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ONLINE BUSINESS

Play Money
 

Founder of simulated stock market confronts decision among three different long-term growth strategies.
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Currently the hottest fad in town, Wall Street Games Inc. must choose among three long-term growth strategies

Last October, bull-marketers were taught an expensive lesson in complacency. But at least one investor closed out that infamous month with an impressive gain. Taking long positions in Blockbuster Entertainment, MCI Communications, and Microsoft, then hedging with a short position in IBM, a gutsy 21-year-old improved his personal stake by nearly 20% in one month. Not bad for a beginner -- except that the certificates involved had no more negotiable standing than houses on Boardwalk.

His -- and millions more -- ersatz shares are held in computerized safekeeping at the offices of Wall Street Games Inc. (WSG), a newly founded corporation in Wellesley, Mass. The company's own stake is expected to produce about $460,000 in sales for fiscal '88, its first full year; for '89, a 360% leap to more than $2 million is projected. And no play dough this: those numbers represent genuine coin of the realm.

Via the 12-person trading room of WSG, would-be investors get a vivid feel for the techniques of investing in stocks by actually going through the steps. Every month, WSG's computers disgorge a ranking of the winners and losers among the 3,000 or so players of its initial product, a game called The Blue Chip Edition. It's not a game in the joy-sticking sense of the word, though. That shibboleth comes from its creator's belief that Wall Street itself is "the greatest game in town'; therefore his should be second greatest, since, as art does life, WSG imitates the authentic version.

And therein lies its essentially solemn mission: to educate the masses -- or, perhaps more often, the classes. Under WSG's aegis, novices and students learn to play the market like the big boys, only they don't lose like the big boys. Of course, they don't win like the big boys, either, but perhaps celebrity -- a mention in the newsletter WSG mails to players -- is its own reward.

As fanciful as the concept is in practice, it was far more so in the spring of '87, when the simulated brokerage operation existed only in the agile mind of Timothy A. DeMello, then a real six-figures-a-year stockbroker in Boston. That March, 27-year-old DeMello quit an L. F. Rothschild vice-presidency to work out the details of the intricate product he envisioned. Between then and September, when WSG's first product was declared ready, DeMello designed the aspects of interactive play, enlisted a software expert to execute them, hired a suite in a mainline suburb of Boston, set up a toll-free phone line and an electronic call distributor, leased a battery of computers, hired a battery of workers to run them, and raised enough money through a private offering to pay for it all.

Why spurn real life for make-believe? "I was tired of those news items that said Mrs. Jones lost her fortune because she didn't know what she was doing and some broker supposedly misled her," WSG's founder explains. "How come she didn't know? It was her money." Concern for widows and orphans aside, DeMello, an '81 graduate of Babson College with a B.S. in finance, founded Wall Street Games mostly because he was inspired by business heroes such as Ray Kroc and Fred Smith who had been inducted into his alma mater's Distinguished Academy of Entrepreneurs. "I wanted to get involved like they did, but when I got out of school I didn't have enough money to start my own company. So I went into the brokerage business," DeMello relates. "After six years I decided it was time -- but what to do? I noticed that most entrepreneurs didn't start things they knew nothing about. Well, I knew financial markets.'

As it happened, a number of colleges -- Ohio State, Texas Christian, and Babson among them -- were considering courses in which business students handle a portion of the college's endowment as a learning experience. But since only a few students at a time could do the hands-on managing, that left millions more still learning the hands-off textbook way. A rightable imbalance, DeMello was alert to note. "On the one hand, here were these investors who needed to be educated, and on the other, students who needed a practical education. I looked around the office and wondered what would happen if I were to duplicate this stuff. Let everyone get burned or make fortunes, receive statements, initiate phone calls, talk to brokers, order stocks -- only don't use actual money. If I could deliver a stock-trading product at the right price and make it realistic, the market was sure to buy it.'

The idea found embodiment as a slender box the size of a typical computer-game package. For a hefty $99 retail, you don't even get a pair of dice, only an 800 telephone number, a stock-symbol guide, and $100,000 in bogus buying power. Yet at first DeMello toyed with an even heftier price, hoping potential users would recognize value in the lessons that lay behind it. However, he conceded, to launch the concept "I had to have a product that was priced under $100, because no matter how great it was, it wasn't going to find a mass market at anything higher.'

