12.12.05

Gabe Newell is the envy of giants in the videogame industry. He designs games--then lets fans make them even better.
A 60-inch plasma screen at the offices of Valve Corp. roars to life with a heavy-metal soundtrack as a new videogame begins, and giant, gnarly aliens creep from the shadows of an ominous alleyway. The game, Alien Swarm, is the work of three creators who have piggybacked off of Valve's big hit, Half-Life 2, replacing the original game's main characters with a cast of their own creation.

Alien Swarm is a "mod," a modified add-on to the Valve title, and the rise of mods--letting your fans and even rivals freely tap into your game to redesign it--is a key reason behind the success of the privately held company. The Half-Life series has sold 15 million copies, and its first hot mod--Counter-Strike, a rapid-fire shoot-'em-up pitting online teams against each other--has racked up 4.8 million units. Never mind that Counter-Strike was designed not by Valve's 50 programmers but by two rookies who had never even met--a high school senior in New Jersey and a college student in Vancouver, B.C. Valve bought the game and hired its two kid creators.

Now comes Alien Swarm, an unfinished mod being shown to Valve Chief Executive Gabe L. Newell by three programmers who make up the entirety of Black Cat Software. They nervously watch for his reaction, and Newell thrills them by leaning his ample 6-foot-4 frame toward them and asking, "So when are you guys going pro?"

They decide that once Alien Swarm is finished, Valve may sell it for downloading on its Web site, steampowered.com, splitting the sales 50-50 with the three game designers. The Steam site has already begun promoting it.

"No one has created the Yahoo for games. That's our opportunity," says Newell, who plans to start selling music and minimovies on Steam next year. He is one of the most sought-after hitmakers in the $8.4 billion U.S. videogame industry. Valve, a nine-year-old Seattle company owned by Newell and a few employees, will do at least $70 million in revenue this year, double last year's sales, with operating profit of $55 million.

Newell's Web storefront, Steam, has 3 million members logging in every week to play games and get automatic upgrades. And while he started out selling in retail stores, in 2004 he became one of the first game developers to successfully sell direct to consumers online--a move retailers typically despise. Newell makes an operating margin of more than 80% on downloaded games; titles sold at retail get a 36% margin.

Users who visit the Steam site get weekly marketing missives and can choose to let Valve scan their computers online to learn new insights. In the spring Valve discovered that its users with the most advanced graphics had tripled to 10% of all players. So it released a new, snazzier level of Half-Life aimed just at them. "Valve has a much better feel for who their customer is than the rest of the industry. It's admirable," says Sega of America President Simon Jeffery.

Says Microsoft Xbox executive Gregory Canessa: "Valve is closest to figuring out how to make online sales work."

Valve has done so by relying on the kindness of strangers: its own customers who are "modders." Valve gives away the software tools that let even amateur programmers make mods, because you must buy a copy of Half-Life to be able to create your own mod or play someone else's.

Newell sells 15 mod versions and knows of 500 mods floating around in cyberspace, but there could be thousands. Half-Life pits a geeky scientist (you) against corrupt government agents and lethal aliens at a top-secret government site. The Counter-Strike mod transforms this into a multiplayer game of terrorists versus counterterrorists. Day of Defeat applies the premise to World War II. Half-Life Rally has cars racing through the original site (and no killing). Vampire Slayer is self-explanatory.

"We let our community of players make up the rules," Newell says. If he likes a mod, he sells it online himself and shares half the sales with the modders. If a modder wants to sell it on his own, he must pay Valve a $200,000 licensing fee, plus royalties, in exchange for using Half-Life's development engine.

Newell, 43, learned from his first employer, Bill Gates, that success in software comes from getting outside developers to write programs that sell more copies of your own. Newell was the 271st employee at Microsoft and, like Gates, is a Harvard dropout. (Steve Ballmer, then Microsoft's head of sales, talked him into leaving college.) Newell spent 13 years in Redmond as the lead developer of the first three versions of Windows.

He was brilliant and wildly productive. "He was doing 30 products a year," says former colleague Alex St. John, now chief executive of WildTangent, a Web shop selling smaller games.

Newell quit Microsoft in 1996 and cashed in his stock options to launch Valve that year. He has put a daunting $15 million-plus of his own money into the company, buying out a cofounder and eschewing venture capital backing. He was inspired by the story of Id Software, producers of Doom and Quake, two massive PC hits that let amateur designers modify the games' code to change details and scenery. One popular mod inserted Homer Simpson as the main shooter.

So Newell licensed some Quake code from Id to create Half-Life, which debuted in 1998 and sold 2.5 million copies at retail in its first year. And there sales would have stalled, but modding extends a game's life and sparks further sales. Newell hired the two young Australian programmers who had created the most popular Quake mod, Team Fortress, and bought the rights to their game. They added more powerful graphics tools for Half-Life modders.

A year later the community produced its first hit: Counter-Strike. Newell bought it for a pittance in 2000 and hired its two creators (the high school kid in New Jersey and the college kid in Vancouver). Half-Life itself didn't reach its sales peak until its third year; most games peak after a few months.

Flush with success, Newell embarked on a five-year, $40 million effort to make Half-Life 2 (similar setting, better tools). Introduced in 2004, it has sold 4 million copies and inspired 100 new mods. Alien Swarm may be the first mod Valve itself will sell for Half-Life 2. Mods now provide 20% of Valve's total revenue and someday could account for up to 50% of sales.

It is the upside, Newell says, of letting customers take total control, and the practice shouldn't be limited to videogames: "George Lucas should have distributed the 'source code' to Star Wars. Millions of fans would create their own movies and stories. Most of them would be terrible, but a few would be genius."

Posted by keefner at December 4, 2005 08:51 PM