The Zynga Hate Has Gone Too Far. Maybe They Should Go Private.

I have been working in free-to-play games for the past 5 years and I have been reading a lot of articles describing Zynga’s recent announcement about a soft Q3 2012 on the back of a less than stellar Q2 2012. The public markets clearly don’t like Zynga’s stock – it’s down substantially since its IPO and every piece of bad news seems to hammer the stock even harder. Whether it’s executive departures, delayed games, or flat revenue, the company can’t seem to catch a break. I think the public market hatred of Zynga’s stock might have gone too far. I’ll lay out my case below.

I just want to get all of the standard bias disclaimers out of the way now:

1. I have never worked at Zynga, but I was VP of BD at Serious Business, which Zynga acquired in early 2010.
2. I do not have any position (long or short) in Zynga stock.
3. I do work in the games industry and believe that you cannot have a healthy market for private companies if the public companies in your space are not healthy as well.
4. Zynga is by no means the most beloved company in the games space. But you have to acknowledge what they’ve been able to accomplish on the business side in a very short period of time.
5. Because of the nature of voting control at the company, this is really only something that could happen if management (as opposed to a hostile outsider) chose to pursue this path.

This is a long blog post. But I want to start with some historical perspective.

Zynga won by dominating distribution and monetization on the back of a platform where 50% of that platform’s user base came back on a daily basis. Let’s just quickly revisit how Zynga got to where they are today. More than any other company in the social games, space, I believe Zynga got two core things right. First, they were (and continue to be) masters of distribution on Facebook. They had the foresight or fortune to leverage their business to the Facebook platform. The Facebook platform not only grew at an unbelievable rate (now reaching over 1 billion people on a monthly basis) but also maintained insane usage, with roughly 40-50% of people logging in daily. Winning on a high growth, high engagement platform creates opportunities to build massive businesses. Zynga clearly won that game – I think it’s hard to argue that their combination of distribution expertise and product portfolio has a rival on Facebook. They have a handful of sticky, high monetizing titles (Farmville, Poker, Mafia Wars, Cityville) that continue to both retain users and monetize well.

The one challenge with platform dominance is that you eventually become so dominant on your platform that you suck out all of the oxygen and are ultimately constrained by the growth of the underlying platform. A few years back I speculated that Zynga was running out of Facebook users to acquire, as they had reached 50% penetration. I still stand by that post as a roughly high water mark on the FB platform – growth requires both new users and continued growth on the underlying platform on which you’ve bet the business.

But let’s zoom out and look at Zynga and think about where they are as a business:

Zynga will do over $1 billion in bookings in 2012, most of which will come from platforms that didn’t exist in meaningful form 5 years ago. Despite the decline in stock price, Zynga does roughly $200-300 million per quarter in bookings, the majority of which comes from a platform (Facebook) that didn’t exist in functional, meaningful form 5 years ago and with most of the growth coming from smartphone app stores that didn’t exist 5 years ago either. That’s really impressive growth. To go from zero to $1 billion in bookings is no small feat. It can be easy to lose sight of that fact in the stock price pummeling the company has taken.

Mobile games today is a “small numbers” business today for a company doing $1 billion in bookings. Just think about this. For a company that does over $1 billion in annual bookings, even a $100 million annual run rate for mobile only adds 10% to the top line. That simply isn’t enough to move the needle for Zynga. For mobile to matter in the grand scheme of things, it needs to be more like 20-30% of total revenue. The challenge right now is that while mobile (tablet and smartphone) is growing quickly, it’s still a small total dollars business for them and frankly for everyone else other than the largest Asian games companies. It will take time for mobile to catch up and eventually eclipse Zynga’s web business. In the meantime, their overall growth rate will be burdened by the slow growth of the Facebook platform.

Zynga is in the midst of managing a really difficult platform transition – this is really hard to do as a public company regardless of what industry you’re in. This is not just a games issue. Look at all of the traditional commerce companies that have tried to compete with e-commerce. And all of the print and analog media companies in music and news that have struggled to cope with the transition to digital. One thing is clear to me – fundamental distribution and platform transitions are hard enough to do – doing them in the glare of being a public company is downright impossible. The reason is simple – public companies are measured quarterly and these kinds of transitions require quarters of hard work to effect. Zynga, and just about every knowledgeable analyst that covers the company, understands that the future is in mobile. Making that transition from a Facebook-centric world to one where they have a meaningful contribution on mobile will take time and that’s hard to do in public.

There is no reason that Zynga can’t build up a strong cross-promotion network in mobile that would be reasonably effective in recreating some (if not all) of the advantages they enjoy on the Facebook platform. Part of what made Zynga successful on the Facebook platform was that they both dominated newsfeed and other forms of on-platform social distribution and that they had a large network of users to which to cross-promote new games. There is one fundamental different between mobile and Facebook, though. While most “social” games were surfaced through the core Facebook walled garden experience, this doesn’t hold on mobile. In mobile, games are not ambient social objects that live in a larger Facebook experience – they’re effectively more like a collection of bookmarks that you save on your desktop. As such, you don’t have a time blackhole application like Facebook where you can capture engaged users – it’s just harder on mobile.

But there’s no reason to believe that Zynga can’t build up a strong, meaningful cross-promotion network that rivals what they have on Facebook. Independent companies like Chartboost, Playhaven, and Papaya (AppFlood) have proven that the model can work across developers. And Zynga has some good assets in mobile when you look at Draw Something, Words with Friends, all of the X-With-Friends games, and upcoming IP. The real secret, though, to making this work is that Zynga needs a sufficiently diverse portfolio of offerings in its quiver to have the right game to suggest to the right user at any given point in time. Right now, they are heavily weighted toward casual. I expect they will add more hardcore, midcore, and casino games so that they eventually have something for everyone.

