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Could This Be The Next Disney? Electronic Arts makes one of every four videogames sold in the world (and that's before it took The Sims online). CEO Larry Probst says he's just getting started building "the greatest entertainment company ever."
By Geoff Keighley

(Business 2.0) – Until her boss showed up, Hecubah, queen of the undead, was having a pretty good day at work. It was the 1999 Electronic Entertainment Expo (known in the industry as E3), and the villainess of the chop-'em-up role-playing PC game Nox had young men flocking to the Electronic Arts booth in Los Angeles's Convention Center. Some undoubtedly came to hear about EA's lineup of new videogames, but many stayed just to stare at the actress playing Hecubah--in devil horns, red contact lenses, and a dominatrix corset just a few threads shy of a misdemeanor rap.

As the gamers milled and gawked, Larry Probst, CEO and chairman of Electronic Arts, pushed his way through. The sight of the queen stopped the 52-year-old executive in his tracks. Blanching, he turned to an assistant, and within seconds one of his minions had backed Hecubah into an inconspicuous corner while another raced off to get her some clothes. When the queen returned to work, she was wearing a skirt. "We want the focus at E3 to be on our products," Probst says about the incident, "not on scantily clad women."

Dressing the "booth babes," as they're inelegantly known at E3, may not be the most significant branding initiative of Probst's 18-year tenure at Electronic Arts, but it's a perfect metaphor for his vision of his company. In an industry that was born catering to adolescent male fantasies, Probst has turned EA into the runaway market leader by mining a largely PG audience. One of every four digital games sold worldwide this year carried the EA logo, despite the fact that the company has no product to compete with raunchy titles like the Grand Theft Auto series, unquestionably the hottest console franchise in the business. EA's gentler focus is evident in its lineup for the all-important 2002 holiday season. Of the 35 titles being rolled out, several are all-but-guaranteed blockbusters--Harry Potter and the Chamber of Secrets, Lord of the Rings: The Two Towers, James Bond 007: NightFire, NBA Live 2003, and the highly anticipated The Sims Online, Chamber of Secrets, Lord of the Rings: The Two Towers, James Bond 007: NightFire, NBA Live 2003, and the highly anticipated The Sims Online, the Web version of the best-selling PC game. The last, which goes live on Dec. 3, could bring EA as much as $100 million a year (see "The Biggest Franchise of Them All?," page 116). But not one is rated M, for a mature audience. As Bing Gordon, a co-founder of EA and now its chief creative officer, puts it, "Management only wants to sell stuff that we'd be proud to have in our homes in front of our families."

If that brings to mind another media power built on wholesome entertainment, the resemblance is wholly intentional. "We've looked at Disney as a model," Probst says. "It is the gold standard for us." Of course, it's almost absurd to compare a $2 billion software maker with a $25 billion diversified media giant. But that's what visions are made of. That, and the $920 million of cash on EA's balance sheet--money Gordon hints could be used to expand into movies or music. In any event, Probst is clearly way beyond thinking of EA as merely a creator of software toys. "Our goal," he says with no hint of self-consciousness, "is to become the greatest entertainment company ever."

If any gamemaker has a shot at realizing such ambitions, it's Electronic Arts. Based in Redwood City, Calif., the 3,800-employee company has more than twice the sales of Activision, its biggest rival, and its expected revenues for this year are around $2.3 billion, a 35 percent increase over 2001. The stock market seems to believe in EA's future: During the past 30 months--a period that left most tech stocks in smoking ruins--EA's shares are up more than 80 percent.

Mike Wallace, an analyst at UBS Securities, calls EA "the Microsoft of the gaming business," in part because of its portfolio of seemingly indestructible franchises, such as Madden NFL Football, James Bond 007, and The Sims. These titles produce revenues year-in and year-out and give the company a breadth and stability that are the envy of the industry. That, in turn, has enabled EA to assemble a massive internal studio system--2,500 game developers in five countries--that produces games that are consistently considered the best in their categories. "In terms of overall lineup, no one else comes close to EA," says John Davison, editorial director of Ziff Davis Media Game Group.

The man at the helm of this success story started his career a long way from Redwood City. A sales director for Clorox in St. Louis, Probst had never even thought about computer games until the early 1980s, when he first played Pong. In that primitive ricochet game, Probst says, he saw the future of entertainment.

