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Zynga in the Doghouse

Zynga in the Doghouse

Thu 09 Aug 2012 6:44am GMT / 2:44am EDT / 11:44pm PDT
MobileBusiness

Stock is down, lawsuits are piling up, execs are leaving; what should it do?

It's been a rough few weeks for Zynga: Its stock sank to below $3 a share (it started at $9.50 in December); it announced financial results that were well below what analysts expected, triggering shareholder lawsuits; and EA filed a copyright infringement lawsuit over The Ville's resemblance to The Sims Social. Zynga has reshuffled its executives and redoubled its efforts to improve its numbers. Now COO John Schappert has left, and apparently Mark Pincus is directly managing the company. Will it be enough? How deep are the problems, and how much ability does it have to fix them?

First, let's look at the problems. Zynga announced its second quarter earnings, and they came in well below expectations; Zynga earned one cent per share, where analysts were expecting six cents a share. Revenue was $332 million, coming in below the expect $344 million. As far as analysts are concerned, Zynga made a mess on the floor; analysts are busy using harsh words and stern tones to teach Zynga not to piddle on their earnings estimates again.

Arvind Bhatia of Sterne Agee was not kind. "While we have been bearish on the story since the beginning, these results and the current trends appear to be much worse than even we had anticipated. We do not share management's belief that these trends are temporary."

"While we have been bearish on the story since the beginning, these results and the current trends appear to be much worse than even we had anticipated. We do not share management's belief that these trends are temporary"

Arvind Bhatia

During the earnings call, Zynga execs attempted to explain the shortfall, citing three main reasons: Changes in the way Facebook does its notifications; later than expected launch of The Ville; and a sharp decline in Draw Something.

That doesn't tell the whole story, though. Average daily bookings per user declined 17 percent, even though monthly uniques grew. Some of this may be due to the mix of games changing, as many of its newer games are arcade games, which Zynga admits do not monetize as well as 'Ville style management games. Overall the trend seems to be that older games continue to lose players (along with the social game industry in general), and many of the newer games either don't monetize as well or just haven't been hits on the scale of the past.

What Zynga execs clearly wanted to say (but didn't for fear of offending Facebook) was that Facebook cost them a lot of money with their notification changes. These changes favored new games heavily and made older games much less visible. This struck Zynga's cash cows like FarmVille hard. It's not clear what changes Facebook may make in the future, and whether that will help or hurt. The uncertainty of the platform that Zynga depends on so heavily must be maddening. Of course, Zynga doesn't want to piss off the company where they derive over 80 percent of revenues, so they were always careful to couch their complaints in the most diplomatic way possible.

Zynga has other problems to worry about than just Facebook. Multiple law firms are investigating the circumstances of Zynga's second quarter shortfall, with an eye toward shareholder suits. These sorts of lawsuits are typical when a company reports unexpectedly poor earnings; add to that the secondary offering just as things were turning south and it would be surprising if we didn't see some shareholder suits. One more distraction for management at a time when they need all their focus.

Electronic Arts has filed a copyright suit against Zynga, claiming that The Ville infringes on EA's The Sims Social. This looks to be a lengthy courtroom battle, as EA certainly has the resources to fight (unlike small developers who felt that Zynga copied them, EA has plenty of money for lawyers). It's yet another executive distraction for Zynga, as well as more bad publicity to overcome.

"Zynga may have a host of problems to worry about, but it's also got an enviable set of advantages"

Zynga may have a host of problems to worry about, but it's also got an enviable set of advantages. Let's start with $1.6 billion in cash; that's a nice chunk of change that can fund many different initiatives. Even more important is a fact that seemed to have been passed over by many analysts: Zynga added $100 million to their cash hoard in the second quarter. So even when times were tough, and Zynga was not living up to expectations, they still tucked away $100 million in cash. They are not about to go away as long as they can keep doing that.

Zynga also has built a huge technical infrastructure to support its games worldwide, and this has proven to be eminently scalable to meet any sort of demand. It's also flexible enough to handle the demands of any type of game that Zynga may choose to do in the future. This is something few other companies possess.

Finally, and not least, Zynga has thousands of highly skilled employees, including some top design talent, with massive experience in all types of games. All together, this means that whatever strategic direction Zynga chooses it has the financial resources, the technical resources, and the talent all available to make it happen. The key question is, can Zynga pick the right strategy?

