December 2011 – The Business of Social Games and Casino

What I Expect in 2012

I recently wrote about how little I believe “expert” predictions of the future and how stupid I think it is for people to follow them. So, of course, I felt it was appropriate for me to now give my predictions for 2012  Actually, I still feel predictions are not worth the paper they are written on and if I (or anyone) could predict the future we would go public this week and be worth billions. But by looking just at 2012, I think you can extrapolate some current trends to anticipate how the upcoming year will shake out.

You will see more cross-platform

Regardless of the institutional hurdles to creating social games that work across platforms (Facebook and iOS for example) the huge value it provides to players will drive a solution. By the end of next year, more and more games will be enjoyable wherever they player might be playing.

A new social gaming genre will emerge

This is an argument that Facebook has been making since at least this summer and I totally agree. There are a lot of great gameplay mechanics that are not yet available on social. Just like Playdom created a huge new space in social with Gardens of Time, someone will create a hit by finding a way to bring a proven mechanic to social.

Investment and M&A activity will decrease

I mentioned in several blog posts that post-Zynga IPO, investors and potential acquirers will look differently at social gaming company. Valuations will be based less on a company’s potential and more on how its numbers compare with Zynga (i.e. comparable price-revenue ratios). As a lot of companies do not have the numbers to justify a deal, the type of dumb money deals we have seen the past few years will dry up.

There will be industry consolidation

With less money out there, companies that do not have a strong business model won’t survive. They won’t be able to finance themselves through cash flow and won’t be able to raise new capital. Overall, this will be great for the industry, as the remaining companies will be the ones with strong management, a good business concept and ability to execute.

International will become a key revenue driver

This started as a blog about international opportunities for social game companies and in the past year I have seen that many firms in the space are starting to realize the same thing. While the US social market, both mobile and Facebook, is increasingly saturated, many European and Latin American markets are still wide open. The competition is lower and in some cases the revenue potential per user is higher. With the cost of user acquisition ever increasing in the US, social game companies will also have no choice but to look elsewhere for new players. Also, as companies scramble to maintain their growth, in 2012 they will find Europe and other foreign markets the low hanging fruit.

But Greece and others will default and everyone will feel it

Since this is about predictions, I would bet Mitt Romney $10,000 that Greece defaults; and its affects will be felt by social gaming companies. First, it will further drive down the value of the Euro, depressing current state EU revenue. It will also have a strong effect on the buying power of the countries that default, though most of these (and I predict defaults by Greece, Italy, Spain, Portugal and Ireland all in 2012) do not generate significant revenue for most social game companies.

Windows Mobile will become a viable social platform

Regardless of what happens in the US with Windows Mobile, it will be a winner in Europe. With Nokia’s launch of its line of Windows Mobile phones, the platform will become a viable contender given Nokia’s reach and reputation in Europe. Given the issues with monetizing Android, I actually expect revenue opportunities on Windows Mobile to exceed Android (on the mobile, not tablet, space) next year. Also, if you haven’t played around with a Windows phone, it is actually a great opportunity system. Given MS and Nokia’s muscle, I just can’t see it fail (and Microsoft did not pay me to say that). I think revenue wise Windows Mobile will be more important to social companies than Android.

Kindle Fire will become a key mobile platform

This is not really much of a prediction given the initial sales numbers (over 3 million sold in a few weeks), but Fire is getting a large installed base of people willing to pay for content. And Amazon is as good, or better, than Apple at creating a customer experience that moves people to monetization.

Traditional marketing will become more important

Another topic I have discussed on this blog and at trade shows is how performance marketing will no longer be the only, or preferred, way to acquire users. With the cost of performance marketing increasing and sophisticated entertainment companies entering the social game space, more publishers will see the benefits of a traditional marketing mix to grow games.

Undifferentiated companies will fade away

As I mentioned earlier, it will be increasingly difficult to raise money in 2012. Thus, the companies who are just doing what other social game companies are doing, but not as well, will not survive. They will have no way of acquiring users and even if they get people to their games, they will not be able to retain (or monetize) the players.

Two new companies will break the top-10

One of the things I most strongly believe is that the top-5 and top-10 on Facebook is still very dynamic and that innovative, well-run companies can still make the top-10. Who last year would of predicted that Wooga and King.com would be in the top-5 (okay, probably Jens from Wooga but who else)? While the copycat companies will have trouble getting any traction, a few companies that approach the space from a different angle will see considerable success.

And one non-social gaming prediction that I feel I need to include

A Republican will win the White House

This is a nod to my belief in analytics over gut, not any personal inclinations. If you look at the current US economic metrics and compare that with virtually any previous election, it bodes very, very poorly for the incumbent. While a lot of pundits argue that this year will be different because of the Republican field or the antipathy to Congress, I always feel it is very, very hard to disagree with the numbers. We’ll see.

Happy holidays to everyone!