A player dials in during the market day, asks for quotes and last-sale prices, buys or sells, and rings off. WSG's computers are networked both to a database for posting and retrieving customer information and to a roof satellite antenna that pulls in up-to-the-minute stock-market prices from the NYSE, the Amex, and NASDAQ. The system automatically logs activity and generates statements, which the postman brings every month in bright green envelopes that won't get lost in the detritus of workaday mail.

But why not simply buy a newspaper, note your stock picks, and see how they come out later -- a savings of some $98.50? "People have been trying that for years," DeMello scoffs at such cut-rate competition, "but they lose concentration. If you've just been given $100,000, you have to keep doing something about it. You need a regimen. You need to talk through the procedures. If you write it down from the paper, are you going to bother to figure out your daily interest on a margin loan? You have to be hit with a statement every month. We give you the discipline.'

At the end of the summer, when The Blue Chip Edition was ready to ship, DeMello coached his two-person (now five) senior staff, "Let's not spend money on advertising until we find out who our customer is. For all we know, it could be 10-year-old kids who end up playing this thing." (A few do, it turns out.) With no promotional to-do, WSG threw open its doors on September 1 and waited to see who walked in. "The strategy was, let's hope it generates some publicity. All we did is declare it available.'

As luck had it, just before Black Monday, WSG had been mentioned in Business Week of September 28, and New York magazine had run a captioned photo in its October 19 edition. Then came the dive, and in the gloom the financial press knew where to turn for a droll sidelight. On October 22, The Wall Street Journal's front-page "Business Bulletin" column led with an item on the "swamped" condition of the Wall Street Games phones. Associated Press wired a feature, DeMello shuttled off to "The Today Show," and various cute pieces about how WSG's "customers" lost "millions" popped up in scores more places.

WSG's switchboard started smoking. "Brookstone called and asked, 'Can you make money selling us games at $50 each?' " DeMello remembers, understanding that that was the best retailers could pay and still get their 100% markup. "I don't know," he told them, "but I think we can." Waldenbooks ordered it; American Airlines, TWA, and Haverhills put it in their catalogs; Marriott's Host International vended it from airport video kiosks. "Don't miss what could be the newest, funkiest, hottest, most challenging toy product for 1988!" advised the Toy Manufacturers of America, apparently misperceiving Blue Chip as Green Slime. Coming into 1988, WSG was becoming entrenched in retail, the market DeMello least expected -- or, for that matter, wanted. "But we were getting good orders," says DeMello, "so we just let it happen. We could afford to do it, because we'd have the use of the money: we were shipping boxes that cost us $4, and taking in $50." It was found money.

But not riskless money. Having only a few weeks' experience in the habits of end users, DeMello could only hope that the direct costs and variable expenses per game would be in line with the price received. When it came time to service the game, were players' phone calls going to average a minute each, or 10 minutes? What if more phoned in from California, the most expensive WATS zone, than from New York? What were the trading patterns -- would WSG have to open earlier, stay later, hire more phone answerers, install more lines?

It's essential to structure play so it requires only a 30- to 45-second phone call, DeMello calculates. Indeed, subsequent months have proved that The Blue Chip Edition's biggest variable expense is the toll-free line, to which is assigned $12 per game per year. Because charges tick irrepressibly upward at 6-second intervals, the software, phone-switching routines, and playing rules are designed to keep them at a minimum. "If a client asks what stock he should buy," DeMello trains his brokers, "you reply, 'If we gave advice, it wouldn't be a game.' '

As for labor costs, ordinarily significant in a service-oriented operation, WSG is sitting pretty, with many of its unregistered reps coming from Wellesley College, right around the corner. Others come from nearby campuses. Each is paid on a part-time basis at $5 an hour with no benefits -- a worse deal than dishwashers get in this high-employment corner of the country. Because of the technology behind his $99 ceiling, "I had to have cheap labor," DeMello insists. "Yet at the same time I need someone capable of responding to complicated questions. That's why I decided to locate where the colleges are. Money isn't a high priority with students; more important is a learning experience and something they can put on their résumés.'

