Sega: The Way the West Was Won

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SEGA: The Way the

West Was Won

History of SEGA before 1984


Coming out of the Air Force after a tour of duty in Tokyo, David Rosen, a 20-year-old Brooklyn native, noticed that Japanese people needed lots of ID photographs, but the local photo studios were slow and expensive. To cater to this need, he established Rosen Enterprises and went into the instant photo booth business. In 1957, the Korean War ended and Japan's economy started to boom. To Rosen, this meant the time was right to get into the entertainment business. He imported used arcade games from Chicago and placed them in Japanese theaters and department stores. With his business prospering, he merged it with another American-owned business in Japan, Service Games, and formed SEGA Enterprises in 1965. In Japan, SEGA was involved in all aspects of the industry. This integrated approach included activities in operations, distribution, and manufacturing. Integration allowed considerable flexibility in the business, and as a reward for this flexibility, profits tended to be more considerably stable than SEGA’s competitors, who were involved in only part of the industry. As a result of this integration, products manufactured by SEGA were not only sold to distributor/operators, but they were used in SEGA’s own operations. SEGA was its own best customer.1

Innovation was the key ingredient in SEGA’s success. SEGA introduced the first generation of commercial video games to Japan in 1973 and marketed its first microprocessor-based game, Rodeo, in 1975. In 1979, SEGA introduced Head On, a game that incorporated SEGA’s MultiPhase technology that allowed players to progress through increasingly difficult levels of the video game as their skills improved. The successful development and application of this feature essentially transformed the game into a learning machine. Introduced in 1980, Astro Blaster was the first commercial SEGA computer video game to combine MultiPhase programs with technology that enabled the game to “talk” to players. The combination of these advanced systems proved to be a magnet for computer video game enthusiasts and has made Astro Blaster a popular model at game centers around the country. SEGA’s Space Fury, introduced in 1981, was the industry’s first game to incorporate X-Y color systems. X-Y color technology produced graphic depth perception, color clarity, and graphic representations that were new benchmarks for the industry.


Operations were the heart of the coin-operated amusement industry. It consisted of the actual installation, operation, maintenance, and coin-collection activities. This was where SEGA originally established itself to become Japan’s number one company in the industry. The Operations Division was responsible for placing equipment on a revenue-sharing basis in restaurants, bowling centers, cocktail lounges, and other locations not primarily devoted to coin-operated amusement equipment. In addition, Operations sold equipment to privately owned businesses for use on their premises.

SEGA had close to 20,000 machines operating in approximately 7,000 locations throughout Japan in 1980. This operation was directed by approximately 75 district managers in the regional areas, who oversaw 330 service and maintenance personnel in the Operation. Because of the extensiveness of this operation, the company developed a sophisticated computer-aided system for monitoring, controlling, and directing the installation, service, and collection for this network. SEGA’s experience in administering its operations in Japan had given it an expertise that was transferable to other markets in other countries around the world.


The Arcades Center Division directed the activities of SEGA arcades that operated the full line of SEGA products. In many cases, arcades were located in buildings housing one or more movie theaters. In addition to conventional arcades, the Arcades Division was also involved in managing amusement casinos. Patterned after Las Vegas casinos, these casinos contained slot machines, group games, and other nonskill machines that were played with tokens and operated for amusement only. There was no redemption for money or prizes.


SEGA’s Sales Division distributed both products of its own manufacture and those imported by the company. SEGA imported into Japan a line of coin-operated phonograph machines for distribution and operation. For more than ten years, SEGA has held exclusive distribution rights in Japan for jukeboxes manufactured by Rock-Ola Manufacturing Corporation, an American company. SEGA also imported, distributed, and operated pinball machines. These machines were imported under a distribution agreement with Williams Electronics, Inc., an entirely American-owned subsidiary of the Seeburg Corporation. SEGA had large facilities involved in first-class reconditioning of used machines. Machines were returned from the Operations and Arcades Center Divisions for rebuilding and reconditioning and then sold to other operators or relocated on SEGA’s routes.


SEGA’s main manufacturing facility is located near the Haneda Airport in Tokyo, Japan. It consists of approximately 135,000 square feet in three buildings and is devoted to assembly and reconditioning functions. SEGA designs and manufactures a broad line of coin-operated arcade games and casino-type machines. Because rapid product changes are necessary in the coin-operated amusement game industry, SEGA subcontracts most component production in order to concentrate mainly on assembly. SEGA’s limited investment in plant and equipment allows it to have maximum flexibility to react quickly to competitive factors. Approximately 120 suppliers, some of which SEGA has welded into a vendor association, support SEGA’s manufacturing effort.

