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The Silent Canary

Fri 30 Sep 2011 7:00am GMT / 3:00am EDT / 12:00am PDT
BusinessOnline

Zynga is the canary in the coalmine for the social games market - and its song no longer seems quite so sweet

As much as I'm an avid supporter of the social gaming movement - which is bringing a vast new audience to the gaming medium and providing opportunities for a host of innovative new creative ideas and business models - I've hardly been a lone voice in arguing that valuations in this sector have become insanely over-inflated. In the past year, billions of dollars have changed hands in acquisitions or funding rounds for companies whose true worth is a long way from being proven, operating in a market whose true scope and potential is little understood.

Throughout all of this, one firm has stood head and shoulders over the rest of the sector, and has rebuffed all acquisition bids in favour of positioning itself for a stock market IPO. Yet as the sector's most successful and most valuable firm, Facebook game giant Zynga is also the canary in the coalmine.

This week, that canary's song faltered. Zynga's most recent financial report makes for slightly grim reading, and should serve as a warning sign to investors and executives - perhaps even casting doubt on the value of Zynga's much-delayed IPO, when and if it finally happens.

It's not that the results are utterly terrible - profits fell off dramatically, dropping almost 95% compared with the same period last year, and revenue growth slowed down but still almost doubled year-on-year. Digging deeper into the figures in the company's S-1 filing, however, reveals a somewhat deeper malaise than the headline statistics suggest.

Zynga has been shuffling the same 200 million consumers around its various new game launches, not really attracting a wider audience.

Due to a quirk of how Zynga recognises revenues (basically, it doesn't record purchases as revenues instantly, instead spreading them out over a period of time), it's important to look at a second figure in the company's filings - "bookings", the actual measurement of money changing hands between customers and Zynga in the reporting quarter. By that measurement, Zynga's sales to customers are almost completely flat. In the past three months, Zynga stopped growing.

That's actually not all that surprising if you look at the company's figures for Monthly Active Users (MAUs), which, in spite of the firm's dramatic growth in other regards, have remained largely flat for quite some time. It looks for all the world as if Zynga has effectively been shuffling the same 200 million or so consumers around its various new game launches, getting better at monetising them (hence the revenue growth) but not really attracting a wider audience.

Which is not to say, of course, that 200 million consumers isn't already a wide audience - it's huge, obviously. However, this isn't the position that one would want or expect a top-flight start-up to be in at this point in its development, especially with an IPO potentially around the corner. Right now Zynga only seems to be growing by raising ARPU, not by growing audience, and there's fairly obviously a cap on how high the ARPU of a videogame can go. The company's most recent S-1 filing suggests that they might be reaching that cap.

Does this mean that Zynga is a failure? No, it doesn't. A company which is generating millions of dollars of quarterly profits from 200 million active monthly users is definitely not a failure - but a company whose growth has hit a brick wall so early in its lifespan is definitely not an attractive IPO option, and it's a stark warning to everyone else pouring millions into the social gaming market. It's a very big market - it just might not be quite as big as its advocates like to think.

Of course, the problem with Zynga isn't entirely down to underlying market factors. The reality is that the company itself has some serious problems that aren't necessarily shared by competitors - primary among them being the extent to which its core products are wedded to the Facebook platform and the Flash plugin, which has left it effectively broadsided by the enormous growth of gaming on mobile devices and particularly on iOS, which makes a point of refusing to support Flash (a decision which is singularly unlikely to be reversed and which now seems to be being embraced by Microsoft as well, with the Metro browser in Windows 8 also dropping Flash support).

The ceiling the company seems to have reached on Facebook suggests audience numbers for social gaming is somewhat lower than many have expected.

Zynga does have some iOS apps for its more popular games - the Farmville app, in particular, launched with some fanfare - but they're somewhat desultory offerings from a company whose heart is still in web-based games on social networks. The reasons for that are baked deep into the DNA of the company, whose strength has never really been in game design (it is still dogged by persistent and often quite well-founded allegations of directly copying the designs of other social game developers) but rather in building and maintaining the vast infrastructure required to run such a successful service, in leveraging the Facebook platform to its best advantage, and in innovating, not in gameplay, but in areas such as subtle, widespread testing of new features and designs on portions of its active userbase.

On Facebook, Zynga is the big beast - the 800 pound gorilla whose extraordinary success continues to breed more success and effectively locks developers of other games out of the system to some extent, since most of the marketing for the launch of a new Zynga game can be done directly to players of an existing Zynga game. On iOS or Android, however, Zynga is just another company, and will have to engage in some very stiff competition in which its advantages on Facebook are largely meaningless. This doesn't mean Zynga can't or won't be successful on non-Facebook platforms, but it's extremely unlikely to replicate the extent of its Facebook success elsewhere.

