Short: The Death of Sega

Transcript from https://podmenti.com/t/c6001587eff8ad9b

Okay.
Let's hear your best Sega Scream impression.
Sega
Is the emphasis more on the set?
SIGA!
They talk about it in console wars. Yeah.
The voice actor.
And he was sick. I think he had thrown up earlier in the day and he was just in such a bad physical and mental state that he could do this insane scream. It was perfect.
The cost you pay for great art.
Who got the truth?
Is it you, is it you, is it you who got
No
Is it you, is it you, is it you?
Down

Another story on the way
Welcome to this episode 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.
Today we have for you
Our first acquired short.
There are some stories that deserve three or more hours to chronicle the entire company history start to finish.
But there are also some stories
Or perhaps chapters of stories.
That can be told in an hour or so.
Now in Nintendo Part Two, I asked David a question.
How exactly did Sega manage to go from
having over half the video game console market in the US.
with the Sega Genesis.
to abandoning the console business entirely after Dreamcast in a few short years.
And David, you gave us a quick short answer.
But we were both sort of looking at each other afterwards, thinking, there is so much more to this story. It really does deserve its own episode.
And frankly, it's a nice opportunity for us here at Acquired.
to take a look at a company that didn't become hugely successful and what the lessons
We can learn from that one R.
So we bring you today.
The death of Sega.
This could be really fun.
Experiment. We get to tell this story right.
Listeners, let us know if you like this and uh we might do more of them.
Yep.
Let us know in the Slack, acquired.fm slash slack. It is the best place to discuss episodes after we release them.
Tons of folks joined after the Nintendo episodes. There's a lot of great video game discussion right now.
Check out ACQ two, our second show with interviews.
The most recent interview was with David Shu, the founder and CEO of Retool.
All right listeners.
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And with that.
This show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only.
We could technically still invest in Sega today.
Sega Sammy Holdings.
Not quite sure we'd want to, but uh let's get into it. Spoilers.
So
We start our story.
in round call it nineteen ninety two
Ninete three.
Sega and it's
Genesis.
as it was known in North America.
has battled Nintendo and the Super NES to basically a tie
in the US home console market. Which
really in practice, if you go listen to our Nintendo series, was beating the pants off of Nintendo. Like Sega had no right
to get to fifty percent, maybe even fifty percent plus.
Market share, given how far behind they came from.
Imagine you're a startup and you're fighting some big incumbent and within three years you get to a basically fifty fifty market share.
It's totally nuts.
Genesis.
I mean it was the cool console in the nineties. It had Sonic
They've got John Madden football. They've got great sports franchises.
They've got the Mortal Kombat version with the blood. Oh, the real red blood, not the Nintendo toned down gray blood.
And
They have about a thirty million total.
unit install base of the Sega Genesis around the world, the vast majority of which, about twenty million.
is in the
The United States.
Yeah, and this is basically the best video game consoles were doing at the time. Years later, the PlayStation 2 with a hundred and fifty million.
But no one was doing hundred million plus units sold game systems at this point in history. So thirty million, rock solid.
Huge player in the market. A great base to build on. Yes. Now
Also at this time in call it nineteen ninety two, nineteen ninety three.
It has become clear that
That compact discs

The future.
Not just for the video game industry, but for everything. CD album sales and like CD players are
on their meteoric rise at this point. It is a
huge driver of business for companies like
Sony?
In the personal computer industry, neighboring to the gaming industry, CD ROM drives are now becoming standard in PCs.
This is how software is shipping. This is how games are shipping in the PC industry.
And the trade off with games is of course a cartridge doesn't really require loading time.
The CD, while it has a ton more storage,
does have trade offs where it needs to load stuff onto the machine.
Yeah, and there's one other
really big advantage of the CD medium for the business side of the industry.
Which is that
CDs are much lower cost to produce.
Than cartridges. Cartridges you gotta like put silicon in there. They have chips.
CDs are just
optical discs, you can stamp these out for
A tenth, a hundredth of the cost of a cartridge. Pennies.
So
It's obvious.
That
the home video game console industry is also going to move to
The CD medium as its primary.
distribution technology going forward.
And the way
Right now.
that people in the industry are thinking that this great migration is gonna happen.
Is not
Via new consoles.
But via add on.
Peripherals.
to existing consoles.
Looking back now.
This was obviously a very, very poor path. An evolutionary branch of the gaming tree that mercifully died off.
But at the time everybody seemed
To be doing it.
There are other consoles like Atari's Jaguar console.
Came out with a CD ROM add on.
the NEC PC engine in Japan in the US, it was called the Turbo Graphics.
console that came out with a C D add on.
And
Of course, famously.
Nintendo
Is working.
On a major partnership that they've announced that everybody knows about
With none other than
Sony.
to make a CD ROM add-on for the Super Nintendo.
That would be known as the
Play
Space station. The Sony Play
Station.
add on to the Super Nintendo.
We'll come back to that in a little bit. That uh doesn't go as planned. This is now our third episode in addition to Sony and Nintendo, where we've talked about this.
So
Of course, back to Sega.
They are
Working on a CD ROM add on too for the Genesis.
And just like
With the Genesis they had beat Nintendo
And the Super Nintendo.
to market with the first sixteen bit console.
They want to make sure.
That they beat.
Nintendo and Sony.
to market.
with the first C D ROM add on.
So in late nineteen ninety two
They launch.
The Sega CD
Add on.
For the Genesis.
in North America.
It comes out with
This game called Night Trap, which
is a full motion video game that uses like
It's basically a playable movie. It's a really crappy game, but people think that this is the future that CD ROM technology is going to enable. It's like a zombie slasher like a teen horror flick that you basically
Play as a video game.
This is one of the games that gets Congress all spun up about video games are corrupting the youth and
Leads to the creation of the uh entertainment software ratings board, the uh video game industry version of movie ratings that comes out. Rated E for everyone.
Yeah. Exactly. Ah so funny. I go back and look at this stuff today and you're like
Yeah, compared to Call of Duty are like this is nothing. Seriously.
Grand Theft Auto.
