SEGA Corporation

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SEGA Corporation

1-2-12 Haneda, Ohta-ku
Tokyo 144-8531
Japan
Telephone: +81-3-5736-7111
Fax: +81-3-5736-7066
Web site: http://www.sega.co.jp

Wholly Owned Subsidiary of Sega Sammy Holdings Inc.
Incorporated: 1960 as SEGA Enterprises Ltd.
Employees: 814
Sales: $1.81 billion (2004)
NAIC: 511210 Software Publishers; 713120 Amusement Arcades; 423920 Toy and Hobby Goods and Supplies Merchant Wholesalers

SEGA Corporation is a developer of software and games for personal computers, wireless devices, and video-game consoles. SEGA, which once ranked as one of the largest manufacturers of consoles, exited the market in 2001 and began making games for platforms marketed by Sony, Microsoft, and Nintendo. The company merged with Sammy Corporation in 2004, becoming a subsidiary of Sega Sammy Holdings Inc., the largest gaming software company in Japan.

Origins

For SEGA, success came at a price. The company did not begin to endure years of hardship until it evolved beyond its modest beginnings and stood as a global contender in a fiercely competitive industry. In its rise in the business world, the company earned esteem as a technological pioneer and, for brief periods, it held sway as the best in its class, but, ironically, its prize for achievement was to become ensnared in a market that nearly caused its own collapse. At those moments of the greatest despair, SEGA executives could be forgiven for wanting a return to the simpler days of the company's existence, back to the considerably less troublesome era that began when SEGA sprang from a small Hawaiian company founded in 1940.

Although SEGA was not incorporated until 1960, the company's roots stretched to a Honolulu-based company named Standard Games. SEGA's predecessor spent roughly a decade in Honolulu before moving to Tokyo in 1951, when it was renamed Service Games of Japan, the immediate predecessor of SEGA Enterprises. Once in Tokyo, the company began importing U.S.-made pinball machines. The pinball business marked the beginning of SEGA's involvement in operating arcades, an aspect of the company's business into the 21st century, but the core of the company—and the source of its much publicized troubles—was not created until the 1980s, when SEGA entered the video-game console market.

SEGA Entering the Console Market in the 1980s

The console market was in its nascence when SEGA joined the fray, years away from developing into what would become a more than $7 billion market. It would prove to be a difficult market for all competitors. A quarter-century after SEGA introduced its first console, no company dominated the market for consoles for more than one generation of machines. SEGA made its debut with the launch of an eight-bit console called the Master System in 1984, the same year the company's path crossed with an individual who would play an important role in SEGA's development. Isao Ohkawa, an enormously wealthy financier, founded an information-processing firm named CSK Corp. in 1968, a company that first invested in SEGA in 1984, eventually becoming the company's largest shareholder. SEGA became a publicly traded company in 1986, two years after the introduction of the Master System, debuting on the Tokyo Stock Exchange.

SEGA struggled with its first entry in the cartridge-based console market, but it scored its first and greatest success with its second system. The company unveiled its Genesis console in 1988, introducing a product that represented a technological leap beyond competing systems. Genesis was built with a 16-bit computer chip, enabling it to provide more colors, faster action, and better sound than existing systems. At the time of Genesis' introduction, Nintendo dominated the industry, controlling the market in Japan and holding an 80 percent market share in the United States. An overwhelming majority of consumers—typically adolescents—were using the company's eight-bit console to play "Mario Bros.," Nintendo's most popular video game, but with Genesis SEGA had a formidable riposte. The company's "Sonic the Hedgehog" video game was hugely popular, tied to a 16-bit console that was superior to Nintendo's eight-bit console because it processed twice as much data at a time. To SEGA's further benefit, Nintendo had the capability to introduce a 16-bit console, but the company chose to wait while it milked whatever it could from the eight-bit market. Nintendo waited until the fall of 1991 to introduce its 16-bit system and SEGA took full advantage of the delay, quickly becoming one of the fastest growing companies in Japan.

