Gabe Newell is the next billionaire in videogames--and he's changing the economics of the industry.
Fully armed with toy cannon, Valve founder Gabe Newell on the roof of his Bellevue, Wash. offices.
Gabe Newell was going blind. The founder of videogame seller Valve suffers from Fuchs Dystrophy, a congenital disease that slowly destroys the cornea. "I have dead-people eyes," he said at the time. Double cornea transplants in 2006 and 2007 cured him and changed him utterly.
"The thing that snuck past my defenses was that not only could I see again but I could see better than I ever had before. I felt like I was in a fantasy story. It reminded me of how fast the future is coming at us and from what unexpected directions."
The symbolism here is almost too juicy. Newell was already one of the most clear-eyed seers in the digital economy even with bad corneas. ITunes, Amazon and Netflix reshaped their slices of the media business by moving people from physical stores to the Web. Valve has done the same thing with PC videogames.
Valve's site, Steam, has 30 million customers downloading PC games and add-ons. Only Nintendo, Microsoft and Sony have larger footprints in the gamer community. A milestone was reached last year when unit sales of PC games via download outstripped sales of boxed games in stores for the first time, according to research firm NPD Group.
"I think Gabe is brilliant. He's one of the smartest people I know," says John Riccitiello, chief executive of one of the world's biggest game publishers, Electronic Arts. "He has some sharp insights for what makes good games and for what's around the corner in technology."
Steam controls half to 70% of the $4 billion market for downloaded PC games, selling titles from bigger firms such as EA and Activision, as well as Valve's own games. Its sci-fi shoot-'em-up thriller Half-Life 2 has sold 12 million copies since 2004 and is the highest-rated PC game on the Web site Metacritic.
The 250-person company releases no financials but, according to Newell, is "tremendously profitable." Ed Barton, a games analyst at IHS Screen Digest, estimates that Valve's revenue in 2010 was in the "high hundreds of millions of dollars." (A 2005 FORBES story on Valve had the company grossing $70 million with a fat $55 million in operating profit.)
Valve announced last October that it was on track for its biggest year ever, with 200% year-over-year growth. Newell says that, per employee, Valve is more profitable than Google and Apple. A potential buyer was rumored to have made an acquisition offer a few years back for the Steam piece only, but Newell supposedly refused to split the online storefront from Valve's game-publishing arm. (Valve denies being made an actual offer, only confirming that it received interest in both Steam and Valve in the past.)
Various sources value the company at $2 billion to $4 billion, which is reasonable, considering the $4 billion to $6 billion valuations being put on Zynga, the maker of Facebook game hits FarmVille and Cafe World. Newell owns more than half of the business, making the Harvard dropout a near billionaire, if not one already.
Newell looms large both in real life and the industry. His 6-foot-4 frame often makes him the target of fat jokes by online wags. He is also unafraid to tweak rivals, once calling the PlayStation 3 a "total disaster." He has since made up with Sony.
Newell started Valve in 1996 with his friend Mike Harrington. Both had been at Microsoft for more than a decade and cashed in their stock options to fund the company. (Valve has never taken a penny of venture capital.) They licensed some code from the hit game Quake to create a new game called Half-Life, which debuted in 1998 and sold 2.5 million copies in its first year. Newell bought out Harrington after he left the company in 2000. Valve launched the Steam storefront in 2004, a time when most U.S. homes had dial-up Internet speeds.
Steam appealed to gamers because it simplified the arduous process of downloading, setting up and patching games. Steam also encourages its community to create, distribute and sell "mods," or modified versions of Valve's existing titles on its network. Newell says that around half of his employees got their careers started from making mods. A onetime manager of a Waffle House in Florida is now a lead software developer on Half-Life.
Steam now helps its customers make money, too. In October it opened a virtual goods store where players can sell items such as weapons and accessories. A few enterprising players have made as much as $20,000 a week. Newell says it would be easy to distribute movies and music through Steam, but he's not as interested in breadth as he is in making a "better piece of content," which involves giving customers more ways to interact with the media. Its Steam Cloud service, launched in 2008, allows players to store their games and data and is accessible from any PC with Steam installed.
Steam's appeal to publishers is in giving them the opportunity to sell directly, cutting out the profits extracted by distributors. Publishers earn a gross margin of around 70% on Steam, compared with 30% via retail stores. They have a lot more flexibility selling through Steam than they do through stores or even a site like Amazon. Steam gives publishers live stats on how customers are reacting to marketing messages or price changes. Discounts on titles, like weekend deals, are common on Steam and have led some titles to see a lasting bump in sales.
Valve's strength in PC gaming may, however, be its limiting factor. The PC game category is a mere 8% of the $50 billion industry. Newell admits to missing out on trends like mobile, Wii-style motion games and Facebook games. "If we tried to blaze new trails of our own and ride all the latest trends, we'd likely be bankrupt by now," he says.
But knowing what not to do is the reason Newell is on top. As EA Chief Riccitiello says about why Newell succeeds: "I don't know what would be the right expression . . . maniacally focused?"
A few years back a friend told Newell he needed a hobby. He decided to teach himself to be a machinist. Newell took the car out of the garage and replaced it with a belt grinder, milling machine and salt pots for heat-treating steel. Since then he's been cranking out geek accessories and toys such as an iPad stand and custom swords. "I thought it would be a good complement to staring at a screen all day."
Competitors and traditional retailers both fear and respect Steam. David Perry, chief executive of competitor Gaikai, called Steam the iTunes of the game industry, warning that, like Apple's digital music service, Steam could become a monopoly. GameStop President Tony Bartel gushes: "They've really ridden a trend and led a trend. There are other people who have tried to get into this space, but they haven't done it with the elegance that Steam has."
Microsoft, Electronic Arts, Blizzard and GameStop have been investing heavily in digital, with download stores of their own. Consolemakers Sony and Nintendo each have their own online game networks, although they don't sell the blockbuster games that Steam does. Microsoft, in particular, has done well with its Xbox Live network, which is thought to have topped $1 billion in revenue last year, both from subscriptions and sales of digital content, including games, videos and music.
Last July a new competitor emerged in cloud-gaming service, OnLive, which does away with downloads entirely. Instead, OnLive streams games directly to a PC or TV. The company won't release how many customers it has, but it is adding its service to Android tablets, smartphones and TV set-top boxes. Newell says OnLive has done admirably figuring out how to stream games, but thinks that distribution method is inefficient and expensive.
OnLive Chief Executive Steve Perlman counters that his company is profitable and its streaming costs are reasonable and in line with the estimated 3 cents per gigabyte that Netflix pays. Perlman dings Valve for having an audience "limited to people who have a high-performance computer." He says he will be on 10 million TVs by the end of this year.
Newell will continue to have it both ways. Despite the media portrayal of Steam as a retail killer, Newell works closely with chains like GameStop. Free weekend game promotions on Steam often lead to sales spikes in stores. The Valve title Left 4 Dead 2 sold more than 4 million copies at stores in 2009. This year it is releasing its first game for the PlayStation 3, a version of the action-puzzle game Portal 2, which will only be sold at retail.
