Epic Games

0:00 Yeah, I actually have on some Zoom calls been listening to Spotify in the background on my headphones, but it makes the video calls so much better. That's so just like low in the background you've got Spotify going. That's amazing. It's like nice of you to join me in the club for our meeting. Really smart.

0:31 Welcome to season seven, episode three of Acquired. the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Now, for everyone new to the show and for everyone who's been with us for a while, it's been a while since we introduced ourselves, so uh we wanted to tell you a little bit about who we are. I am the co-founder of Pioneer Square Labs in Seattle. We are a startup studio and early stage venture fund, and uh my background is primarily in founding companies and product management.

1:03 And I have been a long time venture capitalist. I'm currently a independent Angel investor and advisor to startups based in San Francisco. So I come at things from the Venture and investing side. Most importantly, we are excited to be with you today as peers and practitioners in the industry diving into stories that I think we all talk about at the water cooler when that was a thing. The zoom cooler.

1:27 The Zoom cooler. Exactly. Well, today we will explore what happens when an idealist has full control over a product with perfect global product market fit, unbelievable economics, and has the leverage to shape the world to his idealistic will, even potentially at the expense Today we talk about Epic Games, makers of Fortnite and the Unreal Game Engine. You probably know of them since Fortnite is an absolute international phenomenon. the most played game in the world, and for parents out there, the way Gen Z hangs out with each other.

2:03 Or because they are currently the most credible threat to the world's largest company, Apple. Not to mention, of course, the incredible amount of attention Fortnite consumes. Is a threat to Facebook's advertising business model. Netflix cites it to their investors as the number one threat, and Epic is really the primary US ally of the quiet

2:24 Chinese giant Tencent. But Their ambitions expand far beyond any of this, and we can't wait to bring you the full story today. And for the bootstrappers out there. This may just be the most successful bootstrapping story of all time, going twenty two years from founding before raising a dime of investment. So strap in.

2:43 Incredible. Cannot wait to dive into this one. Well, as always, if you love acquired and you want to hone your craft of company building, you should join the community of acquired limited partners. You'll get access to the LP show where we dive deeper into the fundamentals of company building and investing, in addition to our monthly LP calls where we talk with all of you directly, and of course our book club and the zoom calls that we have with the authors. Our most recent episode on the LP show was on the fundamentals of venture capital, discussing how VC firms make their investment decisions. So tune in if that's of interest to you as a founder. or active or aspiring investor. If you aren't already a limited partner, you can click the link in the show notes or go to acquire.fm slash LP and all new listeners get a seven day

3:27 free trial. While we're introducing and explaining ourselves here. It's been a while since we've talked about why we call this thing the Limited Partner Program. It's because limited partners are the folks that give capital to VCs and venture firms and make everything possible. And that's what you guys are for us too. You are super special. Everyone who is an LP We thank you and If you want to become one.

3:52 Can't wait to have you. Yep. All right listeners. Now is a great time to talk about a new partner of ours here on Acquired, Lagora. The agentic operating system that is redefining how the world's best legal teams work.

4:07 Yep. It's sort of obvious that AI is gonna completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Ligora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry? So the founders did exactly what great founders do. operate with obsessive customer focus. They embedded inside a massive law firm. For months.

4:34 They sat with the lawyers just watching how the work really gets done. And that's how you get features that customers love, like tabular review, where you drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Legor's bet here is interesting. Since it lets each lawyer handle more complexity, any given person can increase the quality of their work. And do higher value work. And this means that the pie can grow even as each individual task takes less time. And they recently launched Lagora Agent, offering greater intelligence and performance. The agent lets lawyers set an objective. Then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required. And Lagora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Lagora numbers essentially

5:30 speak for themselves. When they have a head to head pilot with their top competitor, they win 70% of the time. Ligora now has over a hundred thousand lawyers on the platform from twelve hundred legal teams in fifty countries. And crazily, they went from one million to a hundred million in ARR. In about. Eighteen months.

5:51 truly insane numbers. And that is the real test. Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in-house at a company, you can learn more at Lagora.com/slash acquired. And just tell'em that Ben and David sent you.

6:16 All right, listeners. Time for our episode on Epic Games. Woo, let's dive in. Before we do, we owe a lot of thank yous on this one on the research to uh a whole bunch of people who have written a lot and done a lot of great reporting and analysis of Epic, Apple, Tencent, everything going on here. Three in particular I wanted to call out though

6:41 One is Matthew Ball and Jacob Novak, who wrote just An awesome six part. primer on Epic and all the dynamics around the company. We'll link to that in the show notes. Uh definitely go read that. Second is the gaming website uh Kotaku did this wonderful interview with Tim Sweeney, the CEO and founder of Epic back in twenty eleven when uh I think he was inducted into the uh gaming hall of fame. So many of the quotes that we're gonna use from Tim, direct quotes in this episode are from that interview.

7:13 And then finally, this is so fun, I finally get a chance to use my favorite non-tech industry podcast out there as a source for an acquired episode. You've been waiting for this forever. I've been I Ben knows I've been wanting to do this forever. Wizard and the Bruiser is such an awesome podcast. It's like basically acquired for Nerd history. Then what are we? We're business nerd history. Yes, they're more game nerds, I suppose we're more business nerds. Yeah, games and like anime and stuff. They did a deep dive episode on Epic last year, which was super helpful jump starting our research. So thanks, guys, as always. And for everyone, we've put all of our links to every source that we use in the show notes, so feel free to peruse those. And a special shout out to Griff in the acquired Slack at acquire.fm slash slack, who uh recommended the Matthew Ball piece that really got us started sort of down the rabbit hole of researching this in the first place. So awesome to have um listeners uh help us do some of the research.

8:10 Always great. All right. So we're gonna get to all of the high drama here around Fortnite, Tentin, Apple, the lawsuits, et cetera. As always, onacquired, we start way back. And I think it's particularly important here because I don't think you can understand really. what's going on or epic without

8:28 understanding the man who is its founder and CEO, Tim Sweeney. So who Is Tim. He was born in the year nineteen sixty.

8:40 Seventy. In Potomac, Maryland. He was the third of three brothers but his older two brothers were much older. So one was ten years older than him, and the other one was fifteen years older. So while he was the youngest of three brothers, he uh he was probably almost kind of like an only child for a lot of his life. I mean, by the time he was I guess would have been in elementary school. Both of his brothers were probably in college or out of college at that point.

9:06 Yeah, and I think he he started programming super young, right? Like he was a eleven year old game programmer. Yeah. So it's all wrapped up in this. So his dad worked for the Department of Defense. He worked at the mapping agency as part of the intelligence unit where they were creating military maps from satellite imagery, uh kind of doing um like Palantir and Skybox type stuff like way back in the day before those companies. So early on, young Tim One is that he loves tinkering with like the guts of how things work, like both mechanical and uh as we will soon see, computers and technical things. Two is he also actually loves business. Uh and this is a pretty rare combination. Like he becomes a just

9:53 Fantastic engineer. And A fantastic business mind. But he doesn't love business for the money. I mean, this is a man who really does not have a lot of use for money. Um, he lives in North Carolina, he's not married, he doesn't have kids, he doesn't hang out with celebrities. Yeah, he's like bought a few fancy sports cars and a nice house and stuff, but

10:15 You know, he mostly he's talked about this to the Wall Street Journal. He mostly eats Bojangle's fried chicken and drinks Diet Coke. He wears cargo pants that he probably buys for about twenty bucks. And what he does is he basically writes code and um Works on epic. And uh That's what he cares about in life, which is it's just so refreshing, like seeing that and this man who's running such an important internet company versus all the other larger than life tech CEOs out there. You say he he loves business. He's more of a business engineer.

10:46 Like he's not a mogul. Uh he's not leveraging every component of his business to give him the most cash. He's like Excited about what business gives you the potential to do in the world. And by pulling all the levers, I mean it really is an bringing an engineering mindset to the business or a tinkerer's mindset. Yeah. And he's now taken Most of his wealth and has been applying it to land conservation in North Carolina. Which is just

11:14 So different than you see from so many people these days. One more point to just like paint the classic computer engineer that is Tim Sweeney is David you and I both watched this video from I think two thousand eight where they they interview uh Tim and he's got his sports car at his nice house and he's like here's my Dining room. Here's my dining room table. I've never eaten at it. Mostly kinda go to Burger King. It's like everything you would sort of expect from like an awesome video game programmer, not A uh CEO worth, I don't know, four or five billion dollars.

11:46 Totally. All right. So how did he get this way? Well Ben, as you mentioned, when he's really young, uh, like five or six, he starts Tinkering around and disassembling like lawnmowers and then building them up into go karts and and racing them around. I feel like his parents uh must have by this point in time just been tired of like raising little kids for so many years. They're just like, All right, Tim, do whatever do whatever you want. And then a couple years later, when he's about nine or ten years old.

12:14 A video game arcade pops up pretty near his house. This is like 1980 time frame, so this is kind of Nolan Bushnell, like height of Atari, you know, uh just after Pong, but like Space Invaders was a thing. And Tim becomes super fascinated by This arcade, and eventually his parents get him an Atari twenty six hundred at home. But it's not so much because he loves playing the games, although he thinks they're interesting. He's interested in how they work and in particular like how the Cabinet's work. Atari 2600 that he got. He's like, Yeah, like I liked playing some of the games, but it was a pretty crappy machine compared to the cabinets. Like he wanted to know how these things

12:52 Work then. A little bit after this time, uh after he started getting into games and this being his first sort of exposure to computers, he goes out to visit his oldest brother Steve, who had moved to San Diego and was working on a startup in the computer industry there at that time. Remember, this is like 1981, 1982, so kind of just at the start of the PC revolution. And Steve had bought a bunch of brand new IBM PCs that they were using at the company. And so he shows young 11 year old Tim, you know, how to use these things, how to program it in basic And Tim's like That's it. He's found his calling in life. And he has this great quote.

13:35 You're trying to build a go kart, you can spend months on something like that and it never quite works right, but the computer would do exactly what you say. I could write in just a few hours a really impressive program. It was the ultimate machine to tinker with. It was love at first sight. From that point on, I tried to dedicate all of the time I had free to learning to do more with computers. Which for anyone who's uh a programmer out there knows the computer always does exactly what you telling it is both a gift and a curse because if it's doing the wrong thing, like I mean, it's just running the instructions you put in there. So Tim goes back home from visiting Steve in San Diego and Steve must have been like Seeing the gleam in his kid brother's eye. So he buys the family back in Maryland an apple too.

14:19 And this becomes like Tim's obsession. He starts making games and other programs for it. And he estimates that over the next couple of years, you know, he would spend the canonical like uh Malcolm Gladwell 10,000 hours teaching himself how to program. And this is what's so cool. 'Cause remember his dad works for for DOD. He has access to like early, early proto internet networking type stuff. So he goes on BBS systems from the Apple II and he starts asking questions and learning from folks there everything he needs to know. about programming. So he's completely self taught and he makes a few games during these time this time, but he never he never really shares them with anybody.

15:01 So then. A little bit later in high school. is when he discovers his second passion for for business. As Tim tells the story It's when he gets a summer job at a hardware store. The wage that he's earning at the hardware store must have been minimum wage at the time, four dollars an hour. And he's working there and he's just he kinda realizes he's like, Wait a minute. No matter how hard I work here or how well I do

15:26 I'm only gonna earn four dollars an hour for the summer. Like this is the very like programmer engineering mind like working at this here. He's like there's gotta be a more optimal way. I could use my time. Not because I really need the money, but just like I could do better. So What he decides instead is he sees that uh There are a bunch of lawnmowing. businesses operating in the neighborhood. You know, it's summertime cutting the grass in Maryland. Um, and he goes around and he asked them and he's like, Hey

15:54 Ask these families, how much are you paying your uh lawn mowing services and they're like, Oh yeah, we usually pay like a hundred, hundred and twenty bucks for mowing the lawn. And Tim's like bingo. So he quits his job at the hardware store and he undercuts the market by two X. He charges all the families in the neighborhood sixty bucks to mow their lawns. He runs the math and figures he's using his dad's tractor that he's pulling in about twenty five bucks an hour. That feels like an insanely expensive lawn cutting for the time in I mean, these must have been pretty big lawns. Yeah, no kidding.

16:29 Either that or very high willingness to pay. Yeah, fast growing lawns. Yeah, indeed. He has this great quote. He says, That's when I came to a really clear re realization that by trying harder and striving to find cool business opportunities, you can do far, far better than wage earners, who I was when I was working at the hardware store. At that point it became really clear to me that there were big opportunities in the world. Mm. Super cool. So as we said, he ends up going to the University of Maryland, uh nearby, close to home. He's not a particularly great student. He's spending all of his time, you know, on his Apple II and BBS systems. And he decides to study mechanical engineering because, you know, they have a computer science department there, but like He he thought that would be a waste of time. Like he already knows how to program. He's gonna learn like more interesting stuff and and he actually ends up learning a lot of math, he says uh say the math and the physics here seem like they'll come in really handy. Seem like they'll come in handy, yeah. On the side, though, he'd kept his lawnmowing business going. And then when he goes to university, he says, you know.

17:31 I might want to try and do something even more lucrative. You know, I'm an engineering major here. I really have the skill with computers that not a lot of people have at the time. What if I start doing computer consulting instead? So he starts a company. Uh he calls it Potomac Computer Systems. And he goes around to, you know, families and businesses and helps them set up uh databases and the like. And that's kinda going okay. But uh either as part of that or or maybe um unrelated. He eventually gets A two eighty six IBM computer. And we've talked about this on a bunch of episodes, but like that two eighty six was like

18:06 That was the canonical Intel chip that was would really unlock The P C market and take it. Majorly mainstream. Uh yeah. I mean, this is the thing we talked about on the Intel episode that was their business when their business of memory got destroyed. Indeed.

