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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.