For the rest of the social games market, this is both a blessing and a warning. Few will be sad if Zynga's dominance fades a little, and few would have welcomed it extending that dominance over mobile platforms as it has over Facebook. However, the ceiling the company seems to have reached on Facebook suggests that the ceiling for audience numbers for social gaming is somewhat lower than many optimistic commentators and investors have expected.

Social gaming is huge, and will continue to be huge - but it's about time that developers in this market realised that it's not a limitless market which endlessly throws up fresh new consumers, ripe for the picking. As we start to perceive the limits of the market more clearly, the strategies for retaining customers and keeping them happy - often so wilfully ignored by social game developers - are going to become increasingly important. Investors, meanwhile, are likely to pull back once they realise that the market has limits to its potential growth - limits that may already be being reached. And Zynga? For Zynga, I suspect that the time for a successful IPO may already have passed.

16 Comments

Andrew Goodchild
Studying development

1,200 318 0.3
To put it in perspective though, if 200 million MAU was genuinely 200 million active users (it's not of course, there are plenty of Zynga obsessives who set up multiple Facebook accounts to boost there Zynga mobs/neighbours/covens whatever, but let's say for a minute the figure are really what they first appear) that would be 3% of the entire population (entire worlds population including babies, and people with no access to the internet that is), playing games that most traditional games players find lacking in substance. And that's before you count the people who tried it and either didn't like it, or felt they needed to quit to get other things done How much growth could you really expect it to achieve?

Posted:2 years ago

#1
What do you expect from farming as a game strategy. Click Click Click isnt something to keep one enticed for more than a few hours/days. There is no real depth or feeling on appropriate reward to farming. Of course, that doesnt stop a few million muggins from trying it out and being enticed...and maybe even getting 1-3% parting with some real cash. hehe

Posted:2 years ago

#2

Ryan McGeough
Studying Msc in Strategic Management

6 0 0.0
This article is fantastic, I've recently written a thesis on this very topic and conducted a number of interviews with social gamers. The consensus seems to be that this virtual goods thing is a fad. This of course doesn't mean the whole industry is doomed (or anything like it) but I definitely agree that it's been wildly over-inflated.

Posted:2 years ago

#3

Hurple
CEO

9 0 0.0
Only 5% of the 200m pay and over 59% of their income comes from 20% of that (1%). If you can get to the that 1% then game over(ish). In the meantime, EA are rushing in like loonies (but fair do's The Sims Social has nailed it - advertising spend is?) and Zynga is trying to step up and over into hardcore to make their 'games' more playable to people who spend on games (i.e EA's user base for example)

Posted:2 years ago

#4

Jeffrey Kesselman
CTO

112 0 0.0
Fact of the matter is that, even in their best earning which was right when they filed with the SEC, they were averaging $3.25 a year per active user. That only works if your product costs you *very* little per user to create, support and operate. What people forget is that online requires servers, that have a monthly cost.

As the market continues to mature, and to demand things like better performance and better security, it will put a heavier and heavier load on those servers. The social/casual F2P thing can work, but only in a very limited product range. Anybody who believes its the answer for all MMOs is just engaging in wishful thinking.

What this whole economic experiment has proved is that, in the hard-core and other advanced-game spaces, "F2P' as another word for limited trial is a valid marketing strategy, but in order to support any game that costs significant resources to either develop or run, you need to convert those that will be converted and get rid of those that won't.

Edited 2 times. Last edit by Jeffrey Kesselman on 30th September 2011 3:13pm

Posted:2 years ago

#5

Erik
Senior Product Manager

1 0 0.0
Really nice article, Rob.

Posted:2 years ago

#6
So in summary,
can we get back to some real proper gaming involving real gameplay mechanics that does not prioritize monetization as the main reason for gameplay but may be a integral part?

Personally, i hate hidden costs, hidden surcharge or buy this app or option in game to do XYZ.
I apprecaite is different ways to slice a cake, but at a very deep basic level, inherently its just not great.

Posted:2 years ago

#7

Jeffrey Kesselman
CTO

112 0 0.0
@ Dr. Chee

I agree 100% as a developer. I want an honest relationship with my customer. i make something thats worth something to you, you make a conscious choice to pay me for it.

Posted:2 years ago

#8

Andrew Wafer
CEO

22 16 0.7
Great article, thanks Rob. I especially like the canary in the coalmine analogy, very true.

I do think that we’ve yet to see the fruit of all that A&R activity and huge recruitment drive though, and that investment is clearly a big contributor to the profit decrease, they must be thinking it's worth it. They’ve recently snapped up a bunch of mobile studios, like Astro Ape, Five Mobile, Newtoy Inc and also HTML5 studios which are likely working to reduce that reliance on Flash. Given that Flash can be compiled to run on iOS and other non-flash supported platforms via AIR, I think it’s got a bit of life left in it anyway.

