Gaikai raises $10M as digital distribution hits high tide in video games (exclusive)

This is the year of digital distribution in the video game business.

That helps explain why Gaikai is announcing today it has raised $10 million in a second round of funding. The Aliso Viejo, Calif.-based company, headed by gaming pioneer David Perry (pictured right), has created a game streaming service that feeds games stored in the internet cloud to gamers over broadband connections.

As traditional retail game sales falter, more and more games are being sold via online channels from new online game services to Facebook. Gaikai hopes to accelerate that transition.

The round was led by Rustic Canyon Partners and includes prior investor Benchmark Capital and current partner Triplepoint Capital. Perry said in an interview that more investors are expected to participate in the round, but those deals haven’t yet closed.

Perry said that Gaikai’s first partners will launch cloud-based game distribution services in the July through September time frame. That puts it behind the frontrunner in the market, OnLive, which has raised a considerable amount of money from investors ranging from Time Warner to BT. Once Gaikai goes live, gamers will be able to access games via the internet any time, from any location, through multiple devices and platforms. It can also thwart game piracy, which is a rampant problem in the PC market.

Meanwhile, competitor OnLive has drawn a lot of attention to the digital distribution market; it plans to launch in June in the U.S. and has cut deals with BT and Belgacom to launch in Europe. Gaikai, however, will not deploy its own network. Rather, it will license its software to companies that plan to deploy their own services in competition with OnLive. (I’ve mentioned before that it would be a great option for companies such as Amazon.com, Valve, and GameStop).

Perry contends that his team of 21, headed by technologists Andrew Gault (right) and Rui Pereira (below), has been able to create a more efficient version of game compression technology. That enables it to be deployed at a lower cost and with a smaller team, Perry said. That, in turn, will allow anyone who licenses the technology to deploy it at a lower cost to consumers than the $14.95 a month subscription fee OnLive will charge.

Gaikai previously raised $5 million in venture money from Benchmark Capital. It also lined up server financing from Triplepoint, giving Gaikai access to lots of data centers, though he says Gaikai doesn’t need that many. (Triplepoint has financed other fast-growth companies such as Facebook, YouTube and Netflix.) The financing for servers is released in rounds of $5 million each, as the model is tested.

Perry said that partner companies offering games-on-demand service could vary widely. A big game review site could put up a service that lets someone demo, or even purchase, a game on the review site itself. The review site could collect revenue from the sale through an affiliate marketing program.

Gaikai’s own business model is interesting. The company will charge money to a game company that puts a link — an advertisement, really — to a game demo linked to a Gaikai-based games-on-demand server. While a player is trying out a free demo, Gaikai will charge the game site owner just 1 cent a minute. If, at the end of the time allowed for the free demo, the gamer buys the game, then the publisher gets 100 percent of the revenue. Or, if the sale occurs on a retailer’s site, the proceeds are split between the publisher and the retailer.

The model rewards Gaikai mainly if it gets players to try out a game, and the cost of acquiring a new user is considerably lower than other means of getting new users.

“That 1 cent per minute cost of acquisition is a game changer,” Perry said. “If we can get the customer acquisition costs that low, publishers are happy. They can reach a larger mass market because the games can be played on just about any hardware.”

The Gaikai business model is meant to be disruptive for a high-cost rival such as OnLive. Otoy, another rival, is also trying to offer a games-on-demand technology. Like Gaikai, Otoy will rely on partners such as Advanced Micro Devices, Supermicro and others to deploy its service.

Perry said Gaikai will be announcing other strategic industry investments and partnerships soon.