Yeah.
But ultimately, despite all this
hand ringing over.
These games and everything coming out with these C D add ons.
There is a fundamental
Problem.
With what
Sega is doing here.
And that is
Yeah.
Add on technology for consoles.
is never really a good idea.
Because
the business model of the video game console industry.
It's a razor and blades model.
And the way that
Video game companies like Sega, like Nintendo, like Sony in a minute.
Make all of their profits.
Is from
The software sales, not from
hardware sales. And so you want to have as big of an install base of consoles as possible to amortize the software sales across.
So when you're selling an add on console
You are limiting the target market.
to the thirty million people that already own a Genesis.
it will be smaller by definition than the market base that you've already
Created.
And this creates a huge problem because then developers
Don't want to make.
their best games for a limited install base of consoles.
Consumers don't want to go buy a platform that's only gonna have a very limited number of good games.
And it quickly becomes a death spiral.
So
The Sega C D.
Sales despite starting
off relatively strong.
Stall out.
quickly.
Sega only sells about three million Sega CD units versus the thirty million plus Genesis units that they've sold. This is
A flop for them.
Now, Nintendo
By either luck or skill or
Maybe just being slow in Nintendo.
They never actually come out.
with the C D add on for the Super Nintendo and the Sony partnership.
So they kind of avoid
This disaster that Sega stumbles into.
But after the Sony partnership fell apart, didn't they form a new partnership with Phillips to create the Nintendo CD thing?
They did.
But that delayed everything enough that everybody kinda realized that this was a bad idea and Nintendo
Basically also abandoned that project and let Phillips come out with their own console. I think it was called the CDI.
Nobody supported it. It sucked. It wasn't part of the Super Nintendo ecosystem.
Okay, so what does Sega do after the
Sega Genesis CD add on is abandoned.
Well,
You would think.
Just like Nintendo sort of did here, you would learn your lesson, console add-ons are a bad idea, you've got all these problems with it, it's a limited market.
You cut your losses, you move on, you just embrace the next
generation.
That's the logical thing to do here, right?
Yep.
That is not what Sega does.
They decide that they are going to follow up their failed console add on
With another.
Failed.
Console.
Had on. That's right.
The uh infamous and infamously terrible
Thirty two X.
Which launches in the fall of nineteen ninety four.
This is another hardware add-on for the Sega Genesis system.
The plug into the top of the console.
And it adds a thirty-two bit processor to the Genesis. And it works sort of like the same way a game genie worked, right? You like put it in where your game cartridges go.
And then
That way when you put your actual game cartridge on top, it's sort of like stacked like a tower.
Yes, exactly. This whole thing is so harebrained. I think it added more colors, maybe to
Existing Genesis games, but then it
also had its own thirty two X games that you bought separately for it.
This thing was just an unmitigated disaster.
One of the worst video game industry decisions.
Of all time.
Fa
Okay.
Yeah. So the thirty two X
Sells less than one million units.
Total.
And in the meantime.
Almost immediately thereafter, the
See you.
Also rushes out
A separate brand new
Native thirty two bit system.
to market.
Called.
The Saturn. What a nightmare. This makes no sense what's going on here. The story goes that.
All of this was basically a decision handed down from Sega in Japan.
They ordered
Tom Kalinski, the CEO of Sega of America.
To
Launch.
The Saturn.
Sake of America doesn't really want to do this, but they don't have a choice.
So they spin up their patented brilliant Sega marketing launch playbook for the Saturn.
They announce.
To America.
That September second, Nineteen Nighty Five.
is going to be Saturn Day. It is Saturday, September second. And the Sega Saturn is gonna launch.
But then
At E three.
In May of nineteen ninety five
They shock the world.
Tom Kalinsky comes out on stage for the Sega keynote and says
Actually.
I know we told all of you that we were gonna launch in September.
Well surprise, we're launching today.
The Sega Saturn is coming out right now.
The press, the industry, the developers who are there, they're all like, What?
It's like exciting but confusing.
This makes
No sense.
There's no Sonic game ready.
There's no third party games.
At all.
The retailers
Aren't prepped, they don't know to expect this.
There's been no marketing, none of the groundwork has been laid. In fact, everybody thinks this thing is coming out in September.
It's really weird,'cause it's like everyone's sort of recent hero, the David versus the Goliath of Nintendo is
Seems like they should be firing on all cylinders.
But you have the market confusion with a thirty two X
And the Sega Saturn and now Sega Saturn sooner? What the heck's going on?
Right. On top of this maybe forgivable Sega C D thing that happened, you know, a year or two before, like
This whole thing is just weird.
So
On
the back of this the Saturn.
Flops.
It sells just over nine million units compared to
The Genesis, which sold
Thirty million units.
And if you read it.
Console wars by Blake Harris.
He spends a lot of time with Tom Kalinski, the CEO of Sage of America, and interviews him and
Tom and the other folks who are at Sake of America at this time, like, they're somewhat diplomatic, but they just kinda lambast the
Japanese management of Sega at this point in time.
They say that they at SAG of America fought against all of these decisions.
that the Japanese parent company was jealous of Sega of America's success with the Genesis.
'Cause the Genesis sold really well in America. It didn't sell as well in Japan. No, all of the Genesis's success was in America, Europe, and South America.
It basically did nothing in Japan.
In in Console Wars, the author draws this great analogy of
Japan is the parent and
America's the child, so shouldn't the parent be proud of the child's success?
But in reality the way that
It actually was going on is that
Japan and America
were sort of sibling markets.
and the parent's favorite child used to be Japan and as the parent
showed more favoritism toward America.
the Japan leadership sort of retaliated and found ways to kick and scream and say, Hey, you need to pay more attention to me.
Yeah.
Sega.
at this point, of course, is a Japanese company and the board is Japanese and
At the end of the day.
Japan.
Wind here.
So
Tom and most of the rest of the team at Sega of America, they get super frustrated.
they end up just leaving the company.
Including Steve Reese, who masterminded the whole aggressive marketing strategy behind the Genesis, you know, the Sega Scream, the welcome to the next level. He goes to work for Sony.