Packing up his wife and two boys, Probst traded the Midwest for Silicon Valley in 1984 and joined Trip Hawkins, the former director of product marketing at Apple who had launched EA two years earlier. Back then Pac-Man was the most popular videogame and Electronic Arts's portfolio was limited to a handful of products for the Apple II and Atari computers. Hawkins hoped that Probst would bring the fledgling company some practical business smarts, and he did. As Don Valentine, the Sequoia Capital VC who bankrolled EA, puts it, "Unlike Trip, who is far more evangelical and visionary, Larry was the down-to-earth businessman who really set EA on its course."

Within months of arriving, Probst began to shake things up. At that time, game publishers distributed their titles to thousands of independently owned stores through a handful of big manufacturers' representatives. "I just didn't think that was very effective," Probst recalls. He set out to bypass the distributors and sell directly to retailers, as he had done at Clorox. The benefits, he reasoned, were too good to pass up: higher margins, better market intelligence, and, most important, he says, "the guarantee that your reps aren't also selling competitive product."

The move was risky, expensive, and unprecedented. "Who are you to think you can change the rules of the industry?" demanded Valentine at the board meeting in which Probst outlined his proposal. But Probst promised that it would work, and EA began to put a sales network in place, one store at a time. The distributors howled, but at a board meeting six months later, Probst reported better orders. Today, EA deals directly with 20,000 retail outlets, even those that are part of a national chain--a unique strategy among gamemakers. Instead of shipping exclusively to Wal-Mart's distribution centers, for example, EA also ships directly to individual Wal-Mart stores as often as three times a week. Ken Williams, former CEO of Sierra Entertainment, which published Leisure Suit Larry, calls EA's sales force "unrivaled and a huge competitive edge."

In the late 1980s, EA stumbled upon another of its key competitive advantages: sports games. The beauty of these titles is that fans will buy essentially the same program year after year simply to get updated team rosters (see "How to Build a Bulletproof Franchise," left). EA has been selling sports games since 1989, when John Madden Football first hit the shelves. Since Probst became CEO in 1994--replacing Hawkins, who left to found console and software maker 3DO--EA Sports has grown to 11 franchises, including NBA Live Basketball and FIFA Soccer, and has matured into a virtual annuity, contributing 40 to 45 percent of EA's revenue in any given year. Add in other popular series, such as The Sims and the World War II-themed Medal of Honor, and the share of revenues from such annuities figures to hit 70 percent this year. "In the end," Probst explains, "each year we only have to drive about 30 percent of our revenue with new things."

Minimizing the need for "new things" is no small matter. New games--as opposed to updates of existing games--can take two years and $4 million each to develop, twice the time and money needed just five years ago. For a product like Harry Potter, the license alone can cost as much as $25 million. Most games need to sell at least 400,000 copies to break even. Hits that sell more than 1 million copies are vital, but elusive. In 2001, only seven titles hit that mark--including EA's Madden 2002.

As the stakes climb and costs mount, the industry has gone through spasms of consolidation, leaving fewer independent one-or two-hit companies like Take-Two Interactive, the creator of Grand Theft Auto. Meanwhile, a handful of major publishers like EA, Activision (Tony Hawk's Pro Skater, Quake, Star Trek franchises), Nintendo (Zelda, Super Mario, Donkey Kong), and THQ (WWE Wrestling, SpongeBob SquarePants, Blue's Clues) swallow up smaller developers and publishers to keep the pipelines flowing.

Few acquisitions, though, have paid off as well as Probst's purchase of Maxis for $125 million in 1997. At the time, that company had a series of popular reality simulation games such as SimCity and SimAnt. Two years later EA translated the format to a single simulated suburban neighborhood and called the game The Sims. The worldwide take since then has been a breathtaking $658 million--and The Sims Online is one of the most eagerly awaited launches in the online world.

For all that has gone right for EA, however, it is not infallible. EA.com, launched in 2000 as an online game hub supported by advertising and subscriptions, ran head-on into the advertising recession. A number of newer online subscription games, such as the sci-fi conspiracy title Majestic, also met with lukewarm reactions. To date, EA.com has lost a cool $368 million. That dotcom experiment could come to a very happy conclusion, of course, if The Sims Online proves to be as big a hit as some industry observers predict.