For many years, SEGA has manufactured machines that have introduced new ideas and technology to the industry. SEGA machines have intentionally been overengineered to produce products with great durability and high resale value.

SEGA of America

In 1984, SEGA Enterprise was bought by a partnership of SEGA Enterprises Japan management and CSK forming SEGA Enterprises Ltd., a Japan-based company. In 1986, SEGA Enterprises Ltd.'s stock was listed over the counter on the Tokyo Stock Exchange. Also, in 1986, SEGA of America Inc. was established to adapt and market video game products to a rapidly expanding American market. It was subsequently given the charter to develop software products specifically for the American market.

In the late 1980s, SEGA Enterprises introduced a line of extremely successful video game systems and software titles that propelled the company to international prominence, making it the world’s second largest vendor of consumer video game products. In 1990, SEGA Enterprises Ltd.’s stock was listed on the first tier of the Tokyo Stock Exchange. In 1993, the stock was listed on the pink sheets of NASDAQ and available in ADR in the United States. SEGA’s phenomenal growth over the last several years can be traced directly to growth in its largest division, SEGA of America. From a staff of 35 in 1989, SEGA of America has shot up to its present strength of 700. In two years, SEGA of America had become the largest producer of video games in the world.

Today, SEGA Enterprises Ltd., which operates in Japan, is composed of SEGA Europe Ltd., SEGA of Canada Inc., SEGA of Mexico Inc., and SEGA of America Inc. The company is a $3.5 billion developer and worldwide marketer of video game entertainment systems and software and is known as the leader in interactive digital entertainment media, with operations on five continents.


In the fantasy world of home video games, outsmarting opponents and zapping enemies has been a highly competitive business. Arcade companies survive vicariously through the fickle minds of the young video game junkies. Nintendo and SEGA have been in a constant race for the latest technology and best software. One reason for SEGA entering the U.S. market was that SEGA was better able to compete and thrive against Nintendo in the United States. SEGA has found the key to attaining market share through technological innovation, product quality and diversity, solid distribution, and an aggressive marketing strategy.

Competitors and Products

The home video game business was once dominated by a single company. Nintendo, once the largest home video game firm, started in the market with its 8-bits system NES. Nintendo captured a huge market in Japan as well as in the United States. From being the first mover, Nintendo developed a strong brand name with the NES system. Not long after the introduction of the NES, SEGA started to formulate plans for a more advanced 16-bit system and the race was on. The programming acumen of SEGA’s parent CSK, Japan's largest software house, helped SEGA beat Nintendo in the race for the 16-bit machine, Nintendo worked on a 16-bit machine of its own called the Super NES, which eventually arrived two years after SEGA’s. By the time the Super NES hit the market, SEGA’s software engineers had mastered all the 16-bit video tricks, and America's ever-fickle child consumers decided the rest. Another advantage SEGA had over Nintendo was the compatibility of its software. Patrons could use the same cartridges in 8-bit and 16-bit machines.

The next stretch of the race was the development of the 32-bit CD ROM system. The first company to market this system was 3DO. 3DO is a California-based company whose 32-bit RealMultiplayer came out in 1993. Due to the giants of Nintendo and SEGA, 3DO has only found limited success in attaining market share. SEGA also began the CD-ROM technology that brought Sony Corporation into the race. Sony offers a powerful compact disk-based system backed by its almost unmatched marketing power. Now Sony and SEGA both offer systems that play games on CDs, Sony’s PlayStation and SEGA’s Saturn. With their huge memory capacity and enhanced graphics, CDs enable software companies to create more complex and vivid games. SEGA also introduced a 38X power booster that enabled the 16-bit system to have the 32-bit experience. The compatibility of SEGA’s software and hardware has been a reason for its success and customer satisfaction.

Nintendo has looked even further ahead and will try to fight back with the Ultra 64. The system is basically a robust 64-bit machine that plays games on traditional cartridges. Nintendo has not found great success with this technology. Atari has developed the advantage of being the first with this technology; it already sells the 64-bit Jaguar.

The Real Market

Software has become the problem and the solution to capturing the fast pace of the market and technological continuum. Hiroshi Imanishi, a senior executive at Nintendo, explains, “There are a lot of bad video games and too many of them are not selling.” Nintendo is hoping that better games will boost the market. Terahisha Tokanaka of Sony Computer Corporation explains, “People are looking for something new, something totally different.” Sony’s PlayStation is being promoted in Japan by one of Sony's most lavish advertising campaigns ever. The goal, Tokanaka offers, is to expand the game market to older boys and women. The Japanese colossus Sony is betting on the CD-ROM because at $1 CDs are cheap to manufacture; both SEGA and Sony assert that the new CD games will be cheaper than the traditional cartridges, and this will be the key to growth in the game market. Lower costs should spur creativity as well. In the past, the expense of the cartridge games has made manufacturers wary of producing anything but absolute winners. With cheaper CDs, there is less risk and more willingness to experiment. The reality is that software drives the market, and everybody wants more sophisticated games.