To launch the PlayStation. Oh yes. We'll talk much more about that in
One.
Minute.
So
Sega of Japan is kinda running the ship now at this point in time.
they decide after a couple of years to give up on the Saturn. They launch
Another
New.
internally developed console, the Dreamcast.
The Dreamcast actually had some real innovations to it. Like it was the first true online console.
That's shipped with internet.
Connectivity built in.
It had the little slide out handheld thing that was like a little game boy that popped out of the controller. That was super cool.
Oh yeah, the VMU. That thing was cool.
And a bunch of the design philosophy made a lot of sense. They were using commodity components instead of special silicon for it.
Yeah.
But
Unfortunately.
It launches against
The PlayStation Two.
Which goes on to become the best selling console of all time and completely trounces it. So the Dreamcast
Sells even fewer units than the Saturn.
And it's really sad after just two and a half years on the market.
Sega
Ends up discontinuing.
The Dreamcast.
announcing that they're getting out of the hardware business entirely.
They're gonna go to just being a video game developer and publisher.
on other platforms.
On PlayStation on the Xbox.
Et cetera.
The company really just becomes a shadow of its former self. It limps along
And then finally, after a couple of years from kind of two thousand one, two thousand two into two thousand three.
of Sega just making games for other platforms
The company gets sold off to another Japanese public company.
company called Sami that was a manufacturer of pachinko machines, which is
Kinda like the Japanese equivalent of pinball machines.
It's just sort of sad ending with a whimper for this once legendary Sega Scream.
Company.
Right. You've got the exetus of all the talent.
You're sort of still scratching your head a little bit about how it all fell apart.
So fast.
You know, I started digging into why and how and w what were the corporate transactions that actually happened around here.
And David, I feel like there's more to this story,'cause I pulled up pitch book to look
There are a lot more transactions around this company than you've sort of mentioned so far. Oh, are there? There are. Oh, if only there were a podcast that went and did really deep research on what actually happened here.
Yeah.
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So David
Feels like there's some big things missing from the story here. Yeah, you like that little story that I just told you, right? It almost feels high gloss, apocryphal, and if you really stare at it, you're like, I'm not satisfied. That can't be right.
This is insufficient.
Everything you say is exactly correct.
The funny thing is though that like listeners for you all listening
I bet most of you if you
Knew any version of the story of the death of Sega?
What we just told was the version you probably know.
But
While it's not wrong.
It's only one version of the story. And
The other version.
is both way more charitable to Sega the parent company in Japan.
And also I think way more interesting in terms of like lessons we can take from it. So
Let's tell it.
If you go listen to our
Two part Nintendo saga.
We talked
Quite a bit about Sega along the way. And especially in
Our first Nintendo episode.
When we talk about Sega
We talked about them as this.
Arcade Company.
And that's
Actually what Sega was.
The home console business
The genesis, the
Master system before it
These were like
side project offshoots from what
Was otherwise
An enormous and very successful
Arcade business.
Based back in Japan.
Totally. It started as service games back in the like forties, fifties, this merger of
arcade game makers and arcade distributors.
You even had this story that you were telling I think we actually cut this from the Nintendo episode for time, but on
Periscope, the Sega, very innovative Sega game, they standardize the unit of the quarter as what you pay for an arcade video game session.
Yeah, the arcade industry, it's lost to history now because basically it doesn't exist anymore, but it was bigger than the home console industry, and nobody was bigger in the arcade industry than
Sega, they were the OGs. They literally standardized the quarter, as you say.
Now.
That game.
Periscope.
came out in the sixties. This is before video games. This is what was called an electromechanical game. So there were like
mechanical elements to this cabinet.
Of
submarines and ships that moved around. They were like plastic and cardboard.
And then you fired a gun that had like
torpedoes that traveled on a light bulb path to hit the ships. I think it was pretty cool.
But it became so successful.
Sega.
Actually gets
Acquired.
In nineteen sixty nine.
Yeah, I was shocked to see this in Pitchbook. I scrolled all the way down, like I normally do when I'm looking at like private companies who raise money to see who their seed investors were. And the first transaction for Sega is from 1969.
Yes.
The company that acquires them is Gulf and Western, which is a big oil company based in the US. They're like what the hell is going on here?
Well
Turns out at the time.
Golf and Western also owned
Paramount pictures.
The movie studio.
Oh, I've always seen that at the little like uh I don't think you see it anymore, but the little title screen. Yeah, when the movie's starting. Yep.
So they acquire Sega.
And merge it into
Paramount.
The operations stay separate and they'll like
Boards of Sega and Paramount stay separate, but within Gulf and Western, Sega's part of the Paramount Empire.
So much so
Th they take
They're two most talented
Paramount executives.
And they put them on
The internal Sega board.
Within Golf and Western. Do you know who those two people are?
No.
Michael Eisner.
And Barry Diller.
What? Right.
I had no idea.
So Michael Eisner and Barry Diller are like key parts of the Sega history.
And all of this, all we're talking about, this is before Atari, this is before there is a home console business, this is before there's a video game business. Period. This is how important Sega is in arcades.
twenty years before Michael Eisner becomes the CEO of Disney.
And long before Barry Diller dreams up Interactive Corp.
Yep, this is in the nineteen seventies.
So
We also talked on the Nintendo series about how Atari
Got acquired by Warner Brothers, and this was this crazy like Atari, this video game company becomes part of this movie studio, and then it becomes the biggest part of this movie studio.
Warner Brothers was just copying Paramount and what they did with Sega.
Isn't that so funny? Wild.
So
Part of the strategy.
That Sega adopts during this time.
They're like a truly international company because the arcade business was a truly international business.
They're thriving in the US, they're thriving in Japan, they're thriving in Europe, all over the world.
They start not only
Building.
And creating these games, these arcade cabinets.
They start building out their own arcade.
centers that they operate. They're like, we're gonna make money every which way in this industry. So they're called family fund centers in Japan.
and Sega centers in the US.
The Sega Centers in the US
Change hands a few times, go on to get rebranded. Sega always stays involved. These become timeout arcades.
