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CAN YOU FIND SAFETY ON THE NET?

Headbone, a maker of kids' software, is betting that a Web site will save its bacon

The tale of Headbone Interactive Inc., a children's software developer, has the makings of a great adventure game. Call it The Startup Quest. The set: a funky old warehouse in Seattle. The cast: a bunch of hip young people led by a mellow female fugitive from corporate life. They create cool kid characters named Elroy, Syd, Iz, and Auggie. Crisp, quirky graphics give the software an edge. Their CD-ROMs win rave reviews and a bevy of awards. But it still isn't enough to survive in a super-saturated market.

For Headbone, this is no game. Since the company was founded by ex-Microsoftie Susan Lammers just three years ago, the market for edutainment CD-ROMs has collapsed under the weight of too many titles. With heavyweights like Walt Disney and Microsoft--plus 600 other edutainment publishers--all vying for precious shelf space, exposure is everything: The top ten CD-ROM titles generate 90% of the revenue. What of poor Headbone? It has less than 1% of the market, according to PC Data, its Parents' Choice and software excellence awards notwithstanding. It's the classic small businesses conundrum: ''I knew how to make good products,'' Lammers admits ruefully. ''I just didn't know marketing.''

After a disappointing Christmas season, Lammers has decided to all but abandon the retail market, and take her cartoon characters to the Internet and beyond. It's a risky move by the 38-year-old entrepreneur and her husband, Walter Euyang, who seeded and nurtured the company with their own funds and are now betting their future on an unproven medium. But at least the Net offers Headbone an affordable way to strut its stuff. ''We are leading with our Internet programming as a way to build an audience for our characters,'' says Lammers. ''The Internet is the wedge that will get us into other media like TV.''

BARBIE WATCH. Certainly there is less friction getting a product out on the Internet, agrees Patti Stonesifer, former head of Microsoft's Interactive Division and now a digital consultant. But to really succeed, Stonesifer says, a brand or character has to be everywhere--from the computer screen to television to the toy shelves, just like Disney and Barbie.

For Headbone, the Net is the most affordable place to start. To get people to its Web site, it partnered with content-hungry search engines that receive more than a million hits a day. First Excite featured Headbone prominently on its home page. When that deal ended, Headbone turned to Yahoo!, which caters to kids with Yahooligans, a Web page full of games and news links just for kids.

The partnerships have paid off. Since its launch in mid-January, more than 10,000 people have registered to play Derby, a serial cartoon game featuring characters Iz and Auggie in galactic adventures. The average Headbone visit measures 18 minutes, an eternity in a world where 2 minutes at a site is the average. And it's definitely more attention than Headbone products ever received sitting on a dusty store shelf.

Lammers always believed that if consumers just got a taste of the company's zany style, they would buy Headbone's products. The Internet provides an opportunity to sample. Since the launch of Derby, sales online--where consumers can click and order CDs for $19.95 at Headbone's Web site--have increased 130%.

Lammers is looking to the Internet for more than just a source of cheap advertising. Headbone's site can showcase the company's creativity and build a sense of community with online games, jokes, and chats. This community started building two years ago, when, light years ahead of most other kids' software companies, Headbone created a Web page. It followed up with an electronic newsletter, and eventually, an online store for Headbone products.

The next step last spring was a pilot Internet game for kids aged 8 to 14. The response to the pilot was especially positive among teachers clamoring for Internet content they could use in the classroom. So before launching Derby, Headbone advertised the game in education journals across the country. Excite's extensive database was mined to send a mass E-mail message to teachers announcing Derby's arrival. As a result of this marketing effort, close to 1,000 schools had classrooms of students playing the game. What students found in Derby was a funny narrative featuring Iz, the girl rock musician, and Auggie, her robot friend, who could only escape dire situations when players surfed the Net for answers to such mind-numbing questions as ''What is the largest canyon on Mars?''

Schools are not the only new market Headbone unearthed with its Internet venture. With the second episode of Derby, Headbone is signing deals with on-line newspapers such as the Star Tribune in Minneapolis, Minn. (www.startribune.com). As part of the syndication arrangement, newspapers must promote Headbone online and in print. Eventually, ad revenues will be shared. Headbone is also looking to hook up with other major advertising sponsors for its Internet games and homepage.

MARKET NICHE. While the Internet has not yet proven to be a direct generator of revenue, it's still the place to be for software companies, analysts say. ''The CD-ROM market is bleak,'' says Scott W. McAdams, software analyst at Ragen MacKenzie, an investment firm in Seattle. ''You either ride it out until your Internet product is successful or you sell out.'' But as McAdams cautions, there is not a whole lot of dealmaking going on these days.

This desperate fight for market share is not what Lammers expected when she launched the company in 1993 with money from her Microsoft stock. She and her husband formed Headbone to create a sane working environment while raising their two young sons. The company has always been lean, operating with a minimal staff in a low-rent district of Seattle. But the place has atmosphere. Couches here and there make the loft feel homey. Children run through the open spaces, while Headbone employees toil away.

It would have been the ideal work environment, except that marketing has been a struggle since day one. To get distribution for its products, Headbone first turned to well-known video game manufacturer Sega Enterprises Inc. But the alliance was a mistake. Sega could get Headbone into stores such as Toys 'R' Us, but then Headbone products would languish next to glitzy, proven titles like Mortal Kombat.

The Sega deal made Lammers realize she needed marketing expertise. So she recruited 34-year-old Mark Bolger, a former Disney manager charged with creating new distribution channels for home videos. Last year, Headbone relaunched three existing titles and released five new ones. The company then undertook a print ad campaign in magazines such as Family PC and Home Computing. After the Sega contract expired last May, Headbone formed a distribution alliance with Broderbund Software Inc., a leading edutainment publisher with the heft to compete for shelf space. The alliance opened doors with wholesale buyers like CompUSA and Computer City, and Headbone's sales last year rose by 100%.

WHERE'S THE MONEY? But pushing CD-ROMs on the retail level was expensive. So Lammers sought the aid of venture capitalists last spring. In May, Headbone scored $4.2 million from Bay Partners in Cupertino, Calif. and Applied Technology Investors in Lexington, Mass. That timely infusion is keeping Headbone alive. But, not surprisingly, the company has become very conservative with its spending. After a disappointing Christmas season, Headbone stopped developing new CD titles and started concentrating on its Internet strategy and the development of TV pilots. But this move also leaves the company with a much-reduced revenue stream.

Lammers admits that pursuing this long-term strategy of building up Internet advertising and developing TV pilots for kids' cartoons will probably require an additional round of financing sometime this summer. Applied Technology Investors and Bay Partners have indicated that they will go the second round. ''We invested in Headbone because the characters were so engaging and because Lammers was a strong entrepreneur,'' says Dempsey.

So the game isn't over for the Seattle startup. In fact, you might say the quest is just beginning.

By Seanna Browder in Seattle



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