Epic Games

[0] 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.

[1] That's so good.

[2] Just like low in the background, you've got Spotify going?

[3] That's amazing.

[4] It's like nice of you to join me in the club for our meeting.

[5] That's really smart.

[6] Welcome to Season 7, Episode 3 of Acquired, the podcast about great technology companies and the stories and playbooks behind them.

[7] I'm Ben Gilbert.

[8] I'm David Rosenthal, and we are your hosts.

[9] 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.

[10] So we wanted to tell you a little bit about who we are.

[11] I am the co -founder of Pioneer Square Labs in Seattle.

[12] We are a startup studio and early stage venture fund.

[13] And my background is primarily in founding companies and product management.

[14] And I have been a longtime venture capitalists.

[15] I'm currently an independent angel investor and advisor to startup.

[16] based in San Francisco.

[17] So I come at things from the venture and investing side.

[18] 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.

[19] The Zoom cooler.

[20] The Zoom cooler.

[21] Exactly.

[22] Well, today we will explore what happens when an idealist has full control over a product with perfect global product market fit, unbelievable economics, and has the leverage to shape the world to his idealistic will, even potentially at the expense of his own business.

[23] Today we talk about epic games, makers of Fortnite and the Unreal Game Engine.

[24] You probably know of them since Fortnite 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.

[25] Or because they are currently the most credible threat to the world, world's largest company, Apple.

[26] Not to mention, of course, the incredible amount of attention Fortnite consumes is a threat to Facebook's advertising business model, Netflix cites it to their investors as the number one threat, and Epic is really the primary U .S. ally of the quiet Chinese giant Tencent.

[27] But their ambitions expand far beyond any of this, and we can't wait to bring you the full story today.

[28] 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.

[29] So strap in.

[30] Incredible.

[31] Can I wait to dive into this one?

[32] 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.

[33] 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 talk with all of you directly.

[34] And of course, our book club and the Zoom calls that we have with the authors.

[35] Our most recent episode on the LP show was on the fundamentals of venture capital discussing how VC firms make their investment decisions.

[36] So tune in if that's of interest to you as a founder or active or aspiring investor.

[37] 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.

[38] We realize too, 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.

[39] It's because limited partners are the folks that give capital to VCs and venture firms and make everything possible.

[40] And that's what you guys are for us too.

[41] You are super special.

[42] Everyone who is an LP, we thank you.

[43] And if you want to become one, can't wait to have you.

[44] Yep.

[45] Okay, listeners, now is a great time to thank one of our big partners here at Acquired, ServiceNow.

[46] Yes.

[47] Service Now is the AI platform for business transformation, helping automate processes, improve service delivery, and increase efficiency.

[48] 85 % of the Fortune 500 runs on them, and they have quickly joined the Microsoft's at the NVIDias as one of the most important enterprise technology vendors in the world.

[49] And, just like them, ServiceNow has AI baked in everywhere in their platform.

[50] They're also a major partner of both Microsoft and NVIDIA.

[51] I was at NVIDIA's GTC earlier this year, and Jensen brought up ServiceNow and their partnership many times throughout the keynote.

[52] So why is ServiceNow so important to both NVIDIA and Microsoft companies we've explored deeply in the last year on the show?

[53] Well, AI in the real world is only as good as the bedrock platform it's built into.

[54] So whether you're looking for AI to supercharge developers and IT, empower and streamline customer service, or enable HR to deliver better employee experiences, Service Now is the platform that can make it possible.

[55] Interestingly, employees can not only get answers to their questions, but they're offered actions that they can take immediately.

[56] For example, smarter self -service for changing 401k contributions directly through AI -powered chat, or developers building apps faster with AI -powered code generation, or service agents that can use AI to notify you of a product that needs replacement before people even chat with you.

[57] With ServiceNow's platform, your business can put AI to work today.

[58] It's pretty incredible that ServiceNow built AI directly into their platform.

[59] So all the integration work to prepare for it that otherwise would have taken you years is already done.

[60] So if you want to learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go over to servicenow .com slash acquired.

[61] And when you get in touch, just tell them Ben and David sent you.

[62] Thanks, service now.

[63] All right, listeners, time for our episode on Epic Games.

[64] Woo, let's dive in.

[65] Before we do, we owe a lot of thank yous on this one, on the research, to a whole bunch of people who have written a lot and done a lot of great reporting and analysis of Epic, Apple, Tencent, everything going on here.

[66] Three in particular, I wanted to call out, though.

[67] One is Matthew Ball and Jacob Novak, who wrote just an awesome six -part primer on Epic and all the dynamics around the company.

[68] We'll link to that in the show notes.

[69] Definitely go read that.

[70] 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.

[71] So many of the quotes that we're going to use from Tim direct quotes in this episode are from that interview.

[72] And then finally, this is so fun.

[73] I finally get a chance to use my favorite non -tech industry podcast out there as a source for an acquired episode.

[74] You've been waiting for this forever.

[75] I've been, Ben knows.

[76] I've been wanting to do this forever.

[77] Wizard and the Bruiser, such an awesome podcast.

[78] It's like basically acquired for nerd history.

[79] Then what are we?

[80] We're business nerd history.

[81] Yes, they're more game nerds.

[82] I suppose we're more business nerds.

[83] Yeah, games and like anime and stuff.

[84] They did a deep dive episode on Epic last year, which was super helpful jumpstarting our research.

[85] So thanks, guys, as always.

[86] And for everyone, we've put all.

[87] all of our links to every source that we use in the show notes.

[88] So feel free to peruse those.

[89] And a special shout out to Griff in the Acquired Slack at Acquired .fm slash Slack who recommended the Matthew Ballpiece that really got us started sort of down the rabbit hole of researching this in the first place.

[90] So awesome to have listeners help us do some of the research.

[91] Always great.

[92] All right.

[93] So we're going to get to all of the high drama here around, Fortnite, Tencent, Apple, the lawsuits, et cetera.

[94] As always on Acquired, we start way back.

[95] 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.

[96] So who is Tim?

[97] He was born in the year 1970 in Potomac, Maryland.

[98] He was the third of three brothers.

[99] But his older two brothers were much older.

[100] So one was 10 years older than him.

[101] And the other one was, 15 years older.

[102] So while he was the youngest of three brothers, he was probably almost kind of like an only child for a lot of his life.

[103] I mean, by the time he was, I guess would have been in elementary school.

[104] Both of his brothers were probably in college or out of college at that point.

[105] Yeah.

[106] And I think he started programming super young, right?

[107] Like he was a 11 year old game programmer.

[108] Yeah.

[109] So it's all wrapped up in this.

[110] So his dad worked for the Department of Defense.

[111] He worked at the mapping agency as part of the intelligence unit where they were creating.

[112] military maps from satellite imagery, kind of doing like Palantir and Skybox type stuff way back in the day before those companies.

[113] So early on, young Tim realizes two things about himself.

[114] One is that he loves tinkering with like the guts of how things work, like both mechanical and as we will soon see computers and technical things.

[115] Two, is he also actually loves business.

[116] And this is a pretty rare combination.

[117] He becomes a just fantastic engineer and a fantastic business mind.

[118] But he doesn't love business for the money.

[119] I mean, this is a man who really does not have a lot of use for money.

[120] He lives in North Carolina.

[121] He's not married.

[122] He doesn't have kids.

[123] He doesn't hang out with celebrities.

[124] Yeah, he's like bought a few fancy sports cars and a nice house and stuff.

[125] But, you know, he mostly, he's talked about this to the Wall Street Journal.

[126] He mostly eats Bojangles fried chicken and drinks Diet Coke.

[127] he wears cargo pants that he probably buys for about 20 bucks.

[128] And what he does is he basically writes code and works on Epic.

[129] 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.

[130] You say he loves business.

[131] He's more of a business engineer.

[132] Like, he's not a mogul.

[133] 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.

[134] And by pulling all the levers, I mean, it really isn't bringing an engineering mindset to the business or a tinkerer's mindset.

[135] Yeah.

[136] 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.

[137] One more point to just like paint the classic computer engineer that is Tim Sweeney is David, you and I both watched this video from, I think, 2008, where they interview Tim and he's got his sports car and his nice house.

[138] And he's like, here's my dining room.

[139] Here's my dining room table.

[140] I've never eaten at it.

[141] Mostly kind of go to Burger King.

[142] 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.

[143] Totally.

[144] All right.

[145] So how did he get this way?

[146] 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 racing them around.

[147] I feel like his parents must have, by this point in time, just been tired of, like, raising little kids for so many years.

[148] They're just like, all right, Tim, do whatever you want.

[149] And then a couple years later, when he's about nine or ten years old.

[150] A video game arcade pops up pretty near his house.

[151] This is like 1980 time frame.

[152] So this is kind of Nolan Bushnell, like height of Atari, you know, just after Pong, but like Space Invaders was a thing.

[153] And Tim becomes super fascinated by this arcade.

[154] And eventually his parents get him an Atari 2 ,600 at home.

[155] But it's not so much because he loves playing the games, although he thinks they're interesting.

[156] He's interested in how they work.

[157] And in particular, like how the cabinets work.

[158] So he talks about the Atari 2 ,600 that he got.

[159] He's like, yeah, like, I liked playing some of the games, but it was a pretty crappy machine compared to the cabinets.

[160] He wanted to know how these things work.

[161] Then a little bit after this time, after he started getting into games and 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.

[162] Remember, this is like 1981, 1982, so kind of just at the start of the PC revolution.

[163] And Steve had bought a bunch of brand new IBM PCs that they were using at the company.

[164] And so he shows young 11 -year -old Tim, you know, how to use these things, how to program it in basic.

[165] And Tim's like, that's it.

[166] He's found his calling in life.

[167] And he has this great quote, you're trying to build a go -kart.

[168] You can spend months on something like that.

[169] And it never quite works right.

[170] but the computer would do exactly what you say.

[171] I could write in just a few hours a really impressive program.

[172] It was the ultimate machine to tinker with.

[173] It was love at first sight.

[174] From that point on, I tried to dedicate all of the time I had free to learning to do more with computers.

[175] Which for anyone who's a programmer out there knows, the computer always does exactly what you're telling it is both a gift and a curse.

[176] Because if it's doing the wrong thing, like, I mean, it's just running the instructions you put in there.

[177] 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.

[178] So he buys the family back in Maryland an apple too.

[179] And this becomes like Tim's obsession.

[180] He starts making games and other programs for it.

[181] And he estimates that over the next couple of years, you know, he would spend the canonical like Malcolm Gladwell 10 ,000 hours teaching himself how to program.

[182] And this is what's so cool because remember his dad works for for DOD.

[183] he has access to like early, early proto internet networking type stuff.

[184] 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.

[185] So he's completely self -taught and he makes a few games during this time, but he never really shares them with anybody.

[186] So then a little bit later in high school is when he discovers his second passion for for business.

[187] 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, $4 an hour.

[188] 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 going to earn $4 an hour for the summer.

[189] Like this is the very like programmer engineering mind like working at this here.

[190] He's like, there's got to be a more optimal way I could use my time, not because I really need.

[191] need the money, but just like, I could do better.

[192] So what he decides instead is he sees that there are a bunch of lawn mowing businesses operating in the neighborhood.

[193] You know, it's summertime, cutting the grass in Maryland.

[194] And he goes around and he asks them, and he's like, hey, ask these families, how much are you paying your lawn mowing services?

[195] And they're like, oh, yeah, we usually pay like 100, 120 bucks for mowing the lawn.

[196] And Tim's like, bingo.

[197] So he quits his job.

[198] at the hardware store, and he undercuts the market by 2x.

[199] He charges all the families in the neighborhood $60 to mow their lawns.

[200] He runs the math and figures he's using his dad's tractor that he's pulling in about $25 an hour.

[201] That feels like an insanely expensive lawn cutting for the time in on the East Coast.

[202] These must have been pretty big lawns.

[203] Yeah, no kidding.

[204] Either that or very high willingness to pay.

[205] Yeah, fast -growing lawns.

[206] Yeah, indeed.

[207] He has this great quote.

[208] He says, that's when I came to a really clear.

[209] 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.

[210] At that point, it became really clear to me that there were big opportunities in the world.

[211] Super cool.

[212] So, as we said, he ends up going to the University of Maryland nearby, close to home.

[213] He's not a particularly great student.

[214] He's spending all of his time on his Apple II and BBS systems.

[215] And he decides to study mechanical engineering because they have a computer science department there but like he thought that would be a waste of time like he already knows how to program he's going to learn like more interesting stuff and he actually ends up learning a lot of math he says I was going to say the math and the physics here seem like they'll come in handy seem like they'll come in handy yeah on the side though he'd kept his lawn mowing 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.