An added benefit of a stock-market facsimile is that workers need be employed for only six and a half hours a day -- the interval the stock market is open. Not only that, but DeMello has received requests from university co-op programs for WSG to take on apprentices at no pay at all. The prospect of absolutely cheap labor is alluring, but he admits he'd feel guilty. Still, that's nothing a good psychiatrist or unexpected margin squeeze couldn't overcome.

The low cost of WSG's labor is a function of the high cost of its decor. WSG could be run out of a warehouse across the tracks and customers wouldn't know the difference, but students wouldn't go to work there. This way, they're impressed. "They feel like they're at a trading desk," says DeMello.

To lend the premises the atmosphere of a bona fide operation, WSG doles out $2,976 a year for an overhead ticker, although the instrument has as little bearing on procedures as a ficus plant. For the 3,300-square-foot premises, Wall Street Games pays close to $20 per foot. That's not unusual for Wellesley Square -- the difference being that at WSG's decorated digs, no shoppers come in to browse.

"Now, we have to step out of internal development and get into marketing," DeMello realizes. Although so far 80% of game sales have been through retail, The Blue Chip Edition's shelf-life actuarial tables aren't convincing. When WSG peddled product at New York City's International Toy Fair in February, its price scared buyers away. Retail stores that carry it tend to place it in a games section beside popular items that sell for much less, and it doesn't do well. "In the long run," DeMello predicts, "the campus and training will constitute the bulk of our business.'

DeMello has opted for the former. "Some people insist training is the biggest market, but college business is something we always want to be involved in, if only because of the nature of the beast: new-customer turnover is 25% a year, and word-of-mouth advertising is very cheap on campuses. There are 7,000 colleges and some 12 million students, 30% of whom take business courses. If we produce a product for them at $40 per semester, even if there are only 30 students in a course, the numbers are huge." Catching on in a syllabus is a blessing that extends product life -- forever. WSG adapts playing time to fit a semester's requirements, and gets professors (rather than bookstores, where "the markups would hurt us') to enlist the paying customers. The campaign already has been so successful that a trickle of students even ordered themselves fresh playing time after their classroom allotment expired.

After them, however, the deluge. This fall, as many as 26,000 more students are expected to pay $49.95 each to enter WSG's collegiate investing contest. Armed with the usual $100,000 worth of gossamer, entrants will trade the market for four months. If they're particularly good, they won't just find their names on some obscure list: the top 10 will divvy up $62,000 in WSG-provided ante.

In his marketing plan, such as it was, DeMello had intended to establish this campus contest in '88, then go after cash-paying sponsors the next year (see '89 financial projections, page 5). But sponsors couldn't wait that long. Before summer even began, AT&T had grabbed the title (the event is now officially called The First Annual AT&T Collegiate Investment Challenge) for $200,000 in cash and advertising; Dow Jones had arranged for a scholarship tie-in; and Reebok International had signed up to provide merchandise awards. "This is big for us, credibility-wise," DeMello grants. "AT&T, Dow Jones, and Reebok are definitely three top companies."

By mid-June, WSG had enlisted participants from some 500 campuses in the United States, Canada, Mexico, and England, at which point DeMello decided he'd better limit enrollment before it overwhelmed his ability to service it. And that's only one promotion. Next spring comes a three-month, cash-prize contest, with a $150 entry fee, marketed and promoted with Players International Inc. The response so far has been spectacular, reports DeMello, looking toward yet another sizable piece of change -- and an apparently lawful one in at least 44 states, WSG's attorneys have advised.

Because of such easily placed sales and the possibility of more (WSG has been considering concentrating on such would-be clients as the American Association of Individual Investors, the American Association of Retired Persons, and even Wall Street brokers), DeMello so far has been content to exist without a sales force. "That will kick in in year three, when we have other products," he plans. Until then, DeMello himself insists on doing the selling. "If I had a full sales force going after every market we could possibly get into, and they all hit, I couldn't service all the business," he explains. "I'd rather find out where we're headed and directly identify every market, then put together a sales force and tell them this is what you can sell. We have to make sure we have the core of it right before we can expand." On the other hand, DeMello is willing to second-guess himself: "Maybe we should have the sales force first. If I could throw in $50,000 to increase sales 20%, I definitely should.'

