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Yeah, I actually have on some Zoom calls been listening to Spotify in the background of my headphones, but it makes the video calls so much better That's so you're just like low in the background you get Spotify going. That's amazing. It's like nice of you to join me in the club for our meeting That's really smart Welcome to season seven episode three of acquired the podcast about great technology companies and the stories and playbooks behind them I'm Ben Gilbert. I'm David Rosenthal and we are your hosts Now for everyone new to the show and for everyone who's been with us for a while It's been a while since we introduced ourselves so we wanted to tell you a little bit about who we are I am the co-founder of Pioneer Square Labs in Seattle. We are a startup studio and early stage venture fund and My background is primarily in founding companies and product management and I have been a long-time venture capitalist I'm currently a independent angel investor and advisor to startups based in San Francisco So I come at things from the venture and investing side Most importantly, we are excited to be with you today as peers and practitioners in the industry Diving into stories that I think we all talk about at the water cooler when that was a thing the zoom cooler The zoom cooler exactly Well today we will explore what happens when an idealist has full control over a product with Perfect global product market fit Unbelieveable economics and has the leverage to shape the world to his idealistic will even potentially at the expense of his own business Today we talk about epic games makers of fortnight and the unreal game engine You probably know of them since fortnight is an absolute international phenomenon The most played game in the world and for parents out there the way Gen Z hangs out with each other or Or because they are currently the most credible threat to the world's largest company apple Not to mention of course the incredible amount of attention fortnight consumes is a threat to Facebook's advertising business model netflix sites it to their investors as the number one threat and Epic is really the primary US ally of the quiet Chinese giant Tencent but their ambitions expand far beyond any of this and we can't wait to bring you the full story today And for the bootstrappers out there this may just be the most successful bootstrapping story of all time going 22 years from founding before raising a dime of investment so strap in incredible Yeah, wait to dive into this one Well as always if you love acquired and you want to hone your craft of company building you should join the community of acquired limited partners You'll get access to the LP show where we dive deeper into the fundamentals of company building and investing in In addition to our monthly LP calls where we talk with all of you directly and of course our book club and the zoom calls that we have with the authors Our most recent episode on the LP show was on the fundamentals of venture capital discussing how VC firms Make their investment decisions so tune in if that's of interest to you as a founder or Active or aspiring investor if you aren't already a limited partner You can click the link in the show notes or go to acquire.fm slash LP and all new listeners get a seven-day Free trial. We realize to While we're introducing and explaining ourselves here It's been a while since we've talked about why we call this thing the limited partner program It's because limited partners are the folks that give capital to VCs and venture firms and make everything possible And that's what you guys are for us to you are super special everyone who is an LP We thank you and if you want to become one can we to have you? Yep Our presenting sponsor for this episode is not a sponsor but another podcast that we love and want to recommend called the founders Podcast we have seen dozens of tweets that say something like my favorite podcast is acquired and founders So we knew there's a natural fit. We know the host of founders well David Senra. Hi David. Hey, Ben. Hey David Thank you for joining us. Thank you for having me I like how they group us together and then they say it's like the best curriculum for founders and executives It really is we use your show for research a lot I listen to your episode of the story of akyo marita before we did our Sony episodes this incredible primer You know, he's actually a good example of why people listen to founders into acquired because all of history's greatest entrepreneurs Investors they had deep historical knowledge about the work that came before them So like the founder of Sony who did he influence Steve Jobs talked about him over and over again if you do the research of him But I think this is one of the reasons why people love both of our shows and there's such good Compliments is on acquired we focus on company histories You tell the histories of the individual people you're the people version of acquired and where the company version of founders Listeners the other fun thing to note is David will hit a topic from a bunch of different angles So I just listened to an episode on Edwin land from a biography that David did David it was the third fourth time you've done Polaroid I've read five biographies of Edwin land and I think I've made eight episodes of them because in my opinion the greatest Much puner to ever do it my favorite entrepreneur personally is Steve Jobs and if you go back and listen to like a 20 year old Steve Jobs He's talking about Edwin lands my hero So the reason I did that is because I want to find out like I have my heroes who were their heroes and the beauty of this is The people may die, but the ideas never do and so Edwin land had passed away way before The apex of Apple, but Steve was still able to use those ideas and now he's gone and we can use those ideas And so I think what acquires doing what a founder trying to do as well is find the best ideas in history and push them down their generations Make sure they're not lost history. I love that Well listeners go check out the founders podcast after this episode you can search for it in any podcast player Lots of companies that David covers that we have yet to dive into here on acquired so for more indulgence on companies and founders go check it out All right listeners time for our episode on epic games Woo, let's dive in before we do we owe a lot of thank yous on this one on the research to a whole bunch of people Whoever it in a lot and done a lot of great reporting and analysis of epic apple tens and everything going on here Three in particular. I wanted to call out though One is Matthew ball and Jacob Novak who wrote just an awesome six-part Primer on epic and all the dynamics around the company willing to that in the show notes definitely go read that Second is the gaming website Kotaku did this wonderful interview with Tim Sweeney the CEO and founder of epic back in 2011 when I think he was inducted Into the gaming hall of fame so many of the quotes that we're gonna use from Tim direct quotes in this episode are from that interview And then finally this is so fun. I finally get a chance to use my favorite non-tech Industry podcast out there as a source for an acquired episode you've been waiting for this forever I've been I've been does I've been wanting to do this forever wizard and the bruiser such an awesome Podcast it's like basically acquired for nerd history Then what are we? We're business nerd history. Yeah, so they're more game nerds. I suppose we're more business nerds Yeah games that like anime and stuff they did a deep dive episode on epic last year Which was super helpful jump starting our research so thanks guys as always and for everyone We've put all of our links to every source that we use in the show notes So feel free to peruse those and a special shout out to Griff in the acquired slack at acquired.fm slash slack Who recommended the Matthew ball piece that really got us started sort of down the rabbit hole of researching this in the first place So awesome to have listeners help us do some of the research always great All right, so we're gonna get to all of the high drama here around Fortnight, Tencent, Apple, the lawsuits, etc As always on acquired we start way back and I think it's particularly important here because I don't think you can understand really What's going on or epic without understanding the man who is its founder and CEO Tim Sweeney? So who is Tim he was born in the year 1970 in Potomac, Maryland He was the third of three brothers, but his older two brothers were much older So one was ten years older than him and the other one was 15 years older So while he was the youngest of three brothers he he was probably almost kind of like an only child for a lot of his life I mean by the time he was I guess would have been in elementary school both was brothers were probably in college or out of college at that point Yeah, and I think he started programming super young right like he was a 11 year old game programmer Yeah, so it's all wrapped up in this so his dad worked for the Department of Defense He worked at the mapping agency as part of the intelligence unit where they were creating military maps from satellite imagery kind of doing Like Palantir and skybox type stuff like way back in the day before those companies So early on young Tim Realizes two things about himself one is that he loves tinkering with like the guts of how things work like both mechanical and And as we will see and see computers and technical things two is he also Actually loves business and this is a pretty rare combination like he becomes a just fantastic engineer and a fantastic Business mind, but he doesn't love business for the money I mean this is a man who really does not have a lot of use for money He lives in North Carolina. He's not married. He doesn't have kids. He doesn't hang out with celebrities Yeah, he's like bought a few fancy sports cars and a nice house and stuff But you know, he mostly he's talked about this to the Wall Street Journal He mostly eats bow jangles fried chicken and drinks diet coke He wears cargo pants that he probably buys for about 20 bucks and what he does is he basically writes code and works on epic and That's what he cares about in life, which is it's just so refreshing like Seeing that and this man who's running such an important internet company versus all the other larger than life tech CEOs out there You say he loves business. He's more of a business engineer like he's not a mogul he's not leveraging every component of his business to give him the most cash He's like excited about what business Gives you the potential to do in the world and by pulling all the levers I mean it really isn't bringing an engineering mindset to the business or a tinkerers mindset Yeah, and he's now taken most of his Wealth and has been applying it to land conservation in North Carolina, which is just So different than you see from so many people these days One more point to just like paint the classic computer engineer that is Tim Swini is David You and I both watch this video from I think 2008 where they they interview Tim He's got his sports card his nice house, and he's like here's my dining room. Here's my dining room table I've never eaten at it mostly kind of go to Burger King It's like everything you would sort of expect from like an awesome video game programmer not a CEO worth I don't know four or five billion dollars Totally all right, so how did he get this way? Well, Ben as you mentioned when he's really young like five or six he starts tinkering around and disassembling like lawnmowers And then building them up into go carts and and raising them around I feel like his parents Must have by this point in time just been tired of like raising little kids for so many years there Just like all right Tim. Do I do whatever you want? And then a couple years later when he's about nine or ten years old a Video game arcade pops up pretty near his house. This is like 1980 time frame So this is kind of Nolan Bushnell like Hyde of Atari You know Just after pong but like space invaders was a thing and Tim becomes super Fascinated by this arcade and eventually his parents get him in Atari 2600 at home But it's not so much because he loves playing the games although he thinks they're interesting He's interested in how they work and in particular like how the Capitites work so he talks about the Atari 2600 that he got he's like yeah Like I like playing some of the games, but it was a pretty crappy machine compared to the cabinets Like he wanted to know how these things work then A little bit after this time after he started getting into Games in this being his first sort of exposure to computers He goes out to visit his oldest brother Steve who had moved to San Diego and was working on a startup in the Computer industry there at that time remember this is like 1981 1982 So kind of just at the start of the PC revolution and Steve had bought a bunch of brand new IBM PCs That they were using at the company and so he shows young 11 year old Tim You know how to use these things how to program it in basic and Tim's like that's it He's found his calling in life and he has this great quote He's trying to build a go-kart. You can spend months on something like that and it never quite works right But the computer would do exactly what you say I could rate in just a few hours a really impressive program It was the ultimate machine to tinker with it was love at first sight from that point on I tried to dedicate all of the time I had free to learning to do more with computers Which for anyone who's a programmer out there knows the computer always does exactly what you telling it is both a gift and a curse Because if it's doing the wrong thing like I mean it's just running the instructions you put in there So Tim goes back home from visiting Steve in San Diego and Steve must have been like Seeing the gleam in his kid brother's eye so he buys the family back in Maryland an apple too and This becomes like Tim's obsession. He starts making games and other programs for it And he estimates that over the next couple years You know he would spend the canonical like Malcolm Gladwell 10,000 hours teaching himself How to program and this is what's so cool because remember his dad works for for DOD He has access to like early early prodo internet networking type stuff So he goes on BBS systems from the apple 2 and he starts asking questions and learning from folks there Everything he needs to know about programming so he's completely self-taught and he makes a few games during these time this time But he never he never really shares them with anybody So then a little bit later in high school is when he discovers his second passion for for business as Tim tells the story It's when he gets a summer job at a hardware store The wage that he's earning at the hardware store must have been minimum wage at the time four dollars an hour And he's working there and he's just he kind of realizes he's like wait a minute no matter how hard I work here or how well I do I'm only gonna earn four dollars an hour for the summer like this is the very like program or engineering mind like working at this Here he's like there's got to be a more optimal way I could use my time not because I really need the money But just like I could do better So what he decides instead is he sees that There a bunch of lawnmowing businesses operating in the neighborhood You know it's summertime cutting the grass in Maryland And he goes around he asks them and he's like hey has these families how much are you paying your lawnmowing services and they're like oh yeah We usually pay like a hundred and hundred and twenty bucks for mowing the lawn and Tim's like bingo So he quits his job at the hardware store and he undercuts the market by 2x He charges all the families in the neighborhood 60 bucks to mow their lawns He runs the math and figures. He's using his dad's tractor that he's pulling in about 25 bucks an hour That feels like an insanely expensive lawn cutting for the time in These must have been pretty big lawns. Yeah, no kidding. I do that are very high-willing us to pay Yeah, fast growing lawns. Yeah indeed. Yes, this is great quote He says that's when I came to a really clear Realization that by trying harder and striving to find cool business opportunities You can do far far better than wage earners who I was when I was working at the hardware store At that point it became really clear to me that there were big opportunities in the world Super cool. So as we said he ends up going to the University of Maryland Nearby close to home. He's not a particularly great student He's spending all of his time you know on his apple 2 and bbs systems And he decides to study