Saturday 30 October 2010

Zynga: Social Media Games In, Computer Games Out?

The headline in the October 26, 2010 edition of here speaks for itself: "Zynga's Value Tops Electronic Arts As Virtual-Goods Sales Surge." In a word, according to SharesPost.Inc. here, in an exchange for shares of privately held companies, the estimated worth of Zynga Games Networks Inc., the maker of such social network games as FarmVille and FrontierVille, is valued at $5.51 billion dollars. By comparison, Electronic Arts, the second largest publisher of video games, including such icons as "The Sims" and "Madden NFL", is valued at $5.22 billion on NASDAQ.
For those of you who might not be familiar, Zynga's earns its revenues primarily from selling virtual goods to players of social media games; these goods enable the players to progress in the game. Zynga uses Facebook to distribute its games and it has become the largest maker of games on Facebook. It is reported that Zynga owns six of the 10 most popular game apps on Facebook and that its games have 57.6 million users. Zynga shares with Facebook the income received from the sale of the viritual goods.

For sure, one needs to treat these kinds of valuations with a bit of caution. They are, after all, just informed guesses about a company's worth. (As one informed interviewee noted on a Bloomberg podcast several days ago, if you want to know about a company's position--"follow the cash"). Still, the ascendency of Zynga's social network games is noteworthy. Zynga is not a platform with zillions of users and lacks any proven monetizing model. Rather, Zynga runs a real business with what appears to be real revenues, estimated at about one-third of the $1.6 billion market for (expected to increase to $3.6 billion in three years). The company has raised $350 million in private capital, made six acquisitions since the spring and has increased its workforce in the last quarter (!) by one-third to 1,2000 employees.

Compare that with the recent fate of Electronic Arts, which has cut its staff and is looking to make acquisitions presumably to bolt-on to its current activities. True, contrasting rates of growth between well-entrenched and recently-established companies can sometimes be misleading, but the trends of these respective companies cannot be ignored.

Zynga seems to be engaged in asserting its competitive position across two different axes. Success on both axes will be critical for Zynga's continued flourishing.

First, there is competition with the makers of game products intended for use on computers and consoles (what the article calls the "shrink-wrapped program" business). Electronic Arts, reaching back to its 1982 establishment, has been a leader in the industry. Its speciality is in producing creative contents of a certain kind. But the industry seems to be plagued with high game development costs, a decline in the number of new blockbuster offerings, and a preference for the social media gaming experience (although Electronic Arts is trying to enter the social media space). Zynga provides an enjoyable user experience while leveraging its contents to sell virtual goods to users. The contents are the means for the monetizing, rather than the object of the monetizing itself.

Second, there is the multi-faceted relationship between Zynga, which provides the content apps, and Facebook, which provides the distribution platform for the apps. Zynga must no doubt be grateful for being able to take advantage of the distributional reach of Facebook, but it no doubt also frets about becoming over-dependent on that single disribution channel, hence the attempt to expand its channels. It is no surprise, therefore, that Zynga is seeking to create its own website and diversify its distribution platforms to include, e.g., sites run by Microsoft and Yahoo.

There is nothing wrong, if you are Facebook, from enjoying a revenue share with Zynga, but the greater portion of such revenues will presumably stay with the app owner rather than go to the platform owner. If you are Facebook, you can try to increase that share if you have a commanding distribution postion. But when other channels of distribution are available for the distribution of the app, the ability of Facebook to increase its share may well plateau, perhaps sooner than later.

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