GigaOM

Editor’s note: For the sake of accuracy, we have replaced the edited questions and answers with their unedited version (save for some minor stylistic changes). We sincerely apologize for any confusion.

This week Found|READ interviews software entrepreneur Paul Graham, co-founder of the influential startup incubator, Y Combinator.

Since 2005, Y Combinator has seed-funded 250 founders and over 45 startups including Justin.TV, RescueTime, Weebly and Zecter. Many other “YC shops” have quickly achieved liquidity events, among them Reddit (Condé Nast) and Auctomatic (Live Current Media). Fresh from Y Combinator’s fourth annual Startup School ‘08, Graham talks about the competition, various success factors, and how Y Combinator picks its winners. Continue Reading

I’m no fan of the phone companies’ tactics of stifling competition in broadband through the strategic deployment of lobbyists in Washington. Thanks to FCC Chairman Kevin Martin, they have gotten what they needed. Perhaps that’s why I was struck by this Ars Technica headline: “Grab your wallet: Qwest wants release from line-sharing rule.”

The Ars report points to a study by QSI Consulting which concludes that: “Qwest’s bid for local deregulation will unleash $1.14 billion in higher charges annually for customers in four major Western markets if approved by the Federal Communications Commission (FCC).” Wow, that’s sure to get everyone’s attention — especially mine, since I’ve been watching the slow asphyxiation of the 1996 Telecom Act for some time now. (I should note, however, that I also am skeptical of claims made by the study, mostly because QSIConsulting counts XO Communications as a customer and the study was commissioned by XO.)

If Qwest gets its way, it won’t have to provide its lines (and facilities) on a wholesale basis, which essentially means there is no way independent companies can exist unless they build their own facilities. And that, of course, is why XO Communications is up in arms. The arguments to deny Qwest’s request are many and valid. Verizon also wants to back away from giving wholesale access to its competitors. I think this is a crummy move by the phone companies. They got everything they ever could have wanted out of the 1996 Act; any concessions they had to made they’ve since sneakily reneged on. XO is right.

The casual games market is booming, generating over $2.25 billion in yearly revenue despite virtually no brick-and-mortar representation or advertising and marketing costs. But is this market rewarding for investors? For VCs interested in this space, here’s rundown of how it works.

A casual game is defined as a stand-alone entertainment software title that is digitally distributed by one or many “portals,” or independently owned Internet retail sites. Casual games typically operate under a try-before-you-buy business model –- the downloads allow players to play for a set period of time (usually 60 minutes) before shutting down. If the player wishes to continue playing, they must pay the retail price, which they can do electronically from inside the program, instantly unlocking the game for unlimited play. The average rate of purchase to play is lower than 1 percent, and games that convert higher than 2 percent are considered “hits.” The largest market for these games is women ages 30-60, a significant departure from the standard computer games market.

Development costs

The development cost of a casual game typically hovers somewhere around $100,000. That money goes into paying developers, including artists, programmers, game designers, project managers and audio engineers, as well as the developer’s overhead. This investment usually pays for between eight and 12 months of work. Of course, there are ways to reduce costs. In recent years, many developers have outsourced art and coding to companies overseas, in places like Eastern Europe, India or China. But such a move needs to be carefully managed, as many outsourced games are shipped with little quality control, often sporting poor or confusing English.

The primary profit center for casual games is online retail. Games in the genre retail for $19.99, minus retailer discounts and incentives. Since conversion rates for a casual game usually linger below 1 percent, the only profitable games are hits – mid-level successes rarely recoup their development costs. Causal games are not a high-margin business. Because the market involves so many middlemen, the final slice of the pie that makes it to developers is usually quite small.

Investing

Investment in casual game development can come in two forms: as a publisher or as a development partner. Each carries its own risks and rewards. Typically most VC investment in the casual games industry goes to the publisher, and most of the major publishers (including PlayFirst, Big Fish and iWin) were founded with VC money. Publishers then contract with individual developers to create games, paying them an up-front amount as well as a percentage of sales. Once the game is completed, publishers then distribute the game to portals and handle receivables from those portals. Most of the major publishers also maintain portals of their own, retailing both titles they publish as well as other games.