mechanical engineering because you know they have a computer science department there But like he he thought that would be a waste of time like he already knows how to program He's gonna learn like more interesting stuff and he actually ends up learning a lot of math He says I'm gonna say the math and the physics here. I seem like they'll come in handy Yeah on the side though He'd kept his lawnmowing business going and then when he goes to university he says you know I might want to try and do something even more lucrative You know I'm an engineering major here I really have this skill with computers that not a lot of people have at the time What if I start doing computer consulting instead? So he starts a company? He calls it Potomac computer systems And he goes around to you know Families and businesses and helps them set up databases and the like and that's kind of going okay But there's part of that or or maybe unrelated he eventually gets a 286 IBM computer and we've talked about this on a bunch of episodes But like that 286 was like that was the canonical Intel Chip that was would really unlock the PC market and take it Majorly mainstream Yeah, I mean this is the thing we talked about on the Intel episode that was their business when their business of memory got destroyed Indeed so Tim Realizes this that there's all of a sudden a pretty big Install base out there and so even though he kind of likes programming on the Apple to Better he sees all these other 286 IBM and IBM compatible PCs popping up and he says Hey, there might actually be an even better business rather than selling my time for dollars that I could build around selling Software for this nascent PC market so he decides to do it and he's like okay What software am I gonna write to start writing software? I need to use a text editor on the IBM PC to actually write the software and this is like pre you know for those listeners out there who are engineers are familiar with engineering pre like Vim and Emax days There's no good text editors. So he's like oh great. I'm gonna write a text editor first for other software developers Sensing a theme here. So he sits down He starts trying to do it, but he gets distracted and he keeps thinking about how he could instead of writing this text editor He could make it into a game. He has this quote. He says I realized hey, you know I could make each character on the screen have a collision and I could have the cursor be a game character And I could turn this text editor into a little game similar to Atari Adventure I based it on rooms each screen full of text became a room I had different graphical characters represent different gameplay behaviors Suddenly you could build a text document and hit the play button in this editor And now you're up and running with your game. So he calls this game ZZT Oh, I didn't realize ZZT was the thing that was first a text editor. I knew that was his first game But wow it was it was his first game But this is what's so cool and it really just kind of foreshadows everything to come with epic because he started working on it as a Text editor and like he was just describing in that quote, you know You can kind of design a room in the text editor and hit play and then you can kind of play the game He ships ZZT as a game with well, he actually did it as shareware So the first room was free and then you wrote to him and you paid to get the floppy disk with the other three rooms That would of course he would mail you or even mail you yep Which is pretty awesome in and of itself But because it was an editor itself anybody who had the game could then make their own rooms and could also press play on their own rooms Yeah, so waving my hands around of things to pay attention to in the future here is get started playing this game for free and pay later and then Thing 2 being hey this game is editable Yep, this is when he decides hey, I probably need a different name for this business besides a Potomac computer systems And something that makes us sound like a really big company like a big important, you know Yeah, like we're we're on the same level as you know id software is just getting started around this time And they have a really cool name. Why don't we call it epic mega games and of course by we I mean Tim just just Tim He releases ZZT and it does pretty well like he doesn't make a ton of money But he sells a few thousand copies incredibly they would keep selling the game until 2013 and What yeah, this is incredible. We thought I found it in the research. So Tim's dad Paul ended up taking over distribution of the game It was still just sold through this shareware model of like right to Tim and well and shareware was really big in like I mean, I remember it from the early 90s I guess the mid 90s where you'd go to like a software swaps or you'd go to like user groups or like we Were part of mac users of Delaware and so we'd go to the mud meetings people with demo and you'd swap software there Or you'd sell software there because there's no internet to go find software So you needed to like discover it in some way from other nerds who were writing shareware Yeah, totally and you know the reason shareware was attractive especially to an indie software dev like Tim at the time was your other alternative was to try and go the retail Packaged software model also to do that you had to go get a big publisher like Electronic arts was just kind of getting started at this time and we did our episode with Trip on the beginnings of that industry You know he was thinking about it like Hollywood like you needed these big budgets and like fund these studios and then you had the Relationships with the retailers to get the boxes into retail stores the retailers would take 50 percent You know when all was said and done which is Apple's current argument to congress exactly exactly when all was said and done You know if Tim had gone the traditional publisher plus retail model He would have only been making you know Maybe if he was lucky 10 15 percent of the revenue that he would be seeing out of the game Where is this this shareware path he kept 100 percent pretty cool if you can get the discovery and distribution indeed indeed and Process the payments and do all the other very expensive things involved in I feel like a map over here pedaling Well, that's it was lucky for Tim. He had his dad to you know process the payments. I open the checks And package up the floppy disk and in mailing envelopes and send them out So ZZT does pretty well. They like I said they sell a couple thousand copies of this Tim starts looking around and one thing that he Has always been really good at is observing what's going on in the market now I mentioned Eid software a minute ago and folks who know their gaming history know that It was John Carmack and John Romero and would eventually ended up end up making doom Which we'll talk about in a minute and Quake right and Quake yes after doom But before doom it had released a game called Commander Kean and it was a 2d Side scrolling game. It was a pretty big graphical leap forward Versus the like literally text editor based games like ZZT and so Tim saw a commander Kean out there and he said hmm Okay, that's interesting. I should do something like that. What's a twist? I could put on it Well, what if I do it with a female protagonist and so he basically cloned Commander Kean But called it Jill the Jungle instead Now but because it was a 2d side scrolling game. It wasn't just text base It needed actual like artwork and assets in the game Tim wasn't capable of doing that just on his own So he needs to recruit people and he ends up recruiting some really great folks that he meets you know on Bolton board systems again online on this proto internet Folks like Cliff Blasinski who is a 17 year old high school student and applies to be a programmer At this big mega company epic mega games ends up becoming one of the first employees Cliff known as cliffy bee would go on to be come legendary and super important for unreal and then the Gears of War series He recruits this really great talent and then he also realizes like okay, you know I want to make this great game. I need the talent to make the games But you know, I also need some talent on the business and distribution side here because I'm trying to build a big company And who was the big company of course at the time it was id so he calls up in and he starts talking with their president at the time Mark Ryan who was handling all of id's Distribution and publishing I don't know he's the president of it. Yeah, he was the only way the president Yeah, he was the early president of id wow So at first they're talking about like well, maybe id could Publish Jill of the jungle, but then mark ends up Falling out with Carmack and Romero Leaving it and Tim says hey, I've got an even better idea. Why don't you come join us here at epic and you can be our head of distribution And publishing and so he recruits mark who yeah had been president of id to come join this company remember Tim is crazy career move for him like he's president of one of the biggest game companies in the world at that point and to go and take anything Less than that title as wild totally wild he became vice president at epic what he was as in play what three or two or something Yeah, indeed so he comes and joins Tim Remember Tim is like a junior in college at this point in time and he's got Cliffy B working with him He's a senior in high school But they put out this game and it does really well and then Cliffy B starts working on a few other games that also do really well Next thing you know, they're selling quite a good bit of software through this shareware model and doing quite well And so Tim ends up dropping out of college in his final year and they go full-time on the business so they're selling these games. They're all still two D side scrollers But there's another pretty big revolution that's about to come in the nascent gaming industry here and And it's gonna come in so we're now in like the early 90s like 91 92 so pretty quickly after that Id and John Carmack Start talking about this big project that they're working on and it's a game that's gonna be called doom and I have to assume you know almost no matter what age you are if you're listening to this show You've heard of doom played some version of it over the years, but it's easy to forget and I had kind of forgotten until doing this Research just how revolutionary This game was at the time and it got the first 3d game it was the first 3d game like before doom You know everything looked like a super Nintendo style game and doom was the first game and it ran This is crazy it ran on just these commodity 286 386 Intel PCs And it ran on DOS but the Carmack was able to get a fully 3d world Rendered and working just amazing feats of computer science because this well predates graphics cards or anything that sort of Optimized to do this. It's just like an unbelievable amount of trigonometry and math and and John Carmack used all sorts of Crazy programming tricks to make this work and so it comes out and like This becomes like the fortnight of its day Because it was also distributed via shareware so when you say the fortnight of the day though like let's paint this clear for this tiny Constrained market that was video games it owned that market, but we're nothing like the Hundred plus billion dollar video game market of today. No, I mean for reference, you know fortnight has a 350 million registered players at this time Do men's up be having a few million copies that it Both sells and and distributes via shareware in those in those first couple years ultimately I think it would get to 10 or 20 million copies, but no video game had ever Approached anything like those numbers before so Tim an epic and Mark are like, okay cool Well, this is where the industry is going. We got to skate where the puck's going here We need to work on a similar project and so they do they start getting to work on the project They're gonna call their 3d shooter Unreal, but the problem was that they quickly find out is just like we were saying the things that John Carmack did to make doom run were just like Huge feats of engineering and it was this massive proprietary advantage that it had so anybody like Tim an epic that was trying to Get a competing product out there. It was just gonna be Impossible, but this doesn't deter Tim he starts thinking about an idea. He's like, huh, okay well, I know that It's been all this time and effort working to make doom work They work on other projects and Ben you mentioned Quake that would be the successor to doom that they would that they would come out with they're rewriting the wheel each time they come out with a new game like John did all this work to make doom work, but they have to recreate a whole lot of that each time they're making another game so they have this Lead but it's not like they're gonna keep just like churning out Game after game after game and nobody else is gonna catch up. I can take my time build a engine I'm similar to you know what doom has, but if I make it a little more extensible Then I can use this engine and pump out a bunch of content internally like and not have to go through all these hoops each time That it is having to go through so he's like, okay, cool We're gonna invest the time up front to do this Parallel here is in sort of Jeff Bezos speak the it's Tim is working on a system that uses primitives building blocks rather than sort of starting from zero each time and because you sort of Build from primitives and assemble building blocks that are sort of modular and you can build on top of each time You sort of get compounding value out of each piece of work that you put in. Yeah So he starts working on it and he's not shy about what he's doing He's trying to build hype for the game for unreal He's talking to game magazines and the like a pretty incredible thing happens other Developers start coming and studios start coming to Tim and Mark and saying hey, I hear you're working on this engine We would also love to make 3D type games and compete with it in doom Would you be willing to license it to us and Tim says Yes Whoa, and this is before they released unreal like that he was hyping this so much that they had demand for the unreal engine before Unreal came out. Yes, in fact, I believe some of the first games that were made by third parties on the unreal engine came out Within like you know a few months or a year of unreal itself. Oh wow Crazy. Yeah, totally crazy. So turns out this was a really big idea because these dynamics were If not only not going to get easier in the industry the dynamics of the bar the technical bar to build video games That bar was just going to keep going up and up and up and up exponentially in tandem with Moore's law And so without a tooling system like this you would quickly Become completely locked out no matter how good you were of being able to actually build a game One of the takeaways there is like the timing to create a game engine is so perfect because before that you couldn't Really create a game engine and after that you would be so woefully behind that you better be creating a game engine for like a whole new paradigm because it would be Foolish to start building a PC based game engine five ten years after Tim did yep and It turned out you know almost like in a much bigger way than what Tim saw when he tried to do Start working on Jill of the jungle Somebody who's a really really great technical Engineer game developer programmer who could build an engine or parts of an engine like this Isn't necessarily always going to be the right person that can have a great creative story idea game design You know content and so if something like this didn't start to exist The creative people would just be totally locked out of the industry or would be relegated to Working only within super big companies that had a engineering side of the house and a creative side of the house It makes sense now Listen as I want to pause for a moment and say we keep saying Tim and You know today epic is like a 2000 person company and it's almost appropriate to say Tim when the company makes decisions today It was especially true at this point because it was still less than like 15 people You know the very small operation going on here and Tim was absolutely making these strategic decisions about what the company would be and what it would do Yeah, and not only was it a small operation? It was a remote operation so they didn't even all like live in Maryland together They were communicating via you know early you know early internet technologies here so finally after Just about five years of working on this in 1998 unreal comes out and Along with the on the official unveiling of the unreal unreal