Which is one of the biggest chain of arcades in the US.
Whoa, okay.
So Sega's got hundreds of these arcades that they are just
Printing cash out of.
'Cause they're making money from selling the cabinets to their own arcades and other arcades.
And then the arcades themselves are like hugely profitable businesses.
Yeah, I mean there's a lot of arcades that when you look at the side of them have a gigantic Sega logo plastered over it. I mean, clearly a company focused not just on home consoles, but like making games.
Yeah. When you say a company focused not just on home consoles
From the
Parent company's perspective, they'd rather not focus on home consoles at all. So now you can start to see.
Another perspective on things here.
In nineteen eighty one, Sega publishes the game Frogger.
That Konami had made but Sega published it.
They made hundreds of millions of dollars on that thing. Uh huh.
In nineteen eighty three
Right before the home video game console crash.
Like Atari.
They do two hundred and fourteen million in revenue.
Sega does as a division within kind of Paramount.
Then when the video game crash happens at the end of that year
Paramount, just like Warner Brothers in Atari.
They want out of the business. So they want to divest.
Sega.
And one of the original founders from back in the day
Guy named David Rosen.
And a Japanese entrepreneur of a company Sega had acquired named Hayo Nakayama.
They engineer
A management buyout.

For the grand total price. I don't know if this is in pitch book.
Of thirty eight
million dollars. This is the steel of the century.
Yes, actually. There's a transaction in nineteen eighty four. Looks like the investor name is CSK Holdings. Yes, that's it. So CSK Holdings was a public Japanese company that Rosen and Nakeyama
knew the management of
They financed
this buyout. They were like the P shop. They were the sponsor of this transaction. Oh, interesting.
And this is how Sega becomes an actual Japanese company.
Even though they were started by Americans to serve military bases back in the day.
Right. Okay, so wholly bought out by Gulf and Western, then wholly spun out Yes. They bought the whole thing for only thirty eight million dollars. Like this is ridiculous. This company, which is legendary in the arcade industry
Did two hundred and fourteen million dollars.
In the year ended six months before this.
Why did they
Value it so little. This is the thing. Because of the home video game crash in America.
Oh video games in general just became this toxic asset that nobody wanted to own, especially, you know, Paramount and Warner Brothers was divesting Atari.
So
The arcade business. Yeah, it got hit by the crash, but it actually was fine.
And so this was just an amazing deal.
management bought the dip'cause they knew that they weren't actually really affected by this.
Boy did they
Ever.
So then I think that was in nineteen eighty four. They would go on to take it public, I think in nineteen eighty eight on the Tokyo Stock Exchange.
So now it's a publicly traded company.
Yep. That makes sense because
Pretty quickly after the buyout, Sega gets back to their old tricks and they're crushing it. They're pumping out
Smash arcade hits like Out Run people might have heard of, very famous.
Racing game, Shinobi, Afterburner.
Altered Beast, which was a kind of beat em up brawler that we talked about on the Nintendo episodes. That was the original packing game before Sonic with the Genesis.
So
They're back to making.
hundreds of millions of dollars in their arcade business, both making the games and operating them in their own arcade centers.
Nakayama
Who was one of the two guys involved in the buyout. And Nakiama and Rosen had to get
Hugely wealthy from this.
because of how unbelievably little they paid for the equity that by the time they IPO'd it would have been very valuable.
Yes, I don't know the details, but I'm sure they did.
Nakiyama
He starts pushing the company. He gets worried about what Nintendo's doing and what he sees with the NES. And he says we should also enter the home console business. So it's like a diversification bet.
Exactly.
Rosen.
C S K the rest of the board.
They're not that supportive.
'Cause they're like, We're doing great in arcades, like I don't really care that much, but sure, if you care about this, go do this.
And that's when
Nakayama goes and he recruits Tom Kalinski to come in and run North America.
It's kind of like a
Surpris to everyone, the Genesis in North America. Hm.
You know, there's the
scene that we talked about in Nintendo Part Two, where Tom comes over and presents his four point plan for dethroning Nintendo.
Yeah.
And the Japanese board is like, I don't know, like I don't really like this. Now it all makes sense. They're not dumb.
They're just like, Why would we risk pouring all this capital into the home console business?
When we're killing it in the arcades.
And on the one hand it's an innovator's dilemma. On the other hand
I have to imagine Arcade stayed a very good cash flow business for a long time. It's not like that was actually going away.
Well.
Let's get into it.
So
Nintendo
And the NES and the super NES and the home console business.
turned out was never really a threat to the arcade business.
Because the way
Arcade technology.
And hardware worked.
was very different than the console cycle.
And the types of games were different.
In the arcades, it was all iterative. It was constant iteration.
Every game that came out was its own proprietary hardware cabinet. And they were based on designs. They're called boards. They're arcade boards.
But you can tweak it each time.
You think about it
What SIG is pushing with all their add ons to the home console.
Of course that would make sense to them. That's the way their R and D team worked. They'd have like a core base, you know.
Call it the system sixteen.
Which was
Sega's kind of base 16 bit arcade platform that they based the Genesis on.
Yeah, all these games I was just talking about, Shinobi, Outrun, et cetera, they ran on that.
But each new game, like they tweaked the hardware a little bit. It was iterative.
So they didn't actually have to think about we need to create a standard platform for developers to target for the next five years.
because every cabinet was its own self contained system. So it's not really in their DNA to like
Do a once every five plus year. This is the standard thing, and we promise not to change it, and we will create a bedrock platform for you developers. That's not.
Really a thing.
Yes.
And so that means
couple things for the market that keep the arcade market
Not just viable, but thriving.
The arcades
are where the most technologically advanced games are.
During this era.
Because the hardware cycle is so iterative.
The home systems, even the NES, as amazingly groundbreaking as it was
Because the console cycles have to be designed to last so long.
That's not where the latest cutting age stuff is.
And so those games, the Nintendo games that they're making
You know, the way Sega counter positioned against them with the Genesis, they're slow
They're not exciting.
But that's what home console games became. They became these long adventures, these fantasy lands, a very different thing than you would do in the arcades.