The big picture is really simple enough. Zynga parleyed its first-mover advantage in the social game market into a dominant position; it hitched itself to Facebook and grew explosively along with them. Zynga used its early advantage to go public and garner a stockpile of cash, along the way building a tech infrastructure to sustain games and support future growth. Now, however, the momentum in the social space and the game space has shifted to mobile, where both Facebook and Zynga are not cutting-edge.

The sheer newness of the business model that Zynga is using means increased risk. The overall slowdown in the social game market may signal that players are a little bored with the offerings, or are moving on to games on other platforms. Zynga has built a huge audience, but monetizes less than 2% of them. If the overall number of users isn't growing (which it isn't in social games), Zynga's options are clear. It can attempt to increase the percentage of payers; it can expand rapidly on mobile; it can substantially boost advertising revenue; it can get real-world gambling to be legal; or it can find large numbers of new players (for new games, or new countries for old games).

"Zynga has built a huge audience, but monetizes less than 2 percent of them"

Ad revenue delivered $41 million in Q2, up 170 percent over last year. That's an excellent rate of growth, but it's not the whole story. The question is scalability; if Zynga has to be involved in creating specific game tie-ins, as Pincus discussed in his interview, that is exciting for individual advertisers but not readily scalable. Google's AdWords is the ideal; advertisers can easily book ads with no human intervention, which is how Google has scaled it to tens of billions in revenue. Meanwhile, Zynga's ads displayed next to its Facebook games are advertising its other games; that's good for moving your audience to your other games, but it's not generating revenue.

Real-world gambling is going to happen for Zynga, as announced in its earnings call. It just won't happen in the US at this time, since the laws don't allow it yet. While Zynga lobbies for those changes to be made, it will gain experience with gambling in countries that do allow it. As more countries make it legal, Zynga will be able to take advantage of the experience. The potential market is in the billions of dollars, but how soon it will happen is anyone's guess.

Zynga recognizes the opportunity on mobile, and they are trying to get there; the $210 million spent on the OMGPOP acquisition shows how seriously Zynga takes the mobile market. Unfortunately, Draw Something turned out not to have legs; the audience has dropped significantly, and Zynga has been slow to build on the brand. In general, mobile games have been a tricky market, with the well-known deficiencies in mobile advertising making that avenue for monetization a difficult one. Acquisition costs have been rising, but that's one area where Zynga's scale gives it a massive advantage; it can funnel users from their existing audience into new mobile games. It just has to be able to monetize them better.

The real mobile problem for Zynga is a fundamental design issue. Smartphone screens aren't really big enough to make running a huge farm or a city work very well. Essentially, Zynga's best moneymakers, the Ville games, just aren't designed well for a small screen, even leaving aside the difficulties of porting Flash games to iOS and Android. Barring some clever interface design tricks, Zynga's going to have to look to other games or revenues in order to succeed on smartphones.

The huge opportunity, if it is achievable, is improvement in monetization. Pincus showed in his interview with GamesIndustry International that he's fully aware of the importance of moving that needle. "I really believe that the next great startup is going to be defined more because they invented a new reason for four percent of players to want to spend money in your game, and some of them to want to spend a hundred or two hundred dollars, than because they iterated on the bubble mechanic. We are working at that all the time. I feel like we've just scratched the surface."

Higher monetization levels have been achieved, but typically that's by games with a highly targeted audience; Kixeye's games are a good example. They monetize at multiples of Zynga's percentages (companies don't like to give out exact numbers), but they do by targeting hardcore gamers and having an audience that's an order of magnitude smaller than Zynga's audience (War Commander has 2.3 million MAU, compared to 35.5 million for Zynga Poker). The latest rumor is that Zynga may be working on a game targeted at core gamers; if so that represents a big strategy shift for them, but perhaps a critical one. Zynga declined to comment on this rumor, but it's certainly believable.

Fundamentally, people may just be tired of the same basic game mechanics of so many social games. The industry has seen many games from different companies with essentially similar game play, coated with different graphics. Perhaps this explains why the audiences seem to get bored faster and move away from the game. Copying games, or, more politely, 'fast-following', can be a successful business strategy, especially when a market is growing rapidly. Now it's biting them in the butt, as EA's lawsuit shows. Worse, the market of new users isn't growing, and the existing base is getting bored of a parade of games that have very similar core game mechanics.