On Facebook, Zynga competed with Playfish, Playdom, Wooga and others to build the strongest cross-promo network. They eventually won. Now they’re competing with a new set of formidable competitors in GREE and DeNA. Unfortunately for Zynga, they are competing with those companies on their home platforms (mobile) – but Zynga will compete and I think we’re still in the early days of seeing how this all plays out.

There are really interesting opportunities available to Zynga – they’re just too risky to do as a public company. There is a lot of greenfield opportunity in front of Zynga. Social casino, both for-fun and real money, are both still markets that can be contested with good products and smart marketing spend. There are interesting opportunities in midcore and hardcore mobile games. And very few companies have really cracked social distribution. All of the segments I’ve mentioned above are speculative – they haven’t settled out yet and there’s still a lot of work to do to figure out what it takes to win. Winning in these market spaces will take experimentation, testing, and will inevitably involve some failure. That sounds more like work to do in private than in public.

Overall, I think Zynga has a lot of work to do but it’s all doable work. I’m just not sure how easily they can make the changes to their model that they need to make without going private first and escaping the glare of public company quarterly earnings reports and scrutiny. These are pretty fundamental (but addressable) challenges – I wonder if it would be easier to address these issues as a private company than as a public one. Curious to hear if you feel differently

Thanks for reading this long post. Believe it or not, I wrote the whole thing on my iPad. Feel free to leave a comment below or send me a message on Twitter @chudson.

  • Chris

    Charles, well written. Totally agree on the opportunities in front of Zynga.

    How do you think about staffing against Zynga’s opportunity? At the close of 2011, they had nearly 2,900 employees. By this time I imagine it is well over 3,000.

    Where and when do you see the power of Zynga’s scale coming in to build and run games in a way that does not require what seems like a very aggressive staffing plan?

  • http://www.charleshudson.net chudson

    Glad you liked the post, Chris. Zynga has at least 3,000 employees.

    The staffing question is a great one. I wonder how much it takes to support and maintain their existing Facebook games vs what it takes for mobile. Given that not all of the mobile games are server-heavy and the development teams are likely smaller, I’d guess that they could scale with a lower headcount there. Supporting tens of millions of DAU on Facebook is not cheap or easy – I have no clue what they could save there.

  • Hank Howie

    Just tell me you used a 3rd Party keyboard, Charles. ;-)

  • http://twitter.com/juhapaananen Juha Paananen

    Good analysis Charles. I agree 100% on the difficulty of a platform shift — makes you wonder if Zynga went public too early..?

    To add to the list I think one near term opportunity for Zynga is in the Facebook midcore segment currently dominated by Kixeye. Considering Zynga’s expertise on FB I’d see that as a pretty obvious one to go after, and not nearly as difficult as mobile.

    I agree though that Zynga needs to win on mobile and that’s probably only thing that will satisfy Wall St.

  • http://www.charleshudson.net chudson

    Or maybe they went a year too late – had they gone a year earlier, they would have also had another year of FB growth as a public company before things slowed down.

  • http://www.facebook.com/john.michael.eden John M. Eden

    Charles,

    Great analysis. I used to work in mobile at Zynga, and I think you’ve correctly described the platform change Zynga faces. They are making great strides in building an effective cross-promotion network on mobile, and the folks in mobile deserve a ton of kudos for their achievements on this front.

    Still, Zynga is not a first-order distributor and have to therefore deal with challenges inherent in making apps for ecosystems controlled by 3d parties (Apple, Android). Technically, this was true of Facebook as well – Zynga never controlled that ecosystem. (But at least they had the benefit of the MFN negotiated by OVN.)

    On mobile, there’s no analogue to the MFN. However, it’s worth pointing out that for evergreen games – like WWF, HWF and the other WF titles – it’s really quite easy to get players to try new async titles. And the casino titles that I worked on are really polished and have impressive retention levels.

    I’d like to add something to your analysis of Zynga’s Japanese competitors. Companies like GREE hail from a country where a large segment of the population loves playing engaging, complex, and expensive games on their feature phones and smart phones. These companies, therefore, learned how to build and grow mobile in a very fertile, forgiving market. But the US is a different animal. Here, these Japanese game companies first have to learn how to build for a fragmented mobile games market that heavily leans toward casual games (when compared with Japan). And that means Zynga has a significant advantage in producing mobile hits on its home turf.

    John

  • http://www.charleshudson.net chudson

    This is great stuff – thanks for the comment! Really appreciate your comments and insight.

  • http://www.kennykellogg.com scottorn

    awesome post. you should write more like these, if you have the time. :)

    One thing that also helped Zynga succeed on Facebook was the fact that Facebook really needed a revenue model. So in a sense, Facebook was happy to let Zynga dominate that ecosystem because they were paying big bucks to Facebook.

    I don’t think Zynga (or anybody) will be given carte blanche on mobile by Google & Apple in the same way that they had on Facebook.

  • http://www.charleshudson.net chudson

    I really do like long-form blogging. The only problem is that I cannot predict what will catch my fancy. I’m working on a new blog post that I think you’ll find really interesting.

  • http://www.kennykellogg.com scottorn

    awesome

  • Kevin

    I’d say the Zynga hate has not gone far enough- any company that so regularly screws its own employees and steals games from smaller devs is not deserving of any sympathy. They’ve shown time and time again that they can’t produce anything original, and anyone who seriously thought their business model was a sustainable one was delusional. Being a public company seems largely irrelevant; they’ve shown they were unwilling to take risks even before they went public and instead opted for “every horrible thing in the book, too, just to get revenues right away”

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