CNBC
updated 11/30/2006 11:03:51 AM ET 2006-11-30T16:03:51

It’s a $27.5 billion industry, but the modern video game industry had a humble beginning.

In 1966, a New Hampshire engineer named Ralph Baer who worked for a defense contractor making electronics for the military came up with the breakthrough that got video games out of the lab and into the living room.

The answer was right in front of him -- right in front of everybody.

Looking at his TV, he began wondering what you could do with a TV besides watch "My Three Sons?"

"And I scribbled some notes,” said Baer, “and wrote a four-page paper. That was the Magna Carta of the whole video game business.  It's all there."

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By the 1970s, improvements in computing made widespread development of video games possible. But no one at Atari was prepared for the game that would put the new company on the map.

It all started when computer scientist turned entrepreneur Nolan Bushnell hired a young engineer named Al Alcorn and gave him an exercise to get his feet wet in game design. 

"The idea was to build a video game that was the simplest possible thing you could think of,"  said Alcorn. “So I just went to Walgreen's Drug Store and bought a $75 black-and-white TV."

Bushnell and Alcorn called the game Pong and installed the first Pong machine for a trial run at this bar in Sunnyvale, Calif., then known as Andy Capp's Tavern. What happened next made Andy Capp's the Los Alamos, the Cape Canaveral of the video game industry.

"One day within the first week, I got a call in the evening saying the machine stopped playing, and could I come down and fix it cause they got customers that want to play the game,” said Alcorn.  “So I drove down to Sunnyvale and went to see the machine, opened the coin box up and there was this big fistful of quarters (that) just gushed out of the machine. ... All of a sudden we had a real hit on our hands."

Soon companies like Midway, an old-line maker of equipment for amusement parks, started getting into the game. The coin-op company that brought Space Invaders to America had invaded the space of Atari — then the industry leader — in a big way.

Rather than fight it, Atari CEO Ray Kassar hitched a ride into orbit with the game by licensing the home rights. It's a bet Kassar won.  Sales of the Atari VCS console doubled.

And then Japan invaded again with an even bigger blockbuster: PacMan.

“When they were making the PacMan, the guy who was leading the project took his team to lunch,” said Steven L. Kent, Author of “Ultimate History of Video Games.” "They went for pizza in Tokyo.  And somebody had taken the first slice of pizza.  And then he looked down, and there was PacMan staring at him."

Japan had started a global epidemic.

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Before long, Nintendo had a whopping 90 percent share of the video game market. In 1989, the company's domination of the industry got even bigger when it introduced its video game equivalent of Sony's Walkman -- Game Boy. 

And Nintendo had none other to thank for its success than Mikhail Gorbachev. Well, sort of. 

At the end of the Cold War, a Soviet computer engineer named Alexy Pajitnov created a puzzle game called Tetris.  When the Iron Curtain lifted, Nintendo got its first look at Tetris and started talking rubles. 

"And we knew that that could be the killer game on Game Boy, the launch title," said Howard Lincoln, former chairman of Nintendo of America

Thanks to Tetris, Game Boy became an instant hit, selling 32 million units in its first three years.  Nintendo seemed unbeatable.

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But not for long. Sony launched its own game platform, PlayStation, in the mid-1990s. And the Japanese electronics giant’s plans for a next generation PlayStation, Playstation II, had awakened the gaming instincts of another technology giant, Microsoft. (MSNBC.com is a joint venture of Microsoft and NBC Universal.)

"Sony was saying, 'Look this is gonna replace the PC.  It's gonna replace the DVD player,'"  said Xbox creator, Seamus Blackley. "It's going to be the anchor of your home entertainment experience and can go beyond that as well.'"

Replacing the PC was not what the leading computer software maker in the world wanted to hear -- especially since  PlayStation was outselling the top five PC makers combined.

“The sort of messaging Sony did around PlayStation II certainly catalyzed a lot of kind of competitive spirit among people at Microsoft,” said Blackley, “who really didn't particularly enjoy Sony saying that a game console was going to replace Excel, for instance, or you know, Word for Windows."

Today, the video game platform arms race is in full swing. In a matter of days, Sony's new Playstation 3 and Nintendo's Wii will finally join Xbox on store shelves that Microsoft has enjoyed all to itself for an entire year.

And another marketing shoot-out for gamer dollars will begin.

© 2012 CNBC, Inc. All Rights Reserved

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