Rec Room Part II (with CEO Nick Fajt)

Abstract
Summary Notes

Abstract

In this episode of "Acquired," hosts Ben Gilbert and David Rosenthal are joined by Nick Fajt, CEO of Rec Room, to discuss the evolution of the virtual universe platform. Initially focused on the VR landscape, Rec Room faced a pivotal moment when VR growth stalled, prompting a strategic shift towards user-generated content and multiplatform expansion, including mobile and gaming consoles. This transition, while initially met with community resistance, ultimately led to significant growth, with Rec Room announcing a $100 million raise at a $1.25 billion valuation, driven by a 660% revenue increase and a community of over 15 million users, 2 million of whom are creators. The episode delves into the challenges and decisions that shaped Rec Room's journey, highlighting the resilience and adaptability of the team, as well as the importance of aligning with community, team, and investor interests.

Summary Notes

Product Launch Timing

  • David Rosenthal inquires about the appropriateness of shipping a product the following day.
  • Nick Fajt advises against shipping the product tomorrow and suggests waiting until Wednesday.
  • Nick Fajt plans to send David a press release with an embargo date.

"Don't do it tomorrow. Please wait until Wednesday. Yeah."

"I'm gonna send you the press release, so you just. It has the embargo at the top."

The quote indicates that there is a planned product release with a specific embargo date, suggesting the importance of timing in product launches and communication strategies.

Introduction to Acquired Podcast Season Eight, Episode Four

  • Ben Gilbert introduces the episode and himself as the co-founder and managing director of Pioneer Square Labs and PSL Ventures.
  • David Rosenthal introduces himself as an angel investor based in San Francisco.
  • Both Ben and David are the hosts of the Acquired podcast.

"Welcome to season eight, episode four of acquired, the podcast about great technology companies and the stories and playbooks behind them."

The quote serves as the opening for the podcast episode, setting the stage for the discussion about technology companies and their strategies.

Rec Room's Growth and Funding

  • Rec Room, a Seattle startup, was discussed in a previous episode regarding their seed round from Sequoia.
  • Nick Fajt, CEO of Rec Room, talks about the company's growth from a VR app to a multi-platform product.
  • Rec Room raised $100 million at a $1.25 billion valuation from Sequoia and Index Ventures.
  • The company experienced a 660% revenue growth, reaching over 15 million lifetime users.

"Earlier today, Rec Room announced in the Wall Street Journal that they had raised $100 million at a $1.25 billion valuation from existing investors Sequoia and index ventures."

The quote highlights Rec Room's significant fundraising achievement and valuation, reflecting the company's growth and potential in the technology sector.

Metaverse Category Growth in 2020

  • Ben Gilbert discusses the growth of the metaverse category in 2020, mentioning Epic and Fortnite's rumored valuation and Roblox's IPO.
  • The metaverse industry has seen transformative growth, with Rec Room being part of this trend.

"Indeed, the background of all of this is that 2020 was a heck of a year for the entire metaverse category."

The quote emphasizes the rapid and transformative growth of the metaverse industry, with multiple companies experiencing significant valuation increases.

Nick Fajt as a Repeat Guest on Acquired

  • Nick Fajt is welcomed back to the Acquired podcast as the first repeat guest on the main show.
  • The discussion will cover the evolution of Rec Room from its early stages to becoming a mature company.

"And we are back to tell part two of the rec room story, and again with the best person in the world to join us, Nick fight."

The quote signifies the continuation of Rec Room's story on the podcast, with Nick Fajt providing insights into the company's journey.

Founding Story of Rec Room

  • Nick Fajt shares the founding story of Rec Room, highlighting the lack of a grand vision at the start.
  • The company was formed by a group of individuals who left Microsoft after a reorganization.
  • The initial idea was to continue developing software for HoloLens, but upon not receiving dev kits, they pivoted to VR using HTC Vive.

"Yeah, I mean, I think the founding stories you normally hear, it's like a very cleaned up narrative of, like, I had this vision or I was doing this Mundane task and this light bulb went off, and that was not true for us."

The quote provides insight into the organic and unplanned beginnings of Rec Room, contrasting the common narrative of founding stories with clear visions.