[216] I really have this skill with computers that not a lot of people have at the time.

[217] What if I start doing computer consulting instead?

[218] So he starts a company.

[219] He calls it Potomac computer systems.

[220] And he goes around to, you know, families and businesses and helps them set up databases and the like.

[221] And that's kind of going okay.

[222] But either as part of that or maybe unrelated, he eventually gets a 286 IBM computer.

[223] And we've talked about this on a bunch 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.

[224] 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.

[225] Indeed.

[226] So Tim realizes this, that there's all of a sudden a pretty big install base out there.

[227] And so even though he kind of likes programming on the Apple 2 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.

[228] So he decides to do it.

[229] And he's like, okay, what software am I going to write?

[230] To start writing software, I need to use a text editor on the IBM PC market.

[231] to actually write the software.

[232] And this is like pre, you know, for those listeners out there who are engineers are familiar with engineering pre like VIM and Emacs days, there's no good text editors.

[233] So he's like, oh, great, I'm going to write a text editor first for other software developers.

[234] Sensing a theme here.

[235] So he sits down, he starts trying to do it.

[236] But he gets distracted and he keeps thinking about how he could, instead of writing this text editor, he can make it into a game.

[237] He has this quote.

[238] 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.

[239] Similar to Atari Adventure, I based it on rooms.

[240] Each screen full of text became a room.

[241] I had different graphical characters represent different gameplay behaviors.

[242] 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.

[243] So he calls this game ZZT.

[244] Oh, I didn't realize ZZT, was the thing that was first a text editor.

[245] I knew that was his first game, but wow.

[246] It was his first game, but this is what's so cool.

[247] And it really just kind of foreshadows everything to come with Epic.

[248] 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.

[249] And then you can kind of play the game.

[250] He ships ZZT as a game with, well, he actually did it as shareware.

[251] 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.

[252] Which, of course, he would mail you.

[253] He would mail you, yep, which is pretty awesome in and of itself.

[254] 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.

[255] 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.

[256] and then thing two being, hey, this game is editable.

[257] Yep.

[258] This is when he decides, hey, I probably need a different name for this business besides Potomac computer systems.

[259] And something that makes us sound like a really big company, like a big important, you know.

[260] Yep.

[261] Like we're on the same level as, you know, id software is just getting started around this time.

[262] And they have a really cool name.

[263] Why don't we call it Epic Mega Games?

[264] And of course, by we, I mean, Tim.

[265] because it's just him.

[266] He releases ZZT, and it does pretty well.

[267] Like, he doesn't make a ton of money, but he sells a few thousand copies.

[268] Incredibly, they would keep selling the game until 2013.

[269] What?

[270] Yeah, this is incredible.

[271] I found it in the research.

[272] So Tim's dad, Paul, ended up taking over distribution of the game.

[273] It was still just sold through this shareware model of, like, right to Tim.

[274] 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 software swaps or you'd go to like user groups or like we were part of Mac users of Delaware.

[275] And so we'd go to the mud meetings.

[276] People would demo and you'd swap software there or you'd sell software there because there's no internet to go find software.

[277] So you needed to like discover it in some way from other nerds who are writing shareware.

[278] Yep.

[279] Totally.

[280] And you know, the reason shareware was attractive, especially to an indie software dev like tip at the time was, Your other alternative was to try and go the retail packaged software model.

[281] Well, so to do that, you had to go get a big publisher.

[282] Like, electronic arts was just kind of getting started at this time.

[283] And we did our episode with Trip on the beginnings of that industry.

[284] You know, he was thinking about it like Hollywood.

[285] Like, you needed these big budgets and, like, fund these studios.

[286] And then you had the relationships with the retailers to get the boxes into retail stores.

[287] The retailers would take 50%.

[288] You know, when all of a sudden done, you know, Which is Apple's current argument to Congress.

[289] Exactly, exactly.

[290] 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 % of the revenue that he would be seeing out of the game.

[291] Whereas this shareware path, he kept 100%.

[292] Pretty cool if you can get the discovery and distribution.

[293] Indeed, indeed.

[294] And process the payments and do all the other very expensive things.

[295] involved in.

[296] I feel like I'm Apple over here pedaling.

[297] Well, that's, it was lucky for Tim.

[298] He had his dad to, you know, process the payments, i .e. open the checks and package up the floppy disks in mailing envelopes and send them out.

[299] So ZCT does pretty well.

[300] Like I said, they sell a couple thousand copies of this.

[301] Tim starts looking around.

[302] And one thing that he has always been really good at is observing what's going on in the market.

[303] Now, I mentioned id software a minute ago and folks who know their gaming history, know that it was John Carmack and John Romero and would eventually end up making Doom, which we'll talk about it in a minute.

[304] And Quake, right?

[305] And quake, yes, after Doom.

[306] But before Doom, it had released a game called Commander Kean and it was a 2D side -scrolling game.

[307] It was a pretty big graphical leap forward versus the like literally text editor -based games like ZZT.

[308] And so Tim saw Commander Keene out there and he said, hmm, okay, that's interesting.

[309] I should do something like that.

[310] What's a twist I could put on it?

[311] Well, what if I do it with a female protagonist?

[312] And so he basically cloned Commander Keene, but called it Jill of the Jungle instead.

[313] I love it.

[314] Now, but because it was a 2D side scrolling game, it wasn't just text base.

[315] It needed actual like artwork and assets in the game.

[316] Tim wasn't capable of doing that just on his.

[317] own.

[318] So he needs to recruit people.

[319] And he ends up recruiting some really great folks that he meets, you know, on bulletin 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.

[320] Cliff, known as Cliffie B, would go on to become legendary and super important for Unreal and then the Gears of War series.

[321] He recruits this really great talent.

[322] And then he also realizes like, okay, you know, I want to make this great game.

[323] I need the talent to make the games.

[324] But, you know, I also need some talent on the business and distribution side here because I'm trying to build a big company.

[325] And who was the big company, of course, at the time it was I'd.

[326] So he calls up Ed and he starts talking with their president at the time, Mark Ryan, who was handling all of I'd's distribution and publishing.

[327] I don't know he's the president of I. Yeah, he was the early...

[328] He recruited away the president?

[329] Yeah, he was the early president of Id. Wow.

[330] So at first they're talking about like, well, maybe I'd could publish Jill of the Jungle, but then Mark ends up falling out with Carmack and Romero, leaving Id, and Tim says, hey, I've got an even better idea.

[331] Why don't you come join us here at Epic, and you can be our head of distribution.

[332] and publishing.

[333] And so he recruits Mark, who, yeah, had been president of Id to come join this company.

[334] Remember, Tim is...

[335] That's a crazy career move for him.

[336] Like, he's president of one of the biggest game companies in the world at that point.

[337] And to go and take anything less than that title is wild.

[338] Totally wild.

[339] He became vice president at Epic, which he was...

[340] As in play, what, three or two or something.

[341] Yeah.

[342] Indeed.

[343] So he comes and joins Tim.

[344] Remember, Tim is like a junior in college at this point in time.

[345] And he's got Cliffy B working with him, who's a senior in high school.

[346] But they put out this game and it does really well.

[347] And then Cliffy B starts working on a few other games that also do really well.

[348] Next thing you know, they're selling quite a good bit of software through this shareware model and doing quite well.

[349] And so Tim ends up dropping out of college in his final year and they go full time on the business.

[350] So they're, selling these games, they're all still 2D side scrollers, but there's another pretty big revolution that's about to come in the nascent gaming industry here.

[351] And it's going to come...

[352] And what year are we in?

[353] So we're now in like the early 90s, like 91, 92.

[354] So pretty quickly after that, Id and John Carmack start talking about this big project that they're working on.

[355] And it's a game that's going to be called Doom.

[356] 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.

[357] But it's easy to forget.

[358] And I had kind of forgotten until doing this research, just how revolutionary this game was at the time.

[359] And it got a lot.

[360] Was it the first 3D game?

[361] It was the first 3D game.

[362] Like before Doom, you know, everything looked like a Super Nintendo style.

[363] game.

[364] And Doom was the first game, and it ran, this is crazy.

[365] 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.

[366] Just amazing feats of computer science, because this well predates graphics cards or anything that's sort of optimized to do this.

[367] It's just like an unbelievable amount of trigonometry and math.

[368] And, and John Carmack used all sorts of.

[369] of crazy programming tricks to make this work.

[370] And so it comes out and like this becomes like the Fortnite of its day.

[371] Because it was also distributed via shareware.

[372] So when you say the Fortnite of its day though, like let's paint this clear for this tiny constrained market that was video games, it owned to that market.

[373] But we're nothing like the hundred plus billion dollar video game market of today.

[374] No. I mean, for reference, you know, Fortnite has 350 million million registered players at this time.

[375] Doom ends up having a few million copies that it both sells and distributes via shareware in those first couple years.

[376] Ultimately, I think it would get to 10 or 20 million copies.

[377] But no video game had ever approached anything like those numbers before.

[378] So Tim and Epic and Mark are like, okay, cool.

[379] Well, this is where the industry is going.

[380] We got to skate where the puck's going here.

[381] We need to work on a similar process.

[382] project.

[383] And so they do.

[384] They start getting to work on the project.

[385] They're going to call their 3D shooter Unreal.

[386] 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.

[387] And it was this massive proprietary advantage that it had.

[388] So anybody like Tim and Epic that was trying to get a competing product out there, it was just going to be nigh impossible.

[389] But this doesn't deter it to him.

[390] He starts thinking about an idea.

[391] He's like, huh, okay.

[392] Well, I know that it spent all this time and effort working to make Doom work.

[393] They work on other projects.

[394] And Ben, you mentioned Quake.

[395] That would be the successor to Doom that they would come out with.

[396] They're rewriting the wheel each time they come out with a new game.

[397] 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.

[398] So they have this lead, but it's not like they're going to keep just like churning out game after game after game and nobody else is going to catch up.

[399] I can take my time, build a engine, similar to 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 and not have to.

[400] go through all these hoops each time that it is having to go through.

[401] So he's like, okay, cool, we're going to invest the time up front to do this.

[402] That parallel here is in sort of Jeff Bezos speak.

[403] Tim is working on a system that uses primitives, building blocks, rather than sort of starting from zero each time.

[404] 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.

[405] Yep.

[406] So he starts working on it and he's not shy about what he's doing.

[407] He's trying to build hype for the game for Unreal.

[408] He's talking to game magazines and the like.

[409] A pretty incredible thing happens.

[410] Other developers start coming and studios start coming to Tim and Mark and saying, hey, I hear you're working on this engine.

[411] We would also love to make 3D type games and compete with it in Doom, would you be willing to license it to us?

[412] And Tim says, uh, yes.

[413] 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.

[414] Yes.

[415] In fact, I believe some of the first games that were made uh, by third parties on the Unreal Engine came out within like, you know, a few months or a year of Unreal itself.

[416] Oh, wow.

[417] Crazy.

[418] Yeah, totally crazy.

[419] So it turns out this was a really big idea because these dynamics were 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.

[420] 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.

[421] 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.

[422] 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.

[423] Yep.

[424] And it turned out, you know, almost like in a much bigger way than what Tim saw when he tried to do, started 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.

[425] 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 an engineering side of the house and a creative side of the house.

[426] That makes sense.

[427] Now, listeners, I want to pause for a moment and say, we keep saying Tim.

[428] And, you know, today, Epic is like a 2 ,000 person company.

[429] 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.

[430] There's a very small operation going on here.

[431] And Tim was absolutely making the strategic decisions about what the company would be and what it would do.

[432] Yeah.

[433] And not only was it a small operation, it was a remote operation.

[434] So they didn't even all like live in Maryland together.

[435] They were communicating via, you know, early, you know, early internet technologies here.

[436] So finally, after just about five years of working on this, in 1998, Unreal comes out, and along with the official unveiling of the Unreal engine for game developers, and Unreal itself is a big hit, but also games that are built on it.

[437] So games like Deucex, which people might remember use it.

[438] And then a few short years after all of this comes out, there's a major change in the gaming industry, which is, after many years of talking about it, Microsoft finally enters the picture with the launch of the Xbox in 2001.

[439] This does a whole bunch of stuff.

[440] You know, one, it inserts a huge, you know, amount of weight and marketing muscle behind gaming.

[441] Two, it massively expands the console market because of that marketing weight.

[442] behind it, which was previously just the original PlayStation and N64.