engine for game developers and Unreal itself is a big hit But also games that are built on it so games like Deus Ex which people might remember use it and then a few short years after all this comes out There's a major Change in the gaming industry which is after many years of talking about it Microsoft finally Enteres the picture with the launch of the Xbox in 2001 This does a whole bunch of stuff You know one it inserts a huge you know amount of weight and marketing muscle behind gaming to It massively expands the console market because of that marketing way behind it Which was previously just the original PlayStation and an N64 you know You had previous versions of Nintendo before that and the Atari 2600 But you didn't have like I mean it was really just the PS1 was the PS1 and the N64 really the only and the Dreamcast Where the only how this goes before Microsoft entered that that console market indeed and and really though It was it was two separate parts of the market because Sony and Nintendo were the only viable players Sony was where all the third party developers when Nintendo had terrible owner-ish royalty terms with With third party developers because they really sold their systems based on their first party titles Stuff that they were making in house like Mario and Zelda Nintendo's attitude has always been we're both the best at the technology and the best at the creative gameplay and so The systems are for our games and sure if you want to let us have mostly economics then you two can develop for our system But they're mostly a vertically integrated company when Microsoft came out though now all of a sudden they're duking it out with Sony for Developers so as a developer on the one hand that's good because now you've got two companies competing for your favorite and willing to If you're good and making you know have the promise of making good content willing to give you good deals But really if you want to access the whole market you want to have your title on Both systems on the PlayStation and on the Xbox well Unless you're using an engine like unreal That's almost impossible to do you're gonna have to build from the ground up dual development teams full dual development teams Well it turns out that this is a problem that unreal can now Really help with and solve because they can have you know under the hood It's not quite as easy as just like check a box to deploy to Right right once run anywhere has been promised many times and has been successful zero of them So I mean these days it's pretty close, but it's so much better to react native developer It's so much better even then than having to have two full separate development teams So once this happens they start getting some really huge games and franchises Start moving over to building on unreal So like the Tom Clancy games you just splinter cell rainbow six those games BioShock mass effect borderlands these are all in the kind of early two thousands early to mid two thousands They're coming over building on Unreal and then being able to sell pretty quickly they might do an exclusive voice-owning or Nintendo for six months or whatever that That platform gets it first, but then they're able to access the rest of the market and go to the other half Right, and so by this point epic is a technology company like they make games and they they make this game engine Which is a huge component of the games value chain But there are technology company rather than a first and foremost game company and so when you ask sort of Tim to describe the history He describes we have epic 1.0 which was Potomac computer systems We have epic 2.0 where we sort of realized that oh, yeah This this technology company builds a game engine. It's the the PC gaming sort of revolution of the late 90s to about 2005 and then David exactly you're talking about now This is what he calls epic 3.0 where the massive proliferation of the sort of console wars allowed us a Neutral third party that can dramatically bring your cost down and your efficiency up and developing a game like Full steam ahead on consoles. We will be an essential part of building that business Yep, and and they do keep building some games in house as well But they're thinking about it kind of like Amazon and AWS like they're the first invest customer for the technology that they're building as part of the engine You know, they do unreal tournament. They do unreal championship. They do other games But they're really I love how East Coast that just was. Did you say unreal tournament? That is like that is like how an East Coasters says tournament. Oh my gosh You know, I never even like notice that growing up. I would say orange Jenny has taught me to say orange What's the Nintendo character Mario all right there. You got some New York friends that say Mario. Ah yeah, yeah Anyway, we digress we digress appropriate digressions though So by the mid 2000s like we're saying For a bunch of reasons the big part of the gaming market is really in consoles and specifically it's in Sony and Microsoft with the PlayStation and the Xbox and the PC gaming industry still exists But it's gotten really tough because piracy has become rampant not to mention you know Microsoft is now putting all of their weight in gaming behind the Xbox not so much on PC gaming so Tim once again kind of sees that this is where things are going and decides hey, you know What if we tie up with Microsoft We're gonna be launching a new version of the unreal engine unreal engine 3.0 Microsoft is coming out with their next generation hardware the Xbox 360 at the time. Yep and And We might be able to get some really good marketing dollars here from them if If we're a launcher or near launch exclusive title with the 360 and Microsoft's effectively in this relationship the publisher and Epic is the developer yes I believe that I believe that is correct and so epic develops this game called Gears of War which most Most listeners will probably be familiar with Becomes it's the it's the game where you could push that one button and put your back against a wall and look around a corner. Yep So it's so funny. I was only games had this like signature move and they like that was amazing That was in every commercial that was in every demo and you first played the game like that is the thing that you wanted to try and do and this thing sold So many Xbox 360's Yeah, and so as a result all of this that the thing is this this kind of becomes A red herring for the company so they end up making epic ends up making a hundred million dollars of Revenue on Gears of War it cost them twelve million dollars and I believe that's twelve million across development and Marketing because Microsoft is handling so much of the marketing budget and so wow I'll make that bet all day totally so they're literally making eighty eight percent margin on On a hundred million dollars in revenue, you know, they had been successful in lots of dimensions up to this point Both on the technology and the game side, but this is a whole not the level Why ever be your own publisher? I mean it's it's great if you're the developer you only someone else is gonna spend the money You just have to develop the game. It's great like why ever change? I mean, I remember I was just coming into Cratchin College and getting into media investment banking at the time and people were thinking like oh man Games are gonna be like Hollywood like this is Hollywood movie style money The dynamics are really similar here. This is gonna be great It turns out though that Hollywood is actually not that good of a business and an industry and and why is that it's super capital intensive? So Gears of War one was kind of a red herring for a bunch of reasons you know is a launch title with 360 Microsoft handled so much the promotion and marketing when The epic ends up doing gears of war two and then gears of war three their economics like the games sell Roughly the same amount maybe not quite as much in terms of revenue, but their margins end up shrinking significantly down to like 30 40% and they're having to tie up all this huge amount of capital in the investments in developing these games and then marketing them and So Tim and epic kind of realize like huh? This is not as interesting as we thought it was time to get out and also It was started to show the tension between this sort of developer publisher model And for folks who haven't listened to the EA episode or where else we talked about this on the Activision Blizzard episode You know the developer is the creative It's almost like think about it. That's the director on down on a movie set where you're you're the one sort of having the brilliant Ideas and executing on them and the publisher is the investor they're sort of fronting the money they're doing the marketing They know how to businessify your creative efforts and so the issue is when push comes to shove like it did with what was it Gears of War Or I think after maybe Gears of War three epic wanted to do a multiplayer only version They said look we think multiplayer gaming is the future intent, you know, or a nudge nudge to where they are today and online You know right around the corner started to become a thing and so And Microsoft was like no, we don't care. We want to have more 360s Exactly and so it was basically a stalemate at that point and Microsoft was the publisher Mike Microsoft was the money behind it and so you know they they won So we're now right around like 2009 2010 time frame and Tim as a quote he says There was an increasing realization that the old model wasn't working anymore and the new model was looking increasingly like the way to go So what is the new model? So two things happen right around this time that totally lay the groundwork for what epic is today The first is in October 2009 a little company in LA will start up in LA launches a Game if you could call it that it's really a mod on a mod of an existing game This is a mod of Half-Life 2 No, no, no, I'm talking about League Oh, yeah, yeah So the mod of Warcraft 3 is The mobile online battle arena game of Dota or was it defense of the ancients? Yeah, and of course There's a lot of controversy over if this is idea theft or if this is above bar But you have this very similar looking game that I think you're referring to David being started by a plucky startup in LA in 2009 Yep, and that company is Riot Games and that game is League of Legends and so what is League, I mean, it's it's a MOBA massively online battle arena, but it really represents a completely orthogonal path and kind of a throwback away from this Hollywoodification of the games industry and back to small lean development teams Taking a concept and iterating on it without having to invest, you know tons and tons of development resources and in particular tons of marketing resources It's distributed 100% online. It's a mod of an existing Game engine that's out there rip off I didn't say that but it means that it can get to market so much faster And then the other big innovation that they have is they don't charge for it It's it's free free to play now free to play that term had gotten a really bad name in the industry because mobile games had taken that up and Free to play really meant yeah, you could play it for free But if you wanted to make any progress in the game or win you'd have to and this was just starting I mean that it got a really bad name in sort of that 2012 to 2014 era in this era because thinking about the iPhone was 2007 the App Store was 2008 so it wasn't quite this sort of dirty backwater Social had given it a bad name before mobile game in a bad name. So the free to play stuff on Facebook was you know Bazinga type stuff and I and you know Zingo is Well Probably in many ways not the worst offender in this regard, but um, you know all of the games that you had to pay to make any progress in What league was and what right it's big innovation was that you could buy things but they were just aesthetic They were just virtual goods um, they didn't actually Help you succeed in the game in any way shape or form they just gave you personality Yeah, so it was it was still free to win But you could pay for other things Yeah, and this ends up coming to be known as games as a service which we'll get into in a second The other big thing that happens that epic was directly a part of was in September 2010 Epic demoed on stage at an apple keynote A demo of the unreal engine 3 running on iOS Oh, that's right I forgot about that and that actually was the beginning of these like really long sort of distracting Demos at apple keynotes of games. Yeah, we're like every time they're showing off some new graphics technology But you're watching it over some stream and you're actually not sure what the new thing is and so you're like Okay, they're showing off okay this time it's metal and it's an apple and house technology and Craig's all excited about it But what okay good I glad someone else made another cool game that takes advantage of some harbor feature I don't understand I always have beef with those being in apple keynotes But I get that it was a leap forward well I was leap forward because a you could bring you know this incredible console quality Graphics and gaming technology to mobile But it was even more important for the industry in terms of enabling cross-platform deploying and development and then ultimately on my play of games So epic now is right in the middle of all of this because if you have a Game as a service likely of legends or any other you know free to win type game Importantly, that's fully distributed digitally so you don't there's no more box software It is being distributed over the internet. Yep You want to get that in the hands of as many players on as many platforms as possible You game developers always wanted to do this they wanted to be on Microsoft and on 70 But at the end of the day, they're selling box software and like That's fine. But when you're no longer selling box software You're monetizing based on engagement of players Maximizing your total pool of players is really important And what are the by far at this point and then going forward the vast number of computing devices capable of playing games out there Their mobile devices Yeah, so it's it's the number of devices got multiplied by I don't know 10 for the Sort of accessible market of games or maybe more But importantly, and I think the other thing that is really relevant to this argument that you're making about Having a more direct relationship with those customers and wanting to reach as many customers as possible is They're now all on internet connected devices So rather than your only chance to monetize being every time you ship a new disk to a store and they buy it You have an opportunity at any given moment to monetize as long as there's payment systems in place The thing that digital distribution basically enabled was the idea that Going back to the very beginning of what made epic epic that they could give something away for free But then since you had an always on relationship with that customer you could figure out your monetization down the line What this does to the industry Is it kind of makes it like this ass industry? You know you'd gone from expensive to develop Capitalized software that required years of Development time and was big and monolithic, you know Oracle or your a lot of Microsoft software or you're you know that type of thing to all of a sudden You know developers just like software developers are empowered to do small little things that solve a Point you know niche problem Deploy it on best-in-class infrastructure like AWS out there use something like stripe to accept payments Don't we wish yeah, don't we wish get it out there and be used and build real businesses with great economics So the same thing starts to happen in the gaming industry and Of course, who was the pioneer in doing all of this and in the middle of all of it Not just on their own, but then with riot it's 10 cent. Yep Yeah, I mean this is really interesting because riot is pioneering this in the United States Tencent had already sort of done it with the The ability to do micro transactions on on their early games in China something that they were definitely ahead on and as soon as riots started to succeed in it very early I think it was pre- 2011 maybe maybe 2010 And Tencent invested in riot once ten cents saw riot succeeding with this model in the west They first invested in riot. I think in 2010 and then they bought the company in 2011 so Tim sees all this going on and and He wants to move epic in the direction of becoming essentially the you know a WS plus stripe enabling this future in a renaissance and independent creators and game developers And the current state of their business sort of they had sold gears of war