The Future

With nearly $6 billion in sales, the U.S. video game business is bigger than the movie industry. After a decade of torrid growth the market, however, is slumping and all the major players are vulnerable. Kungoo Lee, an analyst with Dataquest Japan, offers a prediction on the winners and the losers, “Sony’s machine is better than SEGA’s, but SEGA will sell more systems because its games are better.” Lee believes that Sony will acquire the number two position in the game market, followed by Nintendo.

Technology drives the business. SEGA superseded Nintendo on the strength of its superior 16-bit Genesis. Despite Atari’s introduction of the 16-bit machine, the 32-bit CD-ROMS are the current craze. The 64-bit machines are bulky and expensive and use cartridge games. Already CD-ROM PCs have become very popular. In the future, game playing will probably not work on “dedicated machines.” The PC could very well knock the traditional “platforms” out of the market. Nintendo and SEGA could fall to companies such as IBM. Further on the horizon lies the challenge from interactive television, offering the possibility of games being downloaded to home “entertainment.” Through the digital ether, people can simply point, click, and rent any game they want. Nintendo has already made an interactive karaoke arcade that has been popular in the Japanese market.

Market Share

In the beginnings of the game industry, Nintendo's 8-bit machines held 90 percent of the U.S. market. Nintendo is carried in more stores and has a stronger brand name than SEGA. It also has 8-bit machines in over 28 million households. Since the introduction of the 16-bit machine, Nintendo's share price has dropped from a split adjusted high of $188 to $88. This valued Nintendo at 12.5 billion, 3.5 times its sales. In the 16-bit systems SEGA’s market share in 1991 was 20 percent and has become dramatically higher. In 1993 the market began its slump. SEGA’s earning dropped 64 percent and Nintendo reported a 41 percent drop. Since 1991, stock prices have dropped and there is no respite in sight. Currently SEGA holds over 50 percent of the consumer games market. Along with SEGA’s advantage in software, part of its success was due to its introduction of hardware that upgrades current systems. An example of this is the 32X power booster, which enables the 16-bit machines to have the 32-bit experience.

Strategic Alliances

Despite technological innovations and good software, SEGA’s success is attributed to their mastery of collaboration. Unlike Nintendo, SEGA has formed alliances with many huge corporations to take advantage of skills and information that they do not. For communications, SEGA has formed an alliance with AT&T. SEGA uses Hitachi for the manufacturing of its computer chips. For excellent sound effects, SEGA formed a partnership with Yamaha. JVC also helps SEGA in the manufacturing of game machines. Currently the company has made agreements with 48 third-party titles with its 16-bit system. For its Game Gear system, SEGA has 17 third-party titles to develop software. For the SEGA CD multimedia system, SEGA has key licensing agreements with 38 third-party developers.


SEGA of America produces a high-quality product, which is a key to its success, but, without a good distribution channel, no one would be able to purchase it. By reviewing the history of SEGA Enterprises Ltd., one will recognize the importance that their distribution system played in the company's resurrection and boom in the U.S. consumer market.

David Rosen, an American living in Japan, established Rosen Enterprises in 1954 and immediately developed a good rapport with department stores and other retailers who carried his two-minute photo booths. Rosen began to import amusement games (i.e. pinball machines) from Chicago in 1956.

Rosen, with a solid distribution channel in place, decided to develop his own games. Therefore, in 1965 he purchased Service Games to acquire its factory and strengthen his distribution capabilities. Rosen decided to take on the Service Games logo stamped on boxes SEGA (SErvice GAmes). After general success in Japan, with its over 200 arcades, Rosen decided to sell his company to the American Corporation Gulf and Western and expand to the United States. Rosen remained CEO of SEGA Enterprises, and he understood that to be more successful in Japan SEGA required greater distribution capabilities. In 1979, SEGA purchased a distribution company founded and owned by Hayao Makayama.

This strategic move proved crucial to the survival of SEGA, to its current business philosophy in America, and to its initial market-entry strategy. When the bottom fell out of the arcade market, Gulf and Western repurchased its stock and sold all of its U.S. and Japanese assets, while Nakayama, Rosen, and CKS (a Japanese software company) purchased the Japanese assets for $38 million. (SEGA today is worth about $3.5 billion.)