[443] 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 were really the only, and the Dreamcast were the only predecessors before Microsoft entered that, that console market.

[444] Indeed.

[445] And really, though, it was, it was two separate parts of the market, because Sony and Nintendo were the only viable players.

[446] Sony was where all the third -party developers went.

[447] Nintendo had terrible onerous royalty terms 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.

[448] Nintendo's attitude has always been.

[449] We're both the best at the technology and the best at the creative gameplay.

[450] And so the systems are for our games.

[451] And sure, if you want to let us have most of the economics, then you two can develop for our system.

[452] But they're mostly a vertically integrated company.

[453] When Microsoft came out, though, now all of a sudden, they're duking it out with Sony for developers.

[454] So as a developer, on the one hand, that's good because now you've got two companies competing for your favor and willing to, if you're good and making, you know, have the promise of making good content, willing to give you good deals.

[455] 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.

[456] You're going to have to build from the ground up.

[457] Full dual development teams.

[458] Full dual development teams.

[459] 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, uh, it's not quite as easy as just like check a box to deploy to PlayStation.

[460] Turns out right, right wants to run any anywhere, has been promised many times and has been successful zero of them.

[461] I mean, these days it's pretty close, but it's so much better.

[462] Tell that to a React Native developer.

[463] It's so much better even then than having to have two full separate development teams.

[464] So once this happens, they start getting some really huge games and franchises start moving over to building on Unreal.

[465] So like the Tom Clancy games, you know, Splinter Cell, Rainbow Six, those games.

[466] Bioshock, Mass Effect, Borderlands.

[467] These are all in the kind of early 2000s, early to mid -2000s.

[468] They're coming over building on Unreal and then being able to sell pretty quickly.

[469] They might do an exclusive with Sony or Nintendo for six months or whatever that that platform gets at first, but then they're able to access the rest of the market and go to the other half.

[470] Right.

[471] And so by this point, Epic is a technology company.

[472] Like they make games and they make this game engine, which is a huge component of the games value chain.

[473] but they're a technology company rather than a first and foremost game company.

[474] And so when you ask sort of Tim to describe the history, he described we have Epic 1 .0, which was Potomac computer systems.

[475] We have Epic 2 .0, where we sort of realized that, oh, yeah, this technology company builds a game engine.

[476] It's the PC gaming sort of revolution of the late 90s to about 2005.

[477] And then David, exactly what you're talking about now.

[478] 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 in developing a game like full steam ahead on consoles.

[479] We will be an essential part of building that business.

[480] Yep.

[481] And they do keep building some games in house as well, but they're thinking about it kind of like Amazon and AWS.

[482] They're the first and best customer for the technology that they're building as part of the engine.

[483] You know, they do Unreal tournament.

[484] They do Unreal Championship.

[485] They do other games.

[486] but they're really...

[487] I love how East Coast that just was.

[488] Did you say Unreal Tournament?

[489] That is like how an East Coaster says tournament.

[490] Oh my gosh.

[491] You know, I never even like noticed that.

[492] Growing up, I would say Orange.

[493] Jenny has taught me to say Orange.

[494] What's the Nintendo character?

[495] Mario.

[496] All right, there you go.

[497] I've got some New York friends that say Mario.

[498] Ah, yeah, yeah.

[499] Anyway, we digress.

[500] We digress.

[501] Appropriate digressions, though.

[502] 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.

[503] 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.

[504] 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?

[505] We're going to be launching a new version of the Unreal Engine, Unreal Engine 3 .0.

[506] Microsoft is coming out with their next generation hardware, the Xbox 360 at the time.

[507] Yep.

[508] And we might be able to get some really good marketing dollars here from them if we're a launch or near launch exclusive title with the 360.

[509] And Microsoft's effectively in this relationship, the publisher and Epic is the developer?

[510] Yes.

[511] I believe that is correct.

[512] And so Epic develops this game called Gears of War, which most listeners will probably be familiar with, becomes...

[513] It's the game where you could push that one button and put your back against a wall and look around a corner.

[514] Yep, totally.

[515] So it's so funny how so many games had this, like, signature move.

[516] And they, like, that was amazing.

[517] That was in every commercial.

[518] That was in every demo.

[519] And you first played the game.

[520] Like, that is the thing that you wanted to try and do.

[521] And this thing sold so many Xbox 360s.

[522] Like, yeah.

[523] And so as a result of all of this, the thing is this kind of becomes a red herring for the company.

[524] So they end up making, Epic ends up making $100 million of revenue on Gears of War.

[525] it cost them $12 million.

[526] And I believe that's $12 million across development and marketing because Microsoft was handling so much of the marketing budget.

[527] Wow, I'll make that bet all day.

[528] Totally.

[529] So they're literally making 88 % margin on $100 million in revenue.

[530] You know, they had been successful in lots of dimensions up to this point, both on the technology and the game side.

[531] But this is a whole other level.

[532] Why ever be your own publisher?

[533] Sure.

[534] I mean, it's great if you're the developer.

[535] Someone else is going to spend the money.

[536] You just have to develop the game.

[537] It's great.

[538] Like, why ever change?

[539] I mean, I remember I was just coming into graduating college and getting into media investment banking at the time.

[540] And people were thinking like, oh, man, games are going to be like Hollywood.

[541] Like, this is Hollywood movie style money.

[542] The dynamics are really similar here.

[543] This is going to be great.

[544] It turns out, though, that Hollywood is actually.

[545] not that good of a business and an industry.

[546] And why is that?

[547] It's super capital intensive.

[548] So Gears of War I was kind of a red herring for a bunch of reasons.

[549] You know, it was a launch title with 360.

[550] Microsoft handled so much the promotion in marketing.

[551] When the Epic ends up doing Gears of War II and then Gears of War III, their economics, like the games sell roughly the same amount, maybe not quite as much in terms of revenue.

[552] 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.

[553] And so Tim and Epic kind of realize like, huh, this is not as interesting as we thought it was.

[554] Time to get out.

[555] It also started to show the tension between this sort of developer publisher model.

[556] 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.

[557] It's almost like think about it as 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.

[558] And the publisher is the investor.

[559] They're sort of fronting the money.

[560] They're doing the marketing.

[561] They know how to businessify your creative efforts.

[562] And so the issue is when push comes to shove like it did with, what was it, Gears of War, I think after maybe Gears of War III, Epic wanted.

[563] to do a multiplayer -only version.

[564] They said, look, we think multiplayer gaming is the future, hint, hint, you know, or nudge -nudge to where they are today, and online is, you know, right around the corner, starting to become a thing.

[565] And so we think that...

[566] And Microsoft was like, no, we don't care.

[567] We want to move more at 360s.

[568] Exactly.

[569] And so it was basically a stalemate at that point, and Microsoft was the publisher.

[570] Like, Microsoft was the money behind it.

[571] And so, you know, they won.

[572] So we're now right around like 2009, 2010 timeframe.

[573] And Tim has a quote.

[574] He says, there was an increasing realization that the old model wasn't working anymore.

[575] And the new model was looking increasingly like the way to go.

[576] So what is the new model?

[577] So two things happen right around this time that totally lay the groundwork for what Epic is today.

[578] The first is in October 2009, a little company in L. We'll start up in LA, launches a game, if you could call it that.

[579] It's really a mod on a mod of an existing game.

[580] This is a mod of Half -Life 2?

[581] No, no, no, no. I'm talking about League.

[582] Oh, yeah, yeah.

[583] So the mod of Warcraft 3 is the mobile online battle arena game of Dota, or was it Defense of the Ancients?

[584] Yep.

[585] And of course, there's a lot of controversy over if this is idea theft or if this is above bar.

[586] But you have this very similar looking game that I think you're referring to, David, being started by a plucky startup in L .A. in 2009.

[587] Yep.

[588] And that company is Riot Games.

[589] And that game is League of Legends.

[590] And so what is League?

[591] I mean, it's a MoBA, massively online battle arena.

[592] 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.

[593] It's distributed 100 % online.

[594] It's a mod of an existing game engine that's out there.

[595] Rip off.

[596] I didn't say that.

[597] But it means that it can get to market so much faster.

[598] And then the other big innovation that they have is they don't charge for it.

[599] It's free, free to play.

[600] Now, free to play, that term had gotten a really bad name in the industry because mobile games had taken that up.

[601] 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.

[602] And this was just starting.

[603] I mean, that it got a really bad name in sort of that 2012 to 2014 era in this era.

[604] Because think of it, the iPhone was 2007.

[605] The App Store was 2008.

[606] So it wasn't quite the sort of dirty backwater social had given in a bad name before a mobile game in a bad name.

[607] So the free to play stuff on Facebook was.

[608] It was, you know, the Zinga type stuff.

[609] And, you know, Zingo is, well, probably in many ways not the worst offender in this regard.

[610] But, you know, all of the games that you had to pay to make any progress in, what League was and what Riot's big innovation was that you could buy things, but they were just aesthetic.

[611] They were just virtual goods.

[612] They didn't actually help you succeed in the game in any way, shape, or form.

[613] they just gave you personality.

[614] Yeah, so it was still free to win, but you could pay for other things.

[615] Yeah.

[616] And this ends up coming to be known as Games as a Service, which we'll get into in a second.

[617] 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.

[618] Oh, that's right.

[619] I forgot about that.

[620] And that actually was the beginning of these, like, really long, sort of distracting demos at Apple keynotes of games, where, 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.

[621] And so you're like, okay, they're showing off, okay, this time it's metal and it's an Apple in -house technology, and Craig's all excited about it.

[622] But, okay, good.

[623] I'm glad someone else made another cool game that takes advantage to some hardware feature I don't understand.

[624] I always have beef with those being in Apple Keynotes, but I guess.

[625] that it was a leap forward?

[626] Well, it was leap forward because, A, you could bring, you know, this incredible console quality graphics and gaming technology to mobile.

[627] But it was even more important for the industry in terms of enabling cross -platform, deploying and development, and then ultimately online play of games.

[628] So Epic now is right in the middle of all of this, because if you have a game as a service, like League of Legends, or any other, you know, free -to -win type game.

[629] Importantly, that's fully distributed digitally.

[630] So you don't, there's no more box software.

[631] It is being distributed over the internet.

[632] Yep.

[633] You want to get that in the hands of as many players on as many platforms as possible.

[634] You know, game developers always wanted to do this.

[635] They wanted to be on Microsoft and on Sony.

[636] But at the end of the day, they're selling box software and like, that's fine.

[637] 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.

[638] 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?

[639] Yeah.

[640] So 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.

[641] 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.

[642] So rather than your only chance to monetize being every time you ship a new disc 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.

[643] 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.

[644] What this does to the industry is it kind of makes it like the SaaS industry.

[645] You know, you'd gone from expensive to develop capitalized software that required years of development time and was big and monolithic, you know, your Oracle or you're a lot of Microsoft software or your, 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.

[646] Don't we wish?

[647] Yeah, don't we wish?

[648] Get it out there and be used and build real businesses.

[649] with great economics.

[650] So the same thing starts to happen in the gaming industry.

[651] 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 Tencent.

[652] Yep.

[653] Yeah, I mean, this is really interesting because Riot is pioneering this in the United States.

[654] Tencent had already sort of done it with the the ability to do micro -transactions on their early games in China, something that they were definitely ahead on.

[655] And as soon as Riot started to succeed in it very early, I think it was pre -2011, maybe 2010, Tencent invested in Riot.

[656] Once Tencent 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.

[657] So Tim sees all this going on.

[658] on.

[659] And in he wants to move epic in the direction of becoming essentially the, you know, AWS plus stripe enabling this future, you know, Renaissance and independent creators and game developers.

[660] And the current state of their business, sort of they had sold Gears of War, the full franchise, all the IP, everything to Microsoft.

[661] Not quite yet.

[662] Okay.

[663] First, he starts talking to Tencent and agrees in 2012, for the first time, to sell any equity in Epic games, he sells a 40 % stake in Epic to Tencent for $330 million.

[664] So valuing Epic at just under a billion dollars, which was kind of crazy at the time.

[665] People were like, this is nuts.

[666] This is a, you know, video game technology developer that, you know, is having bad economics with their big franchise gears of war.

[667] Like, what's going on here?

[668] 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 hits driven business and what you have with 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 hits driven games business yeah 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.

[669] We're going to do three things.

[670] One, the Unreal Engine is now our most important product and piece of technology, and we need to add much more to it.

[671] It's not going to be just about the engine for creating the game.

[672] It needs to be all the infrastructure to run these games and run live ops and do payments and do all of these things.

