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But all those visions were set in some distant tomorrow -- until last April, that is. That's when Brad Huang, a brilliant China-born economist and entrepreneur, persuaded Sega Enterprises Chairman Isao Okawa to make a preemptive first strike on the Internet front. And to make it happen, Sega announced on Apr. 3 the creation of a new unit, called Sega.com, which Huang is to run. Starting on Sept. 7, the privately held company will offer an ISP service in the U.S. and Canada for $22 a month that gamers can use both to play games on TV and as their primary PC Net connection. Besides the typical Web fare, they'll also get gobs of game reviews, tip sheets full of hints to raise your score, and the like. And those that sign up for two years will get a $200 rebate -- wiping out the $199 purchase price for the Dreamcast console. "HUGE OPPORTUNITY." The goal: to build on the Dreamcast's surprising success and make Sega the early leader in online gaming. Already, 2 million units have been sold, lifting Sega's market share from a minuscule 0.5% to 15% since it was announced last September. Just 2% of gaming revenues come from online gaming today, says Forrester Research -- all of it via PCs. But with Forrester predicting that number will jump to 24% by 2003, Huang convinced Okawa that Sega needed to get out in front of the trend, technical challenges be damned. After all, the conventional wisdom is that graphically rich games need fat broadband connections to work well over the Net -- not the pokey 56K modems most consumers have today. That's why Sony, Nintendo, and Microsoft, which plans to join the game-console fray in late 2001 with its "X-Box" device, are gearing their online plans to mid-decade, when 40% or more of U.S. homes will have a broadband connection such as DSL. But not Sega. "We think that's a mistake," says Huang. "There's a huge opportunity right now for the company that can deliver a good experience. All you'll need is a TV and a phone -- not a broadband connection most people won't have for another five years."
More important, the free-console strategy could quickly transform Sega's business model from that of a money-losing hardware maker to a Net-style company whose revenues come from higher-margin software and service fees. "Brad's team is the future of what Sega will be," says Peter Moore, Sega of America's senior vice-president for marketing. Moore will support the rollout with a $135 million marketing blitz, a 35% increase from last year. That's if the plan works, though. For starters, it will be costly. Okawa has promised to fund up to $100 million out of his own holdings. But if a million customers take the free-console deal in the next year, Sega.com would have to come up with nearly $200 million up front. Huang has already begun seeking additional funding, but that could be tricky given recent Wall Street volatility, which is causing venture capitalists to shy away from higher-risk deals. And if the ISP service doesn't deliver the top-notch play that gamers expect, they'll jump to the rivals -- taking Sega's market share and e-commerce opportunity with them. As such, Huang's giveaway could be the financial straw to break Sega's back. Still, it's worth the gamble for Okawa. "Nobody thought they'd sell 2 million Dreamcasts...but they're facing some really serious competition in the next 18 to 24 months," says Sean P. McGowan, an analyst with Gerard Klauer Mattison. "When the dust settles, [Huang's plan] will either work and be viewed as the most amazing move in consumer-electronics history or people will say, 'Wow, they gave it a great try.'" If Huang is nervous about having the future of 49-year-old Sega in his hands, you'd never know it. A laid-back 35-year-old who enjoys partying in Hong Kong and L.A. with pals like actor Jackie Chan, he has encountered big challenges before. Born at a Chinese airbase, his knack for math and physics landed him in college at the tender age of 15. And when the Chinese government decided it needed more economists, he was handed a load of textbooks and signed up to take PhD-level exams, landing a coveted free ride to a U.S. university. "I didn't understand English or economics -- in China, all I'd learned was this Karl Marx stuff!" SCRIBBLED CHARTS. Yet pass he did. And by the time he got his master's degree from Georgetown University at age 21, he was already working part-time for the Hudson Institute. While there, he helped develop policies for worker retraining -- and even sat in on briefings with Presidents Reagan and Bush, who ultimately adopted the plan that became the Workforce 2000 program.
