Zynga's IPO dream is rapidly turning into a nightmare. Admittedly, it hardly started out as the sweetest of dreams - the company's share price didn't deliver the expected "pop" in its early days on the NASDAQ stock market last December, which led to plenty of criticism of the firm. Although it did make modest gains this spring, it's never exactly been a stock that soared - but even such modest success must seem like halcyon days to Zynga's investors and management team now. So severe has the collapse of Zynga's valuation in recent weeks been that the NASDAQ had to step in to halt short-selling of shares in the company - a humiliating step for a company which only listed six months ago.
What has happened? How could the darling of the social and free-to-play gaming scene have fallen so far, and so fast? A variety of answers have been proposed, some of them more plausible than others. Some explain Zynga's awful performance in purely stock trading terms - ZNGA shares were being used as a proxy for Facebook shares by investors who wanted to have money in FB but couldn't buy shares on the open market yet. With Facebook shares now launched, and not doing terribly well as yet, Zynga's listing is surplus to requirements - investors have withdrawn their holdings and put the stock into free-fall as a consequence.
"With Facebook shares now launched, Zynga's listing is surplus to requirements - investors have withdrawn their holdings and put the stock into free-fall"
That's almost certainly a factor, but it's not the primary reason for Zynga's problems. Facebook's somewhat underwhelming IPO was a catalyst for Zynga's decline, but not a root cause. For the root causes, we have to look at two much more fundamental problems with Zynga - problems which are extremely important to understand, because they give us an insight into serious issues which will impact on almost every business in the video games market at some point down the line.
Firstly, and perhaps most widely discussed up to this point, there is the question of Zynga's transition between the web and the mobile device. This transition is one of the most fundamentally important things that's happening in technology right now. It's not that the web is going away - we're going to continue engaging with games, social services and software through laptop and desktop computers for a very long time, no doubt. However, the bulk of the growth in engagement is coming from people on mobile devices. Smartphone and tablet devices are an enormous growth market, and they're both generating a new market and cannibalising functions which would traditionally have been seen as web functions.
Zynga, though, is primarily a web company. More than that; despite its best efforts, it's primarily a Facebook company. It built its business around titles like Farmville (which at its peak enjoyed almost 100 million people logging in every day), spreading their influence through viral marketing channels, many of which Facebook has since disabled, and through cross-game promotions that drove existing users of one Zynga game across to another one. The shutting down of the viral channels Zynga used to grow so rapidly has led many in the industry to view Zynga as having scrambled up the ladder just before it broke; their path to dominance of the Facebook ecosystem no longer exists, and cannot be followed. They were in the right place, at the right time.
The same thing does not, however, seem to be true of mobile devices. Zynga has struggled on mobile - as, in fact, has Facebook, whose primary threat right now comes not from rivals on the web like Google+, but from the threat of a mobile-first social network emerging which takes users' attention and engagement from Facebook. Both Facebook and Zynga have pursued similar strategies in attempting to overcome this problem - they've whipped out their wallets and paid huge sums of money for companies who do mobile right. Facebook dropped a cool billion dollars on mobile-based photo sharing service Instagram, while Zynga's immense and seemingly ill-advised investment in Draw Something is likely to become the stuff of industry legend.
For all the cash they've spent, neither company seems to have been able to find the acquisition with just the right blend of magic pixie dust that can turn them into competent, mobile-first operations. Facebook's core mobile application is still inexcusably dreadful, and the company's launch of a "Facebook Camera" application which bluntly copies Instagram's functionality only days after the Instragram acquisition was announced didn't do much to convince anyone of the firm's competence in this field either. Zynga, meanwhile, has watched Draw Something's popularity decline sharply and still seems to lack the competencies required to launch a successful mobile property of its own.
The games industry is used to there being casualties from platform transitions, but few are quite as dramatic as this. It's hard to characterise Zynga's behaviour as anything other than panic-buying. The company is terrified of mobile - a platform where it won't enjoy the dominance it did on Facebook, where Apple (in particular) expressly forbids many of the exploitative viral techniques it used to build that dominance in the first place, and where smaller, more nimble developers seem to be building empires while Zynga tries to figure out what the hell to do next. Throwing money at some of those developers is a better strategy than complete inaction, but it's not a winning strategy in the long-term - and the markets know it.
"Zynga is terrified of mobile - a platform where it won't enjoy the dominance it did on Facebook"
The second thing the markets know, or are beginning to realise, is a little less openly discussed right now - perhaps because it makes a fair few investors and commentators look rather bad. That second thing is this: both the stock markets, and Zynga itself, completely misunderstood what kind of company Zynga is. In their excitement over things like the social graph and the undeniable power of free-to-play business models, they forgot that Zynga is still, essentially, a video game company - and they forgot how that kind of company operates.
Video game companies are no different to any other kind of media company - a film studio, a book publisher, a record label. You have a back catalogue that generates some revenue, but your growth has to come from new releases. You're relying on a schedule of new releases to generate at least a few break-out hits which will drive your profits and keep your company looking healthy. A good back catalogue evens out your annual revenue figures, but if you don't make hits, then the strength of your back catalogue is irrelevant - except as a bargaining chip when the time comes to sell out to a healthier rival.
Zynga is no different - but it thought it was, and some investors believed it. Zynga is a games company. It's important for it to keep its back catalogue healthy and thriving, but ultimately, if it wants to grow, it has to generate hits. Farmville is back catalogue - a comfortable set of laurels to rest on, and nothing other. Zynga, like any other media company, is only as good as its last release, and only as bankable as the strength of its forward release schedule. There is a sense that the company and its investors thought that the social graph and F2P business could change that reality, but they were utterly deluded in this. If your business is making games, then no matter which business model you use to monetise those games, the reality is this - you have to be prepared to release new games down the line, and those new games have to match or exceed the market performance and quality of your previous titles, or you're a shrinking business. Zynga, for whatever reason (we could return to the mobile question here, or look a bit more closely at some of the less palatable business practices of which Zynga stands accused), doesn't seem to be capable of that. The stock market sees the problem, and wants out.
"Both the stock markets, and Zynga itself, completely misunderstood what kind of company Zynga is. They forgot that Zynga is still a video game company - and they forgot how that kind of company operates."
This is a hugely important lesson, because Zynga is not alone in having this kind of flaw to its business thinking. There are plenty of other companies out there which have had a couple of hits and which seem to believe, thanks to the new business models enabled by social gaming, that those hits can sustain them almost indefinitely. They've forgotten that media businesses can never, ever rest on their laurels, no matter how impressive the laurels may be. There's a reason why "one-hit wonder" is a term uttered with a sneer - and plenty of businesses that look exciting today are likely to find themselves slapped with that term in a few years time, I suspect.
Zynga is a stark example to those businesses. You're still in the business of making games, and if you can't meet the expectations of that business, you're going to fail. For Zynga, the only route out of their current predicament is to start producing some genuinely exciting, high profile and appealing new games - preferably games which lead on the mobile platforms. My suspicion, sadly, is that neither of those things is in the company's DNA. Social gaming may see its first truly high-profile casualty before long.