(1/2) $2B/year, $20M of venture $$, and class of Aatrox

How Riot Games helped me found my first venture-backed company, like so many other alumni, and what that means for gaming venture capital: Part II

From 2004 to 2007, I ran a profitable bootstrapped cashflow business initially funded by maxing out my credit cards. It had nothing to do with video games. Despite a lifetime of playing them, editing maps for friends to play, and “modding” (i.e. hobbyist tweaking of games), I had no idea how lucrative the industry already was at the time- and that map editing & modding would lead to products representing tens of billions of dollars of revenue in a matter of years.

It was thanks to Deloitte that I found out in 2008 just how big it was. I joined the firm as a strategy & operations consultant. Despite the recession, the industry raked in over $20B that year (a 19% increase over the previous year). I ended up working there right when the firm was in the midst of a massive project advising the merger of Activision and Blizzard (today, the combined entity from back then is consummating a near-$70B acquisition by Microsoft).

After the acquisition of my company in ‘07, I kept a revenue share and picked a new management team. My co-founder and I (a classic “botlane” duo in the vein of this blog’s theme, that’s a story for another time) both wanted to learn what working a “real” job was like, so we went to Hong Kong to buy suits and became a banker (him) and a consultant (me). By 2010 I was leading work within a company think-tank on the emerging software-as-a-service model in gaming and gaming-adjacent verticals. I advised both internally and externally, but the truly catalytic experience was helping a small startup in the space get to a $100M acquisition by an incumbent strategic.

I was hooked and knew as soon as we pulled off the transaction that I had to get closer to the ground of this exploding recurring revenue model as it began to spread across the industry. Over 75% of the near-$200B of revenues in gaming today is services revenue, rather than upfront purchases. The 1000%+ growth of the industry since I joined Deloitte has been fueled by that transition.

Deloitte had a competitive sponsorship program designed to boomerang top consultants into MBA programs and back to the firm (the typical route to climbing the ladder). I was accepted, and then applied to Stanford to get myself to California. Most of the action and innovation in the industry was there, so I figured I would take my shot while doing what consultants are supposed to be doing anyway after their first 4-5 years.

Upon arriving in Palo Alto I started looking at the “best in class” new companies figuring out the service model for their games. Three stood out: Machine Zone, which was already making billions a year with 4x mobile games (essentially social empire-building sandboxes that relied on a minority of “whale” players spending inordinate amounts of money); Scopely, which had some simple puzzle and dice games showing good metrics (the company was recently acquired, a decade later, for ~$5B), and Los Angeles-based Riot Games.

I’ll delve into greater detail in a later post on how Riot became the bellwether of Games-as-a-Service and the lessons its rise has for venture-backed gaming value creation (and how their founder duo is truly a *legendary* “bot lane” comp), but suffice it to say that by 2012 the company had already established itself at the vanguard of the model. It was not anywhere near the juggernaut that it is today, but its only title at the time (League of Legends) had been successful enough at generating services revenue that the largest gaming company in the world, China-based Tencent, had bought a majority stake in the company for almost $500M. I chose to work at Riot because it was the only company I had seen to date that had figured out how to mix two heretofore incompatible mechanics: fair, skill-based competition, and “free-to-play” games-as-a-service.

Technically games-as-a-service simply refers to an operating model that continues to ship monetized content to players after initial release of a game, which can involve selling the game for an upfront price and then repeatedly offering additional purchases afterward. The dominant model, even back in 2012, however, was to not require an initial purchase at all and monetize exclusively on those subsequent purchases- which came to be known as “free to play” since these purchases were entirely optional. Mobile pioneers like Machine Zone relied on selling players “power” (a practice derisively known as “pay to win”), whereas puzzle games like Candy Crush (hundreds of millions of dollars in revenue already in 2012) relied on selling mechanics to help players complete levels. The model that Riot pioneered was an entirely different beast.

Early in the decade, there were still vestiges of an attempt to at least partially monetize the journey of a player’s account to the top level in the game (30), at which point they would have unlocked the maximum level of “power” and reached a balanced playing field at which the game became entirely a matter of skill. Optional cosmetic purchases were already becoming the lifeblood of the game’s revenue and Riot eventually shifted to a monetization model reliant almost entirely on them.

League of Legends was thus a real competitive game (hence the nascent “esports” scene), in which players’ dollars were chiefly going towards purchases to alter the appearance of their favorite characters. Prior to LoL, the only “fair” online competitive games all monetized on an initial upfront purchase. Ranging from online shooters (such as the multi-billion-dollar Call of Duty franchise) in which teams of players competed to eliminate each other or complete an objective faster, to online strategy games in which player commanders hurled armies at each other (StarCraft), they often came packaged with single player campaigns as well.

Growing up as a competitive PvP (player versus player) game aficionado, the moment I first played League I saw why Riot was growing so rapidly: why spend money to buy access to a balanced competitive game, when you could play one just as compelling for free, and only monetize once you felt the need to personalize your appearance? I learned later that there was a direct correlation between time spent in game and likelihood/scale of expenditure; the best predictor of time spent in game, on the other hand, was whether a player had a friend or more in game. Initial monetization of course was the best predictor of future purchase behavior.

{ Social connection -> playtime -> monetization -> further purchases } was the basic formula. I would learn about the second-layer flywheels at work within, but the foundation of the system was a revelation, as was the perfect economic nature of the trade happening here - players were literally buying items that reflected pure affinity, rather than to get ahead in the game, which struck me as a much more sustainable utility play than pure progression, content, or power purchases being made online in other gameworlds.

For a PvP player (like me), it was the perfect bargain. Accepting an offer to join the hiring class of Aatrox (groups of new hires were named after the game character released closest to their start date) for twice the compensation of what I made as a consultant plus equity to work on this perfect storm of meaningful social connection, true competition, and the vibrantly healthy economy fueled by it all was a dream come true. My time at Riot between year 1 and year 2 of the Stanford MBA as a fulltime producer, and in year 2 working part time on esports, is its own story; for now in the sequel post to this one we’ll delve into how accepting that offer ironically led me directly to starting my first venture-backed company right out of Stanford, and how that experience and that of so many other ex-Riot alumni informs the gaming venture capital landscape today.