As the kids software industry continues to mature, multimedia conglomerates are becoming more and more aggressive on the acquisitions front in order to bulk up their brand portfolios. This growing consolidation trend spells doom for some small interactive producers struggling to eke out sustaining profit margins and to keep up with sophisticated marketing techniques. Others are taking up the gauntlet and devising innovative ways to compete in the shrinking interactive market.

The sheer number and complexity of the past year’s software acquisitions boggles the mind-in fact, the who-picked-up-who list is so convoluted and incestuous that it reads like a Days of Our Lives script.

In March, Mattel Media (keeper of the lucrative Barbie franchise and reigning queen of girls software, now cornering a reported 91.8% of that market) acquired indie girls’ CD-ROM publisher Purple Moon, a two-year-old company that had carved out a small interactive niche (5.7% share of the girls software market) for itself with a US$5-million-earning product line and Web site based on the girl-empowering Rockett Movado brand. Purple Moon closed its doors in February, citing consolidation as the culprit behind its failure. Ironic, huh? Going back a bit to a US$3.8-billion deal announced last December, Mattel (which cornered an 8% dollar share in the total games market in fourth quarter `98, reaping US$49 million in retail sales) acquired The Learning Company (TLC), which had an impressive takeover track record itself, having picked up edu-software company Mindscape in March `98 and Br¿derbund Software in June.

Meanwhile, on the TLC front, rumors are circulating about an impending acquisition of indie vid game company NewKidCo International. The speculated pick-up makes sense as a natural progression of a distribution deal signed between the two companies in March. Hank Kaplan, NewKidCo’s president, had this to say about consolidation: ‘I’m not comfortable talking-in a meaningful way-about our own plans, about where we’re going. It’s too unclear.’ NewKidCo will also be exhibiting at E3 as part of TLC’s display area. Interesting.

Hasbro Interactive, Mattel Media’s biggest software rival, garnered an 11.7% dollar share and earned record fourth-quarter `98 net revenues of US$131.8 million, thanks largely to the US$70-million stock-swap acquisition of Microprose that was announced last August.

Another kids player, GT Interactive (which led the race to pick up Microprose until a US$250-million deal between the two companies was mysteriously aborted in December 1997), beefed up its game brand portfolio by purchasing Legend Entertainment, the Chantilly, Virginia-based developer of upcoming action sequel UnReal II, in January, and the U.K.’s Reflections Interactive for US$13.5 million in December.

And on the international scene, in November of last year, Cendant Corporation (publisher of PC Data chart-topping learning series like Jumpstart and Math Blaster) sold its entertainment and educational software division, including holdings like Blizzard Entertainment and Sierra On-Line, to France’s largest book and multimedia publisher, Havas Interactive, for US$1 billion.

This past year has seen more small and mid-sized software companies gobbled up by multimedia conglomerates than ever before, and in the wake of the consolidation-fest, a handful of interactive monopolies are left standing to dominate the digital landscape. With the growing success of total-package brand portfolios that encompass every genre and age range, it’s not surprising that companies like Mattel Media, Hasbro Interactive and GT Interactive are gunning to fill holes in their product lineups by acquiring existing companies. ‘These days, there’s a much larger total audience for software, and the big players want to provide as much of that product as possible,’ explains Russell Kelban, director of marketing services at Disney Interactive. ‘It makes more financial sense to acquire a small company that already specializes in a sought-after genre or demographic than to start up a new division from scratch.’

The Purple Moon pick-up demonstrates this logic perfectly. Mattel needed a product line targeting the eight to 14 crowd to complete its girl monopoly, but it would take a lot of time and money to start up an in-house arm to fill the void. Since Purple Moon already had a multititle interactive brand for tween girls in place (complete with a supporting Web site that has 250,000 registered users, as well as a signed book deal with Scholastic), it could fit tidily into the Mattel machine and start generating revenue almost immediately.

Kids software giants are also rountinely looking to expand their reach into other markets, and floundering independent producers overseas offer ripe expansion opportunities. Thomas Heymann, GT Interactive’s chairman and CEO, says geography was a major factor in the Reflections acquisition. ‘Reflections strengthens our international presence and is well positioned to design products specifically for Europe, as well as titles with broader global appeal.’

As for the advantages to the acquiree, Nancy Deyo, president and CEO of Purple Moon, sums it up positively. ‘Smaller software companies get leverage as part of a larger corporation-whether it be on a marketing or distribution scale, or product development resources, or the availability of new technologies to improve their products.’ Bottom line, Deyo says she’s happy that Purple Moon product will continue to exist period. According to president David Haddad, Mattel Media plans to keep the essence of the brand intact, and is working on two new Rockett Movado CD-ROMs that will debut at E3 this month.

As hard as this industry trend may be on the remaining small to mid-sized players, software circle pundits across the board agree that the heightened drive for consolidation is a natural side effect of an unavoidable market maturation shake-down that has played out in every product category since the dawn of the kids entertainment biz-the home video trade being the most recent to sophisticate. The list of market conditions making it difficult for smaller entities to compete (thereby spurring more acquisitions) is almost formulaic.