While promotions seem to be catching on by themselves, equally fertile but tougher ground awaits in the training market. So does a higher pricing structure, inasmuch as a training course isn't particularly price-sensitive. "Employers know that just to put an employee on a plane is a $500 expense without adding in anything else," assesses DeMello. "We can train them through self-study." Several corporations already have solicited WSG, among them multiservice financial institutions that must familiarize customer-service staffs with the stock market. In Boston, National Financial, a Fidelity Investments company that processes brokerage orders for correspondent banks on the side, has been asked by some of the banks to set up dummy accounts as teaching vehicles. But fearful that the fakes might get mixed up with the real thing, National Financial refused and is now reviewing WSG's proposal to set up a riskless program through its trading desks.

And if pure training works out, won't training cum promotion do even better? In the fall, as part of the Fidelity deal, WSG is proposing to stage such an amalgam for 500 employees of the brokerage arm of New York City's Irving Bank Corp. While the employees sop up training through game play, they also vie for a substantial cash prize. Corporations with employee stock ownership plans also are WSG's fair game. Wide-scale employee education helps the employer in the end, the pitch goes, because ESOPs are a cheap source of capital.

DeMello ought to be familiar with cheap sources of capital, having seeded his enterprise with $20,000 of his own, then offered outside investors 20% of the company for $500,000 in May 1987. Simple arithmetic appraises DeMello's share of Wall Street Games at close to $2 million even back then. And there were no products, no prototype, and no assets; what's more, start-up charges of about $65,000 (of which software design alone ate up $35,000) had yet to hit the books. There was, however, a reassuring written pledge from key personnel (the chief executive officer, treasurer, and sales manager -- each in the person of one Tim DeMello) to work full-time for two years at $60,000 a year plus a bonus of not more than 10% of EBIT (earnings before interest and taxes). Since the second year's EBIT was estimated to be $375,000, that would give key personnel another $37,500 and put DeMello back close to six figures.

"My plan was not to go for debt financing," he explains. "I knew there had to be a certain amount of equity, because if I went in and tried to do the whole thing on debt, no bank was going to give me enough. So I figured, let's get the equity taken care of first to show it's in line, and then the bank will respond positively." (Subsequently, the bank did, extending $250,000 in a line of credit, of which WSG has used $100,000 -- its only debt.) Over the next three months, DeMello doggedly hawked stock, accumulating commitments from fellow brokers and old clients. He stopped when he got to $325,000, concluding that it was enough to proceed with.

Many variable costs haven't settled in yet, but DeMello feels he has understated them in the '89 projections, which are based on selling 35,000 units. Labor is well controlled, because, as DeMello notes, "if we don't sell product, we don't use the students." And if they do sell product, there's no problem, either: in June alone, 26 job applicants were turned away. Shipping will go up as product is freighted to more than 500 campuses. Sales commissions also will rise noticeably: WSG pays campus reps $5 to $10 per game sold for the college competition. As demand for service increased, DeMello hired a full-time director of computer operations. To pay for expanding operations, this time around DeMello intends to do some debt financing. The reason is sound enough: "If I have $300,000 committed from sources like AT&T, it would be crazy to go out and dilute the stock by selling more equity.'

In any event, DeMello has been busy upgrading the verisimilitude of the original version (an uptick restriction for short-selling has been added, for example, and stop and limit orders are upcoming), and is considering exotic variations such as options, futures, and commodities. Hence the leap in '89's R&D budget (see financials, below). Again, big-name partners such as the Chicago Mercantile Exchange have expressed interest in joining in. Indeed, given more computing power and employee expertise, a player's options and futures portfolios might be linked to his equities portfolio, demanding intricate total-income solutions. Add to that the prospect of a worldwide market for a WSG game that is playable round-the-clock, dealing in securities of Japan and England as well as the United States, and growth possibilities seem endless.

But they're not. For one thing, 24-hour world trading would require 24-hour local service. Will low-paid employees be responsive -- or even show up -- at 2:30 p.m. Tokyo time? Won't players run up the WATS line trying to determine the difference between Matsushita and Mitsubishi? Even professional brokers are intimidated by trading soybeans and pork bellies, and as players surely would make more demands on WSG's services. Right now, DeMello calculates, the company can accommodate 48 terminals with 48 students each answering 250 phone calls a day. That's 12,000 "plays" all told, wedged in with utmost precision.