"Zynga has to face the fact that it needs innovation now more than ever"

FarmVille 2 is a perfect example of where Zynga may be going off the rails. What's the point of FarmVille 2? Is the game somehow going to attract a new group of players? Perhaps, but it's difficult to see how it would unless the game play is very different... and then you'll lose the existing players. Is it about reducing the churn for current FarmVille players? Or perhaps increasing their willingness to pay? Those might be good reasons, but one would hope the cost of the revisions are in line with expectations of increased revenue. There is a danger here, too; will existing FarmVille players lose their carefully executed farms and their special items? If the look of everything has changed, and players are forced to migrate, some may not like having to change things on their farm. FarmVille 2 has to avoid the Mafia Wars 2 fiasco, and somehow bring the game back to the heady days of being the number one social game.

Zynga has to face the fact that it needs innovation now more than ever. It's time to let those 150 game designers off their leashes to roam free. Sure, they'll make a few messes on the sidewalk, but one of them just may catch a rabbit. Or, better, a very large whale. The Zynga Platform is also a good way to experiment, and Zynga needs to really open that up swiftly. Make it as transparent as possible, and easy for developers large or small to get onto it. Let the world know the specific deal terms, just as Apple lets you know how much they take when you sell a product in the App Store. Zynga should even be helping small developers bring their products to the Zynga Platform; create a development fund. Wild ideas can be tried with no risk to Zynga, and if they're successful Zynga can always buy the developers.

One of the key advantages - or is it a disadvantage? - is Zynga's ownership. Essentially, Mark Pincus has engineered it so that he is in complete control, with over 50 percent of the voting shares, as well as being chairman of the board and CEO. He has unquestioned authority to do whatever he feels necessary. If he's making the right choices, that's a good thing; Zynga will be able to move swiftly without waiting for internal politics to resolve before they can move forward. Of course, if he makes the wrong choices, there's no one who can stop him. In the end, it's up to Pincus to re-invent the company. He did successfully grow it from nothing to a market capitalization rivaling Electronic Arts, so there's good reason to believe he can come up with the right strategy. It may be difficult, though, to admit that ideas that worked brilliantly a couple of years ago may not work so well in today's market.

It's going to be a very interesting and challenging year for Zynga. The current $3 share price may either look like a real bargain twelve months from now, or it may be a fond memory. Investors, place your bets.

26 Comments

Bruce Everiss
Marketing Consultant

1,692 594 0.4
A fair and well balanced article. Which is unusual when Zynga are involved.
Of course they will succeed. It is not a matter of if they overtake Activision for the #1 crown, it is a matter of when.

reminder to self: Buy Zynga Shares.

Posted:2 years ago

#1
Solution. Make games

Posted:2 years ago

#2

Peter Ohlmann
Technical Director

22 6 0.3
"reminder to self: Buy Zynga Shares"

Buying Zynga shares while all executives of that company are selling theirs.

Posted:2 years ago

#3

Terence Gage
Freelance writer

1,288 120 0.1
"Of course they will succeed. It is not a matter of if they overtake Activision for the #1 crown, it is a matter of when."

Really, Bruce?! I know you and other staff at Kwalee hold Zynga in very high esteem, but you seem to blindly disregard anything which shows them in a bad light and focus only on the positives. Ironic really that you open by saying "A fair and well balanced article", and then follow it with a comment which is anything but fair and balanced.

Posted:2 years ago

#4

Luke Salvoni
Co-Founder & iOS Developer

65 4 0.1
They really can't get much lower in share price; $2.90 at time of writing with a cap of $2.2394bn. Their cash in the bank of $1.6bn is already worth $2.07 per share - admittedly you wouldn't buy this stock for the EPS of 1c. They rise and fall as FB do, and they've lost 45% since they floated in comparison to Zynga's 69%.

Zynga's decline has primarily been since the acquisition of OMGPOP for the outrageous sum of $210m - who cares if they were making $250k a day - there's no way they were ever going to recoup the purchase costs overnight, and as discussed they appeared to have sat idly with the company since the takeover.

What does the future hold for Zynga? Some excellent points in this article, and I can't wait to see how all this will turn out over the next 12 months.

Edited 1 times. Last edit by Luke Salvoni on 9th August 2012 10:12am

Posted:2 years ago

#5
The current $3 share price may either look like a real bargain twelve months from now, or it may be a fond memory. Investors, place your bets.
The article in itself is nicely balanced, and the final quote sums it all up.
I suspect for Zynga to produce a win within the mobile space, will require it to actually produce standalone mobile games not reliant on the facebook platform i.e make mobile games which is a paradigm shift from its original clickathon marketing appraoch to entertainment.