Even as Probst sorts out the struggling online business, he will also have to prepare for every gamemaker's least favorite event, the rollout of a new generation of game consoles. In the game industry, the hardware is upgraded every five years or so, as inevitable as El Nino, presenting gamemakers with a perilous choice: Bet on the right platform and you can get rich; bet wrong and you're a goner. Two console generations ago, in 1990, the then-new 16-bit platforms, Sega Genesis and Super Nintendo, caught Activision low on suitable titles. Activision filed for Chapter 11 (the company emerged from bankruptcy in 1992). By contrast, when the Sony PlayStation 2, Microsoft Xbox, and Nintendo GameCube appeared in 2000 and 2001, EA bet correctly on the Sony system (see "Focusing Where It Counts," page 112). But when the next generation of consoles appears in 2005, there's no guarantee that EA will be so lucky, and Probst knows it. "We're really paranoid around here," Probst says. "Every time we think we have things figured out, an atomic bomb goes off."

Analysts worry that one such bomb--Grand Theft Auto 3--went off last year and that Probst doesn't appreciate how serious it is. That game, wherein players assume the role of mobsters, kill each other over cocaine, and consort with prostitutes, sold 8 million units in the last year and took in $400 million for its creator, Take-Two. The title's success marked the arrival of the "mature audience." Consider this: 60 percent of the original PlayStation audience was younger than 18; 70 percent of PlayStation 2 users are over 18. M-rated games will account for 15 percent of the market this year, and some analysts predict they will grow to a full 25 percent in the next two to three years.

As if to prove the point, the latest Grand Theft Auto title--GTA: Vice City, which is set among drug lords in a Miami-esque city during the 1980s--is expected to break all sales records. Other publishers are chasing the audience. Acclaim Entertainment released BMX XXX, a sports game that incorporates digital video of strippers (using the company's new "jiggle technology"), while Nintendo, the home of Pokemon, is fielding Eternal Darkness, a gory mystery, and Conker's Bad Fur Day, a South Park-like game starring a foulmouthed squirrel.

EA has published mature-rated games in the past--last year it brought out American McGee's Alice, a twisted version of the Lewis Carroll tale, and Clive Barker's Undying, a horror game--and it will again. But relatively speaking, EA's mature material tends to be tame. "Culturally, our executive team just can't get comfortable with the content in a game like Grand Theft Auto," Probst says. "I think there's a spectrum of M-rated content. We're on the M-light side and [Take-Two is] on the M-dark side." Still, EA has no M-rated games slated for this year, and some analysts say Probst is making a big mistake. "It's totally foolish of Larry to have the view he does of mature-themed games," says Michael Pachter of Wedbush Morgan Securities. Not so, Probst says: "We have an obligation to get EA's share price as high as we can, but that doesn't mean we have to prostitute ourselves or violate our code of ethics."

Indeed not. After all, Probst's role model Disney already addressed a dilemma not unlike EA's and found that it could eat its wholesome apple pie and have some edgy products too. In the early 1990s, when the audience for G-rated movies was shrinking, Disney purchased Miramax, the independent film distributor that had made its mark with sophisticated foreign releases like The Crying Game. Under the Disney aegis, Miramax went on to produce mature fare like the gay-themed Priest and the blood-soaked Pulp Fiction, adding hundreds of millions of dollars to Disney's top line--without any apparent damage to its brand image.

That lesson hasn't been lost on Probst. Earlier this year he toyed with buying Take-Two but rejected it. He's not ready to venture that deeply into M territory. But it's still reasonable to expect him to spend some of EA's cash to branch into other forms of entertainment. While industry analysts guess that EA will buy back stock (as says James Lin of Jeffries & Co.) or snap up more game-development houses (as Mike Wallace of UBS suggests), Probst is thinking hard about Disney. "They have the world's most impressive catalog of intellectual property," he notes, "and they have found ways to exploit that intellectual property in more forms than you could have ever imagined."

So how would EA exploit its own bank of intellectual property? Probst won't speculate beyond games, but Bing Gordon will: "In 10 years EA will unquestionably be in entertainment fields other than videogaming." EA's 2,500-strong internal studio is actually twice as big as Disney's animation group, and, Gordon notes, it includes a small army of accomplished Hollywood-expat musicians, writers, animators, and special-effects experts who have worked on movies like Shrek and Titanic--"the guys who know how to make bit hits." Gordon says EA will probably start producing game soundtrack CDs; music videos that tie into EA games are another possibility. And he even hints that EA could someday form a digital animated movie studio a la Pixar. Walt himself would be proud.

Geoff Keighley covers the videogame industry from Los Angeles.