[673] Funny aside at the time, I was actually, when I was at Madrona, we were venture investors in a company called Playfab in Seattle, 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.

[674] yet.

[675] It just turned out, Playfab ended up getting acquired by Microsoft.

[676] 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.

[677] 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.

[678] We'll talk about this, but Epic has Epic Online Services today.

[679] 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?

[680] 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.

[681] Yeah.

[682] So that was one.

[683] Two, as Tim says, we're going to rationalize the console business.

[684] I don't want to be in that anymore.

[685] We're going to sell the Gears of War franchise to Microsoft.

[686] So they do that in early 2014.

[687] The 10 -set investment was in like late 2012.

[688] 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 game makers developing on the Unreal platform.

[689] Well, we can't anymore be charging people a SaaS fee to use our platform because that's going to lock out, you know, the kids in high school who are building stuff at game jams and...

[690] Right.

[691] Incentives are powerful.

[692] If you charge money for something, less people will do it.

[693] Yep.

[694] 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.

[695] And remember, you know, Unity is out there as well, which is a competing third -party game engine.

[696] Ventureback.

[697] Mostly focused on mobile.

[698] Mostly focused on mobile, but you could use it for lots of things.

[699] For sure, but simpler, newer, amazing for 2D stuff, lighter, more accessible, but you're not going to go build the most amazing 3D first -person shooter or PC game with it.

[700] On Unity?

[701] No. They're still charging a SaaS fee.

[702] Unreal now is completely free.

[703] You're getting literally the stuff that Gears of War is developed on for free.

[704] And instead, the business model is switch to a 5 % royalty on revenue that you would earn on your games after publishing.

[705] That's like a pretty good deal.

[706] I mean, if you think about the amount of fixed cost you'd have to capitalize to do this, it would just be huge.

[707] Even your ongoing operating cost to run technology, it would be more than 5 % of your revenue.

[708] Totally.

[709] You'd have to be massive to make more sense for you to build your own game engine now.

[710] then use Unreal, which is exactly the strategy.

[711] 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.

[712] So like think Blue Hole for Player Unknown's Battleground, which of course we will definitely talk about later.

[713] 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.

[714] Yep.

[715] So those are the three big moves that Epic makes after the 10th cent investment.

[716] 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.

[717] Stripe doesn't feel right yet.

[718] Like Stripe to me would be like the Epic Game Store.

[719] yes well this is doing the groundwork for all that yeah yeah like so okay to to put it in tim's parliant's 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 is like incredibly robust primitives that serve as the horizontal layer to make games and so they've stepped back from we're a game maker except 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.

[720] You know, and we have this rich history of making great games that people love.

[721] So they decide that they're going to spin up three teams internally to start working on Epic's new tools to build new games from Epic that are going to run on this games as a service free to win model.

[722] So the first that they start working on is a reboot of Unreal Tournament.

[723] The second is a MOBA that's going to include Gears of War -style kind of action elements.

[724] It was called Paragon.

[725] And the third was going to be a whole brand -new IP that was going to combine elements of Minecraft and crafting with a tower defense type dynamic.

[726] Those games were popular at that moment in time.

[727] And they had a really cool name for it.

[728] They were going to call it Fortnite.

[729] Well, We just got $330 million, and boy, are we going to spend it is the way that I hear that.

[730] Yep.

[731] Well, so spoiler alert, just like a lot of times when a company gets $330 million and has like the core, you know, economic engine of the company.

[732] But then they have other projects that they want to work on.

[733] Those other projects don't go so well.

[734] So none of those three games work at all.

[735] Yeah.

[736] And if you, yeah, it's interesting.

[737] You say none of the three.

[738] I'm excited to talk about that.

[739] Yes.

[740] The other sort of thing to think about here is this is a company with a bootstrapped culture.

[741] They'd always been starved for resources.

[742] They'd always been few people.

[743] 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 going to be worth it for us.

[744] And now they've got so many resources.

[745] I mean, this is exactly what we talked about on the Eventbrite episode with Julia and Kevin, like, raise a bunch of money.

[746] and there's lots of things that seem like good ways to deploy that capital because you can sort of conceptualize why it'll make sense.

[747] But then you become this like a large organization.

[748] There's, I don't want to call it infighting, but conflicting views about what the future should be.

[749] There's people who are sort of vying for political power that's saying, you know, no, my game's the most important game.

[750] And it results in churn and it results in this happened basically all through Epic's history, but they bought companies, some worked, some didn't.

[751] They'd bring in these studios.

[752] Sometimes they'd end up writing them off.

[753] It just increases all of that sort of fervor and churn around trying to do a bunch of stuff.

[754] Yeah.

[755] And remember, what was Epic and Tim really, really good at?

[756] He was good at looking at what was succeeding in the market at that given moment in time, remixing it a little bit to make it fresh, and then putting it back out there quickly.

[757] You know, that's what he did with Zizi T. That's what he did with Jill in the junk.

[758] That's what Unreal was after Doom.

[759] And that's not what they're doing with these three projects here.

[760] It's unclear that the market really wants them.

[761] So they operate for years in development of each of these games.

[762] So started in 2011, 2012.

[763] Yep.

[764] And going all the way through 2017.

[765] And then basically a miracle happens.

[766] So you mentioned Player Unknown's Battlegrounds.

[767] Tell us a little bit about player unknown battlegrounds.

[768] Yeah, so rewind to 1999.

[769] There is a book released in Japan called Battle Royale, or at least that's the English translation of it.

[770] In 2000, this is made into a very popular Japanese movie.

[771] It has sort of basically inspired the Hunger Games.

[772] Think about a battle on an island, a bunch of children.

[773] I think it's a fight to the death.

[774] It's a little dark.

[775] But basically, you want to be a last person standing.

[776] And there's a variety.

[777] of different games and different sort of anime series that through the early 2000s are sort of based on this battle royale concept.

[778] There's early games.

[779] There's daybreak.

[780] In the end of the 2010s or mid -2010s, there's this game H1Z1 that's starting to incorporate this battle royale concept into a game in, is it 2017 that Battlegrounds comes out?

[781] Yep, March of 2017.

[782] And we will henceforth refer to it as PubGee, Player Unknown's Battlegrounds, comes out.

[783] And it is a smash hit.

[784] It is like this notion of there's a fixed amount of time and there's this circle that is contracting and it's going to bring everybody closer and closer and closer together and you have to be the last person standing and the action's fast paced and it's sort of a 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 purchase -like adornments that you can buy for your character's skins.

[785] But it's pretty, like, realistic.

[786] Like, the violence is actual violence.

[787] Like, it is a war game.

[788] It's dark.

[789] It's realistic.

[790] Also, though, when it first comes out, it's in beta.

[791] It's built on Unreal.

[792] You know, it's not a big team.

[793] It's not Activision that's making this.

[794] It's, you know, an indie dev out there.

[795] Raise your hand if you heard of Blue Hole before this podcast.

[796] It's like, unless you're in the industry, you haven't heard of Player Unknown's parent company.

[797] No. And also in these early days, it's only on PC, I think.

[798] I think you're right.

[799] It was not yet cross -platform.

[800] And again, you know, with, especially with a game like this, you want the more, as many people as possible playing it.

[801] You want your friends playing.

[802] And not all your friends are going to have gaming PCs in just like a literally epic move.

[803] The company and Tim see this happening.

[804] Realize that these internal game projects are not getting any traction.

[805] Yeah, the Unreal Tournament team, I think they sort of knew at this point that that wasn't going to ship.

[806] By the way, like the title Fortnite inside of Epic started in 2011.

[807] So it's been six years of development.

[808] And you have this other team here, this Unreal tournament team that I think had already given up at this point, that it was clear that it was not going to ship.

[809] Paragon is taking a crap ton of resources to make that a reality.

[810] That's the internal status of the company when PubG hits.

[811] PubG hits.

[812] So within two months, the Unreal tournament team hops over into the Fortnite assets.

[813] And remember, they're all developing on the Unreal engine.

[814] So they all know how to work with the assets and the code here.

[815] And they build and launch a new mode of Fortnite called Fortnite Battle Royale that is a Fortnite graphic cartoony take on this battle royale concept that PubG has just taken massive.

[816] They ship it in September 2017.

[817] Within two weeks, they get 10 million active players.

[818] This is just bonkers.

[819] Like 10 million players is probably what Doom got in the whole life of the game.

[820] Within six months, they have 125 million.

[821] active players.

[822] Incredibly, you know, there's some dynamics here, like you mentioned, Ben, that, like, there's less violence.

[823] It appeals to kids more, especially it appeals to parents more who are willing to let their kids play this.

[824] Yeah, like when you die, the drone comes and scans your body and warps you away.

[825] Like it's, and 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 PubG.

[826] Yep.

[827] But unlike PubG, which is only on PCs at this point, because of all of Epic's resources, they immediately deploy it cross -platform.

[828] PCs, consoles, mobile devices, all within the first few months of launching.

[829] Sony actually would be a big holdout.

[830] Sony would let Epic release it on the PlayStation, but wouldn't allow PlayStation players to cross -platform play with other platforms because they wanted to keep everything in -house in the PlayStation network.

[831] Epic eventually convinces Sony that, like, hey, you can't keep this cat in the bag here.

[832] I think they may have even gotten to 125 million users before launching mobile.

[833] Like, it was a, I don't know, maybe that's wrong.

[834] But I remember it was this smash hit phenomenon and it wasn't on mobile yet.

[835] 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 e -sports is going to be this massive moneymaker, which it ended up not being.

[836] Like it was interesting.

[837] You were building an e -ports company at the time, right?

[838] Yes, I was very deep in this at this time with taunt.

[839] E -sports was a really good idea for the publishers and really not that interesting for everyone else.

[840] Streaming was interesting for lots of players in the value chain, but the interesting thing about being in that industry in that moment was PubG went from nowhere to being dominant, and we all thought, wow, here is this new arrival of this thing that's going to be a fixture along with Activision Blizzard's games and riots games.

[841] And then like a few months later, boom, Fortnite blows it out of the water and just steals share like crazy and then goes to even bigger, newer heights.

[842] it was the craziest things you're like, God, like the fervor in this industry right now of what, you know, is going to be the staying power franchise is crazy.

[843] And I want to reflect back on the launch a little bit because Fortnite did launch its original game built by the original team, Fortnite saved the world, that basically didn't work.

[844] It came out, PubG came out, PubG one.

[845] Like, this thing was not a battle royale game.

[846] It wasn't a fight because Fortnite wasn't playing the same game.

[847] Right.

[848] No one was talking about it.

[849] It was like this, yeah.

[850] And the craziest thing was internally at Epic, when you said they started working on the Fortnite assets, like what that actually looked like was copying the code base that a whole other team that was basically laying fallow, the Unreal Tournament team, takes that forked code base, rebuilds the whole thing using the gameplay mechanics of PubG and launches it.

[851] 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.

[852] 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.

[853] And all anybody out in the world cares about is Fortnite.

[854] Like, I don't, anything lower level than that or internal politics don't care about.

[855] 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 of the unreal legend.

[856] It's not even the business model of the company.

[857] The business model of the company.

[858] And Tim's, you know, he's really gotten religion at this point in time.

[859] the mission is build the tools, be the AWS and Stripe and, you know, live ops for all developers to make games.

[860] This is, I think, just like such important backdrop to what's going on now, because now we'll run through what's happening.

[861] But Tim, again, like, he's just viewing this.

[862] Like, this is a windfall.

[863] This is awesome.

[864] This means I get more firepower and more ability to play offense in getting my ultimate vision to come true here.

[865] So, like we said, Fortnite Battle Royale, major cultural phenomenon.

[866] Estimates are that they made $2 .5 billion in revenue in 2018 alone.

[867] So it launched in September 2017, $2 .5 billion in revenue.

[868] October 2018, Epic raises their first non -strategic capital raise.

[869] They raise $1 .5 billion from KKR, Disney, and several other investors at a 15.

[870] billion dollar valuation.

[871] Quite the step up.

[872] Quite the step up.

[873] Quite the step up.

[874] In December 2018, they launched Fortnite Creator mode, which is almost bringing like Roblox type elements into Fortnite of letting people create and ultimately monetize their own designs, levels, experiences.

[875] In doing so, at the same time, they launch the Epic Game Store.

[876] So this is now bringing forward all of this.

[877] 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, Fortnite currency, V -Bucks, and other games, and third -party games in the Epic Game Store.

[878] Of course, you can do this on PCs and on the web.

[879] The opportunity is compete with Steam.

[880] I mean, Steam's been doing this forever.