Genesis gave SEGA a taste of the rewards a dominant console could deliver, whetting its appetite for similar success with its next generation of technology. By the mid-1990s, gaming had advanced to 32-bit consoles, with the competitive race intensifying as technological capabilities advanced. Both the games and the consoles—the software and hardware—were becoming increasingly expensive to produce, requiring vast sums of money and considerable labor to bring to market. SEGA, as it worked on developing its 32-bit console, faced its familiar foe, Nintendo, which had learned its lesson with the belated launch of its NES system, and a new, towering competitor. The industry was abuzz about the expected entry of Sony Corp. in the console market, a company whose enormous wealth and proven technological expertise gave SEGA and Nintendo little room for error. SEGA introduced its 32-bit system, Saturn, in Japan in 1994 and in the United States in mid-1995, but ineffective marketing coupled with a wait-and-see-what-Sony-introduces attitude by consumers doomed Saturn nearly from the start. After much fanfare leading up to the launch, Sony released its 32-bit PlayStation in September 1995 and quickly crushed all competitors. By December 1995, in the midst of the all-important holiday shopping season, PlayStation was outselling Saturn by a ratio of seven-to-one.

The failure of Saturn to capture the interest of gamers delivered a crippling blow to SEGA. The company began to record devastating financial losses, losing hundreds of millions of dollars in the years immediately following the launch of Saturn. Vital financial support was provided by its chairman, Isao Ohkawa, who kept the company alive with cash infusions. The precarious financial state of SEGA put added pressure on the development of the company's next console, whose success or failure likely would determine whether SEGA would survive or not. "We wanted a return match," a SEGA employee remarked in a March 28, 2001 interview with the Financial Times. "We said, 'We'll get them next time.' "

Dreamcast Taking Shape in the Late 1990s

Work was underway on the company's next system one year after the U.S. launch of Saturn, a project begun at a meeting in Tokyo's shopping district, Shibuya, in 1996. The project was known to select SEGA employees under the code-name Katana (an ancient Japanese sword), a project that would produce a console known to the public as Dreamcast. As the project progressed, Dreamcast was developed as a 128-bit system with a built-in modem enabling online play and the ability to down-load supplements to existing software. Other console designers were shying away from developing systems capable of connecting to the Internet, theorizing that widespread broadband connections would be needed to make online gaming perform suitably, but SEGA executives charged ahead. As it turned out, however, the problem was that SEGA executives were not all charging in the same direction. The enormous pressure on the success of Dreamcast led to an extended decision-making process and to bickering among senior executives, setting the company up for another fall, one that had the potential of being fatal.

Between 1996 and 1998, the debates about Dreamcast's development occupied the attention of SEGA's senior management. Executives argued about the specifications of the graphics chip—the heart of a video game console—which represented 70 percent of the cost of a console. "We wasted three months on the chip debate," a SEGA executive said in a March 28, 2001 interview with the Financial Times. As management discussed which type of chip to use, memory prices swelled by 40 percent, greatly increasing manufacturing costs. Executives also mulled over whether to add networking capabilities for months, with some arguing that adding a modem would increase the cost of the console beyond the price consumers would pay. Other debates centered on the launch of Dreamcast, a battle fought between those who wanted to introduce the console in Japan first and those who believed it should be introduced first in the United States, the company's second largest market. By 1998, the bickering was over. The 128-bit, modem-equipped Dreamcast debuted in Japan in November 1998 backed by the exuberance of Shoichiro Irimajiri, SEGA's president and the second leader to oversee the Dreamcast project. "We're not really going to compete with Sony or Nintendo," Irimajiri explained in a December 7, 1998 interview with Business Week. "We're going to blow them out of the water."

Key Dates:

1940:: Standard Games, the earliest predecessor of SEGA, is formed in Honolulu.
1951:: Standard Games' operations are moved to Japan.
1960:: SEGA Enterprises is incorporated.
1984:: SEGA introduces the Master System, its first gaming console.
1988:: A second console, Genesis, is introduced.
1994:: SEGA's 32-bit system, Saturn, is introduced.
1998:: Dreamcast, a 128-bit system with a built-in modem is released.
2001:: SEGA decides to exit the console market and concentrate on developing gaming software.
2004:: SEGA merges with Sammy Corporation, creating Sega Sammy Holdings Inc.