18:24 So Tim. realizes this that there's all of a sudden a pretty big install base out there. And so even though he kind of likes programming on the Apple II better, he sees all these other 286 IBM and IBM compatible PCs popping up and he says Hey, there might actually be An even better business rather than selling my Time for dollars.

18:45 That I could build around selling software for this nascent. PC market. So he decides to do it and he's like, Okay, what software am I gonna write? To start writing software I need to use a text editor on the IBM PC to actually write the software. And this is like pre, you know, for those uh listeners out there who are engineers or familiar with engineering, pre like Vim and Emacs days, there's no good text editors. So he's like, oh great, I'm gonna write a text editor first for other software developers. Sensing a theme here. So he sits down.

19:17 He starts trying to do it, but he gets distracted And he keeps thinking about how he could instead of writing this text editor, he can make it into A game he has this quote. He says I realized, hey, you know I could make each character on the screen have a collision and I could have the cursor be a game character and I could turn this text editor into a little game. Similar to Atari Adventure.

19:40 I based it on rooms. Each screen full of text became a room. I had different graphical characters represent different gameplay behaviors. Suddenly you could build a text document and hit the play button in this editor. And now you're up and running with your game. So he calls this game ZZT. Uh Oh, I didn't realize ZZT was the thing that was first a text editor. I knew that was his first game, but Wow. It was it was his first game. But this is what's so cool and it really just kinda foreshadows everything to come with Epic because he started working on it as a text editor. And like he was just describing in that quote, you know, you can kind of design a room in the text editor and hit play and then you can kind of play the game. He ships ZZT

20:23 As A game with uh well he actually did it in shareware. So the first room was free and then you wrote to him and you paid to get the floppy disc with the other three rooms that were part of the thing. He would mail you would mail you, yep. Which is pretty awesome in and of itself. But because it was an editor itself, anybody who had the game could then make their own rooms.

20:46 And could Also press play on their own rooms. Yeah, so waving my hands around of things to pay attention to in the future here is get started playing this game for free and pay later. And then thing two being, uh, hey, this game is editable. Yep.

21:02 This is when he decides hey, I probably need A different name for this business besides uh Potomac Computer Systems. And something that makes us sound like a really big company, like a big important, you know. Yep, like we're we're on the same level as you know, id software is just getting started around this time, and they have a really cool name. Why don't we call Epic mega games. And of course by we, I mean

21:25 Tim. He releases ZZT. And it does pretty well. Like he doesn't make a ton of money, but he sells a few thousand copies. Incredibly They would keep selling the game until 2013. And what? Yeah. This is incredible. We found I found it in the research. So Tim's dad, Paul, uh ended up taking over distribution of the game. It was still just sold through this shareware model of like right to Tim and Well and shareware was really big in like I mean I remember it from the early nineties

21:58 I guess the mid nineties where you'd go to like uh software swaps or you'd go to like user groups, um, or like w we'd were part of Mac Users of Delaware. And so we'd go to the MU meetings, people would demo and you'd swap software there, or you'd sell software there, because there's no internet to go find software. So you needed to like discover it in some way from other nerds who were writing shareware. Yep, totally. And you know, the reason shareware was attractive, especially to an indie software dev like Tip at the time was Your other alternative was to try and go the retail Packaged software model. Well so to do that, you had to go get a big publisher like Electronic arts uh was just kind of getting started at this time and we did our episode with Trip on the beginnings of that industry. You know, he was thinking about it like Hollywood, like you needed these big budgets and like fund these studios, and then you had the relationships with the retailers to get the boxes.

22:51 into retail stores, the retailers would take 50%, you know, when all was said and done. Which is Apple's current argument to Congress. Exactly. Exactly. When all was said and done, you know, if Tim had gone the traditional publisher plus retail model, he would have only been making, you know, maybe if he was lucky, 10, 15%. of the revenue uh that he would be seeing out of the game. Where's this this shareware path he kept a hundred percent? Pretty cool if you can get the uh discovery and distribution. Indeed. Indeed. And process the payments and do all the other very expensive things involved in I feel like I'm Apple over here peddling right. Uh Well, that's it was lucky for Tim he had his dad to uh You know, process the payments, i.e., open the checks and package up the floppy disks in in mailing envelopes and send them out.

23:39 So ZCT does pretty well. They like I said, they sell a couple thousand copies of this. Tim starts looking around, and one thing that he has always been really good at. is observing what's going on in the market. Now I mentioned id software a minute ago and folks who know their gaming history know that It was John Carmack and and John Romero and would eventually end up making Doom, which we'll talk about in a minute.

24:05 And Quake, right? Uh and Quake, yes, after Doom. But before Doom it had released a game called Commander Keene and it was a two D Side scrolling game. It was a pretty big graphical leap. forward uh versus the like literally text editor based games like uh Z Z T. And so Tim saw Commander Keen out there and he said, Hm.

24:27 Okay. That's interesting. I should do something like that. What's a twist I could put on it? Well, what if I do it with a female protagonist? And so he basically cloned Commander Keene, uh, but called it Jill of the Jungle instead. I love it. Now But because it was a two D side scrolling game, it wasn't just text base. It needed actual like artwork and assets in the game. Uh Tim wasn't capable of doing that just on his own.

24:55 So he needs to recruit people and he ends up recruiting some really great folks that he meets you know on bulletin board systems again, uh online and this Proto Internet, folks like Cliff Blazinsky, who is a seventeen year old high school student and applies to be a programmer uh at this uh big mega company Epic Mega Games ends up becoming one of the first employees, Cliff uh known as Cliffy B would go on to become legendary and super important for Unreal and then the Gears of War series. He recruits this really great talent. And then he also realizes, like, okay, you know, I want to make this

25:33 Great game. I need the talent to make the games. But um You know, I also need some talent on the business and distribution side here because I'm trying to build a big company. And who was the big company, of course, at the time, it was Id. So he calls up Id and he starts talking with their president at the time, Mark Ryan, who was handling all of ID's uh distribution and publishing. I don't know he's the president of Id. Yeah, he was the recruited away the president? Yeah, he was the early president of ID. Wow. So at first they're talking about like, well, maybe Id could publish Jill of the Jungle

26:07 But then Mark ends up falling out with Carmack and Romero. And Tim says. Hey, I've got an even better idea. Why don't you come join us here at Epic and you can be our head of distribution and publishing. And so he recruits Mark, who yeah, had been president of ID, to come join this company. Remember That's a crazy career move for him. Like

26:30 He's president of one of the biggest game companies in the world at that point, and to go and take anything less than that title is wild. Totally wild. He became vice president at Epic, which he was as in play what, three or two or something. Yeah. Indeed. So he comes and joins Tim. Remember, Tim is like a junior in college at this point in time and he's got Cliffy B working with him, who's a senior in high school. Uh but they put out this game and it does really well. And then Cliffy B starts working on a few other games that also do really well.

27:04 Next thing you know, they're selling Quite a good bit of software through this shareware model and doing quite well. And so Tim ends up dropping out of college in his final year. And they go. Full time on the business. So

27:18 They're selling these games, they're all still two D side scrollers. But there's another pretty big revolution that's about to come in D nascent gaming industry here.

27:31 And it's gonna come. So we're now in like the early nineties, like ninety one, ninety two. So pretty quickly After that. Id and John Carmack. start talking about this brig project that they're working on and it's a

27:48 game that's gonna be called Doom and I have to assume you know, almost no matter what age you are, if you're listening to this show, you've heard of Doom, played some version of it over the years, but It's easy to forget and I had kinda forgotten until doing this research just how revolutionary this game was at the time. And it got the first three D game. It was the first three D game. Like before Doom, you know, everything looked like a Super Nintendo style game. And Doom was the first game, and it ran. This is crazy. It ran on just these commodity 286, 386.

28:26 Intel PCs. Uh and it ran on DOS. But they Carmac was able to get a fully three D world Rendered and working. Just amazing feats of computer science,'cause this well predates graphics cards or anything that's sort of optimized to do this. It's just like an unbelievable amount of trigonometry and math.

28:46 And and John Carmack used all sorts of crazy programming tricks uh to make this work. And so it comes out. And like This becomes like the fortnight of its day. So when you say the fortnight of its day, though, like let's paint this clear for this tiny constrained market that was video games,

29:08 Yeah. own to that market. But we're nothing like the hundred plus billion dollar video game market of today. No, I mean for reference, you know, Fortnite has uh three hundred and fifty million registered players at this time. Doom ends up Having a few million copies that it

29:25 both sells and and distributes via shareware in those in those first couple of years. Ultimately I think it would get to ten or twenty million copies. But no video game had ever approached anything like those numbers before. So Tim and Epic uh and Mark are like, Okay, cool. Well this is where the industry's going. We gotta skate where the puck's going here. We need to work on a similar project And so they do. They start getting to work on the project. Uh they're gonna call their three D shooter. Unreal.

29:56 But the problem was uh that they quickly find out that It's just like we were saying. The things that John Carmack did to make Doom Run We're just like huge feats of engineering. And it was this massive proprietary advantage that it had. So anybody like Tim in Epic that was trying to

30:13 Get a competing product out there. It was just gonna be nigh impossible. But this doesn't deter Tim. He starts thinking about an idea. He's like, huh, okay. Well I know That It spent all this time

30:29 And ever Working to make Doom work. They work on other projects and Ben you mentioned Quake that would be the successor to Doom that they would Uh that they would come out with.

30:40 They're rewriting the wheel each time they come out with a new game. Like John did all this work to make Doom work But they have to recreate a whole lot of that each time they're making another game. So they have this lead, but it's not like they're gonna keep just like churning out.

30:59 game after game after game and nobody else is gonna catch up. I can take my time. Build a engine similar to you know what Doom has, but if I make it a little more extensible

31:11 Then I can use this engine. and pump out a bunch of content internally, like and not have to go through all these hoops each time that it is having to go through. So he's like, Okay, cool. We're gonna invest the time up front to do this. a parallel here is in sort of Jeff Bezos speak the it's uh Tim is working on the a system that uses primitives, building blocks, rather than sort of starting from zero each time. And because you sort of build from primitives and assemble building blocks that are sort of modular and you can build on top of each time, you sort of get compounding value out of each piece of work that you put in.

31:45 Yep. So He starts working on it and he's not shy about what he's doing. He's trying to build hype for the game for Unreal. He's talking to game magazines and the like. A pretty incredible thing happens. Other developers start coming and studios start coming. to Tim and Mark and saying, Hey, I hear you're working on this engine. We would also love to make three D type games and compete with it in Doom. Would you be willing to

32:15 Yeah. And Tim says. Uh yes. Whoa, and this is before they released Unreal. Like that he was hyping this so much that they had demand for the Unreal engine before Unreal came out. Yes. In fact, I believe some of the first games

32:33 that were made uh by third parties on the Unreal Engine came out within like, you know, a few months or a year of Unreal itself. Oh wow. Crazy. Yeah. Totally crazy. So turns out

32:48 This was a really big idea because these dynamics Were easier in the industry, the dynamics of the bar, the technical bar to build video games. That bar was just going to keep going up and up and up and up exponentially in tandem with Moore's Law. And so without a tooling system like this

33:09 You would quickly become completely locked out no matter how good you were of being able to actually build a game. One of the takeaways there is like the timing to create a game engine is so perfect because before that You couldn't really create a game engine and after that

33:25 you would be so woefully behind that you better be creating a game engine for like a whole new paradigm because it would be foolish to start building a PC based game engine five, ten years after Tim did. Yep. And It turned out, you know, almost like in a much bigger way than what Tim saw when he tried to do um start working on Jill of the Jungle.

33:50 Somebody who's a really, really great technical engineer, game developer, programmer who could build an engine or parts of an engine like this isn't necessarily always gonna be the right person that can have a great creative Story idea, game design, you know, content. And so if something like this didn't

34:11 Start to exist. The creative people would just be totally locked out of the industry or would be relegated to working only within super big companies that had a engineering side of the house and a creative side of the house. It makes sense. Now, uh listeners, I want to pause for a moment and say we keep saying Tim And you know, today Epic is like a two thousand person company, and it's almost appropriate to say Tim when the company makes decisions today. It was especially true at this point, because it was still less than like 15 people. I mean, there's a very small operation going on here, and Tim was absolutely making these strategic decisions. about what the company would be and what it would do.

34:52 Yeah, and not only was it a small operation, but It was a remote operation. So they didn't even all like live in Maryland together. They were communicating uh via, you know, early, you know, early internet technologies here. So finally after Just about five years of working on this. In nineteen ninety eight

35:12 Unreal comes out. Uh and along with the un the official unveiling of the real Unreal engine for game developers. And Unreal itself is a big hit. Uh but also games that are built on it. So games like Daysex, which people might remember, use it, and then A few short years after all of this comes out,

35:33 There's a major change in the gaming industry. Which is After many years of talking about it. Microsoft.

35:42 Finally. enters the picture with the launch of the Xbox in two thousand one. This does a whole bunch of stuff. Um, you know, one It inserts A huge

35:53 you know, amount of weight and marketing muscle behind Gaming. Yeah. massively expands the console market because of that marketing weight behind it. which was previously just the original PlayStation and N an N sixty four. And you know, you had previous versions of Nintendo before that and the the Atari twenty six hundred, but you didn't have like

36:15 I mean it was really just the PS one was the the P S one and the N sixty four are really the only and and the Dreamcast were the only predecessors before Microsoft entered that. That console market. And and really though It was it was two separate parts of the market because Sony and Nintendo were the only viable players. Sony was where all the third party developers went. Nintendo had terrible onerous royalty terms with um uh with third party developers'cause they really sold their systems based on their first party titles. Uh stuff that they were making in house like Mario and Zelda. Nintendo's attitude has always been we're both the best at the technology and the best at the creative gameplay. And so

36:53 the systems are for our games and sure, if you want to let us have most of the economics, then you too can develop for our system. But they're mostly a vertically integrated company. When Microsoft came out though, now all of a sudden they're duking it out with Sony. For Developers. So as a developer, on the one hand, that's good because now you've got two companies competing for your favor and willing to if you're good and making you know have the promise of making good content, uh willing to give you good deals.