Indeed, it was Huang's financial acumen that first grabbed Okawa's attention. Huang has been a close friend and financial adviser since 1994, when the pair set up a high-tech outsourcing company. So last April, as Okawa was preparing a layoff of 25% of Sega's staff amid rising losses, the founder was glad to listen when Huang offered a plan to remake the company. Sitting at a restaurant in Tokyo, Huang scribbled a series of charts describing how Sega could create an online community of more than a million loyal customers, positioning the company to pull in not only one-time video-game revenues but also more profitable Net access, e-commerce, and advertising revenues. COMPAQ INSPIRATION. To keep this option open, he pleaded with Okawa to install a modem in the Dreamcast machine. All of Okawa's management team was dead set against the idea, since it would add $15 or more to the cost. But at a meeting a few weeks later, Okawa read the riot act to his troops, says one executive. Tired of the naysaying, the executive recounts, Okawa blurted out, "Anyone who isn't for having a modem can find another job!" With Huang refusing to come on board full-time, Okawa then hired a consultant to execute the online strategy. But when Huang heard their plan in September during a meeting at San Francisco Airport, he was horrified. They wanted Sega to spend $10 million to build a snazzy Web site -- where gamers could buy games and read reviews but not actually play online. This was a me-too plan, Huang believed, that would fail to give Sega's Internet service any real leg up over perfectly good gaming sites already on the Web. So he quickly called Okawa in Japan to complain. Okawa, who had been asking Huang to join the company for months, agreed to meet with him the next time he came to the U.S. That turned out to be a key meeting. While driving in Okawa's limo to a Sega office in Napa Valley, Huang noticed an ad for a "free" Compaq PC in the newspaper -- and immediately sprang the idea of giving away Dreamcast units on Sega's chairman. For starters, it would be more cost-effective than giving away PCs, he argued. After all, the Dreamcast costs $200, compared with $400 for a low-end PC. And if Sega could build out the network infrastructure to make games play at acceptable speeds, it could fairly easily create a Net community of 2 million users, each paying Sega $22 a month. "HEAD START." Given investors' love of all things Net at that time -- Wall Street was valuing AOL at $9,000 per subscriber, ISPs like EarthLink at $2,000 per subscriber, and cable companies at $5,000-plus per subscriber -- Sega could quickly lift its valuation from a decrepit $2.5 billion to more than $10 billion. Bold stuff, to be sure. But Huang, with characteristic self-assuredness, told Okawa it was just the kind of boldness Sega needed. While Okawa bought into Huang's plan, he decided he would only proceed if Huang came on to run it himself. Huang continued to resist -- until Okawa threatened to bring back the consultants. "I don't want people I don't trust to ruin my idea," says Huang, who took the job with no pay package worked out. He now has a $125,000-a-year salary, but details of his equity stake have yet to be worked out. Okawa has promised to fund the company himself for up to $100 million. Sega Enterprises will get a 40% stake in exchange for rights to its games and marketing support.
The plan relies on some software magic to make it appear the action is all online. Sega's games will still mostly reside on each player's Dreamcast -- only the action that changes second-to-second is transmitted over the wires. There's even "smart-matchmaking" software that makes sure one player isn't getting faster response than the other. And the system won't connect a player who has a full-blown DSL connection (which Sega.com will support by yearend) with a player running only on a pokey modem. "There's none of this throwing the Christians to the lions," says Moore. STAYING ALIVE. Now, Huang must prove he can turn Sega into a feared aggressor. Analyst McGowan thinks that 500,000 or so current Dreamcast owners will sign up for the two-year deal to get the $200 rebate, not to mention a million new customers, lured by the notion of getting a console for no money down. Indeed, he gives Sega an outside shot of reaching its goal of selling 6 million Dreamcast consoles by March of 2001 -- a level that would ensure that Sega lives to fight another day. And further out, Huang wants Okawa to expand into two new markets that are dear to gamers: music and action flicks. Come September, Dreamcast owners will be able to buy an MP3 player that can play songs downloaded to the unit. But Huang has hopes of one day buying or creating Sega's own music label. And he's already making headway on the movie front. He bought a script some 15 months ago for a movie based on one of Sega's games and now is staffing up an office in the Los Angeles headquarters of Warner Bros. While Okawa has not given the green light for this film, he says via e-mail that it is "still under consideration, but I would like to do it." Given Sega's sad history in recent years, that's certainly optimistic. But with giants like Sony, Nintendo, and Microsoft intent on snuffing out Sega's comeback, desperate measures are in order. Says analyst McGowan: "The alternative to doing something radical is getting blown out of the water." With Brad Huang on the case, being radical will be the least of Sega's problems. Burrows covers hardware companies in Business Week's Silicon Valley bureau |