In parting, it remains to be seen if Zyngas current approach will be ville-fied or vindicated. Let the Games (truly) being. Round 2!

Posted:2 years ago

#6

Tamir Ibrahim
Programmer

76 56 0.7
Popular Comment
A fair and well balanced article. Which is unusual when Zynga are involved.
And something which is very unusual when it comes to any of your comments, Bruce. As immediately proven by your next sentence.

Posted:2 years ago

#7

Robin Clarke
Producer

304 691 2.3
For Zynga to reinvent themselves they need a change in their culture.

Posted:2 years ago

#8

Kingman Cheng
Illustrator and Animator

952 180 0.2
Popular Comment
"Solution. Make games"

Desperate times calls for desperate measures?

Edited 1 times. Last edit by Kingman Cheng on 9th August 2012 1:52pm

Posted:2 years ago

#9

Craig Page
Programmer

382 218 0.6
Popular Comment
What should Zynga do? Three things:

1. Clone it's own games.
2. Sue itself for cloning it's own games.
3. Profit!!

Posted:2 years ago

#10

Andrew Ihegbu
Studying Bsc Commercial Music

449 158 0.4
Hmm... it seems building games purely from analytics (and theiveing other people) leaves you with a distinct lack of... art. And as we all know, nothing holds it's value too long with out a certain element of art within it.

Zynga will die. Hopefully the social gaming that is born from it will be a little more intelligent... whether it ends up being Gaikai/OnLive based or goes back to indie games with widespread appeal.

Posted:2 years ago

#11

Mark Venturelli
Game Designer

14 19 1.4
Hope it goes out quickly enough so that the whole industry learns a very important lesson.

Posted:2 years ago

#12

Greg Costikyan
Senior Game Designer

7 10 1.4
Pincus is a brilliant entrepreneur, but perhaps not the best person to be running a billion dollar public compnay.

Posted:2 years ago

#13
Well, what animates our bodies is a soul. Without which, is just an animated puppet without consciousness. As in life, so is art

Posted:2 years ago

#14

Greg Wilcox
Creator, Destroy All Fanboys!

2,175 1,124 0.5
Maybe they need to tank it before they take the whole social games industry down with them? Just sayin' if they drag it out and sink lower and lower, "analysts' start their speculatin' ways, which leads to the burning question 'Will OTHER social games makers be affected?" Which will lead to someone (an analyst, of course) predicting that "social gaming may be in trouble..." which will lead to folks not wanting to invest based on that little slip up guesstimate.

Eh, whatever - you can only monetize something is so many ways, so perhaps the streak is over for everyone because all the ideas on making money (other than making good games) are burning out. Hey, it was a good run while it lasted. Maybe Zynga is the Roy Batty of the industry (and I hope you get that reference, because I'm not going to look up that long quote from the film)...

Posted:2 years ago

#15

Sean Kauppinen
Founder & CEO

46 47 1.0
Excellent article. Anyone can see the company has too many employees for the number of games it operates. Profitability can likely be found from within with several hundred, or a thousand less people to feed. It's a defensive position to keep them internal at this point so they don't go build new companies and games that compete. I hope they turn it around because they do have some stellar designers on board and pretty solid tech to build off of.

Posted:2 years ago

#16

Hugo Trepanier
Senior UI Designer

156 144 0.9
What bothers me considerably is that because of Zynga's excessive success, everyone now thinks that monetizing 2% of your player base is the norm to expect. Doesn't anyone see or understand that this means that 98% of all players think your product is not worth a single cent to them? Where is the fun? Where is the content? Where is the value? I mean, really.

Also, saying Zynga will overtake Activision is ludicrous, not that it isn't possible in terms of market value or whatever, but simply because these two companies are not competing in the same arena! That's like saying a book publisher will overtake James Cameron in the 3D blockbuster sector - two totally different things that cater to different audiences and different "needs".

Posted:2 years ago

#17

Frederic Eichinger
Web Developer

33 27 0.8
The thing is, Zynga simply ran out of fuel after it burnt through various companies it either devoured or copied.
Now we see insider trading and execs bailing ... It just seems like they were planning this. Eat up the market, drive company into the ground, profit off it. And sadly there is still a large amount of people in blind support of Zynga - yes, I'm looking at you there, Bruce.
Zynga's tactic was successful. It yielded a massive amount of money. That's all nice and dandy. But it cripples the market. In both expectation and quite physically through their copycat actions and the suspicious end-of-the-line behavior of the execs.