[881] And frankly, the knock on Valve is those guys haven't had a headache.

[882] hit in forever.

[883] They're just taken a Vig or a rake on all these other games that they basically have a monopoly on PC game distribution.

[884] Yep.

[885] And they're taking a 30 % cut.

[886] And Epic had such a hit with Fortnite where they were like, uh, we had the advantage of never needing to be in your store and always going direct.

[887] So now we have this direct channel to all these customers like, we should leverage that.

[888] Yeah.

[889] So what do they launch the store with?

[890] They launched the store with a 12 percent cut of revenue so they undercut valve by 18 percent and then the kicker is if you build your game on the unreal engine the 5 percent revenue fee gets baked into the 12 percent so they're real on 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.

[891] It's wild.

[892] I mean, it is really, let's, let's even ignore the lack of double dipping on that 5 % from the Unreal Engine.

[893] That 12%, the way that Tim talks about is basically a cost plus pricing model where he says, look, I think it's going to take 5, 7 % to run the store and we don't need to make more than 5%.

[894] We think Apple and Steam are getting away with highway robbery.

[895] And so we're just basically going to make sure that at the maximum we make 5%.

[896] Oh, and, you know, if you're really trusting in us and building on our full stack, we're not going to charge it twice.

[897] Like, it is the exact opposite of what every other CEO in the technology industry these days is doing.

[898] It's not like Google says, hey, if you use a GCE for your infrastructure, whatever you spend on that, we're going to give you credits in AdWords.

[899] No, no. we'll give you a reduced price if you buy more from us, but we're certainly not going to say, yeah, yeah, we'll give you, you know, core assets for free.

[900] Totally.

[901] 2019 is basically the clash between Valve and Steam and the Epic Game Store.

[902] And Valve responds.

[903] They cut their take rate to 25%.

[904] But they're going back and forth.

[905] But really, this is setting the stage for what would happen now this year.

[906] One other conflict that happened previously, too, is with Google, where Epic basically said, look, like, we're not going to go through Google Play anymore because Android, you have this nice open platform.

[907] You brag about it being an open platform.

[908] We are going to have people download the APK where they're just going to side load and install the app directly.

[909] What Epic and all of the people who want to play Fortnite on Android's realizes there's a litany of, oh, my God, you're about to get your phone hacked dialogues that come up between downloading.

[910] that app and getting to play it.

[911] And every time there's an update.

[912] 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 proselytize 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.

[913] So then this year, Epic decides to take this fight.

[914] Directly to, as you say, not just Google, but the Apple, the other Tim, Tim, Tim and Sundar.

[915] I wonder how much the timing of this.

[916] Clearly, Tim had been thinking about this and plotting this move for a while.

[917] 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 K -controversy with Basecamp.

[918] around Apple and the 30 % cut that they're taking on, hey, email software.

[919] 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.

[920] And hey, basically linked to their website or something like that and thus violated an app store policy.

[921] But it's all the same spirit here, right, of like how much.

[922] Pay us 30 % or have this gross and horrible user experience where people have no idea how to sign up for your thing.

[923] So while all this is going on, cracks are starting to form in the developer sentiment with Apple and a little bit Google.

[924] 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 TikTok, you know, social networking.

[925] experience as well, it's a pretty big point of leverage with these ecosystems.

[926] And so finally, on August 13th, 2020, Epic pushes a new version of Fortnite to the iOS App Store and the Google Play Store that offers a permanent discount on V -bucks, the in -game currency in Fortnite, if you buy directly from Epic, which I believe you could.

[927] could do now in this new version of the app.

[928] You actually still can if you have the app on your phone.

[929] Oh, if you still have that version of the app, wow.

[930] Yep.

[931] So Apple and Google immediately delist Fortnite from their app stores.

[932] And then they said you need to upload a new version that doesn't include this.

[933] Yeah.

[934] Right.

[935] And Tim said, nope, not going to do that.

[936] Yep.

[937] So then the pitchforks come out.

[938] Then Apple says, well, you knowingly, and obviously, like this comes right on the heels of the antitrust controversy.

[939] Epic really deeply prepared for this and thought this through, and they released this unbelievable video, this free Fortnite video, where you've got Tim Cook is the evil sort of IBM -like character from the original 1984 commercial.

[940] Epic is sort of this, they're coming in to swing the hammer and throw it at the evil IBM, Tim Cook character.

[941] It is, it's all Fortnite characters.

[942] It's so good.

[943] Deepest dagger you can stab at the Apple executive team and really make them feel like the villains in this story.

[944] And so, you know, the pitchforks continued to come out.

[945] Everyone's escalating.

[946] Apple says, we are going to ban your developer account.

[947] And not just the - So this is a major escalation here.

[948] Yeah, this is, if you don't submit an updated version of Fortnite to the App Store that doesn't violate our terms and services, we are going to ban your developer account.

[949] And what that means, if you really dig into it, is we are going to make it so that you can know, 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 AppStores.

[950] 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.

[951] And so, you know, now they've got a two -front war.

[952] There's a Fortnite War and Apple has dragged the Unreal Engine into this.

[953] And of course, this goes to the courts.

[954] there's an injunction filed.

[955] 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.

[956] Like, that's one step too far.

[957] The thing that you can keep haggling about is whether Fortnite needs to submit a new version that doesn't violate your policies and has only a transaction with Apple that pays the 30 % cut, that's still in fairgrounds to fight about.

[958] So Apple, you can keep Fortnite out of the app store for anyone who wants to download it now.

[959] They didn't mandate.

[960] I don't believe that you have to keep letting the existing version of Fortnite work on people's phones, but it is.

[961] 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 Fortnite.

[962] with the payment loophole that's on 100 million plus phones or tens of millions of phones.

[963] I don't know how many to break.

[964] But that is sort of the state of where things are today.

[965] Yeah.

[966] And just right before we went to record, Epic hit back and announced that existing Fortnite instances running on Apple devices are going to lose access to the next Fortnite season and crossplay ability.

[967] So they're no longer going to be able to play with friends that are on.

[968] other platforms, whether that's Android or console or PC.

[969] So, man. When tech giants clash, customers lose.

[970] But I think we will get to that more in grading.

[971] David, do you have anything else in history and facts here?

[972] I think that is quite the epic story for history and facts.

[973] All right, listeners, our sponsor is one of our favorite companies, Vanta, and we have something very new from them to share.

[974] Of course, you know Vanta enables companies to generate more revenue.

[975] by getting their compliance certifications.

[976] That's SOC2, ISO 2701.

[977] But the thing that we want to share now is Vanta has grown to become the best security compliance platform as you hit hypergrowth and scale into a larger enterprise.

[978] It's kind of wild.

[979] When we first started working with Vanta and met Christina, my gosh, they had like a couple hundred customers, maybe.

[980] Now they've got 5 ,000, some of the largest companies out there.

[981] It's awesome.

[982] Yeah.

[983] And they offer a tremendous amount of customization now for more complex security needs.

[984] So if you're a larger company and in the past, you showed Vanta to your compliance department, you might have heard something like, oh, well, we've already got a compliance process in place and we can't integrate this new thing.

[985] But now, even if you already have a SOC2, Vanta makes maintaining your compliance even more efficient and robust.

[986] They launched vendor risk management.

[987] This allows your company to quickly understand the security posture of the vendors that you're choosing in a standardized way that cuts down on security review times.

[988] This is great.

[989] And then on the customization front, they now also enable custom frameworks built around your controls and policies.

[990] Of course, that's in addition to the fact that with Vanta, you don't just become compliant once, you stay compliant with real -time data pulled from all of your systems, now all of your partner systems, and you get a trust report page to prove it to your customers.

[991] If you click the link in the show notes here or go to vanta .com slash acquired, you can get a free trial.

[992] And if you decide you love it, you will also get $1 ,000 off when you become a paying customer.

[993] Make sure you go to vanta .com slash acquired.

[994] Okay.

[995] So our next section in many episodes is called Acquisition Category.

[996] There wasn't an acquisition here.

[997] And David and I have thought a little bit about what we're trying to accomplish with this category.

[998] 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.

[999] So what are the seven powers?

[1000] They're basically the ways that, and I'm going to, Hamilton, if you're listening, I'm going to butcher the definition here, but they're the ways that a leader in a category can earn outsized profits versus all of their competitors.

[1001] It's basically what's the thing that makes your business powerful versus your competitors?

[1002] 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.

[1003] 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 Fortnite phenomenon, what is the power that Epic has?

[1004] 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.

[1005] Most companies that have power have one, maybe two of these.

[1006] I actually think Epic has three powers that are concurrently going on here.

[1007] I would say they have scale economies because the scale at which you need to operate your infrastructure to power a game like Fortnite or PubG or any of the other large games that run on Unreal, you need a huge amount of infrastructure.

[1008] And then to amortize that infrastructure cost such that you're able to sell it essentially at 5 to 12 % of your end customer's revenue, nobody else can match that.

[1009] No, it's the same way that Netflix draws its power.

[1010] By having the largest subscriber base, it has the sort of lowest per subscriber cost to produce content.

[1011] Yep.

[1012] Or, you know, AWS, same deal.

[1013] Then I think there's the switching cost, right?

[1014] Like, that might be the most directly powerful here.

[1015] Like, if you're PubG or you're any game that's built on Unreal, you have no choice except to continue running on Unreal.

[1016] You're not going to spin up something on your own.

[1017] 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.

[1018] 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.

[1019] So like this thing that lots of developers are like pretty locked into because they committed and 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 five percent of revenue that they're making.

[1020] So, you know, multiply that by 20 to get the amount of revenue that their customers are generating.

[1021] 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.

[1022] But then with Fortnite, they also have this network economy, right?

[1023] And this is where cross platform becomes so important.

[1024] and Fortnite on iOS without cross -platform is so knee -capped.

[1025] Like, you know, imagine you're a kid or anybody who hangs out with their friends on Fortnite, whether that's playing Battle Royale or in creator mode or attending, like, the concerts that are on in there.

[1026] I mean, Travis Scott hosted a concert that...

[1027] Marshmallow.

[1028] And Marshmallow had 14 million people attending.

[1029] Now, interestingly, it's not like there was one room with 14.

[1030] million people, it was limited, I think, to 50, actually, for the Travis Scott concert.

[1031] So you want to be in the instance with your 49 friends.

[1032] You don't want to be with 49 strangers.

[1033] 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.

[1034] Now you can't play with them.

[1035] That, like, hugely removes the value.

[1036] David, I think there's a good time to bring in the other pillars of Epic's business.

[1037] So, of course, we've talked about Fortnite.

[1038] That on its own is somewhere between a billion and two billion dollars a year in revenue right now.

[1039] You got the game engine.

[1040] That's another billion to two billion dollars a year in revenue.

[1041] You have the app store, or I guess what do they call it, the Epic Game Store.

[1042] Epic Game Store.

[1043] 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.

[1044] So there's a lot of sort of dollars that they're pouring in to make that a successful thing on its own.

[1045] They started with a huge head start because they converted all of the Fortnite launchers into Epic Games stores.

[1046] So suddenly, I can't remember how many million it was, but overnight, there was millions and millions of people that suddenly had the Epic Game Store and now had other games in there.

[1047] And if you want to deep dive on the Epic Game Store, you should go read the Matthew Ball piece that we have linked in the show notes.

[1048] It's awesome.

[1049] 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 Sweeney loves that you can sort of plug into any one of these sort of AWS -like services and the Epic Online services, whether or not you're using the engine.

[1050] And there should just be tremendous amount of inter -op across the whole industry where you could use the matchmaking service.

[1051] You could use the friends list.

[1052] 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.

[1053] There it is.

[1054] It took us long enough to get there.

[1055] But yeah, I mean, that's the power.

[1056] Right now, in the current, you know, instantiation of Epic with the Epic Online Services having, you know, just being kind of nascent in adoption and Fortnite being the first and best customer of it, that network economy, power only lives in the fortnight 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.

[1057] Yeah.

[1058] So this really hits at the core of how Tim Sweeney philosophically thinks about what Epic's mission in the world is, and that is how it is diametrically opposed to Apple, Facebook, Google.

[1059] It's not only open versus closed.

[1060] It's more like Tim thinks there's another internet to be built by basically bringing down rents everywhere.

[1061] Like take rates should dramatically go down.

[1062] and interoperability should dramatically go up.

[1063] 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 JavaScript in and collect information on people.

[1064] But think about sort of the ready player one world, but rather than it all being one company, he has this vision of, and he'll name his competitors.

[1065] 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.

[1066] 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 going to be online in this digital space, social connections are going to live there.