By now, dialing-for-fake-dollars habits have become predictable. A typical participant is very active his first month, moderately active the second and third, then eases off markedly. Right now, less than 10% of The Blue Chip Edition's 3,000 players call in each day, so total usage is barely two hours. Thus 98% of capacity is unused. Indeed, some periods are so dull that DeMello often sends the troops home early.

However, that pace should quicken once the cash award promotions hit WSG's trading floor. Each contest likely will strain services for three or four months running, which leaves DeMello a potential of only three sponsored promotions per year. Ironically, one presently in the works is a simulated-investment competition among real stockbrokers, bringing his concept full circle -- and possibly closing it.


EXECUTIVE SUMMARY

The company: Wall Street Games Inc., Wellesley, Mass.

Concept: A simulated stock market, enabling college students, financial-services trainees, and individual investors to play the securities game with mythical money

Projections: Profitable from start. Second-year sales of $2.1 million with pretax profit of almost $500,000

Hurdles: Picking the right market from among retail, academic, or training; creating demand beyond fad appeal; servicing uncertain volume


FINANCIALS

Wall Street Games Inc. projected operating statement

Fiscal Year Ending 9/30/88 9/30/89

Sales

Game sales $385,000 $1,875,000

Sponsor fees 75,000 250,000

Total sales 460,000 2,125,000

Cost of Sales
Game packages 40,000 140,000

Direct labor (service) 12,000 156,000

Toll-free phones 11,000 150,000

Monthly mailings 19,000 115,500

Postage and shipping 8,250 52,000

Sales commissions 12,500 125,000

Total cost of sales 102,750 738,500

Gross Profit 357,250 1,386,500

Operating Expenses
Payroll and related 162,000 197,000

Rent 54,336 61,128

Insurance 6,024 7,500

Equipment and furniture leases 39,840 72,000

Equipment maintenance 1,200 7,500

Quotation service 10,140 30,000

Stock-exchange fees 6,480 22,000

Advertising and promotions 20,000 250,000

Promotional awards 0 150,000

Telephone 4,600 8,800

Legal services 3,200 20,000

Professional services 8,500 18,500

Travel and entertainment 2,100 18,000

Research and development 5,000 25,000

Office supplies 1,500 3,500

Interest expense 3,100 22,000

Miscellaneous 2,500 6,000

Total expenses 330,520 918,928

Net Income Before Taxes 26,730 467,572


THE FOUNDER

Timothy A. DeMello founded Wall Street Games Inc. exactly six years after he was graduated from college with a B.S. in finance. In the interval he, along with thousands more young, upward-moving professionals, had managed to climb several rungs of the financial community's ladder. DeMello successively became a vice-president of Kidder, Peabody & Co., and of L. F. Rothschild, handling individual and institutional accounts -- just the ticket to a dull, seven-figures-a-year existence. Handily, by the time repercussions from the October crash thinned the ranks of other investment-banker aspirants, the personable and persuasive DeMello, then 28, had already departed Wall Street to develop and market his own less hazardous version of it. By then, he had learned his own lessons well. Most of the capital for the venture came from former clients and fellow brokers; DeMello threw in a mere $20,000, signed a debt instrument to secure another $50,000, and kept 86% of equity in the company for himself.


WHAT THE EXPERTS SAY

CUSTOMER

RALPH KIMBALL

Lecturer, Babson College, Wellesley, Mass. Uses WSG's The Blue Chip Edition in course on securities analysis

I've used The Blue Chip Edition for two semesters, and the first semester went very smoothly -- students liked it a lot. In the second semester the students liked the game itself, but there were transaction errors. Records showed purchases of the wrong stock, or stock that students claimed had been bought didn't show up, or the wrong number of shares were recorded. I think as the volume has gone up, there's been some decline in the service.

If that's so, DeMello's got a real problem, especially in the education market. A large number of errors kills the aspect of realism and creates ill will on the part of professors. If I assign the game, I'm essentially vouching for its quality. If there are lots of errors, I can't go on assigning it.