37:22 But really If you want to access. The whole market, you want to have your title on both systems on the PlayStation and on the Xbox. Well

37:34 Unless you're using an engine like Unreal That's almost impossible to do. You're gonna have to build from the ground. Dual development teams. Full dual development teams. Well it turns out that this is a problem that Unreal can now.

37:49 really help with and solve. Because they can have, you know, under the hood Uh it's not quite as easy as just like check a box to deploy to a PlayStation. Has been promised many times and has been uh successful zero of them. So I mean these days it's pretty close, but it's so much better. Tell that to a React Native developer. Yeah. It's so much better even then than having to have two full separate. development teams. So Once this happens, they start getting some

38:19 really huge games and franchises start moving over to building on Unreal. So like The Tom Clancy games, you know, Splinter Cell, Rainbow Six, those games, um Bioshock, Mass Effect, Borderlands, these are all in the kind of early two thousands, early to mid two thousands. They're coming over building on unreal and then being able to sell pretty quickly, they might do an exclusive with Sony or Nintendo for six months or whatever that the that platform gets at first, but then they're able to access the rest of the market and go to the other half. Right. And so by this point, Epic is a technology company. Like they make games and they they make this game engine, which is a huge component of the game's value chain, but they're a technology company rather than a first and foremost game company.

39:05 And so when you ask sort of Tim to describe the history, he described we have Epic one point oh, which was Potomac Computer Systems, we have Epic Two Po, where we sort of realized that Oh yeah, this this technology company builds a game engine. It's the the PC gaming sort of revolution of the late 90s to about 2005. And then David, exactly what you're talking about now, this is what he calls Epic 3.0, where the massive proliferation of the sort of console wars allowed us a neutral third party that can dramatically bring your cost down and your efficiency up in developing a game like full steam ahead on consoles, we will be an essential part of building that business. Yep.

39:45 And and they do keep building some games in house as well, but they're thinking about it kinda like like Amazon and AWS. Like they're the first and best customer for the technology that they're building as part of the engine. You know, they do Unreal Tournament, they do Unreal Championship, they do other games. Um but they're really I love how East Coast that just was. Did you say Unreal Tournament? That is like that is like how uh an east coaster says tournaments. Oh my gosh, you know, I never even like noticed that. Growing up I would say orange. Jenny has taught me to say orange. What's the Nintendo character?

40:20 Mario? All right, there you go. I have got some New York friends that say Mario. Ah, yeah, yeah. Anyway, I we we digress. We digress. Appropriate digressions, though. So by the mid two thousands, Like we're saying. For a bunch of reasons. The Big part of the gaming market is really in consoles and specifically it's in

40:41 Sony and Microsoft with the PlayStation and the Xbox. And the PC gaming industry still exists. But it's gotten really tough because Piracy has become Ramp in

40:55 Not to mention, you know, Microsoft is now putting all of their weight in gaming behind the Xbox, not so much on PC gaming. So Tim once again kind of sees that this is where things are going. And Decides hey, you know. What if we

41:10 Tie up with Microsoft. We're Gonna be launching a new version. Of the Unreal Engine, Unreal Engine 3.0. Microsoft is coming out with their next generation hardware, the Xbox three sixty at the time. Yep. And um

41:26 We might might be able to get some really good marketing dollars here from them. If uh if we're a launcher or near launch exclusive title with the three sixty. And Microsoft's effectively in this relationship the publisher and Epic is the developer. Yes. I I believe that I believe that is correct. And so

41:45 Epic develops this game. Called Gears of War, which most uh most listeners will probably be familiar with becomes it's the it's the game where you could push that one button and put your back against a wall and look around a corner. Yep. So it's so funny how so many games had this like signature move and they like That was amazing. That was in every commercial, that was in every demo, and you first played the game, like that is the thing that you wanted to try and do. And this thing sold so many Xbox three sixties. And so as a result of all of this, the the thing is this this kind of becomes uh a a red herring for the company. So they end up making Epic ends up making a hundred million dollars of revenue on

42:27 Gears of War. It cost them twelve million dollars. And I believe that's twelve million across development And marketing,'cause Microsoft was handling so much of the marketing budget. And so Wow, I'll make that bet all day. Totally. So they're literally making eighty eight percent Margin. on a hundred million dollars in revenue, you know, if they had been successful

42:49 in lots of dimensions up to this point, both on the technology and the Game side, but this is a whole nother level. Why ever be your own publisher? I mean, it's it's great if you're the developer, you only someone else is gonna spend the money, you just have to develop the game. It's great. Like And why ever change? I mean, I remember I was just coming into graduating college and getting into media investment banking at the time. And people were thinking like

43:13 Oh man, games are gonna be like Hollywood. Like this is Hollywood movie style money. The dynamics are really similar here. This is gonna be great. It turns out though That Hollywood is actually not that good of a business and an industry. Uh and and why is that? It's super capital intensive. So Gears of War One was kind of a red herring for a bunch of reasons. You know, it was a launch title. with three sixty, Microsoft handled so much of the promotion and marketing.

43:44 When the Epic ends up doing Gears of War Two and then Gears of War Three. Their economics, like the games sell roughly the same amount, maybe not quite as much in terms of revenue, but Their margins end up shrinking significantly down to like thirty, forty percent. And they're having to tie up All this huge amount of capital.

44:06 in the investments in developing these games and then marketing them. And so Tim and and Evan kind of realized like huh This is not as interesting as we thought it was. Time to get out. It also uh w started to show the tension between this sort of uh developer-publisher model. And for folks who haven't listened to the EA episode or Where else we talked about this on the Activision Blizzard episode, you know, the developer is the creative. It's almost like think about it as the director on down on a movie set where you're you're the one sort of having the brilliant ideas and executing on them. And the publisher is the investor. They're sort of fronting the money, they're doing the marketing, they know how to businessify your creative efforts. And so The issue is when push comes to shove, like it did with what was it, Gears of War I think after maybe Gears of War Three.

44:53 Epic wanted to do a multiplayer only version. They said, look, we think multiplayer gaming is the future. hint, hint, you know, or or nudge, nudge to where they are today. And online is, you know, right around the corner starting to become a thing. And so And Microsoft was like No, we don't care. We want to move more three sixties.

45:13 Exactly. And so it was basically a stalemate at that point, and Microsoft was the publisher. Mike Microsoft was the money behind it. And so You know, they they won. So we're now Right around like Two thousand nine, two thousand ten.

45:29 Time frame. And Tim has a quote. There was an increasing realization that the old model wasn't working anymore and the new model was looking increasingly like the way to go. So what is The new model.

45:42 So two things happen right around this time. Yeah. Totally lay the groundwork for what Epic is today. The first is in October two thousand nine.

45:53 A little company in LA will start up in LA. launches a Game. If you could call it that. It's really a mod.

46:03 On a mod of an existing game. This is a mod of Half Life Two. Uh no, no, no. I'm talking about league. Oh yeah yeah yeah. So the mod of Warcraft three

46:17 is the mobile online battle arena game of Dota or Was it defense of the ancients? Yep. And of course. Uh, there's a lot of controversy over if this is idea theft or if this is above bar. But you have this very similar looking game that I think you're referring to, David, being started by a plucky startup in LA in two thousand nine. Yep. And that

46:39 Company has riot games in that game. Is League of Legends. And so what is League I mean it's It's a MOBA, a massively online battle arena, but it really represents

46:52 a completely orthogonal path and kind of a throwback. away from this Hollywoodification of the games industry and back to Small lean development teams. taking a concept and iterating on it without having to invest, you know, tons and tons of development resources and in particular tons of marketing resources. It's distributed a hundred percent online. It's a mod of An existing

47:22 game engine that's out there. Rip off. I didn't say that. But it means that it can get to market so much faster. And then the other big innovation that they have. is they don't charge for it. It's

47:37 It's free, free to play. Now, free to play, that term had gotten a really bad name in the industry because mobile games had taken that up. And free to play really meant, yeah, you could play it for free, but if you wanted to make any progress in the game or win, you'd have to And and this was just starting. I mean that it got a really bad name in sort of that tw twenty twelve to twenty fourteen era, in this era,'cause think about the iPhone was two thousand seven, the app store was two thousand eight. So It wasn't quite the sort of dirty backwater

48:10 Uh social had given it a bad name before mobile gave it a bad. So the free to play stuff on Facebook was It was you know the Zinga type stuff and and you know Zynga was Well. Probably in many ways not the Worst. offender in this regard, but um you know all of the

48:25 games that you had to pay to make any progress in. What League was and what riot.

48:34 you could buy things, but they were just aesthetic. Uh they were just virtual goods. Um they didn't Actually help you succeed in the game in any way, shape, or form. They just gave you personality. Yeah, so it was it was still free to win. But you could pay for other things.

48:50 Yeah. And this end up coming to be known as games as a service, which we'll get into in a second. The other big thing that happens that Epic was directly a part of was in September twenty ten Epic demoed on stage at an Apple keynote. A demo of the Unreal Engine three running on iOS.

49:10 Oh, that's right. I forgot about that. And that actually was the beginning of these like really long, sort of distracting demos at Apple Keynotes of games. Where like every time they're showing off some new graphics technology, but you're watching it over some stream and you're actually not sure what the new thing is. And so you're like, Okay, they're showing off Okay, this time it's metal and it's an Apple in house technology and Craig's all excited about it, but w okay, good. I'm gl glad someone else made another cool game that takes advantage of some harbor feature I don't understand. I always have beef with those being Apple keynotes, but I get that it was a leap forward. Well, it was a leap forward because A, you could bring, you know this incredible console quality graphics and and gaming technology to mobile But it was even more important for the industry in terms of enabling cross-platform deploying and and development and then ultimately online play of games. So Epic now is right in the middle of all of this because

50:10 If you have a game as a service, like League of Legends or any other, you know, free to win. type game. Importantly, that's fully distributed digitally. So you don't there's no more box software. It is being distributed over the internet. Yep. You want to get that in the hands of as many players on as many platforms as possible. You know, game developers always wanted to do this. They wanted to be on Microsoft and on Sony, but at the end of the day, they're selling box software and like That's fine. But when you're no longer selling box software, you're monetizing based on engagement of players.

50:46 Maximizing your total pool of players is really important. And What are you? The by far at this point and then going forward, the vast number of computing devices capable of playing games out there.

51:01 Their mobile devices. Yeah, so it's it's the number of devices got multiplied by I don't know, ten for the the sort of accessible market of games. Or maybe more, but importantly, and I think the other thing that is really relevant to this argument that you're making about

51:19 having a more direct relationship with those customers and wanting to reach as many customers as possible is they're now all on internet connected devices. So rather than your only chance to monetize being every time you ship a new disc to a store and they buy it, you have an opportunity at any given moment to monetize as long as there's payment systems in place. The thing that digital distribution basically enabled was the idea that uh going back to the very beginning of what made Epic epic, that they could give something away for free, but then since you had an always on relationship with that customer, you could figure out your monetization down the line. What this does to the industry is it kind of makes it like the SaaS industry. You know, you'd gone from

52:01 expensive to develop capitalized software that required years of development time and was big and monolithic, you know, your Oracle or your a lot of Microsoft software or your, you know, that type of thing. To all of a sudden, you know, developers, just like software developers, are empower to do small little things that solve a Point, you know, niche problem. deploy it on best in class infrastructure like AWS out there, use something like Stripe to accept payments.

52:35 Uh don't we wish. Yeah, don't we wish. Get it out there and be used and build real businesses with great economics. So the same thing starts to happen in the gaming industry. And Of course. Who was the pioneer in doing all of this? And in the middle of all of it.

52:53 Not just on their own. But then with Riot. It's ten cent. Yeah. Yeah, I mean this is really interesting because

53:00 Riot is pioneering this in the United States. Tencent had already sort of done it with the uh um the ability to do microtransactions on on their early games in China, something that they were definitely ahead on. And as soon as Riot started to succeed in it very early, I think it was pre twenty eleven, maybe maybe twenty ten. Uh ten cent invested in Riot. Once Tencent saw Riot succeeding with this model, In the West.

53:28 They first invested in Riot, I think in twenty ten, and then they bought the company in twenty eleven. So Tim sees all this going on and in he wants to move epic in the direction of becoming essentially the, you know AWS plus Stripe enabling

53:47 this future, you know, renaissance and independent creators and game developers. In the current state of their business, sort of they had sold Gears of War, the full franchise, all the IP, everything to Microsoft. Not quite yet. Okay. First he starts talking to Tencent. And agrees in twenty twelve

54:05 For the first time ever to sell any equity in Epic Games. Uh he sells a forty percent stake in Epic to Tencent for three hundred and thirty million dollars. So valuing Epic at just under a billion dollars. Which was kinda crazy at the time. People were like, this is nuts. This is a you know video game technology developer that, you know, is having bad economics with their big franchise Gears of War. Like what's going on here? And I think the thing that people didn't realize at the time was uh even ignoring the games as a service bet how stable the platform business was. Like the one of the things that I want to mention later in playbook, but we sh need to talk about now is

54:47 Gaming is classically a hits driven business, and what you have with the Unreal Engine is a smoother on that. And since more and more I mean, that business has just grown steadily since its inception, and you now have this massive Steady business underneath your more spiky hits driven games business. Yeah. So with this investment from

55:09 Tense N. Tim. Maintain Majority control of the company. And he says, All right, we're gonna refocus the entire

55:17 company around this vision of the future. We're gonna do three things. One. The Unreal Engine is now our most important product and piece of technology, and we need to add Much more to it.