the full franchise all the IP everything to Microsoft Not quite yet. Okay first he starts talking to Tencent and agrees in 2012 for the first time ever to sell any equity in epic games He sells a 40% stake in epic to Tencent for $330 million So valuing epic at just under a billion dollars Which was kind of crazy at the time people were like this is nuts. This is a you know video game technology developer that you know is having bad economics with their big franchise gears of war like what's going on here And I think the thing that people didn't realize at the time was even ignoring the games as a service bet How stable the platform business was like one of the things that I want to mention later in playbook But we need to talk about now is Gaming is classically a hit-striven business and what you have what the unreal engine is a smoother on that and since more and more I mean that business has just grown steadily since its inception and you now have this massive steady Business underneath your more spiky hit-striven games business. Yep So so with this investment from Tencent Tim maintains majority control of the company and he says all right We're going to refocus the entire Company around this vision of the future. We're going to do three things one The unreal engine is now our most important product in piece of technology and we need to add Much more to it. It's not going to be just about the engine for Creating the game. It needs to be all the infrastructure to run these games and run Live-ops and do payments and do all of these things Funny aside at the time. I was actually when I was at Moderna. We were adventure investors in a company called PlayFab In Sierra. Yeah, which was an independent startup that had the same vision of We're going to build the infrastructure layer for operating these games as a service and be like Unreal or be like unity their competitor, which we haven't mentioned yet It just turned out that playfab ended up getting acquired by Microsoft. It turned out that Epic and unity were going to do these things themselves as well and it was going to all be part of the platform Yeah, and there definitely was industry speculation at that point that those things would be Not really part of game engines that they were sort of a separate factorable thing We'll talk about this but epic has epic online services today There's a lot that sort of lives in that middle ground of like is it part of the engine or is it really more part of an online service But epic obviously had not only the relationships with developers But the ability to bundle things that might not have used to be considered Part of an engine but sort of add more and more and more to that sort of ball of yarn where it was no longer just physics But it was physics and characters and AI and the way that they'd interact and all sorts of Things to help with the live-ops of your game Yeah, so that was one two as Tim says we're gonna rationalize the console business I don't want to be in that anymore We're gonna sell the gears of war franchise to Microsoft So they do that in early 2014 the 10-set investment was in like late 2012 and then three To make all this work We need to have a thousand flowers blooming out there of people developing on the Creators and developers and and game makers developing on the unreal platform Well, we can't anymore be charging people as fast-fi To use our platform because that's gonna lock out you know The kids in high school who are building stuff at game jams and right incentives are powerful if you charge money for something less people will do it Yep, so in March 2015 and this was this was like super ahead of the curve Epic stops charging a licensing fee for the unreal engine makes it completely Free to use and develop on and remember you know unities out there as well, which is a competing third-party game engine Mostly focused on mobile mostly focused on mobile, but you could use it for lots of things for sure, but simpler newer Amazing for 2d stuff lighter more accessible, but you're not gonna go build the most amazing 3d first-person shooter PC game with it on unity. No, they're still charging a sass fee Unreal now is completely free. You're getting like the literally the stuff that gears of wars developed on for free And instead the business model is switched to a 5% royalty on Revenue that you would earn on your games after publishing That's like a pretty good deal I mean if you think about the amount of fixed cost you'd have to capitalize to do this it would just be Huge even your ongoing operating cost to run Technology it would be more than 5% of your revenue Totally you'd have to be massive fruit to make more sense for you to build your own game engine now then use Use unreal, which is exactly the strategy and when you look at who develops their own proprietary game engines It's only the Activision Blizzard of the world the you know riot games But very large publishers That you know of so like think bluehole for player and non-s battleground which of course we will definitely talk about later Like lots of big cross-platform 3d games from big studios that just aren't quite as big as like Activision Blizzard or riot Use unreal instead of developing their own proprietary thing. Yep So those are the three big moves that Epic makes after the 10 cent investment and they are all just like so spot on and Like really enable them to become you know the AWS plus stripe plus plus plus plus In the industry stripe doesn't feel right yet like stripe to me would be like the epic game store Yes, well, this is the only groundwork for all that yeah Yeah, like so okay to put it in Tim's parlance epic 3.0 was consoles epic 4.0 is free to play games as a service Digital distribution, but exactly what you're talking about David is this like incredibly robust primitives that serve as the horizontal layer To make games and so they've stepped back from Where a game maker except Okay, so just like Amazon though, you know, they still have this view of like well, we can be the internal kind of first and best customer To show what's possible with these tools, you know, and we have this rich history of making great games that people love So they decide that they're gonna spin up three teams internally to start working on epic's new tools To build new games from epic that are gonna run on this games as a service free to win model So the first that they start working on is a reboot of unreal tournament The second is a MOBA that's gonna include gears of war style kind of action elements That was called Paragon and the third was gonna be a whole brand new IP That was gonna combine elements of Minecraft and crafting with a tower defense type dynamic those games were popular At that moment in time and they had a really cool name for it. They were gonna call it Fortnite Well We just got 330 million dollars and boy are we gonna spend it is the way that I hear that. Yeah Well, so spoiler alert Just like a lot of times when a company gets 330 million dollars and has like the core You know economic engines of the company, but then they have other projects that they want to work on Those other projects don't go so well. So none of those three games work Yeah, and if you yeah, it's interesting. He's a none of the three. I'm excited to talk about that. Yes The other sort of thing to think about here is Yeah, this is a Company with a bootstrapped culture. They'd always been starved for resources. They'd always been few people They'd always been cleverly figuring out what's the right partner or what's the right way that you know We can only make a game when we're sure that it's gonna be worth it for us And now they they've got so many resources. I mean this is exactly what we talked about on the event parade episode with Julia and Kevin like Raise a bunch of money and there's lots of things that seem like good ways to deploy that capital Because you can sort of conceptualize why it all makes sense But then you become this like large organization. There's I don't want to call it infighting But conflicting views about what the future should be there's people who are sort of vying for political power that's saying You know know my games the most important game and it Results in churn and it results in this happened basically all through epic history But they bought companies some worked some didn't they bring in these studios sometimes they'd they'd end up writing them off It just increases all of that sort of fervor and churn around trying to do a bunch of stuff Yeah, and remember what was epic and Tim really really good at He was good at looking at what was succeeding in the market at that given moment in time Remixing a little bit to make it fresh and then putting it back out there quickly You know, that's what he did was easy tea That's what he did with deal in the jungle That's what unreal was after doom And that's now what they're doing with these three projects here. It's unclear that the market really wants them so they Operate for years in development of each of these games. So started in 2011 2012. Yep, and going all the way through 2017 and And then basically a miracle happens So you mentioned player unknowns battlegrounds Tell us a little bit about player unknown battlegrounds Yeah, so rewind to 1999 There is a book released in Japan called battle royale or at least that's the english translation of it in 2000 This is made into a very popular Japanese movie. It is a sort of basically inspired the hunger games think about a battle on an island a bunch of children I think it's a fight to the death. It's a little dark But basically you want to be a dark last person standing and There's a variety of different games and different sort of anime series that through the early 2000s Or sort of based on this battle royale concept. There's early games. There's daybreak. There's in the end of the 2010s or mid 2010s There's this game h1 z1 that's starting to incorporate this battle royale concept into a game in is it 2017 that battlegrounds comes out Yep, we're up 2017 and we will henceforth refer to it as pub g player unknowns battlegrounds comes out and it is a smash hit it is like This notion of there's a fixed amount of time and there's this circle that is contracting and it's gonna bring everybody closer and closer and closer together and you have to be the last person standing and the actions fast paced and it's sort of Pretty short amount of time that each game lasts. It's not these 50 minute moba style games. It is like Get in enjoy the action get out even if you win. It's not that long of a game It is really fun and boy does it skyrocket off the charts especially because David exactly as you're saying digital distribution It is free to win. It is leveraging these sort of in-app purchased like Adornments that you can buy for your character skins But it's pretty like realistic like the violence is actual violence like it is so it is a war game It's dark. It's realistic Also though when it first comes out. It's in beta. It's built on unreal You know, it's not a big team. It's not Activision that's making this it's you know an indie Deadly raise your hand if you heard of bluehole before this Podcasts. Yeah, it's like unless you're in the industry you haven't heard of player unknowns parent company No, and also in these early days it's only on PC I think I think you're right. It was not yet cross-platform and again, you know with with especially with the game like this You want the more as many people as possible playing it you want your friends playing and not all your friends are gonna have gaming pieces In just like a literally epic move the company and Tim See this happening realize that these internal game projects are not Getting any traction. Yeah, the unreal tournament team I think they sort of knew at this point that that wasn't gonna ship by the way like the the title fortnight Inside of epic started in 2011. So it's been six years of development And you have this this other team here this unreal tournament team that I think had already given up at this point That it was like clear that it was not gonna ship Paragon is taking a crap ton of resources to make that a reality That's the internal status of the company when pub G hits pub G hits so Within two months the unreal tournament team Hopped over into the fortnight assets and remember they're all developing on the unreal engine So they all know how to work with the assets in the code here and they build and launch a new mode of fortnight Called fortnight battle royale that is a fortnight graphic cartoony take on this battle royale Concept that pub G has just taken massive. They ship it in September 2017 And within two weeks they get 10 million active players This is bonkers like 10 million players is probably what doom got in the whole life of the game Within six months they have 125 million active players Incredibly, you know, there's some dynamics here like you mentioned Ben that like there's less violence It appeals to kids more especially it appeals to parents more who are willing to let their kids play us When you die the drone comes and scans your body and works you away like it's I don't think that's right terminology But like you're you're not bleeding out in the street the way you are in pub G. Yeah, but unlike pub G Which is only on PCs at this point Because of all of epic resources they immediately deploy it cross-platform PCs consoles mobile devices all within the first few months of launching Sony actually would be a big Hold out Sony would let epic release it on the PlayStation But wouldn't allow PlayStation players to cross platform play with The other platforms because they wanted to keep everything in house in the PlayStation network Epic eventually convinces Sony that like hey, you can't keep this cat in the bag here I think they quite they may have even gotten to 125 million users before launching mobile like it was a I don't know Maybe that's wrong, but I remember it was this smash hit phenomenon And it wasn't on mobile yet like that was the craziest thing is and the games industry was it absolutely turned on its head at this point because everyone was just told Esports is gonna be this massive money maker which it ended up not being like it was Building in sports company at the time. Yes. I was very deep in the in this at this time with taunt Esports was a really good idea for the publishers and really not that interesting for everyone else streaming was interesting for lots of players in the value chain but The interesting thing about of being in that industry in that moment was pub G Went from nowhere to being dominant and we all thought wow Here is this new arrival of this thing is gonna be a fixture along with you know Activision blizzards games and riots games and then like a few months later Boom fortnight blows it out of the water and just still share like crazy And then goes to even bigger newer heights and it was the craziest things You're like god like the fervor in this industry right now of what you know is gonna be the staying power franchise is crazy And I want to reflect back on the launch a little bit because fortnight did launch its original game built by the original team fortnight Save the world that basically didn't work It came out pub G came out pub G1 like this thing was not about all right One it wasn't a fight because fortnight wasn't playing the same thing. What is talking about it was like this Yeah, and the craziest thing was internally at epic when you said they started working on the fortnight assets like What that actually looked like was copying the code base that a whole other team It was basically laying fallow the unreal tournament team takes that forked code base rebuilds the whole thing using the gameplay mechanics of pub G And launches it you then have this fascinating internal Struggle of trying to figure out how do you combine these two teams one of which poured six years of their lives into getting it 95% of the way there but got the core gameplay mechanic wrong and the other of which spent the last few months Working on a new project having fresh eyes not being clouded by all the baggage of previous decisions and haggling made over the last six years That has this smash hit and all anybody out in the world cares about is fortnight like I don't Anything lower level than that or internal politics don't care about and so you have to figure out as a company How do you when you know you just have this thing that's magically Captivated the world How do you throw all of your resources at it and bring everyone together in kumbaya to say like we as a company are Doubling down on this thing as our thing along with our other thing the technology platform Well, that's what they're saying It's not even the business model of the company the business model of the company