Despite the protracted debates about various matters related to Dreamcast, critics found little wrong with the console. After the September 1999 launch of the system in the United States, American consumers found little wrong with console as well. Within 24 hours, a quarter-million units were sold. Within five days, 400,000 Dreamcasts were sold, double the company's expectations. Irimajiri's tone, however, contained less enthusiasm than during the console's launch in Japan. "If Dreamcast fails, there is no plan B," he told the Financial Times in an October 14, 1999, interview. Perhaps some of Irimajiri's hesitance stemmed from two problems that occurred before the console was launched. Because of the delay in providing chip specifications, the development of software for the console was stunted. Further, a week before the launch in Japan, the manufacturer of the graphics chip informed SEGA that it could supply only 25 percent of the requested amount of chips by the launch date. When Dreamcast entered the Japanese market, there were only 200,000 consoles available instead of the expected 600,000. Instead of 15 games being available at the launch, the delay in providing chip specifications limited new Dreamcast owners to an offering of only four games. In Japan, many gamers opted against purchasing Dreamcast, preferring to wait for the much heralded arrival of Sony's PlayStation 2, which boasted more memory and better graphics than Dreamcast.

Poor management again had tripped up SEGA, delivering a stinging blow to an already injured company. SEGA, largely because of Saturn, lost $412 million in 1999, while sales slipped 12 percent to $2.2 billion. In 2000, the company lost $398 million. Irimajiri stepped down as president in May 2000, replaced by Ohkawa, who was watching his 22 percent investment in Saga plummet in value. The company still ranked as the third largest console maker, but its size offered little solace to senior executives. "SEGA is now facing a difficult live-or-die stage," a video game analyst remarked in a July 1, 2000 interview with AsiaWeek. "The next year is crucial."

Before the next year was over, SEGA executives made a decision that marked a profound turning point in the history of their company. With Dreamcast failing to deliver expected results and Microsoft preparing for worldwide launch of its console, X-Box, management announced it would exit the console market. Production of Dreamcast systems ended in March 2001, removing what a SEGA spokesman, in a March 7, 2001, interview with Investor's Business Daily, described as a "ball and chain around our ankle." Instead of making consoles, SEGA officials decided to develop games for the other consoles, fashioning itself as a third-party software publisher.

After exiting the console business, SEGA officials expressed relief that the long-fought battle in the hardware market was over. The company's losses did not end immediately, however. The cost of ending Dreamcast production resulted in $689 million in extraordinary losses, contributing to another money-losing year in 2002, when the company's revenue volume was half the total generated a decade earlier. In 2003, thanks largely to growth recorded in its arcade equipment business, the company posted its first annual profit in six years, providing an encouraging sign that a turnaround was underway. As the company celebrated a return to profitability, attention turned to the intriguing announcement that a merger was in the works, an announcement that marked the beginning of another SEGA saga.

Merger Discussions in the 21st Century

In March 2001, just as the production of Dreamcast consoles was winding down, Isao Ohkawa died. The senior executives who replaced the founder of CSK began pressing for a merger, seeking to reduce SEGA's mounting debt by aligning their investment with another corporation. Toward this end, SEGA announced in February 2003 that it had agreed to merge with Sammy Corporation, the largest manufacture of pachinko machines in Japan. The merger was set to be completed in October 2003, when Sammy would gain entry into the game-publishing business in the United States and SEGA would receive the financial help it needed. Within weeks, SEGA officials began looking for a way out of the deal, reportedly because they felt pressured by CSK, SEGA's largest shareholder, to complete the merger. In April 2003, SEGA executives believed they had received the help they wanted when Namco Ltd., a Japanese developer of gaming software, submitted its own proposal to merge with SEGA. Both deals collapsed, however, with Namco withdrawing its proposal in May 2003 and negotiations with Sammy breaking down over numerous issues, including management control.

SEGA's merger with Sammy was revived in 2004. In January, Sammy acquired the 22.4 percent stake held by CSK, paying $419 million to become SEGA's largest shareholder. In May, a $1.4 billion merger agreement between the two companies was announced, with the completion date for the transaction set for October 2004. The two companies merged in October, creating Sega Sammy Holdings Inc., the largest computer entertainment company in Japan. As SEGA, with Sammy alongside it, prepared for the future, the company faced several years of integrating its operations with those of Sammy. The process was expected to take until 2007 to complete. In the years ahead, the value of the merger would be determined, revealing whether SEGA's role as a software developer represented a business foundation capable of reversing more than a decade of troubles as a console maker.