55:30 It's not gonna be just about the engine for creating the game. It needs to be all the infrastructure to run these games and run live ops and do payments and do all of these things. Funny aside, at the time I was actually when uh when I was at Madrona, we were venture investors in a company called PlayFab in Seattle. Which was An independent.

55:53 startup that uh had the same vision of we're gonna build the infrastructure layer for operating these games as a service and be like Unreal or be like Unity their competitor, which we haven't mentioned yet. It just turned out that PlayFab ended up getting acquired by Microsoft. It turned out that Epic. And Unity were gonna do these things themselves as well, and it was gonna all be part of the platform. Yeah, and there definitely was industry speculation at that point that those things would be not really part of game engines, that they were sort of a separate factorable thing.

56:26 We'll talk about this, but Epic has Epic online services today. There's a lot that sort of lives in that middle ground of like, is it part of the engine or is it really more part of an online service? Um, but Epic obviously had not only the relationships with developers, but the ability to bundle things that might not have used to be considered uh part of an engine, but sort of add more and more and more to that sort of ball of yarn where it was no longer f just physics, but it was physics and characters and AI and the way that they'd interact and all sorts of um things to help with the live ops of your game. Yep. So that was one. Two. As Tim says

56:59 We're gonna rationalize the console business. I don't wanna be in that anymore. We're gonna sell the Gears of War franchise to Microsoft. Uh so they do that in early twenty fourteen. The Tencent investment was in uh like late twenty twelve. And then three To make all this work, we need to have a thousand flowers blooming out there. of people developing on the

57:22 creators and developers and and game makers developing on the Unreal platform. Well, we can't anymore be charging people a SaaS fee. to use our platform'cause that's gonna lock out, you know. The kids in high school who are building stuff at game jams and incentives are powerful. If you charge money for something, less people will do it. Yep. So in March twenty fifteen And this was this was

57:47 Like super ahead of the curve. Epic. Stops charging. A licensing fee for the Unreal Engine makes it completely Free to use.

57:58 and develop on and remember, you know, Unity is out there as well, which is a competing Third party game engine. Mostly focused on mobile. Mostly for stone mobile, but you could use it for lots of things. For sure, but simpler, newer, um amazing for two D stuff, lighter, more accessible, but you're not gonna go build the most amazing three D uh first person shooter P C game with it. On Unity, no. They're still charging a SaaS fee.

58:25 Unreal now is completely free. You're getting like This literally the stuff that Gears of War is developed on for free. And instead the business model is switched to a five percent royalty. on revenue that you would earn on your games. After publishing. That's like A pretty good deal. I mean, if you think about the amount of fixed cost you'd have to capitalize.

58:48 To do this. It would just be Huge. Even your ongoing operating costs to run. Technology It would be more than five percent of your revenue. Totally. You'd have to be massive for it to make more sense for you to build your own game engine now than use use Unreal, which is exactly the strategy. And when you look at who develops their own proprietary game engines, it's only the Activision Blizzard of the world, the, you know, Riot games,

59:15 But very large publishers that you know of. So like think Blue Hole for uh Player Unknown's Battleground, which of course we will definitely talk about later. Like l uh lots of big cross platform 3D games from big studios that just aren't quite as big as like Activision Blizzard or Riot. use Unreal instead of developing their own their own proprietary thing. Yep. So

59:38 Those are the three big moves that Epic makes after the ten cent investment. And they are all just like So spot on. And like, really enable them to become, you know, the AWS plus stripe, plus

59:53 Plus plus. Uh, in the industry. Stripe doesn't feel right yet. Like Stripe to me would be like the epic game store. Yes. Well, my groundwork for all that. Yeah. Yeah, like so okay, to to put it in Tim's parlance, Epic three point oh was console's epic four point oh is free to play games as a service. Digital distribution.

1:00:15 But exactly what you're talking about, David, is this like incredibly robust primitives that serve as the horizontal layer to make games. And so they've stepped back from We're a game maker. Except. Except. Okay. So Just like Amazon, though, you know, they still have this view of like, well, we can be the internal kind of first and best customer. To show what's possible.

1:00:40 with these tools. You know, and we have this rich history of making great games that people love. So They decide that they're gonna spin up three teams internally to start working on Epic's new tools, uh, to build new games. uh from Epic that are gonna run on this games as a service free to win model. So the first that they start working on is a reboot of Unreal Tournament. The second

1:01:05 is a MOBA that's gonna include Gears of War style kind of action elements. That was called Paragon. And the third was gonna be a whole brand new IP that was gonna combine elements of Minecraft and crafting with a tower defense type uh dynamic. Those games were popular at that moment in time. And uh they had a really cool name for it. They were gonna call it Fortnite. Yeah. Uh

1:01:31 Well Uh, we just got three hundred and thirty million dollars and boy are we gonna spend it is the way that I hear that. Yep. Well, so spoiler alert, uh, just like a lot of times when a company gets Three hundred and thirty million dollars. And has like the core you know, economic engine of the company, but then they have other projects that they want to work on.

1:01:50 Those other projects don't go so well. So none of those three games. Work. Yeah, I think it's a lot of it. Yeah, it's interesting you say none of the three. I'm excited to talk about that. The other sort of thing to think about here is Yeah, this is uh

1:02:04 a company with a bootstrapped culture. They'd always been starved for resources. They'd always been few people. They'd always been cleverly figuring out what's the right partner or what's the right way that, you know, we can only make a game when we're sure that it's gonna be worth it for us. And now they they've got so many resources. I mean this is exactly what we talked about on the Eventbrite episode with Julia and Kevin. Like raise a bunch of money and there's lots of things that seem like good ways to deploy that capital um because you can sort of conceptualize why it'll make sense. But then you become this like large organization, there's I don't want to call it infighting, but conflicting views about what the future should be. There's people who are sort of vying for political power that's saying, you know, no, my game's the most important game. And it

1:02:50 results in churn and it results in this happened basically all through Epic's history, but they bought companies, some worked, some didn't, they bring in these studios, sometimes they'd they'd end up writing them off. it just increases all of that sort of fervor and churn around trying to do a bunch of stuff. Yep. And remember, what was Epic and Tim. really, really good at. He was good at looking at What was succeeding in the market at that given moment in time.

1:03:17 Remixing a l it a little bit to make it fresh. And then putting it back out there quickly. You know, that's what he did with ZZT. That's what he did with Jill in the Jungle. That's what Unreal was after Doom. And that's not what they're doing with these three projects here, it's unclear that the market really wants them. So They

1:03:38 operate for years in development of each of these games. So started in twenty eleven, twenty twelve. Yep. And going all the way through twenty seventeen. And then Basically a miracle happens. So you mentioned player unknowns battlegrounds. Tell us a little bit about player unknown battlegrounds.

1:04:00 Yeah, so rewind to nineteen ninety nine, uh, there is a book released in Japan called Battle Royale. Or at least that's the English translation of it. In two thousand, this is made into a very popular Japanese movie. It has uh sort of basically inspired the hunger games. Think about a battle on an island, a bunch of children. I think it's a fight to the death. It's a little dark, but basically you want to be dark. Last person standing. And There's a variety of different games and different sort of anime series that uh through the early two thousands are sort of based on this battle royale concept. There's early games, there's daybreak, there's and uh end of the twenty tens or mid twenty tens, there's this game H one Z one that's starting to incorporate this battle royale concept into a game in is it twenty seventeen that Battlegrounds comes out? Yep. March of twenty seventeen.

1:04:49 And we will henceforth refer to it as PUBG, Player Unknowns Battlegrounds, comes out, and it is a smash hit. It is like this notion of there's a fixed amount of time and there's this circle that is contracting and it's gonna bring everybody closer and closer and closer together and you have to be the last person standing and the action's fast paced and it's sort of uh pretty short amount of time that each game lasts. It's not these fifty minute MOBA style games. It is like Get in, enjoy the action, get out. Even if you win, it's not that long of a game. It is really fun and

1:05:25 Boy, does it skyrocket off the charts, especially because David, exactly as you're saying, digital distribution, it is free to win, it is leveraging these sort of in app purchase like adornments that you can buy for your character skins, but It's pretty like realistic. Like the violence is actual violence. Like it is uh it is a war game. It it's dark, it's realistic. Also though, when it first comes out It's in beta, it's built on Unreal. You know, it's not a big team. It's not

1:05:55 Activision that's making this. It's you know, an indie dead. Raise your hand if you heard of Blue Hole before this. Podcast. Yeah. It's like it's unless you're in the industry you haven't heard of Player Unknowns parent company. No. And also in these early days, it's only on PC, I think. Uh it was not yet cross-platform. And again, you know, with with the especially with a game like this, you want the more as many people as possible playing it. You want your friends playing and And not all your friends are gonna have gaming PCs. In just like a

1:06:27 literally epic move. The company And Tim. See this happening. Realize that these internal game projects are not getting any traction. Yeah, the Unreal tournament team, I think they sort of knew at this point that that wasn't going to ship. By the way, like

1:06:44 the the title Fortnite inside of Epic started in twenty eleven. So it's been six years of development. Uh and and you have this this other team here, this Unreal tournament team that I think had already given up at this point, that it was like clear that it was not going to ship. Paragon is taking a crap ton of resources to make that a reality. That's the internal status of the company when uh PUBG hits. PUBG hits, so Within two months The Unreal tournament team.

1:07:12 Hops over into the Fortnite. Assets. And remember they're all developing on the Unreal Engine, so They all know how to work with the assets in the code here. And they build and launch A new mode of Fortnite. Called Fortnite Battle Royale.

1:07:27 That is a Fortnite graphic cartoony take on this battle royale concept that PUBG has just taken massive. They ship it in September twenty seventeen within two weeks. They get 10 million active players. This is just bonkers. Like 10 million players is probably what Doom got in the whole life of the game. Within six months, they have 125 million.

1:07:53 Active players. Incredibly, you know, there's some dynamics here, like you mentioned, Ben, that like there's less violence. It appeals to kids more, especially it appeals to parents more who are willing to let their kids play. Yeah, like when you die, the drone comes and scans your body and warps you away. Like it's I and I don't think that's the right terminology, but like you're you're you're not bleeding out in the street the way you are in PUBG. Yep. But unlike PUBG, which is only on Because Of all of Epic's resources.

1:08:19 They immediately deploy it. Cross platform. PCs, consoles, mobile devices, all within the first few months of launching, Sony actually would be a big Hold out, Sony would let Epic release it on the PlayStation, but wouldn't allow PlayStation players to cross-platform play with. other platforms'cause they wanted to keep everything in house in the PlayStation Network.

1:08:42 Epic eventually convinces Tony that, like, hey, you can't keep this cat in the bag here. I think the qu they may have even got to 125 million users before launching mobile. Like it was a I don't uh maybe that's wrong, but I remember it was this s Smash hit phenomenon. And it wasn't on mobile yet. Like that was the craziest thing is

1:09:03 And and the games industry was it absolutely turned on its head at this point because everyone was just told Esports is gonna be this massive moneymaker, which it ended up not being. Like it was You were building an eSports company at the time, right? Yes, I was very deep in the in this at this time with Taunt. Esports was a really good idea for the publishers and really not that interesting for everyone else. Streaming was interesting for lots of players in the value chain. But Um, the interesting thing about being in that industry in that moment was PUBG went from nowhere to being dominant. And we all thought, wow, here is this new arrival of this thing that's gonna be a fixture along with, you know, Activision Blizzards games and Riots games. And then like

1:09:42 A few months later. Boom, Fortnite blows it out of the water and just steals share like crazy and then goes to even bigger, newer heights. And It was the craziest thing'cause you're like, God, like the fervor in this industry right now of what, you know, is gonna be the staying power franchise is crazy. And I wanna

1:09:59 reflect back on the launch a little bit,'cause Fortnite did launch its original game built by the original team, Fortnite Save the World. That Basically didn't work. It came out.

1:10:11 PUBG came out, PUG won, like this thing was not a battle royale game. It wasn't a fight because Fortnite wasn't playing this thing. At Epic when you said they started w working on the Fortnite assets, like What that actually looked like was copying the codebase that a whole other team, it was basically laying fallow, the Unreal Tournament team, takes that forked codebase, rebuilds the whole thing using the gameplay mechanics of PUBG, and launches it. You then have this fascinating

1:10:46 Internal struggle of trying to figure out how do you combine these two teams, one of which poured six years of their lives into getting it 95% of the way there, but got the core gameplay mechanic wrong, and the other of which spent the last few months Working on a new project, having fresh eyes, not being clouded by all the baggage of previous decisions and haggling made over the the last six years that has this smash hit, and all anybody out in the world cares about is Fortnite. Like I don't uh anything lower level than that or internal politics don't care about. And so you have to figure out as a company how do you

1:11:21 when you know you just have this thing that's magically captivated the world, how do you throw all of your resources at it and bring everyone together in Kumbaya to say like we as a company are doubling down on this thing as our thing. Along with our other thing, the technology platform is Unreal Engine. It's not even the business model of the company. The business model of the company. And Tim's you know, he's really gotten religion at this point in time. The mission is Build the tools, be the

1:11:53 AWS and Stripe and you know live ops for all developers to make games. This is I think just like such important backdrop to what's going on now, because now we'll run through what's happening. But Tim again, like he's just viewing this like this is a windfall. This is Awesome. This means I get more firepower and more ability to play offense.

1:12:14 In getting my ultimate vision. So Like we said, Fortnite, Battle Royale. major cultural phenomenon. Estimates are that they made two and a half billion dollars in revenue in twenty eighteen alone. So it launched in September twenty seventeen. Twenty eighteen, two and a half billion dollars in revenue. October twenty eighteen.

1:12:37 Epic raises. Uh their first Non strategic. capital raise. They raise one and a quarter billion dollars from KKR, Disney, and several other investors at a fifteen billion dollar valuation. Quite the step up. Quite the step up. Quite the step up. In December twenty eighteen, they launch Fortnite creator mode, which

1:12:58 is almost bringing like Roblox type elements into Fortnite of letting people create and and ultimately monetize their own Designs, levels, experiences. In doing so at the same time. They launch.