Rec Room's Improvised Culture

  • Nick Fajt explains how the improvised beginnings of Rec Room have shaped its company culture.
  • The team does not get too attached to ideas and has an improvised style of operation.
  • The lack of a grand plan has led to a culture of flexibility and adaptation.

"I think it certainly gave the culture of the company a specific flavor. I wouldn't claim that it's, like, the right choice, but it was our choice. And I think it's led the rest of rec room to have a very improvised style."

The quote reflects on how the company's improvised beginnings have influenced its culture, suggesting that this approach has been beneficial in navigating the dynamic tech industry.

The Challenge with HoloLens and Transition to Rec Room

  • The HoloLens team shifted focus from consumer products to enterprise and military applications, leaving Nick Fajt's team without a clear direction.
  • After being reorganized to less appealing projects, Fajt and others decided to leave Microsoft.
  • The name "Against Gravity" was chosen as a nod to moving away from the HoloLens project, codenamed "Gravity."

"And so we were just like, well, we don't know what we're doing. We know we're moving away from that. And I guess we'll call it against gravity."

The quote explains the rationale behind the company's name and signifies a departure from their previous work on HoloLens to explore new opportunities in the VR space.

Rec Room's Evolution from VR to Multi-Platform

  • Rec Room initially focused on creating VR content but had to pivot due to the stagnation of VR headset growth.
  • The team decided to embrace user-generated content and expand to other platforms such as PlayStation and PC.
  • The community's initial reaction to the changes was negative, but the team believed in the long-term potential of user-generated content.

"So to give you an idea, from like December 2017, for the next 24 months, VR did not grow at all."

The quote highlights the challenges faced by Rec Room due to the lack of growth in the VR market, prompting the company to diversify its platform offerings.

Decision Against Pursuing Profitability

  • When faced with limited growth in VR, Rec Room considered but ultimately decided against focusing on profitability.
  • The team believed in the long-term vision of a user-generated content ecosystem and chose to pursue growth over immediate revenue.

"But eventually, if we can take these VR creators, if we can scale their creations, if we can get them monetizing a user base that's at a mobile scale, they will be happy."

The quote indicates the company's strategic decision to prioritize scaling the user-generated content ecosystem over short-term profitability, with the belief that it would lead to a more sustainable business model.

User-Generated Content as Rec Room's Bright Spot

  • Rec Room saw potential in user-generated content as a way to scale and provide value to both the company and its users.
  • The flexibility of the creation tools allowed users to easily build and share their own experiences within the game.

"Rec room is just this very flexible environment where you can come together in a 3d world, and users get to build these rooms and they can build and publish them."

The quote describes the core functionality of Rec Room, emphasizing the importance of user-generated content and the creative freedom it offers to users.

Rec Room's Transition to Non-VR Platforms

  • Rec Room's transition to non-VR platforms started with PlayStation and PC, followed by iOS.
  • The team had to adapt to the different dynamics of a mixed VR and non-VR user base.

"Our first flat world experience was actually on PlayStation. So PlayStation and PC, because you had."

The quote marks the beginning of Rec Room's expansion beyond VR, indicating the company's strategic move to reach a broader audience.

Rec Room's UGC Tools and Community Reaction

  • The introduction of user-generated content tools was initially met with resistance from the community.
  • The team learned to balance the pace of innovation with the community's ability to adapt to changes.

"The community was not happy about it. It was a big departure from what we were doing."

The quote captures the initial community backlash against the introduction of user-generated content tools, highlighting the challenges of introducing significant changes to an established user base.

Awareness of Roblox and Creator-Led Growth

  • Roblox was on the radar of the speakers and they drew inspiration from YouTube and Twitch.
  • They admired the creator class system where consumers reward creators they care about.
  • Creators act as evangelists for the platform, potentially reducing marketing costs.
  • The concept of creator-led growth was central to their strategy.

"We were definitely aware of Roblox. We were looking at probably a lot of stuff like YouTube and Twitch. We were like, okay, look, they have this creator class."

This quote emphasizes the recognition of Roblox's success and the influence of other platforms with strong creator ecosystems. It highlights the importance of a creator class in driving platform growth and engagement.