Makes sense.
So
coming out of this era and then into the early and mid nineties.
Sega's arcade unit is just
Killing it. They'd had those hits in the eighties.
Everybody got super wealthy.
And then
They start really pushing the envelope on technology. There was a ton of innovation coming out of Sega.
They
Developed.
The first real modern
Great 3D games.
We all think now of Super Mario sixty four as being the first
three D video game that consumers used and loved.
Actually years before
Sega put out
The Virtua series in the arcades. So this was
Virtual Racing, virtual cop.
And most importantly
Virtua.
Fighter. Now this game, Virtua Fighter, which was a fighting game.
It used to be a
three D polygonal technology.
If you think back to sixteen bit Super Nintendo games, they're flat. They're two D.
three D games like Think Mario sixty four, you're running around in a three D world
All of the
environments and characters are built using
Polygonal math.
We talked about this a lot on the NVIDIA episode.
Right.
Triangles.
Triangles.
This is new. Sega is the one that actually brought really good games.
To market with this and it was all in the arcades.
So Virtual Fighter when it comes out
In nineteen ninety three is so popular.
Sega sells.
Over forty thousand
Virtua Fighter Cabinets worldwide.
At a price of like
ten thousand dollars plus per cabinet.
So that's half a billion dollars in revenue on Virtua Fighter. Wow.
So it's a huge win financially for the company.
Even more so though,
It's so impactful in the video game industry. Once Virtual Fighter comes out.
Everybody realizes
Hey 3D polygonal.
Games are the future.
And what year was this? This was nineteen ninety three, right.
Uh Ken Kudaragi.
And the team over at Sony.
Are working on
Their standalone PlayStation.
Mm. They've broken up with Nintendo. They're gonna come to market with their own console.
And this is
Pivotal.
So
I wanna read now from the Wikipedia page for the PlayStone console.
After Sony witnessed the
The success of Sega's Virtua Fighter
In nineteen ninety three.
In Japanese arcades.
The direction of the PlayStation became quote.
Instantly clear.
And three D polygon graphics became the console's primary focus.
Sony Computer Entertainment president expressed gratitude for Sega's timely release of Virtua Fighter as it proved.
quote just at the right time.
that making games with three D imagery was possible and that this
was the direction the PlayStation should focus.
So
The impact of this
Is
Huge.
Arcades remained viable through the nineties.
because they had the technological
Edge.
Mm.
But now Sony
is gonna come enter the market and they don't care about arcades.
They're gonna bring their technology
And financial firepower.
Oh.
to the home market.
And their goal now
Is to make a machine.
That can rival the arcade technology.
In the home market.
And they have the balance sheet to subsidize it. So they can take a strategy of coming into the home with very, very good technology at a price point that consumers could afford.
Yep. So here we are now.
The end of nineteen ninety three, into nineteen ninety four, Sony has announced that they're coming out with the PlayStation. They're all in on entering the video game market.
They start going around and talking to all of the non Sega
Arcade manufacturers.
Namco midway in the US, Konami.
And they start
Convincing them to bring all of their new arcade games directly
Two.
The PlayStation.
When it first comes out.
And
end of nineteen ninety four in Japan and then nineteen ninety five in the US.
It's an arcade killer.
That's what it is built as. It becomes so much more than that over time. It is Grand Theft Auto, it's Final Fantasy, it's all that. But in the beginning,
The vision for the PlayStation was
We're gonna take
the technological firepower of the arcades and we are gonna bring that in a way that Nintendo can't.
And say
Won't you?
Into the home.
Market.
And of course, all the other arcade manufacturers love this strategy. Right. We can benefit from riding the Sony platform into the living room, but Sega is gonna get caught in the wind here. Because they have a home console that's making it so that they can't go align with another home console.
Namco doesn't have a home console, Konami doesn't have a home console, Midway doesn't have a home console.
So
Before the PlayStation launched, the
The arcade
industry.
was
back up to about seven billion dollars a year globally. And a huge portion of that was controlled by
Sega.
After the PlayStation launches,
By the end of the decade, it's down to two billion dollars. So it drops by sixty percent in just a few short years, and it's all due to the PlayStation. So the PlayStation basically killed Sega's arcade business.
And their console business. Yep. That's what happened. Wow. So now
Let's go look at this kind of
original console wars book type narrative about what happened
We have a whole different perspective now. All this crazy hardware schizophrenic add ons.
These are like panicked responses.
Two
the coming tsunami of Sony.
Not just worrying about the home market, but worried about their arcade
Dominance as well.
Huh.
And I have to imagine at some point
Sega of Japan lost their desire to make a great competitive
home console.
because that was the thing that was preventing them from being able to be in business with Sony.
Now, it doesn't mean that they're gonna stop making consoles right away, but it does sort of plant this seed of
Huh, we have a little bit of a strategy conflict here.
Where
We either have to be all in and winning
in consoles or we just need to make games. Yes. But we can't really
be on a seesaw kind of trying to do both and have a foot in both worlds. So here's what happened.
In September
Nineteen ninety four.
Right before this crazy thirty two X thing comes out.
Sony.
And Namco.
When now Namco was Sega's biggest rival in the arcade business.
They come out with a pretty huge
industry changing announcement.
They're gonna partner together.
To release a
quote unquote virtua fighter killer.
Arcade game.
called Tekken.
Folks might recognize the Tekken series.
Well, I had no idea. Tekken is so much more than Tekken.
The game is gonna come to the PlayStation.
When it launches. It's not out yet, but yeah, like
Great, okay. We all remember Tekken, you played on the PlayStation, I think it was an exclusive, et cetera.
But it's also
Coming out.
Right now.
In September nineteen ninety four.
In the arcades.
And in fact.
It's gonna be running.

Awesome new
System Eleven Arcade Board Platform that they have developed together with.
Sony.
And guess what?
Further surprise.
This System eleven arcade board developed with Sony.
It is.
The PlayStation.
Whoa. So this is just the ultimate knife in Sega's back.