In 1986, SEGA Enterprises Ltd. established SEGA of America Inc. and reentered the U.S. market. SEGA of America immediately signed a distribution agreement with Tonka that provided SEGA with a strong foundation to its marketing and distribution programs throughout the United States and Canada.

Like its Japanese parent, SEGA of America understands the concept of reducing cost to lower prices. In anticipation of an increase in demand for SEGA products, SEGA of America built a distribution center in Hayward, California. It is able to handle the massive number of products imported and distributed throughout North America with an efficiency level of 99.9 percent. Radio frequency is one technique used in the Hayward distribution center to improve its efficiency. Workers scan bar codes on packages, and radio transmitters in their workbelts transmit a message to a central location. This allows better tracking of merchandise and eliminates wasted time.

With such an efficiency process, retailers receive their shipments on time, which means that customers do not have to leave their stores empty handed. One analyst credited some of SEGA’s success during the late 1980s and early 1990s to the simple fact that customers became frustrated with the fact that Nintendo products were always out of stock. By planning ahead, SEGA of America made it easier for consumers to switch to SEGA hardware (e.g., 16-bit SEGA Genesis) because the software that people wanted would be in stock.


SEGA produces a high-quality product geared toward Americans, and stores are full of the products. But how does a Japanese company entice consumers to buy its products? At this point in time, the company had to adopt an American advertising strategy, and here is where Thomas Kalinske steps into the picture.

In 1990, Hayao Nakayama, CEO of SEGA Enterprises Ltd., hired Thomas Kalinske as CEO of SEGA of America. Kalinske's background is in marketing, not in a technical field like many of the top executives in the company. SEGA of America uses Japanese principles in regard to products and distribution. In marketing, they focus on the aggressive American style of advertising with a slight twist of Japanese influence. Almost immediately, Kalinske put the SEGA ad account up for grabs, and the young San Francisco advertising firm, Goodby, Berlin, and Silverstein won the account. G, B, & S launched an ad campaign trying to establish SEGA’s products as the “coolest” on the market. Brash, fast-paced, eccentric ads bombard our televisions to this day, all ending with the signature SEGA scream, “SEGA!” This strong association of company name and product is very Japanese. What is uncharacteristic are the direct comparisons made between SEGA products and those of its competitors. Nakayama was hesitant of direct comparison advertising, but he trusted Kalinske. This trust paid off in profits. G, B, & S ads have a dual function: first, to establish SEGA as the “coolest” for those between ages 10 and 14, and second, to widen the consumer range from 10-14 years old to 10-27 years old. The ads are designed to enthrall an older crowd, and they have succeeded. The ads have sported images of “SEGA!” from a giant Tyrannosaurus Rex, Sonic the Hedgehog, and an American icon, Joe Montana. With an advertising push like this, some say SEGA has become the system that you and your older brother could sit around and play.

Kalinske further expanded his marketing blitz on the 10-14 age group with SEGAVISION, a “gamers” magazine. The magazine offers tips to “gamers.” Kalinske wants to seize all opportunities and now advertises through the Internet. Through the Internet, SEGA offers information on new products and tips for “gamers” between 14 and 27 years old. Marketers at SEGA did their homework and discovered that “gamers” spent a tremendous amount of time testing games before they bought them. As a result of this information, SEGA began building a strong relationship with video rental stores (i.e. Blockbuster). Video game rentals are now a mainstay for video stores across the United States, and they offer “gamers” the opportunity to test any game before they purchase it.

Thomas Kalinske has masterfully formed alliances with major corporations to promote SEGA’s games and hardware. These collaborations open a myriad of possibilities, from 7-Eleven and Coca-Cola collaborating on Slurpee endorsements to Howard Johnson’s, Blockbuster, and MTV promoting a slew of video game competitions. SEGA of America has become a part of American culture, and the SEGA scream is here to stay, SEGA!


Technology waits for no one in the video game business. Realizing this, SEGA has employed its skills and resources to optimum efficiency. The company produces a wide range of quality products including a factor of compatibility that gives its products an absolute advantage over its competitors. Through a staunch distribution system and an aggressive marketing system, SEGA has ensured that the hunger of the market will be sated. Effective collaboration has given SEGA strong alliances to ensure maximum efficiency in production and the best possible quality. By maintaining the Japanese style of operating, while acknowledging the qualities of the U.S. market, SEGA realizes that there is no second place in the technology race.

1Source: This case was written by Masaaki Kotabe.

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