Press release: 1993-07-04:Sega Takes Aim at Disney's World

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Sega Takes Aim at Disney's World

By Andrew Pollack

July 4, 1993

EIGHT pilot trainees take their positions in the small space capsule known as AS-1. Their captain, Michael Jackson (yes, that one), appears on the screen in the front. With Mr. Jackson issuing orders, the trainees launch the capsule and swerve through space, each firing missiles at enemy vessels and competing for points. When the captain is hit, he turns over the controls to the player with the best score, who gets to steer the capsule in for a landing.

"Scramble Training," part movie and part communal video game, is a new amusement-park ride by Sega Enterprises. Sega is best known as the challenger to Nintendo in home video games with its Sonic the Hedgehog character, but its president, Hayao Nakayama, has much grander goals. "Our target," he says matter of factly, "is Disney."

Mr. Nakayama wants to reinvent the amusement park. Whereas Disney built huge parks with roller coasters and log flume rides, Sega wants to build small theme parks that will provide the same thrills using computer simulations known as virtual reality -- a Disneyland in a box. While sitting in an apparatus that shakes and moves in sync with what is on the computer screen, riders will feel as if they are engaging in a "Star Wars" battle, or feel the bumps as they race against other automobiles. By the time it is Fourth of July a few years from now, Mr. Nakayama hopes, dozens of these parks will be scattered around the United States and Japan. (Page 6.)

He may be premature in aspiring to be Disney, but Mr. Nakayama can be forgiven for having big ambitions. Sega's thriving home video game business and its technologically advanced arcade machine business have already transformed the company from an American-owned jukebox distributor to a Japanese leader in the emerging industry of interactive entertainment. Interactive entertainment allows viewers to get more involved, choosing and manipulating rather than just sitting back and watching.

Such entertainment is attracting the likes of computer companies like Apple and I.B.M., consumer electronics companies like Sony and Matsushita, communications titans like Tele-Communications and U S West, not to mention Hollywood studios and publishers.

The Atari Factor

Amid these corporate superpowers, few people, especially in the United States, have heard of Mr. Nakayama, a sometimes whimsical but often demanding executive who is held in fear by his subordinates. Instead of becoming the Disney of the electronic age, Mr. Nakayama's Sega might just as well become the next Atari, a video game company that experienced meteoric growth on the strength of one product in the early 1980's only to nearly collapse when the market shifted. The home video game business is on the cusp of technological transformation and new competitors are jumping in.

But Sega could surprise people. It already has an interactive machine -- its game player -- in millions of homes and has 850 research and development people working on interactive amusements for homes, arcades and theme parks. "No other company in high-technology amusement has this many people," said Hisashi Suzuki, head of research and development.

Led by the stunning success of Sonic, a cheeky blue rodent with red sneakers, Sega has gained ground in home video games against Nintendo, a company that seemed all but unassailable a few years ago. Sega has seized the technological high ground by introducing new technology faster than Nintendo, the latest example being a virtual reality helmet that allows players to feel as if they are actually inside the game they are playing. The helmet is expected to go on the market later this year for about $200.

While Nintendo is still twice as large as Sega in video games, in the important American market Sega's latest generation Genesis machine is said to be running neck and neck with the Super Nintendo Entertainment System.

"Sega has succeeded in positioning itself as the cooler machine," said Gilman G. Louie, chairman of Spectrum Holobyte, a California company that makes software for both players. "The MTV generation plays Sega and your little brother plays Nintendo."

The result has been that Sega has tripled in size in two years. In the fiscal year that ended in March, revenues rose 68 percent to 416 billion yen, or $3.6 billion using the exchange rate at the end of March. Net income more than doubled to 30.76 billion yen, or $265 million, at a time when most Japanese companies were struggling just to stay in the black. Nintendo's sales, by contrast, grew 13 percent, to the equivalent of $5.5 billion, while net income rose less than 2 percent.

Sega's stock has also tripled in value since 1989, although it has been fairly level for the last year or so. Mr. Nakayama's 5.2 percent stake is now worth more than $450 million.

Deals Galore

With Sonic-like speed, Sega has been positioning itself for greater expansion. In April, it said that later this year it would begin testing delivery of video games over the cable television systems of the two biggest American operators, Tele-Communications and Time Warner. And a month ago, it announced a tie with the American Telephone and Telegraph Company that would allow people in different locations to compete in Sega games over the phone lines.

Meanwhile, Mr. Nakayama has been busy fortifying Sega's management ranks. His biggest catch: Shoichiro Irimajiri, who was in line to become president of Honda until he unexpectedly quit last year.

Not bad for a college dropout who never even plays video games. "Not at all," said Mr. Nakayama, 61, who said games are meant for people under 40. "The important thing is not that I enjoy playing but that I understand what it is that causes them to enjoy it."

