Are Tiny Start-Ups New Media Giants?

In 1984, Gulf & Western Industries sold a little-known video game subsidiary to a Japanese investor group for about $40 million. But Gulf & Western kept the much bigger Paramount Pictures, which it then owned.

Today that little game business--Sega Enterprises--has a market value of about $7 billion. With revenue exceeding $3 billion this year, it’s about the size of the entertainment operations at Paramount Communications Inc.--which lives on in the wake of Gulf & Western’s dismantling.

Perhaps more important, Sega has a successful formula for interactive entertainment. That contrasts with Paramount, which, despite recent ambitious forays into the new medium, is far down on the learning curve.

Had Paramount kept its Sega unit, the company that has found success in movies, television and publishing might be considerably better positioned to live up to its billing as a key player in the coming age of interactive entertainment. Paramount’s potential in that arena is often cited as justification for the bidding war being waged over it by Viacom Inc. and QVC Network Inc.

But to the dozens of small software developers whose games make up half of Sega’s sales, and to the myriad start-up firms experimenting with the new forms of interactive entertainment made possible by new technology, expectations for Paramount’s existing media properties in a future of interactivity are overblown.

“It’s pure conceit for Hollywood to think they’ll be central to this,” said Mark Stahlman of New Media Associates, a consulting and venture capital firm in New York. “The problem is old businesses cannot, as a rule, make these sorts of transitions.”

Most of the entrepreneurs involved in the nascent multimedia industry prefer the “garage band” theory of the interactive revolution, which holds that the new media will be spawned not by the convergence of well-established media giants rooted in the past, but by agile little start-ups who can conceptualize non-linear stories and who “get” interaction.

To this way of thinking, tiny Trilobyte of Medford, Ore., may have a better chance at success in this brave new world than a big Hollywood studio. Trilobyte produced “The 7th Guest,” a murder mystery that is the best-selling CD-ROM ever (300,000 copies).

John Scull, whose 22-person company, PF Magic, is in San Francisco’s “multimedia gulch,” said he expects to be successful because “interactive entertainment is all we do and all we’ve ever done in our respective lives.” The company’s “3rd Degree” CD-ROM title, designed for three to six players, presents users with ethical dilemmas to which they must respond.

In Burbank, there’s 7th Level, the Michael Milken-backed company whose first product, “Tuneland,” an educational CD-ROM for children, has impressed multimedia connoisseurs with the smoothness of its animation and the quality of its sound. There are literally hundreds of other companies vying for a spot on the interactive stage.

On the other hand, people will always want to see movies. And studio libraries will be lucrative in a world in which consumers can order up any movie or TV show on demand. But after a while, the small-firm logic goes, even “Star Trek” reruns get old.

“This magic word that’s being used in the multimedia business, re-purposing , is way overvalued,” said Tom Zito, who owns San Francisco-based Digital Pictures. Re-purposing, or turning existing movies or books into interactive products--a concept that brings cross-marketing dollar signs to the eyes of many Hollywood executives--is less compelling to these purists than making something entirely new.

Digital Pictures produced three CD-ROM-based games for Sega this Christmas, all with original scripts and video footage.

CD-ROMs, played on computers or machines hooked up to the TV, can store huge quantities of video, graphics, sound and text and allow the user to manipulate any of the features. There is precedent for these start-ups’ small-is-beautiful argument. The movie studios themselves, after all, sprang from pushcarts and amusement arcades and were nurtured into gianthood by fiery entrepreneurs. The personal computer revolution was driven by companies that arose from dormitory rooms and Silicon Valley garages. Start-ups such as Microsoft, Lotus, Compaq, Apple and Dell surged ahead as traditional computer firms such as Digital Equipment Corp. and IBM flagged.

And the concept of recycling old material for a new medium has never been very successful. Early movies were simply filmed versions of stage productions, but the industry didn’t take off until someone figured out that cameras could be moved. Television got a significant boost when broadcasters tried something other than reading radio scripts.

Thomas Hirshfeld, who has studied multimedia for Salomon Bros., notes that Wall Street supports the bubbling-up theory.

“Electronic Arts is trading at five times revenues,” Hirshfeld said, referring to the Silicon Valley multimedia software publisher. “That’s higher than Paramount is being valued by either of its bidders.”

The high price of small multimedia stocks and the successful public offerings of interactive software firms such as Broderbund, Media Vision and 3D0 have not escaped Hollywood’s notice. Most of the major studios have formed interactive divisions. And in what new media analyst Denise Caruso calls the “we-own-everything, therefore-nothing-will-escape-us” phenomenon, they’ve all begun to invest in or acquire promising multimedia start-ups.

The start-ups need Hollywood as well. Hollywood has money, after all. But MCA Executive Vice President Charles (Skip) Paul, one of a handful of studio executives with a video game background--he used to work at Atari--said money will not be enough.

“Most people believe this is a natural fall forward for Hollywood,” Paul said. “It’s not. It’s a lot of work. It involves creating new skill sets in the studios and dedicating resources to learning to develop interactive products. It doesn’t happen by the passage of time only.”