and Tim's you know He's really gotten religion at this point in time the mission is Build the tools be the AWS and stripe and you know live ops for all developers to make games This is I think just like such important backdrop to what's going on now because now we'll run through what's happening But Tim again like he's just viewing this like this is a windfall. This is Awesome. This means I get more firepower and more ability to play offense in getting my ultimate vision to come true here So like we said fortnight battle royale major cultural phenomenon Estimates are that they made two and a half billion dollars in revenue in 2018 alone So it launched in September 2017 2018 two and a half billion dollars in revenue October 2018 epic raises Uh, their first Non-strategic capital raise there is one and a quarter billion dollars from KKR Disney and several other investors at a 15 billion dollar valuation Quite the step up quite the step up quite the step up in December 2018 they launched fortnight creator mode Which is almost bringing like Roblox type elements into fortnight of letting people Create and and ultimately monetize their own Designs levels experiences in doing so at the same time they launch the epic game store So this is now bringing forward all of this future that Tim wants to come to bear and would ultimately set the stage for this confrontation with apple and google The epic game store they're going to sell their own games online fortnight Uh fortnight currency V box and other games and third party games in the epic game store Of course you can do this on PCs and all the the the opportunity is compete with steam I mean steam's been doing this forever and frankly the knock on valve is those guys haven't had a hit in forever They're just taking a big or a rake on all these other games that they basically have a monopoly on PC The game distribution yep, and they're taking a 30% cut and epic had such a hit with fortnight where they were like Uh We've had the advantage of never needing to be in your store and always going direct so now we have this direct channel to all these customers like we should leverage that yeah So what did they launch the store with they launched the store with a 12% cut of revenue so they undercut valve by 18% And then the kicker is if you build your game on the unreal engine the 5% revenue fee gets baked into the 12% So they're real un literally unreal epic is saying you get The engine you get the live ops you get the distribution in the store and the payment processing that comes with that For a maximum fee of 12% of your revenue It's wild. I mean it is really let's even ignore the lack of double dipping on that 5% from the uh unreal engine that 12% the the way that Tim talks about it is basically a cost plus Pricing model where he says look I think it's gonna take 5 7% to to run the store and we don't need to make more than 5% we think apple and Steam or getting away with highway robbery and so we're just basically gonna make sure that the maximum we make 5% Oh, and you know if you're really trusting in us and building on our full stack. We're not gonna charge twice like it is It is the exact opposite of what every other CEO in the technology industry these days is doing It's not like Google says hey if you use a gce for your infrastructure Whatever you spend on that we're gonna give you credits and ad words No, no we'll give you a reduce price if you buy more from us But we're certainly not gonna say yeah, yeah, we'll give you you know chorus. That's for free totally 2019 is basically the clash between Valve and steam and the Epic Game Store um and valve responds they cut their take rate to 25% And but they're going back and forth, but really this is setting the stage for What would happen now this year? One other conflict that happened previously too is with google where Epic basically said look like we're not gonna go through google play anymore because Android you have this nice open platform you brag about it being an open platform We are going to have people download the apk where they're just gonna side load and install the app directly What epic and all of the people who want to play fortnight on androids realizes there's a litany of oh my god You're about to get your phone hacked dialogues that come up between Downloading that app and getting to play it and every time there's an update And so this is actually something that epic walked back from and eventually did list on the google play store Because google as Tim calls it has a fake open ecosystem where despite getting to To prostilitize about how the app store is not the only way or the google play store is not the only way to launch on their platform In reality it is So then this year epic decides to take this fight directly to As you say now just google but the other time the other tim Tim and sunda Wonder how much the timing of this clearly Tim had been thinking about this and plotting this move for a while But this was the first year where you start to see some cracks Not just in the game developer sentiment about these app store take rates But among other software developers there's the whole hey controversy with base camp Around apple and the 30% cut that they're taking on Hey email software so apple has this Very silly rule where they say either you're using our payments infrastructure or if you choose to use your own There can be no link or reference to it in the app and hey Basically linked to their website or something like that and those violated a app store policy But it's all the same spirit here right of link How much pay us 30% or have this gross and horrible user experience where people have no idea how to sign up for your thing So while all this is going on cracks are starting to form in The developer sentiment with apple and a little bit google Now epic is here sitting on not just the biggest game in the world But kind of the biggest like cultural phenomenon and on par with tic tac, you know social Fem working experience as well It's a pretty big point of leverage with these ecosystems And so finally on august 13th 2020 Epic pushes a new version of fortnight to the ios app store and the google play store That offers a permanent discount on vbucks the in game currency in fortnight if you buy Directly from epic, which i believe you could do now in this new version of the app So you actually still can if you have the app on your phone Oh, if you still have that version of the app well, yep So apple and google immediately De-list fortnight from their app stores and then they said you need to upload a new version that doesn't include this Yeah, right and Tim said nope not gonna do that Yeah, so then then the pitch forks come out then apple says well, you know you knowingly and and obviously like this comes right on the heels of the antitrust Controversy epic really deeply prepared for this and thought thought this through And they released this unbelievable video this free fortnight video where you've got Tim cook is the evil sort of IBM light character from the original 1984 commercial epic is sort of this they're coming into swing the hammer and throw it at the evil IBM Tim cook character It is it is like it's all fortnight characters. It's so good deepest dagger you can stab at the apple executive team and really make them feel like the villains in this story And so the you know the pitch first continued to come out everyone's escalating apple says we are going to BAN your developer account and not just the major escalation here. Yeah, that this is if you don't submit an updated version of fortnight to the app store that doesn't Violate our terms and services we are going to ban your developer account and what that means if you really dig into it is We are going to make it so that you can no longer distribute new versions of the unreal engine to your developers That they can compile in their code and then submit to the iOS or Mac app stores and so they're basically saying Look all iOS and Mac app store We're just going to break the ability to use unreal engine if you're a developer on those app stores And so you know they've now they've got a two front war. There's a fortnight war and Apple has dragged the unreal engine into this and of course this goes to the courts There's an injunction filed the most recent couple of pieces of information that we know are that a judge for at least the next month has said Apple this thing that you've done of bringing The unreal engine into this like you can't put a little ticking time bomb on epic and say that you're going to break their Developer account that deeply to the point where unreal engine won't work for all of these game developers anymore Like that's one step too far the thing that you can keep haggling about is Whether fortnight needs to submit a new version that doesn't violate your policies and and has only an Transaction with apple that pays the 30% cut that's still in fairgrounds to fight about so apple You can keep fortnight out of the app store for any one who wants to download it now They didn't mandate. I don't believe that you have to keep letting the Existing version of fortnight work on people's phones, but it is I expect that apple has a very powerful kill switch at their disposal So we will see if apple decides to stop allowing the existing version of fortnight with the payment loophole that's on 100 million plus phones or tens of millions of phones. I don't know how many to break But that is sort of the state of where things are today. Yeah, and Just right before we went to record epic hitback and announced that Existing fortnight instances running on apple devices are going to lose access to The next fortnight season and cross play ability so they're no longer going to be able to play With friends that are on other platforms whether that's Android or console or PC. So Man when tech giants clash customers lose But I think we will we will get to that more More in grading david you have anything else in history and facts here. I think that is quite the epic story for history and facts Okay, so our next section In many episodes is is called acquisition category there wasn't an acquisition here and David and I have thought a little bit about what we're trying to accomplish with this category and We actually think that it's best described by a book that we're obsessed with and have had an LP call with the author of and Just really think is brilliant of the seven powers. So What are the seven powers? They're basically the ways that and I'm gonna Hamilton if you're listening I'm gonna butcher the definition here But they're the ways that a Leader in a category can earn outsize profits versus all of their competitors It's basically what what's the thing that makes your business powerful versus your competitors And I think this really gets at the core david of like what and why We want to dissect what the core essence of a business is you know There's so much going on here with the technology platforms The evolution of the games industry in real time And then this fortnight phenomenon What is the power that epic has so there's seven categories of power obviously in the seven powers that Hamilton identifies counter positioning scale economies switching costs network economies Process power branding and cornered resources Most companies that have power have one maybe two of these I actually think epic has Three powers that are concurrently going on here. I would say they have scale economies because the Scale at which you need to operate your infrastructure to power a game like fortnight or pubgie or Any of the other large games that run on unreal You need a huge amount of infrastructure And then to hammer ties that infrastructure cost such that you're able to sell it essentially at 5 to 12% of your end customers revenue nobody else can match that No, it's the same way that Netflix draws its power by having the largest subscriber base. It has the sort of lowest per subscriber cost to produce content. Yeah Or um, you know, AWS same deal Then I think there's the switching costs right like that might be the most directly powerful here Like if you're pubgie or you're any game that's built on unreal You have no choice except to continue running on unreal You're not going to spin up something on your own you could maybe try and switch over to unity But that's going to be very very difficult and not going to have the same types of features that you need We've sort of leaned on this a few times and obviously it's a private company So the financials aren't public But it's fair to assume that the unreal engine on its own does about a billion and a half dollars a year in revenue So like this thing that lots of developers are like pretty locked into because they committed and it was a good decision to like We're not saying that you know, they should have picked anything else because Basically if you're building a mobile game that's really pretty simple You should be using unity and if you're building a broader cross-platform 3d complex game Especially one that requires meaningful physics you should be using unreal And so they're generating this I don't know one two billion call it a billion and a half dollars alone from that engine business You know, that's the 5% of revenue that they're making so you know multiply that by 20 to get the amount of Revenue that their customers are generating So those are the two I think powers that apply to the core technology Unreal engine and online services and all the infrastructure part of the business But then with Fortnite They also have this network economy right and this is where cross platform become so important Fortnite on iOS without cross platform Is so kneecapped like you know imagine You're a kid or anybody who hangs out with their friends on Fortnite whether that's playing better royale or in creator mode or Attending like the concerts that are on in there. I mean Travis Scott hosted a concert that Marshmallow and Marshmallow had 14 million people Attending now interestingly that's not like there was one room with 14 million people They were it was limited I think to 50 actually for the Travis Scott concerts You want to be in the instance with your 49 friends. You don't want to be with 49 strangers Now if all of a sudden if most of your friends are not going to be playing on an iOS device They're going to be on a console. They're going to be on a switch. They're going to be on an Android device Now you can't play with them that like hugely removes the value David I think there's a good time to bring in the other pillars of epic's business So of course we've talked about fortnight that on its own is somewhere between a billion and two billion dollars a year and revenue right now You got the game engine that's another billion to two billion dollars a year in revenue You have the app store or I guess what do they call it the epic game store epic game store I think it's losing money right now because of the amount of marketing dollars that they're pouring into it and Deals that they're doing to get games on there exclusively So there's a lot of sort of dollars that they're pouring in to make that a successful thing on its own They started with a huge head start because they converted all of the fortnight launchers into epic game stores So suddenly I can't remember how many million it was but overnight There was millions and millions of of people that suddenly had the epic game store and now had other games in there And if you want a deep dive on the epic game store You should go read the Matthew ball piece that we have linked in the show notes. It's awesome But then there's this fourth pillar of the epic online services which Is not a huge business for epic yet But is exactly the sort of thing that Tim swiney loves that you can sort of plug into any wonder of these sort of AWS like services in the epic online services whether or not you're using the engine and there should just be Tremendous amount of interrupt across the whole industry where you could use the matchmaking service You could use the friends list There's all sorts of ways that you can allow people to play cross platform or for friends to be aware of each other If one person's playing one game on an Xbox and the other person's playing a different game on their phone Using these epic online services. They could all sort of be a part of the same Metaverse There it is Took us long enough to get there, but yeah, we are now in heaven and you know, that's the power right now in the current You know, in station of epic with the epic online services having you know, just being kind of nascent in adoption and fordnight being the first and best customer of it That network economy's power only lives in the fordnight part of epic's business But what you're talking about is they want to bring all