But Sega's markets are changing quickly. Home video games are moving from machines like Genesis that use 16-bit microprocessor chips to ones using 32-bit chips, which allow for more lifelike images.

Leading the way is the 3DO Corporation, whose founder, Trip Hawkins, also started Electronic Arts, a software company whose products have been heavily responsible for Sega's success in the United States. 3DO has electrified the industry with a 32-bit machine that can display nearly three-dimensional images.

The $700 Challenger

A machine using 3DO's technology will be sold later this year at an expected price of $700 by Matsushita, thereby bringing the world's largest consumer electronics company into the video game business. Other Japanese electronics companies, including Sanyo (another 3DO licensee), Sony, JVC and Pioneer are eyeing video games as a way to escape the stagnation in the audio and video markets. In the United States, Atari has enlisted I.B.M. to manufacture its new high-powered Jaguar game machine.

Sega is working on a 32-bit machine of its own but it won't be released until next year at the earliest. Mr. Nakayama said Sega had an early chance to be 3DO's manufacturer but declined because hardware does not make money. Sega, because it makes its profits on software, will be able to sell its 32-bit machine for less than Matsushita, which will depend on hardware for its profits.

Another potential threat to Sega, a fading of the video game fad, does not seem to be imminent, industry executives say.

Longer term, video game machines might be replaced by cable television converters that will deliver not only games but television programs, movies and computer data. "Once they no longer control the box, and once digital distribution of games becomes possible, how then will Sega and Nintendo continue to be successful?" asked Nat Goldhaber, president of Kaleida Labs, a joint venture of Apple and I.B.M. that is involved in developing such cable converters.

Other questions arise about Mr. Nakayama: Has he the skill to manage the company or is he merely lucky? Skeptics point out that in his home market of Japan, Sega is being soundly trounced by Nintendo, in part because of distribution problems and also because Sega's sports-oriented games are not as popular there. Sega is being carried by its American and European operations, which have some autonomy from Tokyo. In particular, Sega of America, which claims sales of just under $1 billion annually, has boomed since 1990 under its president, Thomas J. Kalinske, a former Mattel executive.

Back to Its Roots

To the extent that it is relying on its American subsidiary, Sega is, in a sense, going back to its roots. Until 1984 the company was American owned, a division of Gulf and Western (now Paramount Communications). But Mr. Nakayama, who had been recruited to head Sega's Japanese operation in 1979, organized a buyout backed by CSK, a large Japanese software company that now owns 20 percent of Sega.

Mr. Nakayama strikes Westerners as an American-style manager with a good sense of humor. "There was not a lot of holding the cards close to the chest," said Tom Zito, chief executive of Digital Pictures, a Menlo Park, Calif., company that makes software for Sega. "He's opinionated and he makes decisions."

In Japan, that makes Mr. Nakayama an exception to consensus management. He speaks extremely rapidly and impatiently orders subordinates around in a whiny voice.

A widower since late last year, Mr. Nakayama lives during the week in Tokyo's plush Okura Hotel, and arrives at work each morning at 7:30 in his chauffeur-driven Mercedes.

Former Sega executives say Mr. Nakayama is obsessed with competing with Nintendo. His counterpart there, Hiroshi Yamauchi, is every bit as driven, shrewd and autocratic as Mr. Nakayama, if not more so, industry people agree. And he also doesn't play video games.

Sega has followed Nintendo's successful model in one key respect -- profits come mainly from software. Sega and Nintendo generally manufacture game cartridges for their machine, even for games made by outside companies. This guarantees them a profit on every cartridge.

But beyond that, the companies have somewhat different strategies. Nintendo, supremely sure of itself, tends not to introduce a new game machine until it has compelling software ready for it. Sega, being the underdog, has been more willing to rush out new hardware, even if only a little software is available.

A Long Headstart

This strategy resulted in Sega's biggest success when it introduced its 16-bit Genesis machine in 1989 in the United States, two years ahead of Nintendo's Super NES. With the headstart, Genesis, which sells for $100, has about 50 percent of the installed base of 16-bit machines in the United States, according to Kaori Hasegawa, an analyst with Salomon Brothers.

Sega last year also began selling an attachment to Genesis for playing CD-ROM's, a compact disk that allows for games containing movie-like images instead of just cartoon-like graphics. The company has sold 300,000 machines in the United States, a respectable showing hampered somewhat by lack of software and the machine's poor video quality. Nintendo has yet to begin selling its CD-ROM player.

By being in both home and arcade games (Nintendo is only in home games) Sega can develop technology for expensive arcade machines and then move it to home machines when the prices of chips drop. At Sega's research and development operations in Tokyo, young men (and a few women) in jeans and T-shirts labor in an open room with plush toys and half-finished arcade games strewn about. There are beds and showers for those who choose to stay overnight.