They're just basically shipping Playstations inside of these arcade cabinets. Yeah, it was the PlayStation hardware. Like there was some buffs to it and whatnot. But Namco and now pretty soon all the other arcade guys, they're gonna be like, Oh, great.
We're moving all of our development platform for the arcade industry.
to the PlayStation platform.
the technological bleeding edge is now gonna be yeah, also in the arcades.
Powered by the PlayStation.
But in the home.
Powered by the PlayStation. Wow. What a Trojan horse.
So now.
Sega is like
Oh shoot.
We are.
Screwed.
We need to scramble the jets and just do
Anything we can do.
To try and stave off this apocalypse.
So
They launch the thirty two X.
Seems really dumb.
They gotta do something. Like
Okay, we need to get into market right now.
with a thirty two bit system to just try and preempt
Sony here in the PlayStation launch.
Then they
Massively accelerate.
The Saturn launch. Why did they do that? The same thing. They're just trying to do anything they can think of.

Thunder here.
Yeah, makes sense.
The barbarian is already through the gates on the arcade side of the business,'cause Namco's shipping these system eleven arcade cabinets today.
And it's right at the gates.
coming next year with the PlayStation.
It's funny how much in our Nintendo episode the conflict was Sega versus Nintendo.
But the death of Sega really is
Against Sony.
Yes.
So that brings us
to the
Very famous.
E three conference in May of nineteen ninety five. And this is maybe the most
Incredible.
Video game industry event.
Of all time.
We referenced it earlier in the show.
But we're heading into the conference.
Sony is expected to announce the US release date and pricing.
Of the PlayStation.
At this.
conference. People expect it's gonna be in the fall, you know, kinda know what's gonna happen.
Sega they need to do something, and so this is when Sega of Japan tells Kalinsky and Sega of America.
Do the surprise launch. Get up there, announce the Saturn. Just do it.
Even though the ecosystem isn't ready, the hardware is ready, so we're shipping it. We're shipping it.
So Tom does that, he dutifully goes up, he announces Oh.
Forget Saturn Day. You can buy the console now. It's in limited quantities at Select Retailers for a price of three ninety nine.
And he's basically doing this because Japan has said, either you are doing this or we will find a new CEO for
Sega of America who can do this. Yes.
Three ninety nine. That is the Sega Saturn price point. Available today.
May eleventh, nineteen ninety five.
So Kalinski finishes his speech.
He walks off stage, they usher everybody out of the room, they turn it over, they get ready for the next keynote of the day, which is going to be
Sony.
Sony keynote starts a couple hours later.
Olaf Olofson, who's the president and head of all of Sony America. So like not just the PlayStation, all of Sony's businesses.
He gets on stage, he starts giving his presentation, he says that the PlayStation will release in the US on September 9th.
Nineteen ninety five.
So Sega's like, Phew, great, they're not moving it up. We're gonna beat them to the punch. We're live today.
We got a four month head start.
Let's go.
And then
Olaf invites the new head
of Sony Computer Entertainment.
America.
One.
Steve Race.
Formally of Sega of America.
Up to the podium.

Brief presentation.
He walks slowly up to the podium.
He's got a large stack of notes.
He places them down on the collectorn, he shuffles them around, he waits a beat, he's ready to give his big speech.
He looks up.
He looks at the audience.
And he says
Two ninety nine.
And then he picks up his notes and he walks off stage. And this is I think most people in the industry I think would agree that this is the greatest moment in all a video game.
industry history. Right. Of industry announcement type things. Yes.
Alright, so that's Sony PlayStation One.
Two ninety nine.
for by far the most sophisticated system on the market.
We will link to the video of this in the show notes. It's on YouTube. I mean
People still watch this to this day.
The reaction is amazing. At first there's silence because people are like, What did he just say? What does this mean? What's going on?
And then the crowd starts cheering.
And then you can hear after about like twenty seconds or so when this really sings in of what this means.
People go nuts. There's like another wave of cheering. It's
Unbelievable. It's like that last wave is all the developers realizing, oh my God, we are going to print money because there's gonna be so many people buying this thing.
This
Exact moment.
In the afternoon of May eleventh.
Nineteen ninety five.
Is the death.
Of Sega.
Because let's go back and think about
The three.
Key constituencies in the video game home console.
business kind of flywheel.
You've got the consumers.
Why on earth?
Would any consumer
Go buy a Sega Saturn.
Today on May eleventh, on its launch day.
That has no Sonic game.
has only six games total and it costs three ninety nine.
When you now know that the PlayStation, which is far superior
is gonna come out.
Just four months later.
They're gonna have
Perfect ports of all
The latest and greatest.
Arcade technology video games.
And it's gonna cost
Less.
Wow. You're not gonna buy a sat.
So that's the consumers.
Then the retailers.
The retailers are so mad.
At Sega.
Sega just completely ruined all of their holiday season planning.
Because
For retailers.
Q4 is everything. And why are these consoles launching in the fall in the US so that it can be ready for the holidays? Sega just screwed all this up.
And now more importantly, they've got units on trucks on route to their stores that they know they're not gonna be able to sell now.
So they are
So mad.
At Sega. I think it was KB Toys, which then was a big franchise in America. They drop Sega entirely. They're like, We're not carrying your stuff anymore.
Goodbye. You're gone. And then
You've got
The most important thing.
Piece the developers.
All the third party developers who are sitting there at E three watching these keynotes, they're like, Wow.
We're gonna make a ton of money on Sony.
And Saturn has no chance.
of building a meaningful install base. So like
If I was planning on
developing games for the Saturn, I am now canceling those plans.
This is just the worst thing that could possibly happen to Sega.
And the Saturn and the arcade business.
Now, listeners, as you can imagine, there is a tough path that they have to now traverse to get to the twenty twenty-three Sega that we're gonna talk about.
and what they look like as a games business today. David, I have a couple of stories that I don't think you know about how they made that transition. So I'm curious to know if I will stump you with that or not.
All right listeners.
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Okay, so David, here are a few things that I was curious if you knew about. So I planted the seed earlier.
With the idea that
Some people personally accumulated a lot of wealth through Sega.