of that network economy and network effect of all these friend connections and all the cross platform Into everything that is built on the epic technology Like that's pretty powerful and I think that's probably also what's really scary to Apple and to Google right like and probably to Facebook too Yeah, so this really hits at the core of how Tim's we need philosophically thinks about What epic's mission in the world is and it is how it is diametrically opposed to Apple Facebook Google It's not only open versus closed. It's more like Tim thinks there's another internet to be built by Basically bringing down rents everywhere like take rates should dramatically go down and interoperability should dramatically go up I mean think about when the worldwide web first launch how Wide open it was but Tim's vision is a little bit more privacy protected that you can't just drop arbitrary java script in and collect information on people Hmm, but think about sort of the ready player one world But rather than it all being one company He has this vision of in hill name his competitors It's actually remarkable to listen to him talk that the roblox economy could interact with the Fortnite economy And you could buy goods and bring them between worlds and you can easily shift between those worlds with your friends And I think that the way that he thinks about the world and this metaverse that he wants everyone to live in is Commerce is gonna be online in this digital space Social connections are gonna live there and and it's not just games and it shouldn't all belong to one company And you look at the way that Apple is approaching this particular fight in this whole 30% battle It is we are entitled to 30% of everything that happens on our platform and Tim is pounding his fists and saying nothing is yours And nothing is ours yep Tim's queenie not Tim cook He's bounding to many times. Yeah, well this is as usual. There's like too many too many white men and power in our stories But absolutely totally But I think this is what's really cool and actually You know the whole concept of the metaverse and ready player one and all that it's so cool And people have wanted it to come about for so long and VR was kind of a head fake around this VCs got a lot very excited myself included it really is actually starting to happen now Just not in the way that anybody expected like everything we've talked about so far With all of epic epic technology the Experiences that they make is in the context of thinking about them as games But we've kind of already crossed the Rubicon like they're not just Games anymore. I mean fortnight has observer mode like there's a way if you don't feel like playing You can still go get on chat with your friends and watch them play without you having to be involved in the game It's a hangout place and creator mode where you can create all sorts of experiences and you know play them with your friends And that's what people also do in Roblox. That's what people do in Requiem You know, we've had a Nick fight on the show this year of Requiem I think this is what Tim is talking about here And then you think about the tools that epic makes you know, they're so powerful And can enable Experiences that just like Honestly would have been impossible to imagine two years ago We haven't talked about yet on the episode But things like the Mandalorian the awesome, you know, Disney plus tv series That series was basically made in the unreal engine Like they filmed the whole thing on a sound stage with digital walls and all of the sets were built Virtually in unreal. It's so freaking insane. I'm gonna hold my tongue for now But it is like the coolest Most insane hour there's zero fractical effects in that whole thing Am I stealing your thunder from later? But the point you're making is like you can enable High IP franchises to be filmed and created at a fraction of the cost on a fraction of the time frame You know, and it's not just this like theoretically it could happen like you know that the unreal engine branching out of gaming on fortnight branching out of gaming is actually happening It's already happened real iconic use cases. Yeah Okay, any other powers you had on on your list those were mine too So into the section of what would have happened otherwise if you're looking at transaction here acquisition This would be what would have happened if the big company hadn't bought the little company Uh here the way I want to analyze this of uh, uh, what would have happened otherwise if Tencent had not invested and before we talk about If they had invested I want to talk about their investment for a moment because I ran some numbers and Holy Everything you guys this is this is an crazy investment and we've covered some crazy investments on this show I think the NASPR's Tencent is one of the all-time best, but this one is like it's let's just run through some numbers Okay, so in 2012 Tencent bought 40% of the company for 330 million and That 40% stake played forward six years in October of 2018 when they raised the round on the valuation of 15 billion dollars That's now worth 5.4 billion if I did my delusion math right there So it took him six years to turn 330 million into 5.4 billion Which I think is a 60% annualized return on that money and one way to contextualize that is Uh, if you're a VC and you're listening to this that's like let's say you're a smaller series a firm and you've got a 330 million dollar fund That's like investing the whole fund and generating a 16x only six years into the life of the fund. Yeah The crazy crazy crazy thing though about Tencent and why they are just So like they're just on a whole nother level than anyone else out there Is like this is far from even their best investment You know we covered what's probably their best right now. I haven't run the math on me to on but in Pindu Oduo In two episodes ago that stake I think is worth 20 some odd billion now and they've invested less than a billion Um, yeah, it's it's wild like there are order of magnitude from me to on Unbelieveable investors and they bet huge and with conviction and are often right Anyway, quiet giant the other thing that I want to say about that deal not the 2012 deal But the 2018 deal is when they were valued at $15 billion. I hadn't done my research on the company at that point And I was like oh my god people are caught up in the fortnight hype. This is not gonna end well but In 2018 they did $5.6 billion in revenue with three billion of which was profit So that valuation is five X EBITDA Yeah, like it's that's not crazy at all not crazy at all I like I'd be a buyer It's very rational relative to a lot of these other sort of mid teens and 20 and 30 and 40 billion dollar valuations that we saw from lots of other companies over the last several years So you know this business grew incredibly quickly was spitting off cash and continues to It reminds me a lot in in that way of zoom If here's a company that's been growing incredibly quickly Incredibly capital efficiently zoom my believe generated over a billion dollars in free cash flow last quarter Um, you know, and you contrast that with all of these other you know It's kind of all these other companies out there that are burning capital You know, it reminds me also of just you know kind of how we started at the top of the show with who Tim Sweeney is and What his goals are and how he operates, you know He's not hobnobbing with celebrities even though he's a billionaire He's eating bow jangles fried chicken and spending his time building epic towards his vision and mission for the future and he bootstrapped for um, how long do we say it was a 22 years, I think before 22 years before taking the 10 cent money Yeah, so I mean on the one hand yes, you're right. It's absolutely this reflection of Tim's personality On the other hand, we're comparing it to these companies like uber that are like moving people around their cities and fortnight makes money by selling digital hats like they're selling zero marginal cost items that have zero distribution costs and they're selling a ton of them because Of social proof like Point for to playbook theme Yeah, but anyway Would epic be what they are without the 10 cent investment? Absolutely not like if you think back to 2012 probably 2011 when the conversation started You know, they had no or very little digital distribution expertise They had most recently shipped gears of war on some discs to some Xbox customers They had no live ops experience of Of running anything like the platforms that they have today that are constantly changing and constantly getting updates and constantly getting new seasons There's no games as experience and and I think like Tim would be the first to tell you there's a quote that I grabbed here that Tim says that which is 10 cent is the number one operator of live games in the world the number one game publisher in China and the number three internet company in the world They're not the game developer their expertise is how to operate these games on the very large scale and really appeal to customers And we found that their values are very similar to ours and that we have a great deal that we can learn from them And I think that was in like the 2013-14 time frame that he gave that quote so You know, I think Not only are they investors, but I think The leadership team at epic thinks of them really as strategic advisors and sort of Uh people who brought them into this epic 4.0 era of the company. Yeah, I mean, it's telling that all of the majors to the three majors strategic moves and then the game development in this new way That have remade epic all happened after the Tencent investment You know, and it just underscores to like This themes shows up so much even though it's specific to Tencent That company has been so misunderstood for so long You know when the investment happened in 2012 we didn't talk about this in history in facts But a lot of people left the company left epic because they thought The Tencent coming in meant that they were gonna turn into Zingha They thought of Tencent as like oh free to play like this is not what we want to build This is not how you build real games and the reality was it was totally Wrong it was this whole new vision of a much more sustainable more democratic way of building Games and vision for the industry and people are only now just starting to wake up to that reality of of Tencent It's absolutely right Playbook playbook. Let's do it. Okay, so Ben you mentioned um a virtual digital zero selling hats zero marginal cost goods Same more about that Yeah, so it is literally the greatest business model of all time to have the fixed cost and frankly not even the large fixed cost of Designing a new piece of virtual garb or a character or a skin or you know using the tools that epic has built It is not you know, it is it is a lot of work for an animator to do this and a rigor and all the other things involved But like it's not crazy. It's it's one to five people doing it for less than a couple months and And in some cases a day and then you can sell that thing to 350 million people for like 20 bucks each And it costs zero dollars for you to get it to them like it is the most Incredible operating leverage that you could possibly have on getting something that takes a very small amount of fixed Toss to create relative to its distribution and Have zero marginal cost ends in our distribution cost and getting it out there. It is like the Gods of internet business models come down and knighted epic and said you have this privilege to Just print dollars and there's an ATM machine in their backyard that is just spitting out money and like I'm assigning zero value judgment on that. I'm just saying the reality of The business that they find themselves in is unbelievable This theme that low or zero marginal costs Goods make for Incredible businesses and business models. I feel like is Such an important like mega theme that we've I feel like I have been Rediscovering this past year and we've been discovering on this show The cool thing is well two cool things one And it doesn't only apply to the internet once you start to scratch the surface about this idea You realize it's actually been around for a long time right media was classic media was this yep and and reading the outsiders actually really made me Think about this media doesn't have the advantage of that software has where once you Aside from maintenance costs once you make it then people keep finding value in it over an Asuto infinite time scale like media generally has a shelf life and then you have to kind of create more media Which is the same thing in fortnight to be fair It's also though It's multiple types of the media business. There's the content part of the media business that you're talking about There's also though the distribution part of the media business now This is vastly changed with the internet, but I think about John Malone and TCI and the cable business You know that was a business that had incredibly high fixed costs to Literally run the cables and Launch the satellites for the distribution of signals, but then once you Were a cable operator and you had those lines laid into people's homes It was literally zero marginal cost to keep charging a 100 bucks a month You know every every month Once you start to see this it's really helped me I think Evaluate Business models and start to foresee what a business model of a company is going to be And like no matter how successful Lee you operate Hamilton talks a lot about this in seven powers operational excellence is super important And table stakes for becoming a great company But you kind of have this ceiling of how great you can be Based on the economic characteristics of your business in your industry And it comes down often to this marginal cost aspect Well, and if you just look at the thing and I don't want to say fangs I don't think Netflix deserves to be in it Let me get on my high house for a moment because I slipped up fang should refer to High paying jobs in the valley at big companies and people have used it to refer to a set of stocks That should actually include Microsoft and should not include Netflix especially from a market cap perspective So anyway if you are looking at the big five tech companies by market cap much of the same characteristics are present and all of them I mean online advertising the Google model the Facebook model That's a zero marginal cost zero distribution cost business. I mean you look at like the virtue Virtue is very much the wrong word you look at the Advantage is that even an Instagram has over a YouTube like Instagram doesn't have to pay creators Whereas YouTube has to pay a cut out to creators. So any business where you are able to charge to distribute something that costs you nothing And it also costs you nothing to distribute it. It is like that is present in a lot of these companies Now fascinatingly which I'll foreshadow before grading Apple is one of these companies that does not have zero marginal cost And definitely does not have zero distribution costs there for the longest time business model is making 35% operating margins on shipping Goods to you that are really really expensive to produce even on a on a variable basis Like obviously the R&D is expensive But the crap in an iPhone is really expensive. It's not like a digital hat And so it's no wonder they're trying to get into these these services businesses that you know are creating this clash So I think you know in some ways an interesting takeaway here is epic Has the best business model of all time and Apple is jealous and that is a little bit of what we are seeing here But yes, David. I think you're exactly right that once you see it you can't unsee it totally can't unsee it I think there's another theme to highlight here that Epic first stumbled into with the unreal engine but then Tim Really Tim Sweeney really got religion around and and has driven his whole vision now of Letting a thousand flowers bloom then this is related to the marginal cost aspect of what you're doing But it's one thing to make games yourself and invest lots of resources into doing that That's Really making an assumption that you are gonna be right and know what the market is gonna want And Tim has a pretty good track record of that But as we've seen like even he can slip up sometimes you know those three titles that they started working on in 2012 2013 and Didn't work a much better aspect is if you can find a way to just enable Entrepreneurship and creativity kind of writ large and be able to say hey I don't know what's gonna work But I'm gonna let lots and lots of people try and have their shot That can be way more powerful Yeah, what was the phrase we used with um chase and we had them on the LP show Uh leverage on tinkering