But much of the software and some advanced technology development is now being shifted to the United States, just as other Japanese companies have seen fit to buy Hollywood studios. The United States is unsurpassed in software for both computers and entertainment and is far ahead of Japan in areas like cable television. Even the newest versions of Sonic the Hedgehog, once held up as a prime example of successful Japanese software, are being developed at Sega of America in Redwood City, Calif.

Sega is trying to move beyond auto racing and action games at which it excels to more general "multimedia" entertainment featuring full-motion video, drama and characters besides Sonic that can be as popular as Mickey Mouse.

Such programs will be needed for home entertainment of the future and for high-tech theme parks. Whether Sega can do this will determine, more than anything else, whether Mr. Nakayama can become the virtual Disney of Japan.


SEGA is one of the few Japanese companies started by Americans. In 1951, two Americans in Tokyo, Raymond Lemaire and Richard Stewart, began importing jukeboxes to supply American military bases in Japan. Their company eventually expanded into amusement game imports and adopted the slogan "service and games" from which Sega derived.

A few years later, a Brooklyn-born entrepreneur named David Rosen, who had been stationed in Japan with the Air Force, returned to Japan and began importing amusement machines. In 1965, the "service and games" company merged with Rosen Enterprises to form Sega Enterprises. The next year it began its transformation from importer to manufacturer, producing a submarine warfare arcade game called Periscope.

With Mr. Rosen running the company (the two founders having left many years ago), Sega went through various transformations. It became a subsidiary of Gulf and Western (now Paramount Communications), then was partly spun off, then purchased again and made part of Paramount, the parent's movie studio.

As all this was taking place, Hayao Nakayama was undergoing his own odyssey. The son and grandson of doctors, he was expected to become a doctor as well. But, deciding he was not cut out for medicine, young Hayao dropped out of college.

Through a newspaper ad, he found a job as a salesman for a jukebox leasing company. When that company disregarded his advice to diversify into the new business of arcade games, Mr. Nakayama formed his own arcade game distribution company, Esco Trading, which grew rapidly. One of its suppliers was Sega.

"He always had a marvelous sense of what machines the market would accept," recalled Mr. Rosen, who is still a director of Sega and chairman of its American subsidiary.

In 1979, Sega bought Esco, mainly for the purpose of putting Mr. Nakayama in charge of its Japanese operations. In 1982, Mr. Rosen retired and Mr. Nakayama became chief executive of all of Sega.

In 1984, Sega became a Japanese company when Mr. Nakayama and Mr. Rosen led a buyout with the backing of CSK, one of Japan's largest software companies. CSK owns 20 percent of Sega and its chairman, Isao Ohkawa, is Sega's chairman.


The "virtual reality" theme park, which Sega Enterprises is counting on for growth, uses machinery similar to military aircraft simulators to make customers believe they are somewhere they aren't. The idea is to pack a lot of thrills into a small space.

Whereas the Walt Disney Company has one or two huge parks to attract a nation, Sega plans to build dozens of smaller parks, one to five acres each, to attract people from a single region. And while Disney attractions can stay fixed for decades, a virtual reality attraction can be changed just by changing the software. The same simulator can be used for a space battle or a police chase.

Disneyland's "Star Tours" also uses a simulator but customers merely get taken for a ride. Sega plans to make its attractions interactive, letting people shoot and steer to give them an incentive to try again and again.

A Sega brochure lists several attractions it plans to provide, including a "Star Wars" battle simulation being developed with film maker George Lucas. The Virtua Formula game that is already available allows eight players to race against one another in cars that shake and move, so that riders feel the turns and collisions. Each driver's screen shows the view from his or her windshield.

To make its attractions realistic, Sega has licensed computer graphics technology used in real aircraft simulators from the General Electric Company's aerospace division.

Sega executives say the company plans to build 50 amusement parks in Japan, starting with one opening in Osaka next year, and another 50 in the United States over the next several years. Each might cost $10 million to $50 million. In both countries Sega is seeking partners to help pay the costs.

Some industry experts expect Sega, which sold an unsuccessful American arcade business in 1990, will never build as many parks as it says and will move cautiously. Before it builds the parks, the company will be opening some smaller amusement centers in the United States. One will open in the new Luxor Hotel in Las Vegas later this year.

Many other companies are also developing such parks, though Sega's plan seems more ambitious. Namco, another leading Japanese arcade game maker, has already scored big with a small Tokyo high-tech theme park called the Wonder Egg and is expanding in Japan and the United States. Edison Brothers Stores of St. Louis has three "Exhilarama" virtual reality amusement centers operating in the United States, though they are smaller than those Sega envisions. Paramount is working on a Star Trek virtual reality attraction and Sony is also said to be at work on an ambitious high-tech theme park.