One of these people was Aseo Okawa.
Yes, the chairman of uh
C S K, right?
Yes, exactly. And then ultimately became the chairman of Sega.
So in nineteen ninety nine, he had loaned Sega five hundred million dollars, I believe personally.
In two thousand and one
The writing was on the wall, he was coming to the end of his life.
He actually forgave Sega's debts to him ahead of his death.
and returned six hundred and ninety five million dollars worth of Sega and CSK stock.
Which basically was the bridge that Sega needed to transition
A massive
shift from the Sego that we've been talking about this whole episode to just
being the game creator that they are today.
Yeah, because
All of this.
R and D that was required to go into these new consoles, the Saturn, and then we just talked about how the Saturn basically got the floor wiped with it by Sony and the PlayStation One.
Sega would then turn around and pour a bunch of effort into the Dreamcast.
The same story would happen, but even worse, the Dreamcast sold less than the Saturn, and the PS2, of course, goes on to become the best selling console of all time.
It takes hundreds of millions, if not billions of dollars in R D to create these consoles. Right. They're just destroying their cash reserves. Yeah.
You would think
when the PlayStation comes out and basically
creates a giant sucking sound that takes all of the
business and players in the arcade industry and brings them into the home.
Console with the PlayStation.
That
Sega would also get decimated in
The arcade side of their business, which was the golden goose.
They do.
But they kinda get a stay of execution for a couple of years. Thanks to
This partnership that they do with the Japanese developer Altis.

Pura Cura machines.
So yes, the core gaming experience of the arcades
does get totally gutted and Sega along with it.
But almost like Nintendo and Pokemon.
This
Pure Acura thing.
These are photo booth like selfie booths. Oh, I did read about this. I just didn't know what it was called. Yeah. This kind of becomes sort of the origin of the selfie phenomenon that of course started in Asia and then like moved to the rest of the world.
Sega was right there at the beginning of this. So
The photo booths in the late nineties make
Over a billion dollars in revenue that Sega plugs into their quote unquote arcade business division. Now this is not the arcades by any stretch of the imagination. It makes sense, though. It's the same distribution channel, it's kind of the same locations as arcades. Exactly, but unlike
Cutting edge technology
In
the arcade video game business. There's nothing defensible about this. It's a one time cash grab. Exactly. So
Once both the fad subsides and competition springs up.
By the end of the decade.
Sega no longer can continue in the hardware business on any front.
So what do they become?
Well, they become a games publisher.
You can get Sonic on.
Nintendo platforms and on the PlayStation and on Xbox and
That's great.
They make mobile games. I remember in two thousand and eight, the very first iPhone game that I had was Super Monkey Ball.
Which was a Sega game.
Yeah.
Actually a really good game. Super fun puzzle game.
Yeah, and it was perfect for the iPhone handheld device with accelerometers. Like it was this natural fit on mobile as people were trying to explore that form factor and figure out what it should be. In fact, it was
I believe in one of the original Apple
iPhone OS app store keynotes to show off what games you could make, what types of experiences you could do on this device.
And so we keep talking about the SAMI, what was the SAME transaction and what was SAMI before
Sega Sammy.
Yeah, so Sammy was and is a Pachenko machine manufacturer and operator in Japan.
Beyond the scope of this episode, but
Pachinko is kinda like pinball used to be in the US. It's like gambling meets pinball.
And it's like much smaller than pinball. It's like a small vertical type thing.
Yeah. You know, on the one hand it's sort of gaming
esque. On the other hand, it's also like a slot machine, just like pinball was back in the day in the US.
So that's what Sammy was. They had made some video games.
in the past they had a small video game division and so they acquire Sega.
And merge that into
There.
Video game division.
And it's fine. It's still a public company.
You could say maybe at the bottom end of the majors or the top end of the sort of like mid level.
game publishers out there.
It's
Fine.
Yeah.
And Pitchbooks got this around two thousand and three for the Sega and Sammy merger, and they've just been Sega Sammy publicly traded ever since.
More stats from Pitchbook today, they're a four point three billion dollar market cap company.
If you back out their cash, they have an enterprise value of about three point six billion.
Last year they did 2.7 billion in revenue. So clearly the market doesn't think much of them with a revenue multiple of 1.3.
It's a little bit of like a zombie company. Yeah.
You know, this is a good spot to transition to analysis here. I think there's a couple of interesting things to talk about.
in playbook and then we have a fun sort of way to end the episode.
One of the things I want to talk about is
Despite all of
These matinations and mistakes
They do have some pretty great IP in the company.
The Sonic movie, it's no Mario movie, but it did pretty well.
People still love Sonic the Hedgehog.
The Yakuza franchise is strong. There's lots of other franchises.
within
Sega
Is there almost I'm wondering like a uh L VMH Bernard Arnaud style takeover opportunity here? Like could you come
And acquire.
either the whole Sega Sammy company or the Sega IP out of it.
And like
Do it right. You know, there's so much more that could be done with this stuff. I don't think so. I mean, my take on this whole thing is that.
Sonic was a one trick pony.
and that they never really found a effective way to expand the franchise. They came out with a bunch more stuff that had Sonic on it.
But
I never wanted to play three D Sonic the way that I wanted to play the original Sonic the Hedgehog.
Side scroller game.
It feels to me like
There's a lot of nostalgia to play with, but it
didn't really create any durable, extensible IP.
Or a gameplay, frankly.
Well, right, back to the difference between Sega and Nintendo and the games and the difference between Miyamoto and
Sonic team.
You know, Sega's DNA.
This is the whole point of this episode. It was the arcades.
the type of game you make for an arcade is very different than the type of game you make for a
Sixty dollar packaged good.
Home console.
Sonic was the perfect arcade style game.
That first level in the first Sonic.
was so good. And even the subsequent three D stuff like Sonic Adventure and beyond.
The first level of Sonic Adventure for the Dreamcast
is so good. It really is like you play it and you're like, wow, this is three D Sonic. This is everything I remember.
The first level is in like a island setting and you're like chasing a whale, like running around at sonic speed and doing three D loop to loops. It's super fun.