VC money does not, of course, guarantee a hit game. PlayFirst is the best example of using venture capital to successful ends, commissioning Gamelab (where I currently work) to develop their first set of titles, including the very successful Diner Dash. But another Playfirst-commission title we developed, Subway Scramble, didn’t do nearly as well.

Recently, a few studios have worked with VCs on the development side and then self-published the resultant games. This method eliminates the publisher’s revenue share, meaning more of the total income goes to the developer. Studios that have followed this method are typically more established in the marketplace, with at least one successful title under their belts. However, the lion’s share of the game’s sale price still goes to the portals and distributors, and recoupment can be slow.

Revenue streams

Developers and publishers depend on the revenue from hit games to subsidize their output, and there is still no dependable method to predict which games will be hits. With an average of one new game getting released every weekday, the market is already becoming saturated. Because development time is relatively short, a successful game will see its mechanics and theme copied and cloned within six months to a year of being released. So while the development cost of a casual game is low compared to a standard PC or console title, the chance of a single title turning a profit is also reduced.

Secondary revenue streams from casual games include advertiser-supported, “free-to-play” versions, which are generating a higher revenue-per-download rate than purchased games, as well as boxed
physical retail copies (usually handled through another third-party distributor) and ports of the game to other devices, including mobile phones and portable gaming consoles. Because casual games are
typically small in file size, with simple input mechanics, they make this transition more easily than complex PC games.

Investing in the casual games market is much like investing in any content market – dependent on a large number of unpredictable forces. There are proven marketing and content models that are exploitable, but the saturation of the market with products slavishly following those models steadily reduces their effectiveness. For a VC, the best bet is to work with an established developer with a strong, marketable idea and keep costs low. Anything else is way too risky for a market this crowded and volatile.

Written by K. Thor Jensen, who’s worked in the games industry for nearly 10 years and is currently an associate producer for Gamelab.

Image credits: playfirst.com, bigfishgames.com, and iwin.com.

The New York Times reports that Microsoft is going to raise its bid for Yahoo by a few dollars. They quote an unnamed source, but seem to be pretty confident that Microsoft is upping the ante a bit.

Microsoft, which had threatened to abandon its bid, has increased its offer “by several dollars,” this person said. The merger talks represent an enormous breakthrough following weeks of behind-the-scenes discussions without any progress. Exact terms being discussed could not be learned.

So much for all the posturing from them this week, and petulance displayed by Yahoo. As they say, if the price is right…

Kara Swisher says that Yahoo is looking for a cushion because they think that the Email monopoly that would ensue following the Microhoo deal is going to cause problems.

That’s because Microsoft and Yahoo completely dominate all mail on the Internet. According to the most recent ComScore figures, for example, Yahoo has 256.2 million users, while Microsoft has 254.6 million. Google is a distant third with 91.6 million users and AOL has about half that at 48.9 million.

Sun Microsystems will bring its StartupCamp, a free, two-day “unconference” that gathers together founders, entrepreneurs and technologists, to San Francisco’s Moscone Center starting this Sunday, May 4th. The event will feature a keynote from Sun CEO Jonathan Schwartz that will include an on-stage interview by our own Om Malik, plus panels on topics ranging from cloud computing to social networks to media launch how-to’s. To register, click here.

The great broadband hope, “Broadband over Power Line,” has turned out to be a big broadband nope. Not that I am surprised. I never believed its promise, even despite the incessant hype by none other than the FCC. A court’s decision has proven me right: The U.S. Court of Appeals for the District of Columbia Circuit pretty much concludes that the FCC was misguided and overenthusiastic about BPL, and that it ignored the interference data.

Both former FCC chairman Michael Powell and the org’s current head, Kevin Martin, talked up this technology, even as broadband experts continued to voice their doubts about its viability. All this positive talk led to the investment of millions of dollars and the chasing of what turned out to be a chimera. Google, for instance, bet big on Current Communications, a company that so far has delivered more headlines than broadband over power lines.

Our good friend Karl over at DSL Reports points us to a story in The Dallas Morning News that says the largest BPL deployment in the U.S. is being sold to a local utility that, rather than consumer broadband service, will use it for electrical grid monitoring. Oops!