Incentivizing User Behavior with Rec Tokens

  • Rec tokens were introduced as in-game currency for rewarding specific user actions.
  • Users could use rec tokens to purchase avatar items and virtual food.
  • Creators could charge for access to exclusive spaces or items within their created environments.
  • The economy evolved from giving items for actions to a more complex system involving currency.

"When you launched rec tokens, you got rec tokens for accomplishing specific actions that you guys set up in the environment, right?"

This quote points to the strategic use of in-game currency to incentivize and guide user behavior, which is a common practice in game design to enhance user engagement and retention.

Evolution of the In-Game Economy

  • The in-game economy went through several stages, starting with avatar items and leading to a currency-based system.
  • Users could earn currency through creation and the platform would also inject currency to stimulate demand.
  • The concept of soft and hard currency was discussed, with soft currency earned and hard currency bought.
  • Rec Room's approach was unconventional, focusing on enabling creators to make money.

"We do print a good amount of currency every day to stimulate demand. Right."

This quote reflects the dynamic management of the in-game economy, where the platform controls currency flow to encourage user activity and maintain a balanced economy.

Considerations for Building an In-Game Economy

  • The team focused on evolving the economy to match their goals without relying on specialists like economists.
  • The approach was informed by past experiences and aimed at gradual community adaptation to changes.
  • The team pondered the behaviors of successful creators and how they manage their in-game earnings.

"We really have focused pretty hard on having generalists tackle as many of our problems as possible."

This quote underscores the team's philosophy of employing generalists to address complex issues, suggesting a preference for adaptable skill sets over specialized knowledge in their development process.

User Decisions in the Economy

  • Users face decisions on whether to keep rec tokens or convert them into cash, similar to trading in items at thrift stores or GameStop.
  • Creators consider capital allocation, deciding how much to reinvest in their creations versus taking profits.

"It's probably a scale question. The currency... it kind of depends on what those numbers are."

This quote captures the economic decisions users face within the game, illustrating how the virtual economy mirrors real-world financial considerations.

Managing Wealth in the In-Game Economy

  • The platform needed strategies to manage users with excessive in-game wealth to prevent economy disruption.
  • The goal was to align incentives and maintain game enjoyment for all users.

"One of the classic game economy problems is you will end up with users who have so much currency they can kind of ruin your economy."

This quote highlights the challenge of managing wealth distribution in a game economy and ensuring that it remains fun and engaging for all players.

Growth and Challenges of the Business

  • The business trajectory was influenced by the introduction of multiplatform UGC (User Generated Content) and the in-game economy.
  • During early stages, the company operated with minimal revenue and unconventional hiring practices.
  • The team was committed to overcoming challenges and believed in the long-term vision for the platform.

"Nobody left. Everybody was like, all right, I understand the challenges, and this kind of is painful getting yelled at by the community during these transitions, but we really do think it's in their best interest."

This quote reflects the team's resilience and dedication, indicating a shared belief in the platform's direction despite facing community backlash during transitions.

The Future of VR and Multiplatform Strategy

  • The company remained committed to VR while expanding to other platforms.
  • Multiplatform growth was seen as a way to build a larger business and increase rewards for VR content creators.
  • The team anticipated that multiplatform presence would benefit VR users in the long run.

"We never talked about like, oh, we're just going to do a hard pivot out of VR."

This quote signifies the company's commitment to VR, despite exploring growth through other platforms, showing a balance between innovation and adherence to original goals.

Unique Control Schemes and User Generated Content

  • Rec Room's origin in VR led to an infinite range of possible player actions.
  • The team aimed to maintain flexibility in controls across platforms, which presented challenges.
  • The UGC system allowed for unexpected room designs and activities, necessitating adaptable avatar control.

"We just need to build an avatar that's really flexible. And you, as the controller of that marionette, you need to be able to make this avatar do, like damn near anything."

This quote discusses the need for a flexible control system that can accommodate the limitless actions users might perform in VR, highlighting the complexity of translating this to other platforms.

Business Model and Revenue Growth

  • The business model allowed for significant revenue growth with high margins and minimal user acquisition costs.
  • Revenue growth was scalable, with a shift from platform-owned items to user-generated content.
  • The company experimented with paid advertising but relied on organic growth driven by creators.

"The cost of supporting the service of rec room is relatively small... The business is growing really nicely."