[1067] And it's not just games and it shouldn't all belong to one company.

[1068] And you look at the way that Apple is approaching this particular fight and this whole 30 % battle.

[1069] It is we are entitled to 30 % of everything that happens on our platform and Tim is pounding his fist and saying nothing is yours and nothing is ours.

[1070] Yep.

[1071] Tim Sweeney.

[1072] Not Tim Cook.

[1073] He's pounding his fist.

[1074] Too many Tims.

[1075] Yeah.

[1076] Well, this is as usual, there's like too many, uh, too many white men and power in our stories, but absolutely, totally.

[1077] But I think this is what's really cool.

[1078] And actually, you know, the whole concept of the metaverse and ready player one and all that.

[1079] It's so cool.

[1080] And people have wanted it to come about for so long, and VR was kind of a head fake around this.

[1081] VCs got very excited, myself included.

[1082] It really is actually starting to happen now, just not in the way that anybody expected.

[1083] Like, everything we've talked about so far with all of Epic, Epic's technology, the experiences that they make is in the context of thinking about them as games.

[1084] But we've kind already crossed the Rubicon.

[1085] Like, they're not just games anymore.

[1086] I mean, Fortnite has observer mode.

[1087] 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.

[1088] It's a hangout place.

[1089] And creator mode where you can create all sorts of experiences and, you know, play them with your friends.

[1090] And that's what people also do in Roblox.

[1091] That's what people do in Rec Room.

[1092] You know, we've had a Nick Fight on the show, the CEO of Rec Room.

[1093] I think this is what Tim is talking about here.

[1094] 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.

[1095] 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.

[1096] Like they filmed the whole thing on a soundstage with digital walls and all of the sets were built virtually and unreal.

[1097] It's so freaking insane.

[1098] I'm going to hold my tongue for now, but it is like the coolest, most insane.

[1099] How are there zero practical effects in that whole thing?

[1100] Am I stealing your thunder from later?

[1101] 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.

[1102] 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 sort of real iconic use cases yeah okay any other powers you had on uh on your list those were mine too awesome so uh into the section of what would have happened otherwise if we were 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 what would have happened otherwise if Tencent had not invested.

[1103] And before we talk about if they hadn't invested, I want to talk about their investment for a moment because I ran some numbers and holy everything, you guys, this is a crazy investment.

[1104] And we've covered some crazy investments on this show.

[1105] I think Naspers Tencent is one of the all -time best.

[1106] But this one is like, let's just run through some numbers.

[1107] Okay.

[1108] So in 2012, Tencent bought 40 % of the company for 330 million.

[1109] And that 40 % stake played forward six years in October of 2018 when they raised the round on the valuation of $15 billion.

[1110] That's now worth $5 .4 billion if I did my dilution math right there.

[1111] So it took them six years to turn $330 million into $5 .4 billion, which I think is a 60 % annualized return on that money.

[1112] And one way to contextualize that is if you, if you 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 fund.

[1113] That's like investing the whole fund and generating a 16x only six years into the life of the fund.

[1114] Yeah.

[1115] The crazy, crazy, crazy thing, though, about Tencent and why they're just, like, they're just on a whole other level than anyone else out there is like, this is far from even their best investment.

[1116] We covered what's probably their best right now.

[1117] I haven't run the math on Maituan, but in Pinduoduo in two episodes ago.

[1118] That stake, I think, is worth 20 some odd billion now, and they've invested less than a billion.

[1119] Yeah, it's wild.

[1120] And similar order of magnitude for Maitouin.

[1121] Unbelievable investors, and they bet huge and with conviction and are often right.

[1122] Anyway, quiet giant.

[1123] 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.

[1124] And I was like, oh, my God, people are caught up in the Fortnite hype.

[1125] This is not going to end well.

[1126] But in 2018, they did $5 .6 billion in revenue, $3 billion of which was profit.

[1127] So that valuation is 5x EBITDA.

[1128] Yeah.

[1129] Like, it's, that's not crazy at all.

[1130] Not crazy at all.

[1131] I'd be a buyer.

[1132] 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.

[1133] So, you know, this business grew incredibly quickly, was spitting off cash and continues to.

[1134] It reminds me a lot in that way of Zoom.

[1135] Here's a company that's been growing incredibly quickly, incredibly capital efficiently.

[1136] Zoom, I believe, generated over a billion dollars in free cash flow last quarter.

[1137] 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.

[1138] 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.

[1139] You know, he's not hobnobbing with celebrities even though he's a billionaire.

[1140] he's eating Bojangles fried chicken and spending his time building epic towards his vision and mission for the future.

[1141] And he bootstrapped for, how long did we say?

[1142] Was it 22 years, I think, before taking the 10 cent money.

[1143] Before taking the 10 cent money.

[1144] Yeah.

[1145] So, I mean, on the one hand, yes, you're right.

[1146] It's absolutely this reflection of Tim's personality.

[1147] On the other hand, we're comparing it to these companies like Uber that are like moving people around their cities and Fortnite makes money by selling digital hats.

[1148] 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.

[1149] You're pulling forward a playbook theme.

[1150] Yeah.

[1151] But anyway, would Epic be what they are without the 10 -cent investment?

[1152] Absolutely not.

[1153] Like, if you think back to 2012, probably 2011, when the conversation started, you know, they had no or very little digital distribution expertise.

[1154] They had most recently shipped Gears of War on some discs to some Xbox customers.

[1155] They had no live -ops experience of running anything like the platforms that they have today that are constantly changing and constantly getting updates and constantly getting new seasons.

[1156] There's no games as experience.

[1157] And I think, like, Tim would be the first to tell you.

[1158] There's a quote that I grabbed here that Tim says that, which is, Tencent 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.

[1159] They're not the game developer.

[1160] Their expertise is how to operate these games on the very large scale and really appeal to customers.

[1161] And we found that their values are very similar to ours and that we have a great deal that we can learn from them.

[1162] And I think that was in like the 2013 -14 time frame that he gave that quote.

[1163] 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 people who brought them into this Epic 4 .0 era of the company.

[1164] Yeah, I mean, it's telling that all of the three major strategic moves and then the game development in this new way that have remade Epic all happened after the Tencent investment.

[1165] You know, and it just underscores, too, like this theme 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 and facts, but a lot of people left the company, left Epic, because they thought that Tencent coming in meant that they were going to turn into Zinga.

[1166] They thought of Tencent as like, oh, free to play, like, this is not what we want to build.

[1167] This is not how you build real games.

[1168] And the reality was that it was totally wrong.

[1169] It was this whole new vision of a much more sustainable, more democratic way of building games and vision for the industry.

[1170] And people are only now just starting to wake up to that reality of Tencent.

[1171] It's absolutely right.

[1172] Playbook.

[1173] Playbook.

[1174] Let's do it.

[1175] Okay.

[1176] So Ben, you mentioned a virtual digital zero selling hats.

[1177] Zero marginal cost goods.

[1178] Say more about that.

[1179] Yeah.

[1180] So it is literally the greatest business model of 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 $0 for you to get it to them.

[1181] Like, it is the most incredible operating leverage that you could possibly have on getting something that takes a very small amount of fixed costs to create relative to its distribution and have zero marginal costs and zero distribution costs in getting it out there.

[1182] It is like the gods of internet business models come down and nighted at 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.

[1183] And like, I'm assigning zero value judgment on that.

[1184] I'm just saying the reality of the business that they find themselves in is unbelievable.

[1185] 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've been rediscovering this past year and we've been discovering on this show.

[1186] The cool thing is, well, two cool things.

[1187] One, it doesn't only apply to the internet.

[1188] Once you start to scratch the surface about this idea, you realize it's actually been around for a long time.

[1189] Right.

[1190] Media was classic.

[1191] Media was this.

[1192] Yep.

[1193] And reading the outsiders actually really made me. think about this.

[1194] Media doesn't have the advantage of that software has where once you, aside for maintenance costs, once you make it, then people keep finding value in it over a pseudo infinite time scale.

[1195] Like media generally has a shelf life and then you have to kind of create more media, which is the same thing in Fortnite, to be fair.

[1196] It's also though, it's multiple types of the media business.

[1197] There's the content part of the media business that you're talking about.

[1198] There's also, though, the distribution part of the media business.

[1199] 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.

[1200] 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 them 100 bucks a month, you know, every, uh, every month.

[1201] Once you start to see this, it really helps me, I think, evaluate business models and start to foresee what a business model of a company is going to be.

[1202] And like, no matter how successfully you operate, Hamilton talks a lot about this in Seven Powers, operational excellence is super important and table stakes for becoming a great company.

[1203] But you kind of have this ceiling of how great you can be based on the economic characteristics of your business and your industry.

[1204] And it comes down often to this marginal cost aspect.

[1205] Well, and if you just look at the Fang, and I don't want to say because I don't think Netflix deserves to be in it.

[1206] Let me get on my high house for a moment because I slipped up.

[1207] Fang should refer to high paying jobs in the valley at big companies.

[1208] 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.

[1209] So anyway, if you are looking at the big five tech companies by market cap, much of the same characteristics are present in all of them.

[1210] I mean, online advertising, the Google model, the Facebook model, that's a zero marginal cost, zero distribution cost business.

[1211] I mean, you look at like the virtue, virtue is very much the wrong word.

[1212] You look at the advantages that even an Instagram has over a YouTube, like Instagram doesn't have to pay creators, whereas YouTube has to pay a cutout to creators.

[1213] 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.

[1214] 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.

[1215] 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 variable basis.

[1216] Like, obviously, the R &D is expensive, but the crap in an iPhone is really expensive.

[1217] It's not like a digital hat.

[1218] And so it's no wonder they're trying to get into these services businesses that, you know, are creating this clash.

[1219] 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.

[1220] And that is a little bit of what we are seeing here.

[1221] But, yes, David, I think you're exactly right that once you see it, you can't unsee it.

[1222] Totally can't.

[1223] I don't see it.

[1224] I think there's another theme to highlight here that Epic at first stumbled into with the Unreal Engine.

[1225] But then Tim really, Tim Sweeney, really got religion around and has driven his whole vision now of letting a thousand flowers bloom.

[1226] Then this is related to the marginal cost aspect of what you're doing.

[1227] But it's one thing to make game.

[1228] yourself and invest lots of resources into doing that, that's really making an assumption that you are going to be right and know what the market is going to want.

[1229] And Tim has a pretty good track record of that.

[1230] 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 didn't work.

[1231] A much better aspect is if you can find a way to just enable.

[1232] entrepreneurship and creativity kind of writ large and be able to say, hey, I don't know what's going to work, but I'm going to let lots and lots of people try and have their shot.

[1233] That can be way more powerful.

[1234] Yeah, what was the phrase we used with Chatham?

[1235] We had them on the LP show, leverage on tinkering, which is like anytime you can empower a creator to do more with their same skill set, it can be really powerful.

[1236] The way that I had what you were describing written out, my notes here are steady platform revenues to smooth hit -driven spikes from games.

[1237] Yep.

[1238] 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 strategery.

[1239] 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.

[1240] They're trying to say, no, you don't need the budget of a Hollywood studio to make an amazing online experience.

[1241] Hans?

[1242] Yep.

[1243] Yep, that's a great point.

[1244] Okay, some other themes that I had here.

[1245] A few of them roll up under control.

[1246] One of them is don't be beholden to a publisher.

[1247] You know, creative differences with Microsoft over the future of Gears of War is an example of this.

[1248] And, you know, Epic definitely publishes Fortnite, publishes and develops Fortnite.

[1249] And so it's important to kind of have the final say.

[1250] And Tim found a way to do that.

[1251] 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.

[1252] Like, in stark contrast to the lesson learned from Eventbrite, which was, it's nice being public because you have more flexibility when you need to do things like raise capital.

[1253] It forces more capital allocation discipline than when you have sort of deep pockets from VC money.

[1254] In this scenario, if he had public shareholders, it's very unlikely, I think, that he could have gone 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.

[1255] He's doing something on behalf of an ecosystem for value that Epic itself and their shareholders may not get to realize.

[1256] And so I think this notion of having control so 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, being a controlling shareholder allows you to do things that you certainly could not do that may pay off compared to being a public company.

[1257] Yep.

[1258] Totally.

[1259] I mean, could you imagine what the share price would be doing through all this if this were a public company?

[1260] Oh, my gosh.

[1261] Yeah.

[1262] Well, if you look at Apple's only going up.

[1263] Yeah.

[1264] Which actually, you know, I think to be fair to the Eventbride episode, I think Kevin or Julia, maybe both when we were talking about this, said, yes, there absolutely are situations where being private is better.

