The Disappearing Cd Rom Players

Small makers of kids' software sell out--or get squeezed out

It was another sleepless night for Donna Stanger, acting CEO of Edmark Corp., a small education-software developer in Redmond, Wash. Edmark's former CEO, Sally Narodick, had resigned in September, citing the stress of running an embattled company in the fiercely competitive kids' software business. But that night, instead of worrying about how to get shelf space for Edmark's products, Stanger was negotiating the sale of the company to IBM. At 4 a.m. on Nov. 13, she signed the last piece of paper for the deal she hopes will save Edmark.

Edmark is just the latest software company to be swallowed up by a bigger player (table, page 124). Less than two weeks before, on Nov. 5, CUC International Inc. announced it was buying Knowledge Adventure Inc., the third acquisition the phone-order and online retailer has made in the past 10 months in the area of family entertainment/education software.

It's a case of simple arithmetic that any grade-schooler who has played Math Blaster from Davidson & Associates Inc. (acquired by CUC last February) could solve: There are currently about 2,000 CD-ROMs in the "edutainment" category--programs that blend education and entertainment. Yet major retail outlets have room for just 250 titles, tops. To make the picture worse, Fairfield Research Inc. predicts that consumers will buy 25% fewer CD titles this holiday season than last. And shoppers will stick with the tried and true. Consumers are looking for titles they already recognize, marketing gurus say, from companies with well-established reputations. That puts the squeeze on lesser-known entities. Since it costs $500,000 to $1 million on average to produce and market a high-quality CD-ROM, companies must sell a lot of product to make ends meet.

"A LOT OF FIREPOWER." So as shoppers hit the stores, makers of kids' CD-ROMs are bracing for a massive shakeout. The industry is entering "the Pac Man phase," says Lawrence F. Marcus, new-media analyst at Alex. Brown & Sons. "The smaller players are being gobbled up or failing." On top of an overcrowded market and pricing pressures, he says, big names such as Walt Disney Co. and Mattel Inc. "are coming in with a lot of firepower." Mighty Microsoft Corp. is a presence, too, ranking No.7, with $14 million in sales for its edutainment titles in the past nine months. With titles such as Magic School Bus and the Goosebumps series, produced in a joint venture with DreamWorks Interactive, Microsoft is sure to be a contender this holiday season, when close to 40% of all the software known as edutainment is sold.

Already, the top 10 suppliers control 90% of the market, according to Ann Stephens, president of PC Data, which tracks retail software sales (chart). Battling for top position is SoftKey International Inc. and CUC, which acquired Davidson and Sierra On-Line last February. SoftKey and CUC sold about 16% each of all the education CD-ROMs for the first nine months of this year, according to PC Data. CUC's acquisition binge is paying off, though: In September, it grabbed almost 20% of volume sales for the month. Its November takeover of Knowledge Adventure, which has 6% of the market, should keep it in the lead. Davidson chairman Robert M. Davidson, now CEO of CUC Software, says mergers equal marketing clout. During the Christmas season, for example, CUC will have 600 reps in retail stores "helping people figure out what to buy," Davidson says. "There is no way a small company like Knowledge Adventure could afford to do that."

Such a shakeout is typical of any young industry. And the edutainment CD-ROM business is younger than most of the kids it's targeting. The business grew up almost overnight as entrepreneurs, including former educators such as Jan Davidson, Robert's wife, saw that the CD-ROM drives and multimedia hardware first offered on PCs in 1993 would make it possible to create elaborate, cartoon-like programs for kids. With more and more parents buying home PCs, there was a ready market for programs that would entertain the kids while imparting some learning. The costs of producing the relatively unsophisticated CD-ROMs of those days were so low that hundreds of companies rushed in, producing thousands of titles--that most consumers will never see.

Despite the crunch, the edutainment market itself will survive. Be it CD-ROMs, hybrid CD-ROM and Internet titles, or even digital videodisks, there will always be demand for kids' software. The growth rate for that market--an estimated $550 million for 1996--hovers around a healthy 25%, says Dan Lavin of Dataquest Inc., a research firm in San Jose, Calif.

TEMPTING PRICE. But to survive, edutainment companies must have the resources to buy rather than be bought. Edutainment-software makers are a bargain these days, and big companies are on a shopping spree. IBM, for example, is buying Edmark to expand its presence in home software, an area the computing giant has barely penetrated. And with Edmark's stock around 15, down from a high of 42 1/2 last spring, the price was right. IBM snatched the highly acclaimed software company for $15.50 a share, just three times revenues.

That's a far cry from the prices edutainment companies were fetching a year ago. Last spring, CUC paid seven times sales for Sierra and nine times sales for Davidson. Humongous Entertainment Inc. in Woodinville, Wash., maker of the top-selling Putt-Putt series, was scooped up by GT Interactive for six times sales last summer. "Prices [of companies] are dropping like a rock and will continue to do so," predicts Scott W. McAdams, an analyst at Seattle investment firm Ragen MacKenzie.

Who will be snapped up next? Analysts figure any company with a decent product line and sales under $100 million is a candidate. A small company might skate by if it forms strong alliances. Besides, size may become less critical. That's why, after SoftKey bought The Learning Company earlier this year, it launched into a corporate makeover that would transform the distributor of sometimes schlocky, always cheap, CD-ROMs into a household name. On Oct. 24, it renamed the merged organization The Learning Company, in hopes of capitalizing on the more stellar brand, built up with well-regarded titles such as Reader Rabbit. "We're no longer trying to represent ourselves as the cheapest company," says Michael J. Perik, CEO of the combined company.

Edutainment-business survivors will need a solid name to compete with heavyweights such as Disney and Mattel. "Our strategy is to make sure our core brands keep pace," says Doug Glen, president of software subsidiary Mattel Media Inc. Mattel's Barbie Fashion Designer CD-ROM is getting prominent placement this year because retailers see incremental sales from girls' software, Glen says. Disney, meanwhile, is releasing CD-ROMs as tie-ins to hit movies such as 101 Dalmatians and the Toy Story video.

For retailers, at least, the wave of mergers has made life easier. Now the few dominant companies will select and push their own best products into stores. "In a sense, the retail world is telling us to determine who the winners are by the amount of support we give a product," says Ralph Giuffre, executive vice-president for marketing at GT's Humongous.

LATE TO THE PARTY. But all is not lost for small software developers. For those without distribution clout or a recognizable brand name, there is the Internet, where more and more small fry are offering free samples of their wares. If consumers like the sample, they can then order the disk. For three-year-old Headbone Interactive in downtown Seattle, the Internet is a lifesaver. Headbone makes adventure games for ages 4 and up, but it has trouble promoting its product line. With titles such as Elroy Goes Bugzerk and Iz and Auggie: Escape from Dimension Q, the products are hard to categorize. The Internet gives consumers an opportunity to sample Headbone's wares without having to wade through a computer superstore's selection, says Headbone President Susan Lammers.

Potential customers can try out a game on the Web before going into the stores to buy the CD. "The Internet is to software what the radio is to the album," Lammers says. "We had 1,000 people send away for our software after sampling it." Headbone has joined forces with Excite, the Internet search company, to promote contests on Excite's home page and manage sponsorships.

Across Lake Washington, Edmark is launching its Internet strategy. In November, the company announced its Mighty Math line on its Web site--where consumers can drop in and download supplements to the game. But Edmark is already late to the Internet party, analyst McAdams says. Most small software companies have been using the Net for a year or more. If IBM hadn't decided to play Santa Claus, he says, it would have been a rough holiday at Edmark. Not anymore. Stanger can now sleep at night, and perhaps even dream of CD-ROMs under the tree.

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