Pushing the Right Buttons at Activision

CEO Robert Kotick talks about how the game developer climbed to the industry's No. 2 spot and how he sees gaming's future

Over the past 11 years Robert "Bobby" Kotick has overseen a transformation of video-game software company Activision (ATVI ) from a has-been to a must-have for gamers around the world. Under CEO Kotick, the once sleepy company has vaulted into the No. 2 spot in the sector, behind industry leader Electronic Arts (ERTS ). What started with a single hit, the Tony Hawk's Pro Skater series, has blossomed into a booming business with dozens of successful game titles.

On Dec. 11, Activision raised its revenue forecast 25% for the third fiscal quarter of 2002 (ending Dec. 31, 2001) to $330 million in sales, up from previous guidance of $285 million. The company also said it expects sales of $725 million for all of 2001, up 17% from its previous forecast of $680 million. Activision CEO Kotick talked with BusinessWeek Online's Technology Editor Alex Salkever on Dec. 11 about his company's success and the future of video games. Here are edited excerpts from that conversation:

Q: You were known as the guys who rode Tony Hawk to success. Is that still the case?


This year, 75% of our revenues are coming from things other than the 16 Tony Hawk titles we have out. We're really expanding in the action-sports business beyond Tony Hawk. We control more than 65 action-sports athletes right now. But it takes time to build franchises out of athletes -- out of Kelly Slater the surfer, or Shaun Palmer the snowboarder. It usually takes two or three iterations. We're very fortunate that, with more than $700 million in revenues, we can take our time and build properties that we intend to have the attributes of our Tony Hawk franchise.

Q: How important are the releases of the Xbox and the GameCube in terms of driving your software sales?


We have seen [new consoles] many times before, but there are some key differences. For the first time, you have two very financially stable and very competitive companies that have committed a lot of capital to the category.

Where you're really going to see the impact is not this year but two or three Christmas' from now, when you have price declines and much bigger libraries of software. That's when the mass market starts to emerge for next-generation video-game software.

Q: What do you mean when you say mass market?


Today, it's very much a hobbyist and enthusiast business. It reaches tens of millions -- but not hundreds of millions. When it grows into a mass-market business, that's where you see the dramatic changes in software sales. When every house has a game console. The one elusive goal we have as an industry is to broaden the customer base. We have never been able to get more than 30% household penetration. Compare that to VCRs with 95%, or TVs with 98%.

Q: What will drive this adoption?


I think the addition of a broadband capability and multiplayer capability to the next generation of hardware will really drive consumption, so that, in years that would historically have been transition years, sales will continue to grow. That growth will come from the same things you have in the online world...things like digital downloads of games off the Net. That interests us, because it allows a customer to do a trial or sampling, which today there is no great mechanism for. If you want to try a game now, you go to your friend's house or go to Blockbuster and rent it.

Q: What do you think are the drivers that could push this into a mass-market business?


The same thing we've seen in past video-game cycles. You need hardware price points that are under $150 to drive up the installed base. Then you need a few years of software development to get to where we have the chance to take advantage of the unique capabilities of the hardware.

Q: A question about Activision in the past has been your operating margins.


The last five years for Activision were spent getting to $600 million or $700 million [in annual revenues]. That allows us to have scale and to afford to build the necessary infrastructure, the support services, and the management depth. These are all the things we felt we needed as a company to become a $1 billion or $2 billion competitor in this market.

So all of the focus was on driving the revenue growth and building scale. While we were intent on getting earnings growth, we weren't as concerned about the operating margin. We figured that once we got to this scale, we would be able to leverage it for better margins. That is starting to happen now.

Q: How do your margins compare with those of competitors?


We probably will have the highest operating margins in the business this year [largest competitor Electronic Arts has operating margins in the 6% range right now, largely due to its losses in the online gaming venture EA.com. By comparison, Activisions operating margins are higher, although still in single digits]. Next year, we will add more than $100 million in revenues, and we won't have to [hire more workers]. And more than 80% of our revenues are coming from proven and predictable franchises. We have been able to reduce sales and marketing expenses as a percentage of revenues because we now have much more predictable products.

Q: Will we see a lot more competitors in your market?


The barriers to entry keep getting higher. It's harder to develop the retail relationships and get access to the shelf space. Then you have to build rigor into quality assurance. Our concept identification and development processes have taken years to refine, to the point where you have consistently high production quality.

This is my 11th year at ATVI, and it has taken a long time for us to get to the point where we have among the industry's best on-time delivery records. We have offices in Bentonville, Ark., and offices in Germany to service the major retailers over there that you have probably never heard of. Those are things that are very hard for people to duplicate.

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