Posted:2 years ago

#18

Steve Peterson
West Coast Editor

108 73 0.7
I wouldn't see Schappert's exit as evidence that he saw Zynga as failing; rather, I think he didn't meet Mark's expectations in some way. The very fact that he wasn't present at the Zynga Unleashed event in June, when he was a key speaker at their similar event last October, was evidence that he was not in favor for some reason. The stock sales by execs at the secondary offering in May, though the timing looks bad, was a standard part of the IPO process. Usually execs sell some stock then regardless of how they feel about the company prospects just to generate some cash.

Posted:2 years ago

#19

Steve Ball
Software Engineer

18 5 0.3
There has also been a pretty damning anonymous insider talk on a few things too:

http://www.quora.com/Zynga-Stock-Price-Collapse-Summer-2012/How-do-Zynga-employees-feel-about-the-companys-summer-2012-stock-price-drop

Makes for some more harsh reading...

Posted:2 years ago

#20
"When you're making entertainment you can't just keep making the same things over and over again. Innovation doesn't mean inventing a kind of game that nobody's ever ever seen before. You'll be lucky if you make one or two things like that in a whole career of game design," he adds. "But innovation also means combining the things we know in new and innovative ways."
Apparently Zyngovation involves 80 parts pillage and 19 parts assimilation and 1 part Re-villed. Genius!

Posted:2 years ago

#21

Neil Young
Programmer

296 372 1.3
"What bothers me considerably is that because of Zynga's excessive success, everyone now thinks that monetizing 2% of your player base is the norm to expect. Doesn't anyone see or understand that this means that 98% of all players think your product is not worth a single cent to them? Where is the fun? Where is the content? Where is the value? I mean, really."

It's hardly for everyone, but it's a valid business model for some. Yes, 98% of users pay you no money, but that doesn't mean they aren't of worth to you. For an MMO, they may be the armies of casual players who provide the population to keep it fun for the committed players.

Posted:2 years ago

#22

Sandy Lobban
Founder and Creative Director

314 206 0.7
I think Zynga have done well to create momentum and convince investors that their ideas were worth investing in. Cant say fairer than that from a business point of view. The only thing that's constant is change, and they have some fundamental creative challenges ahead to make the transition to other platforms outside of facebook. They are on a level playing field with other publishers and individual developers now, so its up to them to get it right. With the financial backing they have, there really is no excuse for not getting it right with new original IP.

Posted:2 years ago

#23

Scott Davis
Product Analyst

15 8 0.5
The problem is, 2% isn't the expected norm - it is the norm and pushing for anymore than 2% on a non-promotional basis can sometimes drive those not willing to pay away, over saturating the game with content not designed for both free and willing-to-pay parties.

Posted:2 years ago

#24

John Bye
Senior Game Designer

480 451 0.9
"The real mobile problem for Zynga is a fundamental design issue. Smartphone screens aren't really big enough to make running a huge farm or a city work very well"
I'm not convinced that's true - Ice Age Village, Smurf Village and similar games work fine on a phone screen and make a lot of money. There's no reason Zynga couldn't put Cityville or Farmville (or something very similar to their traditional Facebook games) on a phone. Plus the tablet market would be perfect for this kind of thing.

Quite why they've not done this yet, and instead waste vast amounts of money buying into flash-in-the-pan fads like Draw Something and then running them into the ground is a mystery to me.

Edited 2 times. Last edit by John Bye on 10th August 2012 1:38pm

Posted:2 years ago

#25

Hugo Trepanier
Senior UI Designer

156 144 0.9
John, actually Zynga did release CityVille on iOS in a version called CityVille Hometown, free to play and supported by micro transactions like everything else. It doesn't look like they've promoted it as much as their other titles though and as a result is fairly unpopular compared to its parent title.

Neil, in the case of an MMO I can understand the value of players who exist to populate your world but in the typical social games of today, these people don't really do much of anything for other players considering how limited interactions really are. Most of these games don't really offer direct cooperation or competition outside of leaderboards and freebie gift exchanges. We need to rethink this approach for social games to become more significant as a form of entertainment.

Edited 1 times. Last edit by Hugo Trepanier on 10th August 2012 3:27pm

Posted:2 years ago

#26

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