Harmonix Rebounds With Dance Central, Bets on Music Downloads

(Corrects fourth paragraph to show a former Harmonix partner sold Guitar Hero. Corrects ninth paragraph to show revenue figure accidentally identified as profit by Harmonix.)

When Harmonix unveiled its Dance Central video game at the industry conference E3 in June 2010, the once-mighty music games company was perched on a financial precipice. Sales of the interactive music game Rock Band, once the company’s golden goose, had started plummeting the previous year.

Viacom (VIA), which purchased Harmonix in 2006 for $175 million, was trying to find a buyer for the company and its $200 million in liabilities. Harmonix Chief Operating Officer Florian Hunziker watched the E3 announcement with head bowed and fingers crossed, worried whether Dance Central would appeal to the hundreds of attendees.

What happened next signaled a possible turnaround for Harmonix. When the game demonstration began, even the most unlikely players jumped to their feet. “Dancers were lining up 20 people deep ... getting down to [Lady Gaga’s] ‘Poker Face,’ ” says Hunziker. While the demo garnered Dance Central positive buzz, speculation about Harmonix’s impending fire sale drowned it out.

(For more stories on entrepreneurs changing the music business, see our special report.)

The Cambridge, Mass., company had put music games on steroids in 2005 when it created Guitar Hero, one of the first games to encourage players to live out their rock star fantasies with plastic controllers shaped like instruments. A former Harmonix partner sold Guitar Hero to Activision (ATVI) that year. When it became one of the fastest-selling games of all time, Viacom snapped up Harmonix, looking for a repeat performance. Harmonix came up with Rock Band in 2007, and the rival platforms fueled a music games frenzy.

Music Games Peak

The fad was short-lived. Michael Pachter, games analyst for Wedbush Morgan, estimates the market for music games peaked at $2 billion in 2008. Sales retreated to $900 million in 2009, and then continued their precipitous decline throughout 2010 and 2011.

Unfazed by the slump, Harmonix founders Eran Egozy and Alex Rigopulos focused on the next big thing. “You’re only as good as your last game ... and while Guitar Hero and Rock Band are great, we just can’t live on that alone,” says Egozy. The duo found inspiration for their next game in one of the company’s favorite after-hours activities: dancing. Harmonix is run by a bunch of musicians. When they party, they like to hire a big boat in Boston Harbor and boogie down.

Egozy and Rigopulos imagined a dance game that allowed for the same kind of fun at home, but they felt constrained by technology. In 2008, players still needed a special mat or handheld console to be seen by the computer. All that changed a year later when Microsoft began developing the Kinect, a game system that can track players in 3-D. By November 2010, Harmonix was ready to launch Dance Central for the Kinect.

That same month Viacom sold Harmonix to a private investor named Jason Epstein. Epstein, a senior partner at Columbus Nova Private Equity, raised part of the money for the deal from Egozy and Rigopulos, making them part owners. All intellectual property, including Rock Band, was included in the deal.

Most Profitable Year

Fast-forward a year, and Dance Central has sold more than 2.5 million copies at $60 each, making it the No. 2 bestselling game for the Kinect (the top game is Kinect Sports, which often comes bundled with the console). Thanks to Dance Central, 2011 will be the most profitable year Harmonix has ever recorded, says Hunziker, and he expects $100 million in revenue for the 200- employee company.

Downloads are part of the turnaround story. Harmonix built a music downloading service into its games when they launched, so that players could buy new songs. While hardware sales remain the bulk of the company’s business, Hunziker says Dance Central has spurred downloads of a wider variety of music than Rock Band and Guitar Hero, including dance and techno titles. Since 2006, Harmonix has sold more than 100 million music downloads, he says. “We’re going to continue to invest in the [downloadable content] business.”

In the past, the problem with downloadable music as a revenue stream was the high cost of licensing the music. Michael Pachter of Wedbush Morgan estimates that on average 20 percent of the wholesale price of a Rock Band game has historically gone to pay licensing fees. Now that Guitar Hero is no longer bidding for the same music as Rock Band, he expects those fees to come down. (Activision announced it would put Guitar Hero “on hiatus” earlier this year.) Licensing fees that looked high to begin with will also look more reasonable over time, according to Hunziker, since Rock Band players continue to download new music onto the platform years after purchasing the game.

Last month, Harmonix released Dance Central 2, a multiplayer version of the Kinect game with voice commands. Now players can have dance-offs -- the experience Harmonix originally wanted to capture. Of course, Harmonix acknowledges that improvements to Dance Central won’t be enough to keep it ahead in the fast-growing dance game market. Hunziker says the company is developing multiple new music games that won’t resemble Rock Band or Dance Central. If those games do as well as Hunziker expects, he says profits will double again in the next few years.

“They’ve retrenched and are quietly rebuilding a profitable business,” says Scott Steinberg, head of Seattle-based technology consulting firm TechSavvy Global and author of a new book on the rise and fall of Rock Band. “It’s like bands. When you have a bad album, you step back a bit and you let the work speak for itself.”

To contact the reporter on this story: Alexandra Dean at adean13@bloomberg.net

To contact the editor responsible for this story: Nick Leiber at nleiber@bloomberg.net

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