But the problem with these
games and with Sonic is
It's super fun.
For five minutes. Yeah.
And then you're like
Okay. I'm done.
Whereas Mario and Zelda
It's not as fun in the first five minutes.
But
You can play it for
fifty hours and
Lose yourself in it.
Since we did most of the kind of analysis commentary in the story
Let's just ask the question, what could have saved Sega?
And
This is where it's probably worth sharing.
The Jim Clark story.
Yes.
So
This is a great excerpt from Console Wars.
And
I had no idea. I mean we have talked a few times about
Netscape and Jim Clark and SGI and how the internet almost happened on N sixty fours with Mark Andreessen.
And Jim Clark together.
And you may know that
The N sixty four was based on SGI's architecture. You needed an expensive SGI workstation to
create the amazing graphics.
Games.
A big reason why.
The best N sixty four games were first party and there weren't a lot of third party games.
Right.
But the way that that came about
is crazy.
It was actually
Tom Kalinski.
The CEO of Sega America
who wanted to do the partnership with SGI.
He saw the potential cutting edge chips.
And after the
potential Sony partnership that we referenced earlier fell apart between Sega and Sony.
He came back to Sega of Japan with a pitch saying, I just met with Jim Clark. I really think we should do something with SGI. I think our next
generation console should be powered by SGI.
And Sega of Japan got back to Kalinski and said
No.
And when Kalinsky pressed them and said why it's a no brainer, they said
The chip is too big.
And Kalinski was like, What?
This doesn't make any sense. And they were like, That's our decision. And so he had to have a this
Really hard phone call with Jim Clark saying
I'm sorry, man. I actually don't have a deal for you here.
Japan is against it.
And so Jim Clark goes, Well, what am I supposed to do now?
And Kalinski in this incredible moment of frustration where he seems half a foot out the door.
Looks in the phone book.
Looks up Howard Lincoln's phone number.
and says you should call Nintendo of America.
Which I can't
believe that actually happened.
I know.
So crazy.
But again, you know, understanding what we know now.
From the Sega story.
It's not just that
Take of Japan was being really dumb and arrogant here.
Right. That was a reasonable business decision.
Because at that very same time that Tom was
calling up Japan and being like, Oh, we're gonna do this thing with SGI.
The Sony.
Apocalypse was coming in the arcade business with the system eleven and Namco and the PlayStation.
And I can totally understand Sake of Japan being like
look, doing this SGI thing, that's not what we have time for right now.
Yeah. I also think there was probably some kind of like not invented here sentiment where it has to happen
in Japan within Sega's walls in order to be a viable strategy.
It is a little weird.
You know, it's not like they already were thinking we should just be a software business because they did have the Dreamcast after this.
To me it feels more like a lack of willing to partner than it does a sort of business model conflict. Had it happened a couple years later, y you would have been like
Okay, clearly you should get out of the console business and so
Don't invest in new hardware partnerships. But
I think this is just um
We don't know those guys. We don't trust those guys. So we're not working with them thing.
Who knows if it could have saved Sega, but maybe.
That's probably the closest thing.
That I can think of too. Like had that happened.
Probably still wouldn't have saved Sega.
But at least the Dreamcast might have had more of a chance of success.
Maybe.
We'll never know.
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Carve outs.
Carve outs. Let's do quick carve outs.
I have one funny story before giving my carve out.
This is a thing that also got cut from both last episode and I'm not letting it get cut from this episode.
The Sonic origin story is hilarious.
In a interview years later, Nayoto Oshima, who is one of the creators, I think he was the designer of Sonic.
He was asked.
How did you come up with Sonic, this blue hedgehog? Why does he look like that?
And uh his answer, he just says.
Well, I put Felix the cat on the body of Mickey Mouse.
That's right.
And I ha I was reading that, I I couldn't believe it. And you look it up and you're looking at Felix the cat and you're looking at his eyes and his head shape, and you're like, Oh my god
It's Felix on Mickey Dyed Blue with sneakers. Yes. It's
Ridiculous.
Uh, to your point about
Sonic.
While being beloved isn't really like the super deep IP. No.
Kalinski and team gave it a good run, but man, it was thin all the way around.
It was.
All right, what do you got on car routes?
My carve out, I wanna re-carve out your carve out from a couple episodes of Daryl Morey on Invest Like the Best.
I listened to it after you recommended it.
Daryl, now the GM and president of basketball operations at the Sixers, formerly the GM of the Houston Rockets.
He's just brilliant and so fun to listen to, whether you care about basketball or sports at all. I mean he was a computer science.
Major like he's very, very interesting.
And Patrick is just such a good interviewer.
It really is a master class.
How to
conduct a truly interesting
Explorative discovery based interview.
And I learned
So much from it. I really enjoyed it.
Yeah, so good.
Okay, I have three. They're gonna be fast.
One is my God, if you are not watching this season of Succession, it's the best television I've ever seen.
Just remarkable storytelling.
Two
I'm keeping a close eye and I suspect many of you are as well. In the next month, Starship is scheduled to launch.
And so nice.
SpaceX launches always sort of our who knows on the date and Elon things always slip, but it is on the launch pad. They're doing lots of pre launch inspections and tests and
It is gonna be so freaking cool to watch that thing do its first launch.
And then three.
I said this to David. I don't know, David, have you watched it yet? Six days to air.
I haven't yet.
Alright, if you like this
And you like South Park.
You will love that.
If you like this and you like watching creativity in action.
but you're not so sure on South Park, you may still love it.
It is a documentary about the
Process.
Of conceiving of a South Park episode idea on a Thursday.
And then having it air the following Wednesday.
And the unbelievable six day turnaround.
There's just nothing more special than watching creativity in action.
I think the documentary is like ten years old at this point, but a pretty special view into their process.
Nice.
We could learn some stuff for uh acquired. Lot we can learn.
All right, listeners, that's it.
Thank you so much for joining.
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And with that listeners.
We will see you next time.
We'll see you next time.
Who got the truth?
Is it you, is it you, is it you Who got the truth now