[1265] It's not like being public is better writ large, and this is one of those situations.

[1266] Right.

[1267] Right.

[1268] Yeah, that's a great point.

[1269] Okay, a couple more.

[1270] One is that game engines in particular are of a type of product that have incredible inertia that are hard to build.

[1271] It's hard to get customers, but then they're almost impossible to displace.

[1272] Like, no one's going to swap out their game engine for a different game engine.

[1273] And you also aren't going to be able to start a successful competitor to the Unreal engine right now.

[1274] Like if you look at when Unity successfully started a game engine, it took off because of the birth of mobile.

[1275] There was this brand new paradigm where you needed to have an engine with a very different set of resources.

[1276] 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.

[1277] Like, if you're going to do that, it better be worth it because you're also developing for PC and consoles.

[1278] And the only way to compete with one of those products, once it has momentum behind it, is in a displacement of paradigm.

[1279] So mobile coming out and who knows what the next one will be.

[1280] But it's definitely one of these companies where the sort of inertia around it makes switching basically impossible until the next technology generation.

[1281] Yeah, 100%.

[1282] Okay, and my last one.

[1283] So in my notes, I wrote down iteration and compounding.

[1284] So iteration is standard dogma in startups and engineering.

[1285] I mean, you hear about agile development.

[1286] And compounding is standard dogma in investing.

[1287] But this is one of the first times that I really grasped how interlinked the two concepts are.

[1288] The sort of methodical, small iterations that Epic is able to do all of these years on, say, on Real Engine, compounds on each of other to provide extraordinary value.

[1289] So it's not just dollars that compound on their own, the way that you would think about a stock growing over the years.

[1290] 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.

[1291] And it just really concretized, like iteration is almost like the implementation of the abstract concept of compounding and investing.

[1292] Yeah, I love that.

[1293] That's...

[1294] It'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?

[1295] Like, it's not just that you're allocating resources and sitting back and watching them compound.

[1296] I mean, maybe you're doing that if you're like a public markets investor.

[1297] But what somebody like a Tim is doing, you know, what a, well, both Tim's, what a, what a, what a, what a CEO is doing, you know, especially a outsider type CEO in the Will Thorndyke sense of the word, of which Tim Sweeney would 100 %, 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?

[1298] Yeah, I love that.

[1299] Our sponsor for this episode is a brand new one for us.

[1300] Statsig, so many of you reached out to them after hearing their CEO, Vijay, on ACQ2, that we are partnering with them as a sponsor of Acquired.

[1301] Yeah, for those of you who haven't listened, Vijay's story is amazing.

[1302] Before founding Statsig, VJ spent 10 years at Facebook where he led the development of their mobile app ad product, which, as you all know, went on to become a huge part of their business.

[1303] He also had a front row seat to all of the incredible product engineering tools that let Facebook continuously experiment and roll out product features to billions of users around the world.

[1304] Yep.

[1305] So now Statsig is the modern version of that promise and available to all companies' buildings.

[1306] in great products.

[1307] Statsig is a feature management and experimentation platform that helps product teams ship faster, automate A -B testing, and see the impact every feature is having on the core business metrics.

[1308] The tool gives visualizations backed by a powerful stats engine, unlocking real -time product observability.

[1309] So what does that actually mean?

[1310] It lets you tie a new feature that you just shipped to a core metric in your business and then instantly know if it made a difference or not in how your customers use your product.

[1311] It's super cool.

[1312] Statsig lets you make actual data -driven decisions about product changes, test them with different user groups around the world, and get statistically accurate reporting on the impact.

[1313] Customers include Notion, Brex, OpenAI, FlipCart, Figma, Microsoft, and Cruise Automation.

[1314] There are like so many more that we could name.

[1315] I mean, I'm looking at the list, Plex and Versailles, and Versailles, S .L. Friends of the show at Rec Room, Vanta.

[1316] They literally have hundreds of customers now.

[1317] Also, Statsig is a great platform for rolling out and testing AI product features.

[1318] So for anyone who's used Notion's awesome, generative AI features and watched how fast that product has evolved, all of that was managed with Statsig.

[1319] Yep.

[1320] If you're experimenting with new AI features for your product and you want to know if it's really making a difference for your KPI's Statsig is awesome for that.

[1321] They can now, ingest data from data warehouses.

[1322] So it works with your company's data wherever it's stored so you can quickly get started no matter how your feature flagging is set up today.

[1323] You don't even have to migrate from any current solution you might have.

[1324] We're pumped to be working with them.

[1325] You can click the link in the show notes or go on over to stat sig .com to get started.

[1326] And when you do, just tell them that you heard about them from Ben and David here on Acquired.

[1327] All right, David.

[1328] So grading.

[1329] So normally for anyone new to the show, we would normally grade a transaction.

[1330] So was, uh, was it a good use of capital for Facebook to buy Instagram?

[1331] In that scenario, that is RA plus.

[1332] And then everything else sort of rolls down from there to our, I think, F for AOL Time Warner.

[1333] 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?

[1334] The big thing that we all should be grading right now is, uh, this fight with Apple.

[1335] Like, what is going to resolve here?

[1336] And what should each company do?

[1337] And so, The way that I want to evaluate this is if Epic holds strong, what should Apple do?

[1338] And if Apple holds strong, what should Epic do?

[1339] 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 sort of contextualize this fight.

[1340] So the App Store last year generated an estimated $18 .3 billion of revenue for Apple.

[1341] So that's their 30 % cut.

[1342] So $61 billion that was spent on the App Store.

[1343] that went to Apple and developers.

[1344] For Apple, for anyone who's been following the stock and listening to earnings, when Tim says, Tim Cook, says services revenue, 40 % of that is App Store.

[1345] So this $61 billion represents 40 % of the services revenue.

[1346] Fortnite makes right now about $200 million a year on iOS, which means about $60 million is going to Apple.

[1347] And that's a 12%, which actually came out in a court proceeding, today.

[1348] So, Fortnite last year did $1 .8 billion in revenue across all of its platforms.

[1349] So, you know, you take a 12 % of that comes to $200 million that they're making on iOS.

[1350] So that's sort of what's at stake here, is that $200 million.

[1351] 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.

[1352] 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.

[1353] Like you can deploy to these five other platforms, but not the sixth, which is a big one, so that's a problem.

[1354] It'd be one thing for Epic to lose $200 million of Fortnite revenue over this.

[1355] It'd be a whole other thing for them to massively disappoint all of their Unreal Engine and all of their services customers.

[1356] Right.

[1357] But when evaluating push comes to shove on that, the biggest game on iOS that uses the Unreal Engine is Fortnite.

[1358] night.

[1359] The second biggest game is PubG.

[1360] And when you look down the list of the top hundred grossing apps, very, very few of them use Unreal Engine.

[1361] 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.

[1362] And so I don't know in practice if a big game developer who is thinking about making a AAA -style title to deploy across Sony platforms and Xbox and I shouldn't say Sony platforms, PlayStation and Xbox and the PC.

[1363] I think mobile's 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 revenue is going to come from.

[1364] And so I actually, I don't think it would be that big a deal.

[1365] 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.

[1366] So I really do think what it actually comes down to is the $200 million a year that Fortnite makes on iOS and the $60 million of that that goes to Apple.

[1367] This is super interesting, right?

[1368] Like, I actually think the question, or the context is, is not what you said of like, I don't know, take two, I make Grant Theft Auto.

[1369] I'm not going to put that on the app store because I'm not going to make my revenue there.

[1370] As we've talked about, that whole model, like, yeah, that's going to be right.

[1371] That whole Hollywood style of game making.

[1372] That's going to be around for a while.

[1373] It's going to be fine.

[1374] But that's not where the big industry is.

[1375] The really interesting question is, like, these dynamics, like, why is Overwatch not on the app store?

[1376] Why is League of Legends not on the app store?

[1377] Why is Dota 2 not on the app store?

[1378] Why are all these modern game as a service, e -sports style, true, like, big, big winners, big platforms in this era?

[1379] Why are they not on mobile?

[1380] It's not because of technical limitations.

[1381] An iPad or iPhone 11 Pro, like, is very, very capable of running these things.

[1382] And so it's only moderately because of tech.

[1383] It's more like it's really difficult, like it better be really worth it if you're going to 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 WASD controls and all that.

[1384] Totally, totally.

[1385] But doable.

[1386] I mean, 10 cents done it with Honor of Kings in China.

[1387] Yeah, totally.

[1388] And I played Fortnite on my phone last week.

[1389] Yep.

[1390] Totally.

[1391] So it's doable.

[1392] I think the reason that it hasn't happened is because of this economics issue, right?

[1393] Like if you're operating your game as a service and making revenue in a SaaS like manner through subscriptions and or virtual good economies, you don't want to pay 30 % to Apple or Google, like, that's just a non -starter.

[1394] Actually, I think Apple's kind of like zooming out even more.

[1395] 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 niche electronic pieces.

[1396] They had the opportunity to eat game consoles as well, but that never happened.

[1397] happened.

[1398] And I think this is the reason why.

[1399] Yeah, instead they segmented it and they they ate a lot of handheld gaming.

[1400] The switch has still done well, but they, there are mobile type games that have done exceedingly well.

[1401] Facebook gaming and web gaming.

[1402] Yeah.

[1403] Oh, that's a great way to put in.

[1404] The candy crushes of the world.

[1405] I think those types of games are still the most played even more so than Fortnite.

[1406] But you're right that they could have eaten AAA titles too and they, and they didn't.

[1407] 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.

[1408] 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.

[1409] To your point, Honor of Kings did work.

[1410] So, but you're right that, like, the economic model is just not as appealing.

[1411] Right.

[1412] Like, again, because these games are network economies, it's in the developer's interest to want to have as many, as large and 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 should be done there?

[1413] And I did another little fun calculation.

[1414] The money that Apple receives from Fortnite per year on the App Store comes to about a third of a percent of App Store revenues.

[1415] Like, you know, what is on trial here is Apple's, like, emergent business model of the last five years with this sort of app store fees.

[1416] So if it means dropping their take rate 1%, like they should not do that.

[1417] They should say, okay, we're happy to lose you, Fortnite, goodbye.

[1418] And they should make it unplayable on everyone else's phones.

[1419] Like the counter argument to that is that, first of all, that it would trigger new legislation, that it would sort of have antitrust implications.

[1420] And, you know, there's another thing around maybe that they would turn off more developers from doing that because people would go, oh my gosh, like you don't have this trustworthy development platform even for even my mobile game anymore.

[1421] The epic revenue is really a drop in the bucket for Apple.

[1422] Here's what I think the biggest danger is for Apple.

[1423] If you believe that this trend that Tim Sweeney definitely believes in of these things are becoming more than games, they're becoming a metaverse.

[1424] 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 going to want to play on your platform just like none of the MoBas and the games as a service have?

[1425] And so as that industry becomes bigger and bigger and bigger, none of those play on your platform.

[1426] And then all the consumers that want to consume that content, now go to other devices to do that.

[1427] You're absolutely right.

[1428] Yes.

[1429] Apple's risk here is much less about the Fortnite revenue.

[1430] And frankly, I don't think it's that much about the Unreal thing either.

[1431] Because as we talked about, like, it's really not the games people are playing on their platforms.

[1432] Are people so loyal to Fortnite that they'll say, you know what, screw this.

[1433] My next phone is an Android phone?

[1434] Like, is Apple going to be shut out from participating in the more sort of open?

[1435] Well, one of two things.

[1436] Are they going to be shut out from the Tim Sweeney's version of the Metaverse when people are picking their next device?

[1437] or even long before that, are people going to say, look, I want to play freaking Fortnite and I can't on your phones and not by phones.

[1438] That would be the argument that Apple should blink.

[1439] Yep.

[1440] But it's major business model disruption to them if they do blink.

[1441] Totally, totally.

[1442] I mean, I think it'd be a different thing here if it was Unity.

[1443] If Unity made Fortnite, I think then Apple's like, yeah, we're not going to, like, we will definitely not kick all Unity games off of the platform.

[1444] But there's some chance, right, that Unity joins in with Unreal here.

[1445] And why would they do that?

[1446] They have a per seat license model, not a cut of revenue model.

[1447] Frankly, I mean, without having studied Unity enough, they may want to switch to the cut of revenue model at some point.

[1448] I mean, actually, if anything, like, it's sort of surprising that Unreal is the one with the cut of revenue model.

[1449] given that they are the high -end platform and Unity is the SaaS 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 in this you wouldn't want to have any incentive or any barrier for them not to.