1:13:13 The epic. Game store. So this is now bringing forward. All of this future that Tim wants. to come to bear and would ultimately set the stage for this confrontation with Apple and Google. The Epic Game Store, they're gonna sell

1:13:28 their own games online, Fortnite. uh Fortnite currency V Bucks. And other games. And third party games in the Epic Game Store. Of course, you can do this on PCs and all the things that we're gonna do. Totally the the the opportunity is compete with Steam. I mean Steam's been doing this forever and frankly the knock on Valve is those guys haven't had a hit in forever. They're just taking a a Vig or a Rake on uh all these other games that they basically have a monopoly on PC game distribution. Yep, like and they're taking a thirty percent cut.

1:13:59 And Epic w had such a hit with Fortnite where they were like Uh We had the advantage of never needing to be in your store and always going direct. So now we have this direct channel to all these customers like Well we should leverage that. Yeah. So What do they launch the store with?

1:14:16 They launched the store with a twelve percent cut of revenue. So they undercut Valve by eighteen percent. And then the kicker is if you build your game on the Unreal engine, the five percent revenue fee gets baked into the twelve percent. So they're real. Un literally unreal, Epic is saying. You get

1:14:38 The Engine. You get the live ops, you get the distribution in the store and the payment processing that comes with that for a maximum fee.

1:14:51 Of twelve percent of your revenue. It's wild. I mean it is really let's let's even ignore the lack of double dipping on that five percent from the uh Unreal Engine. That twelve percent, the the way that Tim talks about it is basically a cost plus pricing model where he says, Look, I think it's gonna take Five, seven percent.

1:15:09 to to run the store and we don't need to make more than five percent. We think Apple and Steam or uh getting away with highway robbery. And so uh we're just basically gonna make sure that at the maximum we make five percent. Oh, and uh, you know, if you're really trusting in us and building on our full stack, we're not gonna charge twice. Like it is It is the exact opposite of what every other CEO in the technology industry these days is doing.

1:15:33 It's not like Google says, Hey, if you use uh GCE for your infrastructure, whatever you spend on that, we're gonna give you credits in AdWords. No, no. We'll give you a reduced price if you buy more from us, but we're certainly not gonna say, Yeah, yeah, we'll give you, you know, core assets for free. Totally. Twenty nineteen. is basically

1:15:57 The clash between Valve and steam. and the Epic Game Store. Um, and Valve responds, they cut their take rate to twenty five percent. But they're going back and forth. But really this is setting the stage for What would happen.

1:16:12 Now this year. One other conflict that happened previously too was with Google, where uh Epic basically said, look, like We're not gonna go through Google Play anymore because Android, you have this nice open platform, you brag about it being an open platform. We are going to have people download the APK where they're just gonna sideload and install the app directly. What Epic and all of the people who want to play Fortnite on Androids realizes there's a litany of Oh my God, you're about to get your phone hacked dialogues that come up between downloading that app and getting to play it, and every time there's an update. And so this is actually something that Epic walked back from and eventually did list on the Google Play Store because Google, as Tim calls it, has a fake open uh ecosystem where despite getting to proselytize about how the

1:17:00 App Store is not the only way or the Google Play Store is not the only way to launch on their platform in reality. It is. So then this year Epic. Decides.

1:17:11 Two Take this fight directly to As he's saying that just Google. But The other Tim. Tim and Sundar.

1:17:21 I wonder how much the timing of this clearly Tim had been thinking about this and plotting this move for a while. But this was the first year where you start to see some cracks. Not just in the Game developer. uh sentiment about these app store take rates. But among other software developers, there's the whole hey controversy with Basecamp um around Apple and the 30% cut.

1:17:46 That they're taking on Hey email software. So uh Apple has this payments infrastructure, or if you choose to use your own, there can be no link or reference to it in the app and hey basically linked to their website or something like that and is that thus violated a app store policy. But it's all the same Spirit here, right? Of like

1:18:10 Right. Pay us thirty percent or have this gross and horrible user experience where people have no idea how to sign up for your thing. So while all this is going. On cracks are starting to form in the developer sentiment with Apple and a little bit Google.

1:18:28 Now Epic is here sitting on not just the biggest Game. in the world, but kind of the biggest like cultural phenomenon and on par with TikTok, you know, social networking. experience as well. It's a pretty big point of leverage with these

1:18:47 Ecosystems Mm. And so finally on August thirteenth, twenty twenty. Epic pushes a new version of Fortnite to the iOS.

1:18:58 App Store and the Google Play Store. that offers a permanent discount on V Bucks, the in-game currency in Fortnite. If you buy Directly. From

1:19:10 Epic, which I believe you could do now in this new version of the app. You actually still can if you have the app on your phone. Oh, if you still have that version of the app. Wow. Yep. So Apple and Google immediately D list Fortnite from their app stores. And then they said you need to upload a new version that doesn't include this. Yeah. Right. And Tim said Nope, not gonna do that.

1:19:32 Yeah. So then then the pitchforks come out, then Apple says, Well, you know, you knowingly and and and obviously like this comes right on the heels of the antitrust controversy. Ep Epic really deeply prepared for this and thought it thought this through. Um and they release this unbelievable video, this free fortnight video where you've got Tim Cook is the evil sort of IBM like character from the original nineteen eighty four commercial. Epic is sort of this They're coming in to Swing the hammer and throw it at the evil IBM Tim Cook character. It is it is like It's all Fortnite characters. It's so good.

1:20:05 deepest dagger you can stab at the Apple executive team and really make them feel like the villains in this story. And So the you know, the pitchforks continued to come out, everyone's escalating. Apple says, We are going to ban your developer account and not major escalation here. Yeah. We are going to ban your developer account. And what that means, if you really dig into it, is we are going to make it so that you can no longer distribute new versions of the Unreal engine to your developers that they can compile in their code and then submit to the iOS or Mac app stores. And so they're basically saying, W look, all all IOS and Mac

1:20:52 App store we we're just gonna break the ability to use Unreal Engine if you're a developer on those app stores. And so, you know, they've now they've got a two front war. There's a Fortnite war and Apple has dragged the Unreal Engine into this. And of course, this goes to the courts. There's an injunction filed. the most recent couple of pieces of information that we know are that uh a judge for at least the next month has said, Apple, this thing that you've done of bringing um the Unreal Engine into this, like you can't put a little ticking time bomb on Epic and say that you're gonna break their developer account uh that deeply to the point where Unreal Engine won't work for all of these game developers anymore. Like that's one step too far. The thing that you can keep haggling about is whether Fortnite needs to submit a new version that doesn't violate your policies and has only an uh transaction with Apple that pays the 30% cut. That's still it in fair grounds to fight about. So Apple, you can keep Fortnite out of the app store for anyone who wants to download it now. They didn't mandate, I don't believe, that you have to keep letting the existing version of Fortnite work on people's phones, but it is. I expect that. Apple has a very powerful kill switch at their disposal, so we will see if Apple decides to stop allowing the existing version of Fortnite with the payment loophole that's on

1:22:08 100 million plus phones or tens of millions of phones, I don't know how many to break, but that is sort of the state of where things are today. Yeah. And Just right before we went to record. Epic. Hit back and announced that Existing Fortnite instances running on Apple devices are gonna lose access to

1:22:29 The next Fortnite season. and cross play ability. So they're no longer gonna be able to play with friends that are on other platforms, whether that's Android or console or PC. So When tech giants clash, customers lose. But I think we will uh we will get to that more.

1:22:48 More in grading. David, do you have anything else in industry and facts here? I think that is quite the epic story for history and facts. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would nod and you're done.

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1:24:41 That Ben and David sent you. Okay, so our next section In many episodes is is called acquisition category. There wasn't an acquisition here and David and I have thought a little bit about what we're trying to accomplish with this category, and we actually think that it's best described by a book that we're obsessed with and have had an LP call with the author of, and uh just really think is brilliant, uh, of the seven powers. So

1:25:09 w w what are the seven powers? They're basically the ways that And I'm gonna Hamilton, if you're listening, I'm gonna butcher the definition here, but there are the ways that A leader in a category can earn outsize profits versus all of their competitors. It's basically what what's the thing that makes your business powerful versus your competitors. And I think this really gets at the core, David, of like what and why We wanna dissect

1:25:36 What core essence of a business is. You know, there's so much going on here with the technology platforms. The evolution of the games industry in real time. And then this Fortnite phenomenon.

1:25:51 What is the power Epic has so there's seven categories of power, obviously in the seven powers that Hamilton identifies. Counter positioning scale economies, switching costs. Network economies. process power, branding, and cornered resources. Most companies that have

1:26:10 Power have one, maybe two of these. I actually think epic. Has Three. Powers.

1:26:18 that are concurrently going on here. I would say they have scale economies because The scale at which you need to operate your infrastructure. To power. A game like Fortnite or PUBG or

1:26:33 Large games that run. on Unreal. You need a huge amount of infrastructure. And then to amortize that infrastructure cost such that you're able to sell it essentially at

1:26:47 five to twelve percent of Your end customers' revenue. Nobody else can match that. No, it's the same way that Netflix draws its power by having the largest subscriber base, it has the sort of lowest per subscriber cost to produce content. Yep. Or um you know AWS. Same deal.

1:27:05 Then I think there's the switching costs, right? Like that might be the most directly powerful here. Like if you're PUBG or you're any game that's built on Unreal. You have no choice except to continue running on Unreal. You're not gonna spin up something on your own. You could maybe try and switch over to Unity, but that's gonna be very, very difficult. And not gonna have the same types of features that you need. We've got sort of leaned on this a few times, and obviously it's a private company, so the financials aren't public, but it's fair to assume that

1:27:38 the Unreal Engine on its own does about a billion and a half dollars a year in revenue. So like this thing that lots of developers are like pretty locked into because they committed and and it was a good decision to. Like we're not saying that You know, they should have picked anything else'cause basically if you're building a mobile game that's really pretty simple, you should be using Unity. And if you're building a broader cross-platform 3D complex game, especially one that requires meaningful physics, you should be using Unreal. And so they're generating this I don't know, one, two billion, call it a billion and a half dollars alone from that engine business. You know, that's

1:28:13 the five percent of revenue that they're making. So you know, multiply that by twenty to get the amount of revenue that So those are the two I think powers that apply to the core technology Unreal engine and online services and all the infrastructure part of the business.

1:28:32 But then with Fortnite They also have this network economy, right? And this is where cross platform becomes so important. Fortnite on iOS without cross-platform. is so kneecapped. Like, you know, imagine You're a a kid or anybody who hangs out with their friends on Fortnite, whether that's playing Battle Royale or in creator mode or attending like the concerts that uh are on in there. I mean Travis Scott hosted a concert that Marshmallow and Marshmallow had fourteen million People attending. Now

1:29:07 Interestingly. It's not like there was one room with fourteen million people. They were it was limited, I think, to fifty actually for the Travis Scott concert. So you wanna be in the instance with your 49 friends. You don't want to be with 49 strangers. Now if all of a sudden If

1:29:27 Most of your friends are not gonna be playing on an iOS device. They're gonna be on a console. They're gonna be on a switch. They're gonna be on an Android device. Now you can't play with them. That like hugely removes the value. David, I think this is a good time to bring in the other pillars of Epic's business. So of course we've talked about Fortnite. That on its own is somewhere between a a billion and two billion dollars a year in revenue right now. You got the game engine, that's another billion to two billion dollars a year in revenue. You have the app store, or I guess what do they call it, the epic game store. Epic game store. I think it's losing money right now because of the amount of marketing dollars that they're pouring into it and deals that they're doing to get games on there exclusively. So there's a lot of sort of uh dollars that they're pouring in to make that a successful thing on its own. uh they started with a huge head start because they converted all of the Fortnite launchers into epic game stores. So suddenly I can't remember how many million it was, but overnight there was millions and millions of uh of people that suddenly had the Epic Game Store and now had other games in there. And uh if you want to deep dive on the Epic Game Store, you should go read the Matthew Ball piece that we have linked in the show notes. It's awesome. But then there's this fourth pillar of the Epic online services, which uh is not a huge business for Epic yet, but is exactly the sort of thing that

1:30:44 Tim Sweeney loves that you can sort of plug into any one of these sort of AWS like services and the Epic Online services, whether or not you're using the engine. And there should just be tremendous amount of interop across the whole industry where you could use the matchmaking service, you could use the friends list. Um, there's all sorts of ways that you can allow people to play cross platform or for friends to be aware of each other. If one person's playing one game on an Xbox and the other person's playing a different game on their phone, using these epic online services, they could all sort of be a part of the same Metaverse. Ha ha there it is. It took us long enough to get there. But yeah, an hour and a half in and

1:31:27 In the current you know, instantiation of Epic with the Epic online services having, you know, just being kinda nascent in adoption and Fortnite being the first and best customer of it. Uh that network economy's power only lives in the Fortnite part of Epic business. But what you're talking about is they wanna bring

1:31:46 all of that network economy and network effect of all these friend connections and all the cross platform. into everything that is built on the epic technology. Like that's pretty powerful. And I think that's probably also what's really scary to Apple and to Google, right? Like And probably to Facebook too. Yeah.

1:32:10 So this really hits at the core of how Tim Sweeney philosophically thinks about What Epic's mission in the world is. And it is how it is diametrically opposed. to Apple, Facebook, Google. It's not only open versus closed.