Downward pressure on pricing

At the advent of the computer age, there was so little software available to meet skyrocketing consumer demand that digital publishers could get away with charging as much as US$50 or US$60 per title, reaping profit margins of as much as 20% to 25%. But a reduction in computer prices and the veritable flood of product that’s hit retail shelves in recent years has shifted the fragile supply-and-demand balance drastically. Today’s generation of consumers, who can purchase a computer for under US$600, balk at spending more that US$25 for a piece of kids software. ‘We’ve reached the saturation level,’ says Disney Interactive’s Kelban. ‘There’s much more product fighting for fewer consumer dollars, so most companies are offering some of their titles at a loss in order to hook customers.’ As a result, overall profit margins have deteriorated to the point that the once-simple feat of breaking even is difficult enough for the big players-and, in many cases, impossible for independent producers.

Refinement of mass marketing and merchandising techniques

After seeing years of limited sell-through at computer specialty outlets, kids software has finally hit the big time of mass market meccas like Wal-Mart, Kmart and Target. While this increased exposure has done much to bolster sales, the move into mass outlets (which often require suppliers to provide their own endcaps, palettes, promotions and point-of-purchase displays) also necessitates some expensive marketing and advertising groundwork. ‘The disciplines of merchandising and understanding the mass-merchant category of trade have become extraordinarily important,’ says Mattel Media’s Haddad, ‘as has the ability to effectively communicate directly to the consumer, whether it’s through advertising, a Web site or direct response. Some smaller publishers don’t have the resources for these crucial retail elements.’

Disappearing distribution outlets

Given the merchandising difficulties mass-market outlets present for smaller software publishers, computer specialty stores such as Computer City and CompUSA have long been the little guy’s sanctuary. However, in September 1998, CompUSA bought out Tandy subsidiary Computer City for US$211 million and closed 50 stores in the U.S., causing a considerable reduction in already-scarce shelf space. The digital retail monolith has also embarked on a 1999 quest to convert many of its remaining outlets into superstores run with the same mass-merchandising expectations that are anathema to indie players.

The never-ending need to innovate

Another hurdle that smaller interactive companies must constantly overcome is the rapid-fire pace at which technology evolves. On the PC side of things, CD-ROM producers must constantly adapt to accommodate new CPU speed capacities, and video game console innovations, such as Sega’s 128-bit Dreamcast system (which debuts in North America in the fall) and Sony’s PlayStation II counter-creation (slated to launch in March 2000), require expensive investment in both high-tech gear and game revamping efforts. ‘You can never rest on your laurels in this industry,’ says Haddad, ‘because technology is constantly shuffling the cards and changing the playing field.’

Brand dominance

Strolling down today’s kids software aisle, one can’t help but notice the dominating presence of brand clusters. Barbie’s pink trappings, the Magic School Bus logoed series and Disney’s slew of blockbuster-based activity centers immediately capture the attention of browsing consumers. ‘You have to remember that parents are buying these products,’ explains PC Data president Anne Stephens, ‘and they tend to trust known entities like Disney and Sesame Street more than unfamiliar, stand-alone titles.’ Smaller companies that produce only three or four titles a year generally need to spread this meagre slate to cover a variety of genres and target demographics. To focus an entire year’s production on a three- or four-title branded line that stands just as good a chance at flopping as a single title is too risky a venture for most independent software producers.

Despite the pitfalls present in the current interactive kids market, consolidation hasn’t become an inevitable outcome for smaller players. Many indies are hooking up with larger entities in licensing deals (exemplified by Activision’s ongoing relationship with Disney Interactive to produce blockbuster-based video games) and affiliations, in turn benefiting from a greater pool of retailing, marketing and promotional resources. Ralph Guiffré, executive VP of marketing, licensing and sales for Humongous Entertainment, explains: ‘Small companies need to align themselves with organizations that can buy shelf space or floor space, and who can put the product out there in meaningful enough numbers to give it a shot at success.’ As an affiliate label, the independent entity pays the larger firm a sales percentage to market its titles.

Another alternative is to move onto the Internet. ACS Games, developer of Animaniacs Ten Pin Alley for Sony’s PlayStation, has set up shop on its Web site (www.acsgames.com) in order to supplement the income it generates from software specialty outlets in the U.S.

One other way to beat the software shake-down in the North American market is to go global. Red Storm Entertainment, a small Morrisville, North Carolina-based strategy/action game producer responsible for creating Tom Clancy’s Rainbow Six title, signed an exclusive European distribution deal last July with the U.K.’s Take 2 Interactive Software Europe, which will market all of Red Storm’s upcoming game releases alongside its own slate.

As to where it will end, Stephens believes that the kids software market, unlike other children’s industries that have already matured, is different in that it’ll loop on a never-ending cycle driven by changes in technology. ‘Inevitably, there will be another period of expansion when the next new technology rolls in and requires a new kind of software. Then, the whole cycle [of growth and consolidation] starts again.’