I also think their products are increasingly well designed, perhaps that design is focused on monetisation as much as traditional gameplay, but that’s why they’re the market leaders right?

There certainly is a limit on how far they can push their existing install base’s ARPU, but I’m expecting them to surge into other platforms and technologies over the next 6 months, as well as new genres to boost that 200 million. And didn’t they just sign a deal with Tencent for China? I think the future is uncertain and exciting, but isn't it a bit soon to write off Zynga’s IPO chances in the longer term?

Edited 1 times. Last edit by Andrew Wafer on 30th September 2011 4:47pm

Posted:2 years ago

#9

Gary Lucero
QA Analyst, Advanced

27 6 0.2
It's no surprise that the market is not constantly growing. Casual gamers are fickle, trying one thing today and another tomorrow. Even most core gamers are somewhat fickle, and might enjoy a social game for a while but then tire of it. I think Zynga would either have to find deeper experiences or just go all out for a Sims style persistent online game that will allow creative people to get lost in (and spend lots of money on) the game.

Posted:2 years ago

#10

Jeffrey Bacon
Director of Mobile Strategy

10 0 0.0
I agree that, so far, they have yet to be very successful in the mobile space. But saying they can't be is folly. The current executives at Zynga may be far more knowledgeable and competent at running and monetizing a web-based audience but if they hire a good mobile guru who understands marketing and how to cross-promote, they can leverage that 200 million web user base into a very sizeable mobile base and get overall customer growth through mobile. There's a world of opportunity for Zynga to achieve revenue growth by expanding from their core business model as well -- but all of that takes people who understand more than copy-and-upsell (which I give them full credit for being successful at).

Posted:2 years ago

#11

Nicholas Lovell
Founder

179 120 0.7
Pleasingly, we've moved away from knee-jerk core fans saying "Zynga sucks" into a rational debate about how social games will develop and grow.

I believe that there is much more opportunity for free-to-play games still (more so than Rob suggests here). The business model of charging people upfront (and hence driving marketing costs up to get people over that hurdle) both costs more to acquire customers AND limits the upside from those customers.

Zynga focuses on whales. Other companies are emerging that focus on true fans. Both use the same business model, but the underlying ethos is different. (See http://www.gamesbrief.com/2011/09/whales... That is why I think Zynga is faltering.

But free-to-play has a lot further to go.

Posted:2 years ago

#12

Mary Hilton
Community Manager

35 17 0.5
I've seen some informal charts from Quantcast and Alexa that could have been the true canary in the mine-the figures are dropping for Zynga's audience on a monthly basis-have been for the past year:

Quantcast: [link url=http://www.quantcast.com/zynga.com;jsessionid=3DA684C5200AB9A38A570BBA70970108
]http://www.quantcast.com/zynga.com;jsess...[/link]

Alexa: [link url=http://www.alexa.com/siteinfo/zynga.com
]http://www.alexa.com/siteinfo/zynga.com
[/link]

Social gaming may or may not be a fad-but Zynga has to be able to withstand the pressures that will undoubtedly come to bear on it such as EA's "Sim Social" which was guaranteed to be a hit. You don't get that kind of built in audience with just a 'click click game' without a lot of back story to it.

EA annihilated Zynga and it will be a while before Zynga can properly recover, if it can.

Posted:2 years ago

#13
My hunch is Zynga knew that it hit its peak MAUs with its existing games and internal analytics, and decided to go appropriately on a spending spree of social game devs whilst the iron was hot, for just such a potential scenario. Quality content and diversification would be the key to Zynga 2.0

The next round has already begun

Posted:2 years ago

#14

Charlie Cleveland
Game Director/Founder

17 0 0.0
Brilliant article mate.

Posted:2 years ago

#15

John Ozimek
Director

6 0 0.0
100% agree with Nick @Gamesbrief - the issue here is less the Freemium model that Zynga has helped to pioneer, and more about how it as a company has executed it's strategy. I'm working with 2 start-ups who are seeing amazing traction with Freemium. The key is making it a positive thing for gamers - not herding them into paying to play.

Zynga's dominance came from a rather over-cosy relationship with Facebook, with preferential traffic and ad placement. That, and Zynga's aggressive use of viral tools on Facebook, led it to the leadership position it maintains today.

However, where Zynga is suffering, is not just the stagnation of it's DAU/MAU audience - is the cost of acquiring each new paying customer. It's focus on the IPO has, in my opinion, led to an over reliance on building scale via acquisition over winning gamers through great games.

I can't help but think though that this is a weakness of capitalism that a company that has captured 30% of an addressable market in less than 4 years is seen as a company in crisis ;-) Maybe this will cool down all the crazy valuations? I won't hold my breath...

Posted:2 years ago

#16

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