1:32:25 It's more like Tim thinks there's another internet to be built. Bye. Basically bringing down rent everywhere. Like take rates should dramatically go down and interoperability should dramatically go up. I mean, think about when the world wide web first launched, how wide open it was. But Tim's vision is a little bit more privacy protected, that you can't just drop arbitrary JavaScript in and collect information on people. But uh think about sort of uh the ready player one world, but rather than it all being one company,

1:32:57 he has this vision of y and he'll name his competitors. It's actually remarkable to listen to him talk that the Roblox economy could interact with the Fortnite economy and you could buy goods and bring them between worlds and a you can easily shift between those worlds with your friends. And I think that The way that he thinks about the world And the this metaverse that he wants everyone to live in is commerce is gonna be online in this digital space, um, social connections are gonna live there, and and it's not just games and it shouldn't all belong to one company. And you look at the way that Apple is approaching this particular fight and this whole thirty percent battle, it is We are entitled to thirty percent of everything that happens on our platform and Tim is pounding his fist and saying, Nothing is yours and nothing is ours.

1:33:42 Yeah. Tim Squeenie, not Tim Cook. Too many Tim's. Yeah. Well, this is As usual, there's like too many, uh too many white men in power in our stories, but Absolutely. Totally. But I think this is what's really cool. And actually You know

1:33:58 The whole concept of the metaverse and ready player one and all that, it's so cool and people have wanted it to come about for so long. And VR was kind of a head fake around this. VC's got a lot very excited, myself included. It really is actually starting to happen now. Just not in the way that anybody expected. Like Everything we've talked about so far. with all of Epic Epics technology, the Yeah.

1:34:27 is in the context of thinking about them as games. But we've kinda already crossed the Rubicon. Like they're not Just games anymore. I mean Fortnite has observer mode. Like there's a way if you don't feel like playing, you can still go get on chat with your friends and watch them play without you having to be involved in the game. It's a hangout place. And creator mode where you can create all sorts of experiences and, you know, play them with your friends. And that's what people also do in Roblox. That's what People do in Recroom. Uh, you know, we've had a Nick Fight on the show, the CEO of Recroom. I think this is what Tim is talking about here.

1:35:02 And then you think about The tools, the Epic makes you know, they're so powerful. Mm. And can enable

1:35:11 Experiences that just like honestly would have been impossible to imagine two years ago. We haven't talked about yet on the episode, but things like The Mandalorian, the awesome, you know, Disney Plus TV series. That series was basically made in the Unreal engine like they filmed the whole thing on a sound stage with digital walls and all of the sets were built Virtually and unreal.

1:35:38 It's so Frickin' insane. I I'm gonna hold my tongue for now, but it is like the coolest Most insane. How are there zero practical effects in that whole thing? Stealing your thunder from later. high IP franchises to be filmed and created at a fraction of the cost on a fraction of the time frame. You know, and it's not just this like theoretically it could happen, like you know, that the Unreal engine branching out of gaming and Fortnite branching out of gaming is actually happening. It's already happening.

1:36:09 real iconic use cases. Yeah. Okay. Any other powers you had on uh on your list? Those were mine too. So uh into the section of what would have happened otherwise, if we were looking at a transaction here, acquisition This would be what would have happened if the big company hadn't bought the little company. Uh here, the way I want to analyze this of uh uh what would have happened otherwise if Tencent had not invested. And before we talk about if they hadn't invested, I want to talk about their investment for a moment because I ran some numbers in

1:36:39 Holy everything, you guys. This is this is a a crazy investment. And we've covered some crazy investments on this show. I think NASPR's ten cent is one of the all-time best, but this one is like it's it let's just run through some numbers. Okay, so in twenty twelve, Tencent boughtty percent of the company for three hundred and thirty million. And that forty percent stake Played forward six years in October of twenty eighteen, when they raised the round on the valuation of fifteen billion dollars.

1:37:09 That's now worth five point four billion if I did my dilution math right there. So it took him six years to turn three hundred and thirty million into five point four billion, which I think is a sixty percent Annualized return. on that money. And One way to contextualize that is uh if you're a VC and you're listening to this, that's like let's say you're a smaller series A firm and you've got a three hundred and thirty million dollar fund.

1:37:33 That's like investing the whole fund and generating a sixteen X Only six years into the life of the fund. Yeah. The crazy, crazy, crazy thing though about Tencent and why they are just

1:37:46 S like they're just on a whole nother level than anyone else out there. Is like this is far from even their best investment. We covered what's probably their best right now. I haven't run the math on Maiton, but in Pin Duo Duo in uh two episodes ago. That stake I think is worth Twenty some odd billion now. And they've invested less than a billion. Um

1:38:10 It's wild. Unbelievable investors and they bet huge and with conviction and are often right. Anyway, quiet giant. The other thing that I want to say about that deal. Not the twenty twelve deal, but the twenty eighteen deal. Is

1:38:27 When they were valued at fifteen billion dollars, I hadn't done my research on the company at that point, and I was like, Oh my God, people are caught up in the Fortnite hype. This is not gonna end well. But In twenty eighteen, they Did five point six billion dollars in revenue, three billion of which was profit. So that valuation is five X eBit Doc. Yeah.

1:38:48 It's that's not crazy at all. Not crazy at all. I'd be a buyer. It's very rational relative to a lot of these other sort of uh mid teens and twenty and thirty and forty billion dollar valuations that we saw from lots of other companies over the last several years. So Yeah, this business. grew incredibly quickly, was spitting off cash, and could continues to.

1:39:11 It reminds me a lot in in that way of Zoom. If here's a company that's been growing incredibly quickly, incredibly capital efficiently. Zoom I believe generated over a billion dollars in free cash flow last quarter. You know, and you contrast that with all of these other, you know, it's kind of all these other companies out there that are burning capital You know, it reminds me also of just, you know, kinda how we started at the top of the show with who Tim Sweeney is and what his goals are and how he

1:39:42 operates, you know, he's not hobnobbing with celebrities, even though he's a billionaire. He's eating Bo Jangle's fried chicken and spending his time building epic towards his vision and mission for the future. And he bootstrapped for Um How long did we say was it twenty two years, I think before twenty two years. Twenty years ten cent money. Before taking the ten cent money. Yeah, so I mean on the one hand, yes, you're right. It's absolutely this reflection of Tim's personality. On the other hand, we're comparing it to these companies like Uber that are like moving people around their cities and Fortnite makes money by selling digital hats.

1:40:18 Like they're selling zero marginal cost items that have zero distribution costs and they're selling a ton of them because Of social proof. You're pulling forward a playbook theme. Yeah. But anyway. Would Epic be what they are without the Ten Cent investment? Absolutely not. Like if you think back to 2012, probably 2011, when the conversation started, you know, they had no or very little digital distribution expertise. They had most recently shipped gears of war on some discs to some Xbox customers. They had no live ops experience of

1:40:50 running anything like the platforms that they have today that are constantly changing and constantly getting updates and constantly getting new seasons. There's no games as experience. And and I think like Tim would be the first to tell you. There's a quote that I grabbed here. that Tim says that which is uh Tencent is the number one operator of live games in the world, the number one game publisher in China, and the number three internet company in the world. They're not the game developer, Their expertise is how to operate these games on the very large scale and really appeal to customers. And we found that their values are very similar to ours and that we have a great deal that we can learn from them. And I think that was in like the twenty thirteen, fourteen time frame that he gave that quote. So uh you know. I think

1:41:32 Not only are they investors, but I think the leadership team at Epic think of them really as strategic advisors and sort of uh people who brought them into this Epic four point oh era of the company. Yeah, I mean it's telling that all of the major st the three major strategic moves And then the game development in this new way.

1:41:54 uh that have remade epic. All happened after the ten cent investment. You know, and it just underscores too, like This theme shows up so much, even though it's specific to Tencent. That company has been so misunderstood for so long. You know, when The investment happened in 2012. We didn't talk about this in history and facts, but a lot of people left the company, left Epic, because they thought that Tencent coming in meant that they were gonna turn into Zynga. They thought of Tencent as like, oh, free to play, like this is not what we wanna build. This is not how you build real games.

1:42:30 And the reality was that it was totally wrong, it was this whole new vision of a much more sustainable, more democratic way of building. Games and and vision for the industry. And people are only now just starting to wake up to That reality of of Tenton.

1:42:48 It's absolutely right. Playbook? Playbook. Let's do it. Okay, so Ben, you mentioned um virtual digital

1:42:58 Zero uh Selling hats. Zero marginal cost goods. Say more about that. Yeah, so uh it is literally the greatest business model of all time to have the fixed cost and frankly not even the large fixed costs of um designing a new piece of virtual garb or a character or a skin or you know

1:43:20 using the tools that Epic has built. It is not You know, it is it is a lot of work for an animator to do this and a rigor and all the other things involved, but like It's not crazy. It's it's one to five people doing it for less than a couple months.

1:43:34 And And in some cases a day. And then you can sell that thing. to three hundred and fifty million people for like twenty bucks each. And it costs zero dollars for you to get it to them. Like it is the most

1:43:49 incredible operating leverage that you could possibly have on getting Something that Takes a f very small amount of fixed toss to create relative to its distribution and have zero marginal costs and zero distribution costs and getting it out there. It is like the

1:44:04 gods of internet business models come down and knighted Epic and said, You have this privilege to uh just print dollars and there's an ATM machine in their backyard that is just spitting out money. And like I'm assigning zero value judgment on that. I'm just saying the reality Of The business that they find themselves in is Unbelievable.

1:44:25 This theme that Low or zero marginal cost. Goods make for Incredible. businesses and business models.

1:44:36 I feel like is Such an important like mega theme. That we've I feel like I've been rediscovering this past year and we've been discovering on this show.

1:44:48 The cool thing is Well, two cool things. One. It doesn't only apply to the internet. Once you start to scratch the surface about this idea, you realize it's actually been around for a long time. Right, media was classic. Media was this, yep. And and reading the outsiders actually really made me Think about this.

1:45:25 It's it's multiple types of the media business. There's the content. part of the media business that you're talking about. There's also though the distribution part of the media business. Now this has vastly changed with the internet, but I think about John Malone and TCI and the cable business. You know, that was a business that had incredibly high Fixed cost to

1:45:45 literally run the cables and launch the satellites for the distribution of signals. But then once you Were a cable operator and you had those lines laid into people's homes. It was literally zero marginal cost to keep charging'em a hundred bucks a month, you know, every uh every month. Once you start to see this It's really helps me.

1:46:08 I think Evaluate. business models and start to foresee what a business model of a company's gonna be. And like no matter how successful

1:46:20 you operate. Hamilton talks a lot about this in seven powers. Operational excellence is super important. and table stakes for becoming a great company, but you kind of have this ceiling of how great you can be. based on the economic characteristics of your business and your industry. And it comes down often to this marginal cost aspect. Well and if you just look at the Fang and I don't wanna say Fang'cause I don't think Netflix deserves to be in it. I

1:46:47 Let me get on my high hearse for a moment,'cause I slipped up. Fang should refer to High paying jobs in the valley. uh at big companies and people have used it to refer to a set of stocks that should actually include Microsoft and should not include Netflix, especially from a market cap perspective. So anyway, if you are looking at the big five tech companies by market cap, much of the same characteristics are present in all of them. I mean online advertising, the Google model, the Facebook model, that's a zero marginal cost, zero distribution cost business. I mean, you look at like the virtue virtue is very much the wrong word. You look at the um advantages that even an Instagram has over a YouTube

1:47:26 Like Instagram does doesn't have to pay creators, whereas YouTube has to pay a cutout to creators. So any business where you are able to charge to distribute something that costs you nothing and it also costs you nothing to distribute it, it is like that is present in a lot of these companies. Now, fascinatingly, which I'll foreshadow before grading, Apple is one of these companies that does not have zero marginal costs and definitely does not have zero distribution costs. They're for the longest time business model is making thirty five percent operating margins on shipping goods to you that are really, really expensive to produce, even on a on a variable basis. Like obviously the R D is expensive, but the crap in an iPhone is really expensive. It's not like a digital hat. And so it's no wonder they're trying to get into these these uh services businesses that, you know, are creating this clash. So I think uh You know, in some ways an interesting takeaway here is Epic has the best business model of all time and Apple is jealous. And that is a little bit of what we are seeing here. But um yes, David, I think you're exactly right that once you see it, you can't unsee it.

1:48:28 Totally can't unsee it. I think there's another Theme to highlight here. That's Epic.

1:48:36 first stumbled into with the Unreal Engine But then Tim. Really Tim Sweeney, really got religion around And it and it's driven. His whole

1:48:49 Vision now of letting a thousand flowers bloom, then this is related to the marginal cost aspect of what you're doing. But it's one thing to make games yourself. And invest lots of resources into doing that. That's

1:49:04 really making an assumption that you are gonna be right and know what the market is gonna want. And Tim has a pretty good track record of that, but as we've seen, like even he can slip up sometimes, you know, those three titles that they started working on in twenty twelve, twenty thirteen. Didn't work.

1:49:23 A much better aspect is if you can find a way to just enable entrepreneurship and creativity kind of writ large. And be able to say Hey. I don't know what's gonna work.

1:49:37 But I'm gonna let lots and lots of people try and have their shot. That can be Way more powerful. Yeah, what was the phrase we used with um Cha thin when we had him on the L P show, uh leverage on tinkering. Which is like any time you can empower a creator to do more with their same skill set, as a it can be really powerful.

1:49:57 The way that I had what you were describing written out in my notes here are uh steady platform revenues to smooth hit driven spikes from games. Yep. The only other kind of second layer of nuance I'd add to that, I remember Ben Thompson talking about this in the early days of Stratekery. The very best way you can do that is if you can lower the bar to Creation and entrepreneurship. And that's what Epic and Tim are really trying to do. They're trying to say, No, you don't need the budget of a Hollywood studio to make An amazing online experience.

1:50:28 Yeah. Yep, that's a great point. Okay, um some other themes that I had here. A few of them roll up under control. Uh one of them is don't be beholden to a publisher. You know, creative differences with Microsoft over the future of Gears of War um is an example of this. And you know, Epic definitely publishes Fortnite, publishes and develops Fortnite. And so it's important to kind of have the final say.