[1450] Now, I think you can start using Unity for pretty low or no fees as an indie developer.

[1451] Yeah.

[1452] Yeah, that's an interesting point too.

[1453] too.

[1454] Getting back to if Epic refuses to blink and then Apple kicks them off.

[1455] So obviously some kind of compromise is the best thing for everyone, including customers.

[1456] It's only 12 % of Fortnite's revenue.

[1457] Like, it would suck to lose out on that revenue, but it's also not the end of the world.

[1458] Like, it's not where most people are playing Fortnite.

[1459] And so to me, is it that bad for Fortnite to not be on your iPhone?

[1460] I don't think it's that bad.

[1461] Is it that bad for Apple that the most popular game is not on your phone.

[1462] I actually think it's worse for Apple.

[1463] I think it's worse.

[1464] Yeah, I think it is worse.

[1465] Because again, like, think about if you're playing Fortnite on iOS, chances are high that if you really, really love Fortnite, you're able to go buy a switchlight for $150 or $200 and keep playing Fortnite.

[1466] Yep.

[1467] Okay.

[1468] So if it's worse for Apple, then what we're saying is, okay, Apple should blink.

[1469] Apple should not bring down the ban hammer and, and, and, and kick all Fortnite users off the phone.

[1470] There's some middle ground where they just keep them banned, but I think that's actually just as bad for them.

[1471] It's just as bad a look as disabling functionality from all the phones that currently have Fortnite installed, or as John Gruber would put at the Kill Switch.

[1472] So, what does Apple do?

[1473] Like, Apple's actually in the hot seat then, and let's say that Epic's going to hold strong.

[1474] Like, Epic's demands are very interesting here.

[1475] They want an app store.

[1476] 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.

[1477] 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, their whole business, like their whole strategic positioning is totally screwed.

[1478] Like, they make all the services revenue because the app store is a monopoly.

[1479] If they do the second and budge on the 30%, you know, that's an $18 billion a year business for them.

[1480] That's every single percent you budge on is incredibly impactful.

[1481] So, like, I mean, it's not clear that Apple should blink either.

[1482] I actually think, like, the best long -term value preserving and ultimately value -creative move for Apple is not to give in to Epic on saying you can have your own app store here.

[1483] but to lower their own takery in line because it's not just about epic here.

[1484] It's like there's a bigger thing going on, which is that developers no longer love Apple.

[1485] It's not just epic.

[1486] Totally.

[1487] It's base camp.

[1488] It's everybody.

[1489] I mean, it's everyone that they privately communicated with and tried to make some distinction between a B to B app versus a B to C app.

[1490] Right.

[1491] Anytime you're doing something like that, like, you're, losing.

[1492] I don't care what you're saying.

[1493] If it's coming to that, you're arguing against your most, arguably your most important constituency.

[1494] 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.

[1495] Apple would say customers, well, Apple would say Apple is their most important.

[1496] They wouldn't say that, but Apple is the most important.

[1497] Customers second, developers last.

[1498] They were very fortunate to get all the developers onto iOS.

[1499] very early and have had tremendous lock -in in their sense.

[1500] So I think they're really putting themselves at risk here in the long term.

[1501] Like, yeah, you know, if Fortnite weren't on iOS, would some people switch to Android?

[1502] Sure.

[1503] But like...

[1504] Oh, and you know they've, they have people out trying to figure that out right now.

[1505] What, what, how many customers would we lose now and in the future?

[1506] Sure.

[1507] But like, what's the big risk here?

[1508] The big risk is, like, like, I certainly wouldn't switch.

[1509] You wouldn't switch.

[1510] But what if Spotify were?

[1511] I just reinstalled Fortnite.

[1512] because I had deleted it a year ago but I actually could I could reinstall it because I had previously downloaded it at some weird loophole but what if Spotify weren't on Apple?

[1513] Right, right.

[1514] Like, yeah, I have a lot of lock in there like I'm not leaving.

[1515] I'm not going to do the Apple music thing.

[1516] So what if what if Netflix weren't on Apple?

[1517] 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.

[1518] I mean, Spotify is a...

[1519] Right.

[1520] So each of these things on their own, yeah, yeah, yeah, okay.

[1521] But now there's another device out there that has all these things.

[1522] And oh, yeah, they're cheaper and they're better experiences because it's a more developer -friendly platform.

[1523] It doesn't take too, too many of those where you're like, do I really need an iPhone?

[1524] 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...

[1525] keeping our monopoly position by being the only app store, or do we want to let other people compete with us?

[1526] And in that case, we're just going to get competed down on price anyway.

[1527] So they should probably just figure out a way to drop their rate to something that Epic will agree to.

[1528] Gosh, are they going to roll that out?

[1529] I mean, the implications are so huge.

[1530] 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 if 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 percent but like no on 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 to this magical question of, is Fortnite 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?

[1531] And maybe, maybe not.

[1532] You know, that's the dice roll.

[1533] Yeah.

[1534] Well, here's though the other big calculus for Apple to bring back in is Tencent, right?

[1535] Like, who is the most important company and partner to Apple in the world can make an argument that's 10 cent.

[1536] Why is it 10 cent?

[1537] Well, Apple has a huge, huge business in China.

[1538] If WeChat is not on iOS in China, that business goes to zero.

[1539] That's a great point because WeChat has the closer relationship with the customer than Apple does.

[1540] Yep, much, much closer.

[1541] I think it's probably not even a question.

[1542] Like, no WeChat on iOS, everybody's moving to Android.

[1543] You're right.

[1544] Yeah, there's so many games of chicken that this could start.

[1545] Tim Sweeney's willing to take risks, but who else is?

[1546] Who will throw in with him?

[1547] I mean, because like if you're WeChat, like, come on, that's crazy to lose all that distribution on all those phones.

[1548] But you could maybe argue that they don't need it, right?

[1549] Like, WiiChat is more important than...

[1550] Don't they also have a special deal where people can use WeChat pay for virtual goods in China and go around the app store there?

[1551] Oh, I didn't research that.

[1552] They may. I think there's...

[1553] Then Apple's already compromising.

[1554] Right.

[1555] 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 Fortnite comes and does this again.

[1556] Which is for sure not going to be the case.

[1557] It's a losing strategy.

[1558] I think you're right.

[1559] 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.

[1560] And that is long -term value creative.

[1561] need to become a great platform for developers again.

[1562] Yep.

[1563] Make Apple great again for developers.

[1564] All right.

[1565] Well, we moved a section after grading that we normally have before, which is value creation and value capture.

[1566] A couple of ways I want to talk about this.

[1567] So Epic has done a tremendous job of creating value in the world and frankly capturing less of it than I think they create.

[1568] The fact that they only charge 5 % for the Unreal Engine, like it is fair.

[1569] And I think the fact that they undercharge for the Epic Game Store also, you know, again, capturing far less value than they create.

[1570] You always have to capture less value than you create in order to enable value for your customers.

[1571] So no one's just trading a dollar for a dollar.

[1572] But, you know, I think they capture dramatically less value than they create.

[1573] And they've got lots of headroom above them.

[1574] 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.

[1575] Like, the customer is the one that's bearing the brunt of these tech giants clashing.

[1576] And that's, you know, value destructive, ultimately for the end user that these tech giants are at war over who gets what economics.

[1577] Yeah.

[1578] Well, and that's also a game, you know, where regulation and the government comes into play.

[1579] And in that part of the game, the deck is stacked against the big tech companies.

[1580] Are regulators really going to say, oh, no, you know, independent, much smaller business in North Carolina, like, you are being unfair to Apple here?

[1581] No way.

[1582] This $17 billion business is being mean to the $2 .2 trillion business.

[1583] Also, I do want to point out, Apple grew by 10 epics this week.

[1584] wow the scale is just unbelievable with these compound interest continues to blow my mind and uh yeah well listeners on on the grading and on the value creation value capture there's so many nuanced points here uh we would love to hear from you so you should join us um in the acquired slack acquired at fm slash slack or just go to our website and talk about it or we'd love to you know chat on twitter too we're at acquired fm i think there's obviously the situation changes every day um there's um There's probably going to be new news that comes out between this episode and, you know, recording and release.

[1585] But also, there's just lots of nuance points here.

[1586] So we'd love to to hear your perspective on what we sort of missed.

[1587] Carvouts.

[1588] Let's do it.

[1589] All right.

[1590] I'm going to go first because mine is a continuation of this episode.

[1591] So I have a three -part carve -out that is going to be in the order that I experienced these three pieces of media.

[1592] And I recommend the same to you.

[1593] So when was this?

[1594] 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.

[1595] And what was amazing about this, first of all, you're like, why is this short little video put out by Epic?

[1596] 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.

[1597] And the other amazing thing was that the camera was moving slightly, as you would expect, you know, a dollied camera on a set to move, and the background shifted perspective in the right way that you would expect with the camera.

[1598] So not only were you like, whoa, that background is real and certain things are, you know, a thousand feet away and other things are five feet away, but there's no artifacts.

[1599] 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 the stuff on the screen shifts in the exact right way with the camera as it moves and pans in real time, undetectable to the, no lag detectable to the human eye, unfreaking believable, breakthrough technology.

[1600] So I remember watching that and being like, holy God, the future of filmmaking is here.

[1601] It's amazing this games company, and I'd heard of Epic, obviously, because of the Fortnite and because of the Unreal Engine.

[1602] It's amazing the Unreal Engine can sort of like do this now.

[1603] I wonder if anybody's going to...

[1604] Okay, so flash forward, the Mandalorian happens.

[1605] Watch it.

[1606] It's fantastic.

[1607] Literally worth the Disney Plus subscription just for the Mandalorian.

[1608] Oh, so good.

[1609] I mean, it's a, it's a Star Wars Western.

[1610] It's excellent.

[1611] And so then February 2020, there's this video that gets released of the making of the Mandalorian in what they call the volume.

[1612] And this is a soundstage, David, exactly as you described, 360 degree, you know, screens all around a sort of like horizontal screen above you.

[1613] And that's used for lighting the scene.

[1614] So not only are they rendering all of the elements around, by the way, amazing that that's CG, right?

[1615] It all looks so real.

[1616] People are wearing costumes.

[1617] Uh, they have some props, like desks and stuff.

[1618] 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.

[1619] Mind blowing.

[1620] So really cool video.

[1621] It's short.

[1622] It's like five, six minutes.

[1623] then a friend sends me this thing in ASC, it's ASCMag .com.

[1624] I think it's like the American Society of Cinematographers or something like that.

[1625] Is this an incredible long form read on the physics of how the whole thing works.

[1626] If you're into like film at all, 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.

[1627] And it is totally worth carving out some time to go and read because it is, what's the quote, sufficiently developed technology is indistinguishable from magic.

[1628] Something along those lines is absolutely true.

[1629] And I am so amped up about Unreal and the future of filmmaking.

[1630] It's so cool.

[1631] It's so amazing.

[1632] And the net of all this is like it's better you enable more creativity at an order of magnitude lower cost too.

[1633] Like they talk about this is how the Mandalorian was able to be made and be so awesome as a TV series versus a multi -hundred million dollar budget movie because they just did it in a room and it truly would have been yeah a 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'm gonna try i'm gonna try uh i have been rereading isaacizizumov's foundation series i might have had this be a carve -out years ago on acquired ah 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.

[1634] It was, you know, an allegory for Rome or, you know, whatever you could apply it to the current state of the world right now.

[1635] I think you could also, maybe, maybe it's a stretch, but maybe you could apply it here to Apple and Epic to, you know, the galactic empire that falls, falls because it stops doing its job.

[1636] It becomes all about politics.

[1637] And it loses its technological edge.

[1638] 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.

[1639] Having the ability to be on the cutting edge of technology and the nimbleness to move fast with it, probably going to win.

[1640] Indeed.

[1641] Well, that's a great, great place to leave it.

[1642] Well, listeners, if you aren't subscribed and you like what you hear, you totally should.

[1643] And if you have a friend who you think 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.

[1644] We love when you share with new folks.

[1645] So thanks so much for doing that.

[1646] 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.

[1647] 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 talk directly with all of you and of course our book club and our Zoom calls with the authors.

[1648] 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've got to decide.

[1649] 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 and you're active today.

[1650] If you aren't already a limited partner, you can click the link in the show notes or go to Acquired .fm slash LP.

[1651] And of course, all new listeners get a seven -day free trial.

[1652] If you want to hang out with the Acquired community, join us in the Slack.

[1653] And with that, listeners, we will see you next time.

[1654] We will see you next time.