But it is the right market, especially if WSG can broaden the product. I use it only in my introductory courses now. For advanced courses the game needs options and futures, and more than the allotted $100,000 in funds -- make it $10 million, say -- so a student could act as a portfolio manager rather than a private investor. But the price is right. Most college textbooks are $30 to $60, and if a student is paying $1,000 tuition for a course, another $45 for WSG doesn't seem too far out of line.

The education market offers a customer base that's continually renewing at a low market cost. There are several thousand professors of finance in the country, and DeMello will have to figure out how to get to them. But the nice thing is that once you've got professors on, you don't have to go back and resell them every quarter. I teach four of these sections a year, and each course has about 40 people -- that means I deliver 160 customers per year. That's where WSG can come up with a sustainable customer base -- not from onetime promotions in catalogs.

CUSTOMER

JOHN D. SPOONER

Stockbroker; senior vice-president at Shearson Lehman/Hutton

DeMello did a wonderful job. It's well thought out, packaged very well, and easy to understand. As a learning tool, it's terrific. But I just don't see the demand. There is zero need for it among my customers. Most of them are passive. They want me to do it. Sure, if I lost money for them they'd ask why, but a game isn't going to teach them. The only thing that will do that is life.

The main problem with anything that deals with money in a hypothetical way, whether it's betting on horses or playing the stock market, is that unless you're emotionally involved, it's not valuable. When it's play money, you're not emotionally influenced. To learn anything, you have to have put real dough on the line. Students can say they were up 400% in a college course on the stock market, but the result would be different if they had their own money at risk.

Another problem for WSG is timing: nobody cares about the underlying product right now. Wall Street is in a full-fledged depression. The average investor, even one with plenty of money, is buying CDs or staying in the money market. The atmosphere is one of fear, anxiety, or at least indifference. I think we may be in this climate for quite some time. If at first the game was bought as a fad, that thrust is now completely taken away. DeMello might as well paint the windows of his brokerage office black, because right now nobody cares.

The college market is viable. But how much is marketing going to cost? I think his projections are way off, given the climate. Even college stock-market courses tend to decline in periods when nobody cares. So he's in for some tough sledding. There already have been layoffs on Wall Street, and you haven't seen the half of it. The average stockbroker isn't even making $200 a week. It's not a glamorous job anymore.

This is a business you can't force. At most, you can cut prices, advertise, reposition. But you can't make people buy stocks -- for real or for pretend -- when there's no appetite for it. I would hate to start a business with something that may be out of favor for a long time.

DeMello is obviously a true entrepreneur. He's going to make it big in one direction or another. But this isn't the one.

MARKETER

JOSEPH CORNACCHIA

President, The Games Gang Ltd., marketers of Pictionary; turned down DeMello's request to market The Blue Chip Edition

This is a tough call. I think WSG's product is well done, but I can't tell whether it's going to be successful or not. When Tim showed us the product, we were fairly excited at first to take it into our line and sell it to stores. Then we estimated the number of phone calls each player would generate and realized we could get into a real jam if we sold 200,000 or 300,000 units over the next two years. Tim says that not everyone calls, that the phone calls dry up after the first month. Well, if that's the case, then it's not going to be successful. I told him I still think it's a great product, but maybe he should rethink it.

To me, he's selling $100 worth of smoke -- the phone calls. And if Tim's right about usage patterns, the player is going to figure out he's paying a lot of money for phone calls he's not using. That's what I thought was wrong. I would bring out the game for much less and have people pay an extra charge for the toll-free calls, or pay for the calls themselves.

The game needed testing. What has to be determined is whether the public will respond to the product and have fun playing it. Is it a game or an educational tool? I perceived it as a game, because the stock market is a game. If the public sees it that way and is willing to spend the $100 or so, it will be successful. If, on the other hand, it's educational, then the educational emphasis should be reflected in its packaging and accompanying materials -- it should teach you about the stock market. Then say, "By the way, if you want to play with fake money, for another $5 or $10 you can join up and get monthly mailings and an account, and you can phone in and play the market like it really is the market." Tim's had it in Brookstone, and my guess is it didn't sell. I don't think it can work at retail.

Last updated: Aug 1, 1988




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