1:50:51 And Tim found a way to to do that. It also is interesting if you look at their capital structure. I don't think they could pull the thing that they're pulling with Apple if they were a public company. Like It it in v in stark contrast to the lesson learned from Eventbrite, which was uh it's nice being public because you have more flexibility when you need to do things like raise capital. Um, it forces more capital allocation discipline than when you have sort of deep pockets from VC money.

1:51:17 In this scenario If he had public shareholders, it's very unlikely, I think, that he could have gone out after Apple in this way, because as we'll talk about, Yeah. it's likely short term value destructive. And

1:51:31 it's not necessarily clear that it's long term value creative either. He's doing something on behalf of an ecosystem for value that Epic itself and their shareholders may not get to realize. And so I think this notion of having control So it you can sort of do what you want. And I'm sure he very much checked with Tencent and had a deep conversation, especially about what Tencent wants from Apple before doing this. Uh being a controlling shareholder uh allows you to do things that you certainly could not do that may pay off compared to being a public company. Yeah.

1:52:03 Total I mean, could you imagine what the share price would be doing uh through all this if this were a public company? Oh my gosh. Yeah. Well If you look at Apple's only going up. Yeah.

1:52:15 Which actually, you know, I think To be fair to Eventbrite episode. I think Kevin or Julia or maybe both When we were talking about this said Yes, there absolutely are situations where being private is better. It's not like being public is

1:52:30 Better writ large, and this is one of those situations. Right. Yeah, that's a great point. Okay, a couple more. One is that game engines in particular are of a type of product that have incredible inertia, that are hard to build, it's hard to get customers, but then they're almost impossible to displace. Like no one's gonna swap out their game engine for a different game engine and You also aren't gonna be able to start a successful competitor to

1:52:57 the Unreal Engine right now. Like if you look at when Unity successfully started a game engine, it took off because of the birth of mobile. There was this brand new paradigm where you needed to have uh an engine with a very different set of resources. We haven't gone deep on this on this show, but if you're developing a mobile only game, like you would be pulling your hair out trying to do it just with the Unreal Engine. Like If you're gonna do that, it better be worth it. because you're also developing for PC and consoles and i the only way to compete with um One of those.

1:53:28 products once it has momentum behind it is in a displacement of paradigm. So mobile coming out and who knows what the next one will be. But it's definitely one of these companies where the sort of inertia around it Make switching it basically impossible until the next technology generation. Yep. Hundred percent. Okay, and my last one. So in my notes I wrote down iteration and compounding.

1:53:52 So iteration is standard dogma in startups and engineering. I mean, you hear about agile development. And compounding is standard dogma in investing. But This is one of the first times that I really grasped how interlinked the two concepts are. The sort of methodical small iterations that Epic is able to do all of these years on, say, on Real Engine, compounds on each other to provide extraordinary value. So it's not just dollars that compound on their own, the way that you would think about a stock growing over the years, it's dollars deployed into

1:54:25 Like every single day. into people building that next building block of software that future engineers and non-engineers can build on top of. And it just really concretized like Iteration.

1:54:39 is almost like the implementation of the abstract concept of compounding and investing. Yeah, I love that. That's like I think that's a really elegant way to describe What the job of Capital allocation actually is, or maybe better put, resource allocation. Right. Like

1:54:58 It's not Just That's the Your allocating resources and sitting back and uh watching them compound. I mean, maybe you're doing that if you're like a public markets investor.

1:55:12 But what somebody like uh Tim is doing, you know, would a uh well, both Tim's what a um what a what a CEO is doing, you know, especially a outsider type CEO in the Will Thorndike uh sense of the word, of which Tim Sweeney would a hundred percent, uh a thousand percent qualify. Is is that iterating every day with and the allocation of resources. With an eye towards what's the most optimal compounding rate that's not a how will a dollar invested in what we're building today

1:55:45 become a building block to make us able to build more tomorrow rather than starting from scratch every time. Yep. I love that. All right listeners. Now is a great time to thank our longtime friend of the show, ServiceNow. If you are running a large enterprise, AI agents are likely spread across every team, and deploying them is uh no longer the hard part. Yeah. The hard part is knowing what permissions they have, what employees are using them for, or what decisions AI is making.

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1:57:29 Who's managing them all? So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely at scale. Go check out service now.com slash acquired and tell'em that Ben and David sent you. All right. David, so grading So normally uh for anyone new to the show, we would normally grade a transaction. So was uh was it a good use of capital for Facebook to buy Instagram? In that scenario, that is our A plus, and then everything else sort of rolls down from there to our I think F for AOL time warner. So

1:57:59 In this scenario, because I mean, I guess we could grade like was it a good idea for Tencent to deploy capital or something like that? The big thing that we all should be greating right now is uh this fight with Apple. Like, what is gonna resolve here? And what should each company do? And so The way that I wanna evaluate this is if Epic holds strong, what should Apple do? And

1:58:21 If Apple holds strong, what should Epic do? And To set the table for that, uh I pulled up a bunch of numbers that I think are worth sort of walking through here to to sort of contextualize this fight. So

1:58:35 The app store last year. generated an estimated$18.3 billion of revenue for Apple. So that's their 30% cut. So$61 billion that was spent on the App Store that went to Apple and developers. Um, for Apple, for anyone who's been following the the stock and listening to earnings when Tim says Tim Cook says services revenue, uh, 40% of that is App Store. So this 61 billion represents 40% of the services revenue. Fortnite.

1:59:03 makes right now about$200 million a year on iOS, which means about$60 million is going to Apple. And that that's a twelve percent, which actually came out in a court proceeding today. So Fortnite last year did one point eight billion in revenue across all of its platforms. So you know, you take a twelve percent of that comes to two hundred million dollars that they're making on iOS. So that's sort of what's at stake here. is that that two hundred million. So then there's this other thing that has entered the arena, which is Apple Pulling out the hammer and saying, We are going to

1:59:42 make it so that anyone using Unreal Engine can no longer deploy onto Apple platforms. Which sounds really scary and most people analyzing this are looking at it saying Well, that's actually the real problem here because the Unreal Engine sort of loses credibility with developers if this major platform where there's an incredible amount of spend going on in the app store no longer has Unreal Engine as a deployment target. Like you can deploy to these five other platforms, but not the sixth, which is a big one.

2:00:13 So that's a problem. Two hundred million dollars of Fortnite revenue over this. It'd be a whole nother thing for them to massively Disappoint all of their Unreal engine and all of their services customers.

2:00:32 Right. But when a evaluating push comes to shove on that The biggest Game. On IOS that uses the Unreal Engine.

2:00:42 is Fortnite. The second biggest game Is PUBG. And when you look down the list of the top hundred grossing apps

2:00:51 Very, very few of them. Unity is actually the preferred sort of mobile game two D candy crush style game engine. And so I don't know in practice if a big game developer who is thinking about making a triple A style title.

2:01:11 to deploy across the Sony platforms and Xbox and I shouldn't say Sony platforms PlayStation and Xbox and the PC. I think mobile's a little bit of an afterthought where they're saying, like, yeah, it'd be nice, but like that's not where most of my revenue is gonna come from. And so I actually

2:01:29 I don't think it would be that big a deal. I mean it'd be a big deal, but I don't think it would be this like catastrophic loss for the whole ecosystem that people are sort of chalking it up to be If the Unreal Engine was no longer available on iOS. So I really do think what it actually comes down to is the two hundred million dollars a year that Fortnite makes on IOS. And

2:01:50 the sixty million of that that goes to Apple. This is super interesting, right? Like I actually think the the question there the context is is not what you said of like I'm I don't know.

2:02:03 Take two, I make Grand Theft Auto, like I'm not gonna put that on the app store'cause I'm not gonna make my revenue there. As we've talked about, that whole model like yeah, that's gonna be right, that whole Hollywood style of game making, that's gonna be around for a while. It's gonna be fine, but that's not where the big industry is. The really interesting question is like These dynamics, like, why is Overwatch not on the app store? Why is League of Legends not on the app store? Why is Dota two not on the app store? Why are all these modern game as a service, esports style

2:02:38 true like big, big winners, big platforms in this era. Why are they not on mobile? It's not because of technications. An iPad or uh iPhone eleven pro Like is very, very capable of running these things. And so it's only moderately because of tech it's more like it's really difficult. Like it better be really worth it if you're gonna go and do all the hoops to make it actually run on those devices and modify all your input controls to be touch and not have the WASD controls and all that. Totally, totally. But doable. I mean Tencent's done it with um Honor of Kings in China. Yeah, totally. And I played Fortnite on my phone last week. Yep. Totally. So it's doable.

2:03:17 I think the reason that it hasn't happened is because of this economics issue, right? Like if you're operating your game as a service and making revenue in a SaaS like manner through subscriptions and or virtual good economies. You don't wanna pay thirty percent to Apple or Google. Like that's just a non starter. Actually I think Apple's kinda like zooming out even more. One of the kinda

2:03:40 big failures of Apple And Android too, in a different way, but really Apple. Is that they have like they had an opportunity to have iOS devices you know, which sort of became the Uber device that ate lots of other specialized niche electronic pieces.

2:03:58 They had the opportunity to eat game consoles as well, but that never happened. And I think this is the reason why. Yeah, instead they segmented it and they they ate a lot of handheld gaming. The Switch has still done well, but they there are mobile type games that have done exceedingly well. Facebook gaming and web gaming. Yeah. Oh that's a great way to put it.

2:04:19 The candy crushes of the world that I think those types of games are still the most played, even more so than Fortnite. But you're right that they could have eaten Triple A titles too, and they didn't. And the question is, I I do think there's some combination of like the devices aren't that great of a user experience to be playing those types of games. So there's the developer has to like jump through extra hoop to make it a better experience and then it still doesn't feel totally right. To your point, Honor of Kings did work. So but you're right that like the economic model is Just

2:04:53 Not as appealing. Right. Like again, because these games are network economies. It's in the developer's interest to wanna have as many As large an addressable audience of potential players as possible. And the mobile platforms have so many

2:05:09 so large installed bases that like they should want to be on these things. But You know. So anyway, what should people what should each party do here? So here's my straw man. So let's right now say that the courts hold that Apple can't drag the Unreal Engine into this. And let's say Epic holds strong.

2:05:32 and decides that we are going to leave the version in the app store that lets me buy directly from Epic and you know, what what should be done there and I did another little fun calculation. Money that Apple receives from Fortnite per year on the App Store comes to about a third of a percent.

2:05:52 of app store revenues. Like Well you know, what is on trial here is Apple's like emergent business model of the last five years with this this sort of app store fees. So if it means dropping their take rate one percent, like They should not do that. They should say, Okay.

2:06:10 We're happy to lose you, Fortnite. Goodbye. And they should make it unplayable on everyone else's phones. Like the the ar the counter argument to that is That's Well, first of all, that it would trigger new legislation, that it would sort of have antitrust implications and

2:06:27 you know, there's another thing around maybe that they would turn off more developers from doing that because people would go, Oh my gosh, like you had don't have this trustworthy development platform even for even my mobile game anymore. The epic revenue is really a drop in the bucket for Apple. Here's what I think the biggest danger is for Apple. If you believe that a this trend that Tim Sweeney definitely believes in of these Things are becoming more than games. They're becoming a metaverse. And if you think that is going to keep happening and accelerating.

2:07:02 Do you box yourself out of participating in that as Apple? Because none of the creators and developers are gonna wanna play on your platform just like none of the MOBAs and and the games as a service have. And so as that industry becomes bigger and bigger and bigger, none of those play on your platform. And then all the consumers that want to consume There's That content.

2:07:25 Now go to other devices to do that. You're absolutely right. Yes. Apple's risk here is much less about the Fortnite revenue. And frankly, I don't think it's that much about the Unreal thing either, because as we talked about, like it's really not the games people are playing on their platforms. You know, are people so loyal to Fortnite? Um that they'll say, you know what, screw this, my next phone is an Android phone. Like is is Apple gonna be shut out from participating in the more sort of open

2:07:50 Well, I one of two things. Are they gonna be shut out from the the Tim Sweeney's version of the metaverse when people are picking their next device? Or even long before that, are people gonna say, Look, I wanna play freaking Fortnite and I can't on your phones. Yeah, so and not buy phones. That would be the argument that Apple should blink. Yeah. But it's It's major business model disruption to them if they do blank. Totally. Totally. I mean I think it'd be a different thing here if it was Unity. If it was if Unity made Fortnite, I think then Apple's like so yeah, we're not gonna like we will definitely not uh kick all Unity games off of the platform. But There's some chance, right, that Unity

2:08:28 Joins in. With Unreal here. Yeah. And why would they do that? They have a per seat license model, not a

2:08:38 cut of revenue model. Frankly, I mean, without having studied Unity enough. They may want to switch to the cut of revenue model at some point. I mean, actually, if anything, like it's sort of surprising. that Unreal is the one with the cut of revenue model, given that they are the high end platform.

2:08:59 And unity is the SAS. model given that they're the low end platform. You would think that as a low end platform you'd want as many developers coming onto the platform as possible and this you wouldn't want to have any incentive for

2:09:14 Or any barrier for them not to. Now I think you can start using Unity for pretty low or no fees as an indie developer. Um yeah. Yeah, that's an interesting point too. Getting back to F

2:09:29 Epic refuses to blink and then Apple kicks them off. So obviously a some kind of compromise is the best thing for everyone, including customers. It's only twelve percent of Fortnite's revenue. Like it would suck to lose out on that revenue, but it's also not the end of the world. Like it's not where most people are playing Fortnite. And so

2:09:46 To me, is it that bad for Fortnite to not be on your iPhone? I don't think it's that bad. Is it that bad for Apple that the most popular game is not on your phone? I actually think it's worse for Apple. I think it's worse. Yeah, I think it is worse. 'Cause again, like think about If you're playing Fortnite on iOS Chances are high that if you really, really love Fortnite, you're able to go buy a switch light for a hundred and fifty or two hundred bucks.