Which is like anytime you can empower a creator to do more with their same skill set as it can be really powerful The way that I had what you were describing written out in my notes here are steady platform revenues to smooth hit driven spikes from games Yep The only other kind of second layer of nuance I'd add to that I remember Ben Thompson talking about this in the early days of Stratekery The very best way you can do that is if you can lower the bar to creation and entrepreneurship and that's what epic and Tim are really trying to do They're trying to say no you don't need the budget of a Hollywood studio to make An amazing online experience. Yep. Yep. That's a great point Okay, um some other themes that I had here a few of them roll up under control Uh one of them is don't be beholden to a publisher You know creative differences with Microsoft over the future of gears of war Um is an example of this and you know epic definitely publishes fortnight publishes and develops fortnight And so it's important to kind of have the final say and Tim found a way to To do that. It also is interesting if you look at their capital structure I don't think they could pull the thing that they're pulling with apple if they were a public company Like it in in stark contrast to the lesson learned from event bright which was uh It's nice being public because you have more flexibility when you need to do things like raise capital Um it forces more capital allocation discipline then when you have sort of deep pockets from VC money In this scenario if he had public shareholders it's very unlikely I think that he could have gone out after apple in this way because as we'll talk about It's likely short-term value destructive And it's not necessarily clear that it's long-term value creative either He's doing something on behalf of an ecosystem for value that epic itself and their shareholders may not get to realize And so I think this notion of having control So it you can sort of do what you want and I'm sure he very much checked with Tencent and had a deep conversation Especially about what Tencent wants from apple before doing this Uh being a controlling shareholder Uh allows you to do things that you certainly could not do that may pay off compared to being a public company Yep total. I mean Could you imagine what the share price would be doing uh through all this if this were a public company? Oh my gosh Yeah Well if you look at apples only going up. Yeah Which actually you know, I think to be fair to the event bright episode I think Kevin or Julia are maybe both when we're talking about this said Yes, there absolutely are situations where being private is better It's not like being public is better writ large and this is one of those situations right right Yeah, that's a great point Okay, couple more one is that game engines in particular are of a type of product that have incredible inertia That are hard to build it's hard to get customers But then they're almost impossible to displace like no one's gonna swap out their game engine for a different game engine and I You also aren't going to be able to start a successful competitor to the unreal engine right now Like if you look at when unity successfully started a game engine It took off because of the birth of mobile there was this brand new paradigm where you needed to have uh an engine with a very different set of resources We haven't gone deep on this on this show But if you're developing a mobile only game like you would be pulling your hair out trying to do it just with the unreal engine Like if you're going to do that it better be worth it because you're also developing for PC and consoles and The only way to compete with One of those products once it has momentum behind it is in a displacement of paradigm So mobile coming out and who knows what the next one will be But it's definitely one of these companies where the sort of inertia around it Makes switching basically impossible until the next technology generation. Yeah, 100% Okay, and my last one so in my notes I wrote down iteration and compounding So iteration is standard dogma in startups and engineering I mean you hear about agile development and compounding is standard dogma and investing But this is one of the first times that I really grasped how interlinked the two concepts are the sort of methodical small iterations that Epic is able to do all of these years on say on real engine compounds on each other to provide extraordinary value So it's not just dollars that compound on their own the way that you would think about a stock growing over the years It's dollars deployed into like every single day Into people building that next building block of software that future engineers and non-engineers can build on top of And it just really concretized like iteration is Almost like the implementation of the abstract concept of compounding and investing Yeah, I love that that's like I think that's a really elegant way to describe what the job of capital allocation actually is or maybe better put resource allocation right like it's not just that You're Allocating resources and sitting back and Watching them compound. I mean maybe you're doing that if you're like a public markets investor But what somebody like a Tim is doing you know what a uh, well both Tim's What a what a what a CEO is doing you know, especially a outsider type CEO in the will Thorn Deic sense of the word of which Tim Sweeney would a hundred percent a thousand percent qualify is is that iterating Every day with and the allocation of resources With an eye towards what's the most optimal compounding rate that how will a dollar invested in what we're building today Become a building block to make us able to build more tomorrow rather than starting from scratch every time Yeah, I love that All right David so grading Hahaha so normally for anyone new to the show we would normally grade a transaction So was was it a good use of capital for Facebook to buy Instagram in that scenario that is R a plus and then everything else sort of rolls down from there to our I think f for a well-time Warner so in this scenario because I mean I guess we could grade like was it a good idea for 10 cent to deploy capital or something like that The big thing that we all should be grading right now is Uh this fight with apple like what is gonna result here and what should each company do and so The way that I want to evaluate this is if epic holds strong what should apple do and if apple holds strong what should epic do and To set the table for that I pulled up a bunch of numbers that I think are worth sort of walking through here to To sort of contextualize this fight so the app store last year generated an estimated 18.3 billion dollars of revenue for apple So that's their 30% cut so 61 billion dollars That was spent on the app store that went to apple and developers For apple for anyone who's been following the the stock and listening to earnings when Tim says Tim cook says services revenue Uh 40% of that is app store so this 61 billion represents 40% of the services revenue fortnight Makes right now about $200 million a year on iOS which means about 60 million dollars is going to apple and that that's a 12% Which actually came out in a court proceeding today. So fortnight last year did 1.8 billion in revenue across all of its platforms. So you know you take a 12% of that comes to 200 million dollars that they're making on iOS. So that's sort of what's at stake here Is that that 200 million? So then there's this other thing that has entered the arena which is apple pulling out the hammer and saying we are going to Make it so that anyone using unreal engine can no longer deploy onto apple platforms which Sounds really scary and most people analyzing this are looking at it saying Well, that's actually the real problem here because the unreal engine sort of loses credibility with developers If this major platform where there's an incredible amount of spend going on in the app store No longer has Unreal engine as a deployment target like you can deploy to these five other platforms But not the sixth which is a big one So that's a problem it'd be one thing for epic to lose 200 million dollars of fortnight revenue over this It'd be a whole another thing for them to massively Disappoint all of their Unreal engine and all their services customers right But when evaluating push comes to shove on that the biggest game on iOS that uses the unreal engine is fortnight The second biggest game is pub G and when you look down the list of the top 100 grossing apps Very very few of them use unreal engine as we've been talking about the rest of the episode Unity is actually the preferred sort of mobile game 2d candy crush style game engine and so I don't know in practice if a big game developer who is thinking about making a triple a style title to deploy across Sony platforms and Xbox and I shouldn't say Sony platforms playstation and Xbox and the PC I think mobile is a little bit of an afterthought where they're saying like yeah, it'd be nice But like that's not where most of my revenues can come from and so I actually I don't think it would be that big a deal. I mean it'd be a big deal But I don't think it would be this like catastrophic loss for the whole ecosystem that people are sort of chalking it up to be if The unreal engine was no longer available on iOS So I really do think what it actually comes down to is the $200 million a year that fortnight makes on iOS and the 60 million of that that goes to Apple This is super interesting right like I actually think the question there the context is is not what you say to have like I'm I don't know Take two I make grant that auto Like I'm not gonna put that on the app store because I'm not gonna make my revenue there as we've talked about That whole model like yeah, that's gonna be a real that whole Hollywood style of game making that's gonna be around for a while It's gonna be fine, but that's not where the big industry is the really interesting question is like These dynamics like why is overwatch not on the app store? Why is League of Legends not on the app store? Why is do it to not on the app store? Why are all these Modern game is a service esports style True like big big winners big platforms in this era. Why are they not on mobile? It's not because of technical limitations an iPad or a iPhone 11 Pro Like is very very capable of running these things and so it's only moderately because of tech It's more like it's really difficult like it better be really worth it If you're gonna go and do all the Hoops to make it actually run on those devices and modify all your input controls to be touch and not have the WSD controls and all that Totally totally, but doable. I mean 10 cents done it with honor of kings in China Yeah, totally and I played Fortnite on my phone last week. Yep totally so it's doable I think the reason that it hasn't happened is because of this economics issue right like if you're operating your game as a service And making revenue in a sass like manner through subscriptions and or virtual good economies You know what a pain 30% to Apple or Google like this is a non starter Actually, I think Apple's kind of like zooming out even more one of the kind of big failures of Apple and Android too in a different way, but really Apple is that they have like they had an opportunity to have iOS devices You know, which sort of became the uber device that ate lots of other specialized nitro electronic pieces They had the opportunity to eat game consoles as well, but that never happened And I think this is the reason why Yeah, instead they segmented it and they they ate a lot of handheld gaming the switch has still done well But they there are mobile type games that have done the Facebook gaming and web gaming Yeah, oh, that's a great way to put it The candy crushes of the world that I think those types of games are still the most played even more so than fortnight But you're right that they could have eaten triple a titles too and they didn't and the question is I do think there's some combination of like the devices aren't that great of a user experience to be playing those types of games So there's the developer has to like jump through extra hoops to make it a better experience And then it still doesn't feel totally right to your point honor of kings did work So but you're right that like the economic model is just not as appealing Right like again because these games are network economies It's in the developer's interests to want to have as many as large an addressable audience of potential players as possible And the mobile platforms have so many so large installed bases that like they should want to be on these things But You know so anyway, what should people? What should each party do here? So here's my straw man So let's right now say that the courts hold that apple can't drag the unreal engine into this and let's say Epic holds strong and decides that we are going to leave the version in the app store that lets me buy directly from epic and You know what what should be done there and I did another little fun calculation the money that Apple receives from fortnight per year on the app store Comes to about a third of a percent of app store revenues like You know what is on trial here is apples Like emergent business model of the last five years with this this sort of app store fees So if it means dropping their take rate 1% like they should not do that They should say okay, we're happy to lose you fortnight goodbye And they should make it unplayable on everyone else's phones like the the the counter argument to that is that First of all that it would trigger New legislation that it would sort of have antitrust implications and You know, there's another thing around maybe that they would turn off more developers from doing that because people would go My gosh like you had don't don't know this trustworthy development platform even for even my mobile game anymore The epic revenue is really a drop in the bucket for apple Here's what I think the biggest danger is for apple if you believe that this trend that Tim Swini definitely believes in of these things are becoming more than games. They're becoming a metaverse And if you think that is going to keep happening and accelerating Do you box yourself out of participating in that as apple? Because none of the creators and developers are gonna want to play on your platform Just like none of the mobas and and the games of the service have and so as that industry becomes bigger and bigger and bigger and bigger And none of those play on your platform and then all the consumers that want to consume those That content now go to other devices to do that you're you're absolutely right. Yes The apple's risk here is much less about the fortnight revenue and frankly I don't think it's that much about the unreal thing either because as we talked about like it's really not the games people are playing on their platforms You know are people so loyal to fortnight That they'll say you know what screw this my next phone is an android phone like as apple gonna be Shut out from participating in the more sort of open Well, I one of two things are they gonna be shut out from the the Tim Swini's version of the metaverse when people are picking their next device Or even long before that are people gonna say look I want to play freaking fortnight and I can't on your phones Yeah, so and not by phones that would be the argument that apple should blink yeah But it's it's major business model disruption to them if they do like Totally totally. I mean, I think it'd be a different thing here if it was unity if it was if unity made fortnight I think then apples like so yeah, we're not like we will definitely not Uh, kick all unity games off of the platform, but there's some chance right the unity joins in with unreal here And why would they do that they have a per se license model not a cut of revenue model Frankly, I mean without having studied unity enough They may want to switch to the cut of revenue model at some point I mean actually if anything like it's sort of surprising That unreal is the one with the cut of revenue model given that they are the high-end platform and unity is the sass Model given that they're the low-end platform You would think that as a low-end platform you'd want as many Developers coming onto the platform as possible and this you wouldn't Want to have any incentive for or any barrier for them not to now I think you can start using unity for pretty low or no fees as an indie developer Um, yeah Yeah, that's an interesting point too Getting back to if epic refuses to blink and then apple kicks them off So obviously some kind of compromise is the best thing for everyone including customers It's only 12% of fortnight's revenue