This quote explains the favorable economics of the business model, with low operational costs and potential for significant revenue growth driven by user-generated content and creator-led expansion.

Pinball Analogy and Diminishing Product-Market Fit

  • The conversation opens with an analogy comparing performance marketing to playing pinball.
  • Initially, you get good fits (users who love the product), but as you continue, the fit worsens.
  • This is likened to a golf game on iOS attracting users who love both cartoons and golf initially, and then having to reach out to less interested users.

"Yeah. Somehow there's worse and worse product market fit with every additional pinball that gets loaded in."

The quote emphasizes the idea that as marketing continues, each new set of users is less aligned with the product, leading to a diminishing return on investment in marketing.

Creator-Led Sub-Communities

  • Paying creators more to find specific sub-communities that resonate with their content is preferred.
  • Creators don't need to love every aspect of the platform, just the part they're involved in.
  • Twitch is given as an example of a platform that successfully fosters diverse sub-communities.

"I would much rather pay creators more money and help them figure out like, okay, here's more money. Now your incentives just went up. Go find the sub community that really vibes with the content that you've created."

This quote highlights the strategy of incentivizing creators to cultivate their own sub-communities, which can lead to a more engaged and satisfied user base.

Marketplace Liquidity

  • The concept of marketplace liquidity is discussed, drawing parallels to the trucking industry.
  • The more users and flexibility a platform has, the easier it is for people to find their "tribe."
  • The internet is praised for its high level of marketplace liquidity, which is seen as beneficial for metaverses.

"The reason we need tons and tons of loads and tons and tons of truckers is because there is one trucker load pair that is optimal."

The quote is used to illustrate the importance of having a large number of options on a platform to find the perfect match, which is applicable to both the trucking industry and online platforms.

The Business of Rec Room

  • Rec Room experienced a surge in activity due to the pandemic, with users engaging in non-gaming activities.
  • The platform raised a Series C round and launched on Xbox, which contributed to significant growth.
  • The discussion includes the unpredictability of VR's popularity and the importance of a robust business model that can withstand market fluctuations.

"The pandemic had been, it had definitely driven activity for rec room."

This quote reflects on how external factors like the pandemic can unexpectedly drive user engagement and growth for a platform.

Fundraising and Business Evolution

  • Rec Room's fundraising approach evolved from needing money to build the platform to not needing to raise money due to strong business performance.
  • The latest round of funding was described as an internal gut check about the company's long-term vision.
  • The discussion covers the company's growth and the challenges of predicting non-linear growth.

"This is our opportunity to untether ourselves from the emotions of the market and really take a long term play here."

The quote captures the strategic mindset behind the fundraising, focusing on long-term stability and growth rather than short-term market sentiments.

Company Powers and Competitive Advantage

  • Network economies, scale economies, and switching costs are identified as key powers of Rec Room.
  • The company's unique position allows for a high conversion rate from user to creator, adding value to the ecosystem.
  • The discussion also touches on the potential for counter-positioning relative to competitors like Roblox.

"The bigger rec room is, the more people you're theoretically reaching. And so the higher your potential reward is."

This quote explains the scale economies at play, where creators benefit from the platform's growth as it increases their potential audience and rewards.

Counterfactuals and Strategic Decisions

  • The conversation explores what might have happened if different strategic decisions were made, such as sticking solely to VR or being acquired by a larger company.
  • The importance of maintaining control over the company's direction and agenda is emphasized.

"The moment that you accept that you're giving up your agenda for someone else's agenda, it's no longer like our rec room. It's no longer the community's rec room."

The quote stresses the significance of maintaining autonomy and staying true to the company's and community's vision, rather than succumbing to the influence of a potential acquirer.

Dichotomy of Company Outcomes

  • The traditional view of tech company outcomes is no longer valid.
  • Companies used to either sell for a large sum or become a standalone big business.
  • This dichotomy has shifted, particularly in the consumer app space.

"You're going to sell your company for a lot of money to a big tech company or you're going to be one of the very few that can be an enduring standalone big business. And I don't think that dichotomy exists anymore."

The quote challenges the traditional binary outcome for tech companies, suggesting a new landscape with more diverse potential paths to success.

