The problem with Zynga

Zynga hasn’t been faring too well lately. A year ago, the company was about to go public and seen as a giant cash cow and perhaps the future of gaming. Successes such as FarmVille and Mafia Wars had brought the start-up huge revenue, user bases and mind share. In fact, the company was making so much money that Facebook mentioned changes in Zynga’s fortunes as a potential risk for the social network. Now, having floated on the public markets just under a year ago and reaching a peak share price of $15.91 in early March, the social gaming company last night announced that it was cutting 5% of its workforce and slowing or halting development on a number of games, plunging its stock to a low of $2.17 a share.

The most obvious problems have been rapid user migration to mobile devices, which has hit both Zynga and Facebook rather hard, and the acquisition of Draw Something creator OMGPOP, the value of which was written down by $95m (nearly half of the initial deal value) within half a year of closing the transaction. The way I see it, though, the problems go deeper than that do the type of games that the company turns out.

Consumers’ attention spans are getting shorter and shorter and, if there’s nothing new, they’re unlikely to come back in numbers anywhere near high enough to sustain Zynga’s valuation. The companies with the biggest games have built franchises, not just simple cash cows that they can expect to milk forever. Nintendo’s biggest games are those that tie in with well-established and well-loved characters (Mario, Kirby, Pokémon et al. all feature in a string of games that bring in a lot of money and repeat players). Activision Blizzard’s two biggest franchises are probably Call of Duty and Warcraft. The former relies on strong gameplay and iterations that bring with them new stories, new scenarios and advancements in graphics etc., plus a multiplayer experience that is second-to-none. The World of Warcraft series draws on a large, ever-expanding and well-populated world of varied and interesting characters. The key to both is meaningful, ongoing interaction between players, who come back time after time because those worlds and those characters hold something of ever-increasing (or at least ever-refreshing) value.

Rovio, the maker of Angry Birds, is a different proposition but has also been clever. After the initial success of the original Angry Birds, the company exploited the brand to explore merchandising opportunities (which they have done almost to death by this point) and by releasing sequels in the same way the bigger, traditional game studios do. Angry Birds Rio was a combination of those two approaches, while Angry Birds Seasons and Angry Birds Space were ways to introduce new worlds and gameplay experiences. For those users who stick with the games, updates with more levels are pushed out to each occasionally. Like the games or not, it keeps people coming back (which is useful for getting eyeballs on in-game ads and building brand value and penetration). Extending the franchise with the recent release of Bad Piggies was a smart move too, as it allows the company to continue to exploit the characters from the original games alongside a new gameplay experience. I don’t know what kind of reception Amazing Alex has been getting, but it’s good that Rovio has been experimenting with different games to build the company with.

Zynga, by comparison, has little to offer in its games to keep people coming back. For a company that relies on its biggest-spending customers (so-called ‘Zynga Black’ users), kept there because of the social elements of the games, it needs to be able to build something that the long tail of less lucrative users will be able to remain invested in. Without it, the games are no longer really social and lose the one thing that they had going for them in the first place. There are no interesting or amusing characters, the gameplay is pretty dull and repetitive, and it is basically impossible for the company to create value without regularly producing new and interesting games, since little new is introduced to the games save for the occasional new in-game purchase. That makes sustainability pretty difficult, and that’s exactly why VCs tend not to like content businesses. Throw in the fact that consumer goodwill to the company keeps going lower due to the perception of the company as one that will acquire or copy any competition (see: Mob Wars v Mafia Wars, The Sims Social v The Ville and the acquisitions of the companies behind Words with Friends and Draw Something), and you’ll see problems like the precipitous post-buyout drop in Draw Something users.

That’s why I don’t think Zynga is going to recover and why I think that, even at a $1.6bn valuation, is still vastly overpriced. What’s amazing is that, less than 10 months ago, the company was valued at near to where Activision Blizzard is now (>$12bn) and even today is apparently worth more than a third of what EA is valued at (~$4bn). Zynga was a smart company that had its beginnings in a pretty revolutionary business model, but in the end it’s a content business, and it’s a content business that’s failing.

UPDATE: Mere hours after I first posted this, Zynga posted better-than-expected Q3 earnings that caused its stock to jump by 15%. Good timing on my part, eh? I stand by what I said, though: this is not the future of gaming and the company has a lot to prove before it can justify its valuation in my eyes (it still lost $0.07 a share this quarter).