From Russia with Games

When it comes to PC games, Sergei Orlovskiy put the country on the map. Now, he has teamed with American VCs to take on consoles

Sergei Orlovskiy blames incompetent Russian officials for his addiction to computer games. Thanks to a bureaucratic slip-up, his school computer class in the far eastern Russian province of Magadan was equipped with a Yamaha MSX gaming computer. That didn't much help Orlovskiy's grades, but it did foster a love of gaming that led the then-23-year-old information-technology student to found his own company, Nival Interactive, in 1996.

Orlovskiy had his heart set on designing his own game. Despite a lack of business experience, he managed to persuade five friends to join him in the venture, and a local publisher, Buka, to put up $250,000 to finance it. It proved to be a smart move. Orlovskiy's idea blossomed into Rage of Majors, which sold 100,000 copies worldwide -- a strong debut for a PC game. Ten years and several more successful titles later, Nival has grown into Russia's largest game developer, with 200 employees.


  Nival's ambitions don't end there, though. Last year, Orlovskiy teamed up with a U.S. venture-capital fund, Ener1 Group, which acquired 70% of Nival last April for an undisclosed amount estimated at $10 million. It's the first step in an ambitious plan to transform Nival from a purely Russian outfit into an international company with headquarters and top management based in the U.S.

"Our strategy is to use experienced development resources in Russia, and marry them with experienced and well-known production and creative resources in the States," says Orlovskiy.

The idea for the partnership came from Fort Lauderdale-based Ener1 Group, which invests in Russian technologies with a view to commercializing them in the U.S. market. Ener1 Chief Executive Charles Gassenheimer says that outsourcing game development to Russia provides a vital competitive advantage, in a market where revenues are flat and competition cutthroat.


  In the next few days, Gassenheimer says, Ener1 is preparing to announce a new management team for Nival, consisting of veterans of the U.S. gaming industry. "We believe we've put together a dream team, in terms of the top U.S. management that's available in the market. The quality will blow you away," he predicts.

Gassenheimer notes that outsourcing games development to Russia offers "first-degree Russian programmers at a reduced cost to U.S. counterparts." Russian programmers typically earn between $1,000 and $2,000 a month, four or five times less than their American equivalents.

But Russia also has advantages that other low-cost locations, such as China and Eastern Europe, can't offer, says Orlovskiy. "Since the Russian [game-development] community has already been going for 10 years, we have a huge pool of experienced talent," he says.


  Nival and other Russian game developers have a track record to back up the boast. Russian-designed titles have increasingly penetrated the PC-gaming mainstream in recent years. Nival's first major international success came in 2003 with the release of Blitzkrieg, a World War II strategy game, which has sold 1.5 million units worldwide. That compares with typical sales of about 500,000 for a PC game.

Other Russian games to enter the big league include Il-2 Sturmovik, an internationally acclaimed flight simulator by Russian developer 1C, and Pirates of the Caribbean, the game tie-in to the Hollywood blockbuster, by Russian studio Akella.

The growing international success of Russian-designed titles has helped draw the attention of big league publishers and developers. Nival's next big break came in 2003, when it landed a contract from French entertainment software giant Ubisoft to develop the fifth installment of Heroes of Might & Magic, a best-selling fantasy strategy series, which has sold 12 million units to date. Nival's version, featuring the latest 3-D graphics, is due to hit the shelves in April.


  Still, despite a growing number of internationally successful titles, Russia's total computer-game exports are probably worth no more than around $15 million a year, reckons Orlovskiy. And while the country's developers are becoming recognized in the global PC-gaming market, that market as a whole is still a relatively small niche. It pales compared to the much larger market for console games, played on specialized gaming machines such as Microsoft's (MSFT) Xbox and Sony's (SNE) PlayStation 2. U.S. retail sales of PC games last year were just $953 million, compared with some $4.7 billion for console games, according to market research company NPD Group.

That's why a key part of Nival's strategy is to move beyond the PC. "We understand that it's already the limit for us. We can't just be the best Russian company -- we have to move forward and also be the best international company. To do this, we have to switch from the PC market to the console market," Orlovskiy says.

He adds that now is an ideal time to get into console games, because a new generation of consoles, such as the PlayStation 3 and Xbox 360, have either been recently introduced or are about to hit the market. That will fuel market growth and provide similar technological challenges to both established players and new entrants such as Nival.


  Nival has big expectations. "Normally, our revenues increase from 20% to 50% a year. Starting from 2006, we're going to increase it by 100%, because we're changing the business model," Orlovskiy says. Nival's revenues are currently in the millions of dollars, he adds, though the plan is to reach "tens of millions" from this year. Profit margins are around 30% for both PC and console games, according to Orlovskiy.

It's certainly an ambitious leap. Each console game takes $8 million to $10 million to develop, about three times more than a PC game. Orlovskiy also notes that Russian game developers' traditional strength has been designing relatively abstract games, such as strategy games, where the emphasis is on complex artificial intelligence. Such games are most suited to the relatively esoteric PC market. Console games, on the other hand, are more geared towards the mass market and also have to meet the very high quality standards demanded by console manufacturers.

That means emphasizing artistic presentation, well-developed characters aimed at local audiences, and the crossover between games and mass culture. (Many games are based on Hollywood movies, for example.) That's where the U.S. expertise comes in. "To do really huge, triple-A console games, which is what we're now focused on, we need American creative resources," says Orlovskiy.


  Nival hopes that bringing in U.S. marketing and design skills will also give the company a competitive edge over game developers in even lower-cost countries such as China, where cultural differences remain a barrier to penetration of the U.S. mass market.

But Nival isn't taking any chances. It's looking East as well as West, and exploring several options for entering China, to be ready to exploit cheaper labor costs as the Chinese development industry gets off the ground. A company originating in Russia, with management in the U.S. and production in China? There's globalization for you.

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