like it would suck to lose out on that revenue But it's also not the end of the world like it's not where most people are playing fortnight And so to me is it that bad for fortnight to not be on your iPhone I don't think it's that bad is it that bad for apple that the most popular game is not on your phone I actually think it's worse for apps worse. Yeah, I think it is worse Because again, like think about if you're playing fortnight on iOS Chances are high that if you really really love fortnight You're able to go by a switch light for 150 or 200 bucks and keep playing fortnight Yeah, okay, so if it's worse for apple then what we're saying is okay apple should blink Apple should not bring down the ban hammer and and kick all fortnight users off the phone There's some middle ground where they just keep them banned But I think that's actually just as bad for them It's just as bad a look as Disabling functionality from all the phones that currently have fortnight installed or as John Gruber would put at the kill switch so What does apple do like apples actually in the hot seat then and and let's say that that Epic's gonna hold strong like Epic's demands are very interesting here. They want an app store They want to be able to compete with the app store by putting the epic game store on the phone And they want to be able to charge consumers money directly through their app if apple says yes to the first one Like if they want to give on one of these two things they say yes to the first one like They're a whole business like their whole strategic positioning is totally screwed like They make all the services revenue because the app stores them monopoly if they do the second and budget on the 30% You know, that's an 18 billion dollar a year business for them. That's every single percent you budget on is incredibly impactful So like I mean, it's not clear that apple should blink either I actually think like The best long term value preserving and ultimately value creative move for apple is Not to give into epic on saying you can have your own app store here But to lower their own take rate In line because because it's not just about epic here. It's like there's a bigger thing going on Which is that developers no longer love apple. It's not just epic. It is its base camp It's every thousands. Yeah Yeah, I mean, it's everyone that they privately communicated with and said and tried to make some distinction between A b2b app versus a b2c app right anytime you're doing something like that like you're losing I don't care what what you're saying if it's coming to that you're arguing against You're most arguably your most important constituency Because like they have customers who buy their devices But customers only buy their devices because they get great experiences on the devices that developers create for them Apple would say customers or well, Apple would say apples. They're most important I would they wouldn't say that but Apple is the most important customer second developers last They were very fortunate to get all the developers onto iOS very early and have had tremendous lock-in in their sense So I think they're really putting themselves at risk here in the long term like yeah, you know if fordany weren't on iOS Would some people switch to android sure But when you know they've they have people out trying to figure that out right now what what how many customers would we lose now in the future? Sure, but like what's the big risk here the big risk is like like I certainly wouldn't switch you wouldn't switch But what if Spotify I just reinstalled fortnight because I want I deleted it a year ago But I actually could I could reinstall it because I had previously downloaded it some But what if Spotify were not Apple Right right like yeah, I have a lot of lock-in there like I'm not leaving. I'm not gonna do the Apple music thing so what if What if Netflix were not Apple That's easier because I don't watch it on my phone like it would be very easy for me to go and buy something other than an Apple TV but Yeah, that's a good point. I mean Spotify's a right so each of these things on their own. Yeah, yeah, yeah Okay, but now there's another device out there that has all these things and oh yeah They're cheaper and they're better experiences because it's a more developer-friendly platform It doesn't take too too many of those where you're like Hmm. Do I really need an iPhone? Yeah, so the question for Apple comes down to do we want to preserve our monopoly position And take less economics for the privilege of keeping our monopoly position By being the only app store or do we want to let other people compete with us In that case, we're just gonna get competed down on price anyway So they should probably just figure out a way to drop their rate To something that Epic will agree to Gosh, are they gonna roll that out? I mean the implications are so huge But I think where we're both landing is like Apple needs to give on something here and it probably needs to be either on economic terms Or letting other letting people use alternate payment methods in apps and like Uhhh, I'm Apple. I'm not doing that. I'm trying to go back to Epic and say we will cut it to I don't know 20% But like no one the store and no on alternate payment methods Preserve monopoly Try and make everyone happy and feel like you're not overly rent seeking on your device and I think that's the strategy Yeah It all comes down to this magical question of is fortnight actually impactful enough to be The catalyst of all the bad things that we've just talked about with Apple actually happening if it weren't there And maybe maybe not you know that's that's the dice rule. Yeah, well Here's though the other Big calculus for Apple to bring back in his Tencent Right like who is the most important company and partner to Apple in the world Can make an argument that's Tencent why is it Tencent? Well Apple has a huge huge business in China If we chat is not on iOS in China that business goes to zero That's a great point because we chat has the closer relationship with the customer than Apple does Much much closer like it's like I think it's probably not even a question like no we chat on iOS everybody's moving to Yeah, right. Yeah, there's so many games of chicken that that this could start Tim Sweeney's willing to take risks But who else is who will throw in with him and I mean because like with your we chat like come on That's crazy to to lose all that distribution on all those phones But you can maybe argue that they don't need it right like we chat is more important Then don't they also have a special deal where people can use we chat pay for virtual goods in China and go around the app store there Oh, I researched that they may I think then Apple's already compromising Right, Apple needs to find a way to quietly compromise and talk about why this is a special case and have it hold water And then do that and then hope that no one as big as fortnight comes and does this again Which is for sure It's a losing strategy. Yeah, I think you're right Ultimately, we've said this eight different ways But yeah long term they need to figure out a way to preserve their control and give on economics a little bit And that is long term value creative. They need to become a great platform for developers again. Yep. Make Apple Great again for developers Okay, all right. Well, we moved a section after grading That we normally have before which is value creation and value capture a couple ways I want to talk about this So epic has done a tremendous job of creating value in the world and frankly Capturing like less of it than I think they create the fact that they only charge 5% for the unreal engine like It is fair and I think the fact that they undercharge for the epic game store also, you know Again capturing far less value than they create you always have to capture less value than you create in order to enable value for your customers So no one's just trading a dollar for a dollar But you know, I think they capture dramatically less value than they create and they've got lots ahead room above them The other way to evaluate this value creation value capture is like in this whole dance with Apple The unfortunate thing is the consumer is losing Like the customer is the one that's bearing the brunt of these tech giants clashing and That's You know value destructive Ultimately for the end user that these tech giants are at war over who gets what economics? Yeah One that's also a game, you know Where regulation and the government comes into play and in that part of the game the deck is stacked against the big tech companies Right like our regulators really gonna say oh no you you know Independent much smaller business in North Carolina like you are being unfair to Apple here No way this 17 billion dollar business is being mean to the 2.2 trillion dollar business Also, I do want to point out Apple grew by 10 epochs this week Ha Well the scale is just Unbelievable with these compound interest continues to blow my mind and Yeah, well listeners on on the grading and on the value creation value capture There's so many nuance points here. We would love to hear from you So you should join us in the acquired slack acquired that FM slash slack or just go to our website and talk about it Or we'd love to you know chat on twitter too or add acquired FM. I think there's obviously the situation changes every day Um, there's probably going to be new news that comes out between this episode and you know recording and release But also there's just lots of nuance points here So we'd love to to hear your perspective on uh on what we sort of missed Carvouts, let's do it All right, uh, I'm gonna go first because mine is a continuation of this episode So I have a three-part carve out that is going to be in the order that I experienced these three pieces of media and I recommend the same to you. So when was this August of 2019? So this is before Disney plus launch before the Mandalorian came out There was a demo video put out by epic with a guy walking over getting on a motorcycle and revving the engine And what was amazing about this? First of all, you're like why is this short little video put out by epic? What was amazing about this is the fact that it was shot in a studio with a guy Sitting on a real motorcycle, but with a screen behind and to the side of him that was rendering the full background And the other amazing thing was that the camera was moving slightly as you would expect uh, you know a dollied camera on a set to move And the background this shifted perspective in the right way that you would expect with the camera So not only were you like whoa that background is real and certain things are our you know a thousand feet away and other things are five feet away But there's no artifacts like it also just looks like the real world and there's the appropriate amount of blur for you know what the Depth of field on this lens is so like it all actually looks right and then they show you the behind the scenes and oh my god It's a screen and the screen is just super high density pixels And so there's no sort of like crazy artifact that you would normally see if you took a picture of a screen the Physics of the like there were accelerometers on the camera that are tied to What is being projected on the screen so that this stuff on the screen shifts in the exact right way with the camera as it moves in pans in real time Undetectable to the no lag detectable to the human eye Unfreaking believable breakthrough technology. So I remember watching that mean like Holy god the future of filmmaking is here. It's amazing this games company and I'd heard of epic obviously because of fortnight and because of the unreal engine It's amazing the unreal engine can sort of like do this now. I wonder if anybody's gonna okay So flash forward the Mandalorian happens watch it. It's fantastic literally worth the Disney plus Subscription just for the Mandalorian. Oh, it's so good. I mean, it's a it's a Star Wars western. It's excellent And so then February 2020 that there's this video that gets released of the making of the Mandalorian in what they call the volume And this is a soundstage David exactly as you described 360 degree You know, uh screens all around a sort of like horizontal screen above you and that's used for lighting the scene So not only are they rendering all of the elements around by the way amazing that that CG right it all looks so real People are wearing costumes. Uh, they have some props like desks and stuff But like other than that all the backgrounds at all depths are just rendered on these screens and then lit using the unreal engine From above from this like crazy huge horizontal screen that is making sure that the lighting that is falling on the character exactly matches the right lighting based on what the background in the scene is Mind blowing. So really cool video. It's short. It's like five six minutes Then a friend sends me this thing in ASC it's ASC mag.com. I think it's like the American Society of cinematographers or something like that Is this an incredible long form read on the physics of how the whole thing works if you're into like film at all at movies or Photography or whatever it is just the most fascinating read on the technical details of how they accomplish a lot of these shots And it is totally worth carving out some time to go and read because it is uh, what's the quote? Uh, uh, uh, sufficiently developed technologies indistinguishable from magic something along those lines is absolutely true and I Am so amped up about unreal in the future of filmmaking It's so cool. So amazing and the the net of all this is like it's Better you enable more creativity at order of magnitude lower cost too like they talk about this is how the Mandalorian was able to be made and be so awesome as a tv series versus uh Multi-hundred million dollar budget movie Because they just did it in a room and it truly would have been yeah whole thing shot in the same room Amazing Okay, so my carve out more of a stretch to connect it to the current episode But I haven't I'm gonna try I'm gonna try uh, I have been rereading Isaac Asimov's foundations series I might have had this be a carve out years ago on acquired. Oh so good. It's classic You know, the whole thing is about the fall of a Dominant society and its replacement by an upstart society was you know an allegory for Rome or you know Whatever you could apply it to Current state of the world right now Yeah, I think you could also maybe maybe to stretch, but maybe you could apply it here to apple and epic too You know with the galactic empire that falls Falls because it stops doing its job It becomes all about politics and it loses its technological edge like one of the main themes in the book is that nuclear power and knowledge of You know how to harness it and continue developing it gets lost in the empire And it's only the foundation this tiny little you know edge of the galaxy upstart that has that power Having the ability to be on the cutting edge of technology and the nimbleness to move fast with it probably gonna win Well, indeed Well, that's a great great place to leave it Well listeners if you aren't subscribed and you like what you hear you totally should and if you have a friend who you think should Should check out this episode or any other episode, you know Maybe they are a gamer or maybe they've also talked about the Mandalorian with you and Want to understand more about the company that powered it share the episode we love We love when you share with new folks So thanks so much for for doing that As always if you love acquired and you want to hone your own craft of company building You should join the community of acquired limited partners You'll get access to the LP show where we dive deeper into the fundamentals of company building and investing in addition to our monthly LP calls Where we talked directly with all of you and of course our book club and our zoom calls with the authors To give you a little preview of our most recent LP episode It was one in our fundamentals of venture capital series of which we're doing six maybe seven David we got to decide um, but this was the one on basically how VC firms make decisions mechanically as different people in the firm Are involved which is helpful to know if you're pitching or if you're aspiring to be an investor or frankly if you just want to know how other Investors do it in your active today if you aren't already a limited partner You can click the link in the show notes or go to acquire.fm slash LP and of course all new listeners get a seven day free trial If you want to hang out with the acquired community join us in the slack and with that Listeners we will see you next time. 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