Consumer Apps Moving Away from Advertising Models

  • Consumer apps are increasingly rejecting advertising models.
  • Subscale ad businesses are less viable due to market domination by giants like Google and Facebook.
  • Alternative models allow for the creation of better businesses at smaller scales.

"I think especially on the consumer side with more, I think you've seen more consumer apps shift away from the advertising model."

This quote highlights the trend of consumer apps distancing themselves from reliance on advertising revenue, opening the door to different business models.

Social Media and Microtransactions

  • Social media is exploring microtransactions over advertising.
  • The next generation of social media, potentially in VR and AR, may adopt direct support models.
  • This shift could create a more diverse ecosystem with varied platforms and experiences.

"Especially as social media heads into the world of microtransactions and a little bit away from advertising."

The quote points out the transition in social media towards microtransactions, suggesting a move away from traditional advertising revenue streams.

Market Dynamics in China

  • The Chinese market appears less driven by advertising, particularly companies like Tencent.
  • This environment may allow for the rise of more medium-sized companies.
  • Multiple concurrent trends make attribution of success to any single factor challenging.

"The market in China is less advertising driven ten cent."

The quote implies that the Chinese market operates differently from the West, with less emphasis on advertising and perhaps more opportunities for diverse companies to thrive.

Staying Independent vs. Joining a Big Company

  • Founders often face the decision to stay independent or join a larger entity.
  • Personal characteristics and company alignment play a role in this decision.
  • The desire to bet on oneself and past success with this strategy can influence the choice to remain independent.

"The warm embrace of a big company is a very rational decision for founding teams to make, particularly economically."

The quote acknowledges the appeal and rationality behind selling to a larger company, which often offers economic security and resources.

The Value of a Centralized, Cohesive World in Rec Room

  • Rec Room's cohesive world provides brand recognition and economic control.
  • Centralization is a strategic choice, contrary to the decentralized nature of NFTs and cryptocurrencies.
  • Maintaining a centralized economy allows for flexibility and adaptability in business decisions.

"The value that rec room derives out of its economy and its things is they are centralized. That's the value."

This quote emphasizes the strategic decision by Rec Room to maintain a centralized economy, which is crucial for the brand and allows for effective management and change.

Growth Controlled by External Platforms

  • Startups need to consider whether their growth is self-determined or dependent on external platforms.
  • Venture capital can push companies towards aggressive growth strategies.
  • Understanding the expectations and pressures of different funding sources is critical for aligning with business goals.

"Your growth was governed by someone else's growth, and by being captive to one platform and betting on that future."

The quote reflects on the risk of startups being too dependent on external platforms for growth, highlighting the importance of autonomy.

The Venture Capital Learning Curve

  • Founders often start with little knowledge of venture capital and learn through experience.
  • Venture capital incentivizes a specific type of growth and requires a long-term view.
  • Startups need to adapt their strategies to align with venture capital expectations.

"When we first started the company, I had never heard of a series A round. I didn't know how you pitched investors."

The quote illustrates the initial lack of venture capital knowledge and the steep learning curve faced by many founders.

The 'A' Scenario for Rec Room

  • The best-case scenario for Rec Room is to become a cultural phenomenon beyond just a game.
  • Success is measured by the impact on digital entrepreneurship, events, and the metaverse.
  • Creator-led growth and the ability to build businesses on the platform are key factors.

"We have grown into a space where rec room can have a positive impact well beyond gaming."

This quote describes the aspirational 'A' scenario for Rec Room, where the company's influence extends far beyond its initial scope.

Avoiding Complacency

  • The risk of becoming complacent after achieving success is a concern.
  • Startups must continue to experiment, grow, and avoid dwelling on past victories.
  • Embracing new challenges and maintaining a forward-thinking mindset are essential.

"It's so easy to get complacent. It's so easy to be like, look at all the things that we've done."

The quote warns against the danger of complacency in startups, emphasizing the need for continuous innovation and progress.

Final Thoughts and Recommendations

  • The speakers share personal recommendations and insights on various topics.
  • Discussions include the importance of long-term thinking and understanding economic principles.
  • The conversation concludes with encouragement for listeners to explore opportunities in startups or with Rec Room.

"You always overweight the risk of joining a startup."

This quote encourages listeners to reconsider the perceived risks of joining a startup, suggesting that the potential rewards often outweigh the risks.

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