2:10:13 And keep playing Fortnite. Yep. Okay, so if it's worse for Apple, then what we're saying is okay, Apple should blink. Apple should not bring down the banhammer. And and kick all Fortnite users off the phone. There's some middle ground where they just keep them banned, but I think that's actually just as bad for them.

2:10:31 It's it's just as bad a look as disabling functionality from all the phones that currently have Fortnite installed, or or as John Gruber would put it, the kill switch. So What does Apple do? Like Apple's actually in the hot seat then. And and let's say that f that f Epic's gonna hold strong, like Epic's demands are very interesting here. They want an app store. They want to be able to compete with the app store by putting the Epic Game Store on the phone.

2:10:57 And they want to be able to charge consumers money directly through their app. If Apple says yes to the first one, like if they want to give on one of these two things, if they say yes to the first one, like There are whole business like their whole strategic positioning is totally screwed. Like They make all this services revenue because the app store is a monopoly.

2:11:19 If they do the second and budge on the thirty percent. You know, that's an eighteen billion dollar a year business for them. That's h every single percent you budge on is incredibly impactful. So like I mean It's not clear that Apple should blink either. I actually think like

2:11:38 The Best long term value preserving and ultimately value creative. Move for Apple. Is Not to give in to Epic on saying you can have your own app store here.

2:11:54 But to lower Their owners Take care. in line. Because because it's not just about Evercare. It's like the there's a bigger thing going on, which is that developers no longer love Apple.

2:12:07 It's not just epic. Totally. It's base camp. It's everything. Thousands. Yeah. Yeah. I mean it's everyone that they privately communicated with and said and tried to make some distinction between a B to B app versus a B to C app. Any time if you're doing something like that. Like

2:12:23 You're losing I don't care what what you're saying, if it's coming to that, you're arguing against Your Most Arguably your most important constituency'cause like they have customers who buy their devices, but customers only buy their devices because they get great experiences on the devices that developers create for them. Apple would say customers or well, Apple would say Apple's their most important, right? But they wouldn't say that, but Apple is the most important customers second, developers last. They they were very fortunate to get all the developers onto iOS very early and have had tremendous lock in in there since.

2:12:57 So I think they're really putting themselves at risk here in the long term. Like, yeah, you know, if Fortnite Weren't on IOS. Would some people switch to Android? Sure. But like you know they've they they have people out trying to figure that out right now. What what how many customers would we lose now and in the future? Sure, but like what's the big risk here? The big risk is like like I certainly wouldn't switch, you wouldn't switch. But um what if spot I just reinstalled Fortnite because uh

2:13:24 I w I had deleted it a year ago, but I actually could. I could reinstall it because I had previously downloaded it. It's some weird loophole. But what if Spotify were not Apple? Right. Right.

2:13:37 Like Yeah, I I have a lot of lock in there. Like I'm not leaving. I'm not gonna do the Apple music thing. So What if um What if Netflix weren't on Apple?

2:13:46 That's easier'cause I don't watch it on my phone. Like it would be very easy for me to go and buy something other than an Apple TV, but Yeah, that's a good point. I mean Spotify's a Right. So each of these things on their own. Yeah, yeah, yeah. Okay. But now there's another device out there.

2:14:03 That has all these things. And oh yeah, they're cheaper and they're better experiences because it's a more developer friendly platform. It doesn't take too too many of those where you're like Mm. Do I really need an iPhone? Yeah. So the question for Apple comes down to

2:14:17 Do we want to preserve our monopoly position? Yeah. less economics for the privilege of keeping our monopoly position. Uh by being the only app store. Or do we want to let

2:14:28 other people compete with us. And in that case we're just gonna get competed down on price anyway. So they should probably just figure out a way to drop their rate. to something that Epic will agree to. gosh, are they gonna roll that out? I mean the implications are so huge. But I think where we're both landing is like

2:14:46 Apple needs to give on something here and it probably needs to be Either on economic terms or Or letting other letting people use alternate payment methods. in apps and like Uh, I'm if I'm Apple, I'm not doing that. I'm trying to go back to Epic and say we will cut it to I don't know, twenty percent, but like

2:15:05 No on the store and no on alternate payment methods. Preserve Monopoly. try and make everyone happy and feel like you're not overly rent seeking on your device and I think that's the strategy. Yeah.

2:15:19 It all comes down to this magical question of is Fortnite actually impactful enough to be the catalyst of all the bad things that we've just talked about with Apple actually happening if it weren't there. And maybe, maybe not. You know, that's that's the dice roll. Well,

2:15:38 Here's though the other big calculus for Apple. To bring back in. It's ten ten. Right. Like Who is the most important company and partner to Apple?

2:15:48 In the world. Can make an argument it's ten cent. Why is it ten cent? Well, Apple has a huge, huge business in China. If WeChat is not on iOS in China.

2:16:00 That business goes to zero. That's a great point because WeChat has the closer relationship with the customer than I than Apple does. Yep. Much, much closer. Like it's like I I think it's probably not even a question. Like no WeChat on iOS, everybody's moving to Android. You're right. Yeah, there's so many games of chicken that that this could Start. Tim Sweeney's willing to take risks.

2:16:23 But who else is? Who will throw in with him and I mean'cause like if your WeChat Like, come on, that's crazy to to lose all that distribution on all those phones. But you could maybe argue that they don't need it. Right, like WeChat is more important. Don't they also have a special deal where people can use WeChat Pay for virtual goods in China and go around the app store there? Oh, I didn't research that. They may.

2:16:46 I think it's a very important thing. Then Apple's already compromising. Right. Apple needs to find a way to quietly compromise and talk about why this is a special case and have it hold water and then do that and then hope that no one as big as Fortnite comes and does this again. Which is for sure. Not gonna be the case. It's a losing strategy. It does yeah I think you're right. Uh ultimately we've said this eight different ways, but yeah, long term they need to figure out a way to preserve their control and give on economics a little bit. And that is long term value creative. They need to become a great platform for developers again.

2:17:18 Yeah. Make Apple Great again for developers. All right. Well, we moved a section after grading uh that we normally have before, which is value creation and value capture. A couple of ways I want to talk about this. So Epic has done a tremendous job of creating value in the world and frankly capturing like less of it than I think they create. The fact that they only charge five percent for the Unreal Engine, like

2:17:43 It is fair. And I think the fact that they undercharge for the Epic Game Store also, you know uh again, capturing far less value than they create. You always have to capture less value than you create in order to enable value for your customers. So no one's just trading a dollar for a dollar. But you know, I think they capture dramatically less value than they create and they've got lots of headroom above them. The other way to evaluate this um value creation, value capture is like

2:18:08 In this whole dance with Apple The unfortunate thing is the consumer is losing. Like the customer is the one that's bearing the brunt of these tech giants clashing. And That's

2:18:24 you know, value destructive. Uh ultimately for the end user that These tech giants are at war over who gets what economics. Yeah. Well, that's also a game, you know.

2:18:35 where regulation and the government comes into play. And then That part of the game, the deck is stacked against The big tech companies.

2:18:45 Right, like our regulators really gonna say Oh no, you you know Independent. much smaller business in North Carolina. Like you are being unfair to Apple here. No way.

2:19:00 This seventeen billion dollar business is being meme to the two point two trillion dollar business. Also, I do want to point out Apple grew by Ten epics this week. Ha Wow.

2:19:15 Unbelievable with these. Compound interest continues to blow my mind. And uh Yeah. Well, listeners, on on the grading and on the value creation, value capture, there's so many nuanced points here. Uh we would love to hear from you. So you should join us um in the acquired Slack, acquire.fm slash slack, or just go to our website. and talk about it, or we'd love to, you know, chat on Twitter too, or at acquired FM. I think there's obviously the situation changes every day. Um, there's probably gonna be new news that comes out between this episode and, you know, recording and release. But also there's just lots of nuance points here. So um we'd love to to hear your perspective on uh And what we sort of missed.

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2:20:52 Carvouts. Let's do it. All right. Uh I'm gonna go first because mine is a continuation of this episode. So I have a three part carve out that is going to be in the order that I experienced these three pieces of media and I recommend the same to you. So when was this? August of twenty nineteen. So this is before Disney Plus launch, before the Mandalorian came out. There was a demo video put out by Epic with a guy walking over, getting on a motorcycle and revving the engine.

2:21:21 And what was amazing about this First of all, you're like, why is this short little video put out by Epic? What was amazing about this is the fact that It was shot. In a studio. With a guy sitting on a real motorcycle, but with a screen behind and to the side of him that was rendering the full background.

2:21:39 And the other amazing thing was that the camera was moving slightly, as you would expect uh you know, a dollyed camera on a set to move. And the background. the shifted perspective in the right way that you would expect with the camera. So not only were you like, Whoa, that background is real and certain things are are, you know, a thousand feet away and other things are five feet away. But

2:22:02 There's no artifacts. Like it also just looks like the real world and there's the appropriate amount of blur for, you know, what the depth of field on this lens is. So like it all actually looks right. And then they show you the behind the scenes and oh my God. It's a screen and the screen is just super high density pixels. And so there's no sort of like crazy artifact that you would normally see if you took a picture of a screen. The Physics of the Like there were accelerometers on the camera that are tied to what is being projected on the screen so that the stuff on the screen shifts in the exact right way with the camera as it moves and pans in real time.

2:22:42 Und detectable to the no lag detectable to the human eye. Unfreaking believable breakthrough technology. So I remember watching that and being like Holy God. the future of filmmaking is here. It's amazing. This games company, and I'd heard of Epic, obviously,'cause of Fortnite and'cause of the Unreal Engine. It's a it's amazing the Unreal Engine can sort of like do this now. I wonder if anybody's gonna Okay. So Flash forward The Mandalorian happens. Watch it. It's fantastic. Literally worth the Disney Plus. Subscription just for the Mandalorian. Oh, it's so good. I mean it's a it's a Star Wars Western. It's excellent.

2:23:11 And so then February twenty twenty, they they there's this video that gets released of the making of the Mandalorian in what they call the volume. And this is a sound stage, David, exactly as you described, three hundred and sixty degree you know, uh screens all around a sort of like horizontal screen above you, and that's used for lighting the scene. So not only are they rendering all of the elements around, by the way, amazing that that's CG, right? It all looks so real. People are wearing costumes, uh they have some props, like desks and stuff, but like other than that All the backgrounds at all depths are just rendered on these screens and then lit using the Unreal Engine from above, from this like crazy huge horizontal screen that Is making sure that the lighting that is f falling on the character exactly matches the right lighting based on what the background in the scene is. Mind blowing. So

2:24:03 Really cool video. It's short. It's like five, six minutes. Then a friend sends me this thing in ASC, it's ASCMag.com. I think it's like the Americety of Cinematographers or something like that. It's this uh incredible long form read on the physics of how the whole thing works. If you're into like film at all, uh movies or um photography or whatever. It is just the most fascinating read on the technical details of how they accomplish a lot of these shots, and it is totally worth carving out some time to go and read because it is uh What's the quote, uh uh sufficiently developed technology is indistinguishable from magic, something along those lines is absolutely true. And I

2:24:43 I'm so amped up about Unreal in the future of filmmaking. It's so cool. So Amazing. And the the net of all of this is like it's

2:24:53 better you enable more creativity. at a order of magnitude lower cost, too. Like they talk about this is how the Mandalorian was able to be made and be so awesome as a TV series versus uh multi hundred million dollar budget movie. 'Cause they just did it in a room. And it truly would have been. Yeah.

2:25:10 Whole thing shot in the same room. Amazing. Okay, so my carvel More of a stretch to connect it to the current episode, but I I'm I'm gonna try. I'm gonna try. Uh I have been rereading Isaac Asimov's foundation series. I might have had this be a carve out years ago, onacquired. Oh, so good. It's classic.

2:25:30 You know, the whole thing is about the fall of a dominant society. And its replacement by an upstart society was, you know, an allegory for Rome or you know, whatever you could apply it to current state of the world right now. Yeah, I think you could also, maybe maybe it's a stretch, but maybe you could apply it here to Apple and Epic. Two.

2:25:50 Galactic Empire that falls. falls because it stops doing its job. It becomes all about politics. And it loses its technological edge. Like one of the main themes in the book is that nuclear power and knowledge of you know how to harness it and continue developing it. gets lost in the empire and it's only the foundation, this tiny little, you know, edge of the galaxy upstart. That has that power. Having the

2:26:18 ability to be on the cutting edge of technology and then nimbleness to Move fast with it. Probably gonna win. Indeed. Well that's a great, great place to leave it.

2:26:29 Well, listeners, if you aren't subscribed and you like what you hear, you totally should. And if you have a friend who you think should uh should check out this episode or any other episode, you know, maybe they are a gamer or maybe they've also talked about the Mandalorian with you and uh want to understand more about the company that powered it, share the episode. We we love uh we love when you share with new folks. So thanks so much for for doing that. As always, if you love acquired and you want to hone your own craft of company building, you should join the community of acquired limited partners. you'll get access to the LP show where we dive deeper into the fundamentals of company building and investing, in addition to our monthly LP calls where we talk directly with all of you, and of course our book club And our Zoom calls with the authors. To give you a little preview of our most recent uh L P episode.

2:27:15 It was one in our fundamentals of venture capital series, of which we're doing six, maybe seven. David, we gotta decide. Um, but this was the one on basically how VC firms make decisions mechanically as different people in the firm are involved, which is helpful to know if you're pitching or if you're aspiring to be an investor, or frankly, if you just wanna know how other investors do it and you're active today. If you aren't already a limited partner, you can click the link in the show notes or go to acquire.fm slash LP. And of course, all new listeners get a seven day free trial. If you want to hang out with the acquired community, join us in the Slack. And uh with that Listeners.

2:27:49 We will see you next time. We will see you next time.

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