Tales of Social Game Industry Demise are Greatly Exaggerated

There seems to be growing momentum behind the thinking that social gaming is just a fad and that the industry will shrink dramatically in the near-term. While I do agree that the Zynga IPO will effect valuations throughout the ecosystem (see my two blog posts on this issue, Zynga Effect and Change in Zynga’s Valuation), I also feel that the social game industry has by far the strongest fundamentals of any part of the computer and video game industry (and possibly the broader entertainment business).

My optimism (and everyone who knows me will agree that my and optimism are usually not in the same sentence out of my mouth) is grounded in the numbers. For better or worse, I have now been in the game industry over eighteen years and have seen firsthand how the core gaming space, traditional mobile and casual behave. The opportunity, even for a second or third tier company in the social space is still orders of magnitude greater than anywhere else in the game industry.

Second and Third Tier Social Games Still Generate Strong Revenue

As always, I would like to use numbers to substantiate my claim about the opportunities in social gaming. I analyzed the mid-50 games on AppData, that is games that rank from number 50 in terms of DAU (daily active users) to number 100. This market segment is not dominated by the highly capitalized social game companies who have huge performance marketing budgets, allowing them to “buy” their way into the top 20. Let’s start with game ranked 50 among apps, which currently has a DAU of 960,000. For the purpose of this analysis, I will assume an ARPDAU (average revenue per daily active user) of $0.05. This number is on the low side for a successful social game (and I would consider any game in the top-100 successful). At these numbers, game number 50 would generate $48,000/day, $336,000/week and $1,440,000/month. Even game number 100 has 570,000 DAU. With the same ARPDAU assumption, we are looking at $28,500/day, $199,500/week and $855,000/month in revenue.

Still Opportunities for New Companies

Reinforcing this opportunity is the fluidity in the top-5 and top-10 among social game publishers. I do not have the AppData numbers for last December, but I know two of the current top four social game companies did not have a major presence. Wooga (currently number 3) was just starting to have its presence felt outside of Europe and King.com did not release its first Facebook game until earlier this year.

Much stronger than other areas of the game industry

If you compare those numbers above with other parts of the gaming ecosystem, it becomes very clear that social gaming is probably the best opportunity for a mid-tier company. In the casual game space, a game that ranks 50-100 won’t generate $336,000 over its life, let alone in a week. The mobile app market (discreet purchases rather than social games) is even worse, with an app that doesn’t make into the top-10 (maybe top 20) often not generating even $10,000 in revenue. Finally, the traditional (console and core PC) game market is suffering even worse dynamic. Other than the few top titles marketed by EA and Activision/Blizzard (or an existing franchise), most other games do not recoup development costs. The problems in the traditional gaming space are encapsulated by THQ’s decision to pull out of the DS market; while THQ was long-considered the only third party publisher truly successful on Nintendo platforms. So I feel it is ironic when people from these other game sectors try to knock down social gaming even when it is out-performing almost everything else game related.

It is not easy

I do not want readers to come away from this post thinking that social gaming is a money machine and there is not an imminent rationalization coming. First, it is not easy hitting the top-100. There are many, many games released worldwide every week, so to hit the top-100 requires a compelling title, strong marketing but most importantly effective monetization, virality and engagement loops; and that is not easy. Development costs are also much higher than the casual or mobile app space (though a fraction of console) and the on-going costs of a successful game have a huge impact on profitability. You just have to look at all the companies that have tried to go into social and failed (topic of a later post).

I wanted to post today so people realize that the underlying economics of the social game space are still probably the most attractive in the gaming space. There will probably be more gloom and doom as Zynga stock moves each day (and inevitably has some bad days) but that does not disguise the fact that the economics of social gaming still work.

What Social Game Companies Can Learn from Organized Crime

There was a very interesting, and entertaining article in the November 2011 issue of the Harvard Business Review about what businesses can learn from organized crime. Without restating the article (I recommend you read it), I thought it would useful to apply the lessons for the benefit of social gaming companies.

Use the news to create opportunity

In the HBR article, they point out that criminal groups are very effective at scanning the macro-environment and capitalizing on what they find. Major events, both locally and globally, are great opportunities to build interest in a social game, create new monetization opportunities or improve virality. By tying into news events, a social game company can leverage all the interest and buzz around a current event. These events can range from a big sporting event (e.g., World Cup or Super Bowl) to a big news item (a lost drone, the European debt crisis) to a natural disaster (the Japanese tsunami). With a big positive event, there are opportunities to sell special limited edition virtual goods or creating particularly compelling wall posts and other virals. In the case of a disaster, social game companies in the past have increased engagement (and benefitted victims) by donating the proceeds of special virtual items. For some reason, this practice seems to have ebbed recently.

Outsource to specialists

Rather than doing everything internally as in the “Godfather” days, modern organized crime has created a loosely affiliated cooperative network (think freelance thugs or hackers). For social game companies, there is a great opportunity to move their user acquisition to agencies (such as TBG), to have contractors help analyze their data, to generate more revenue by using international publishers (such as Plinga and Pixonic), etc. Rather than find a team of several hundred, with (at least) some of them not being the best in the field, you can outsource multiple functions to great partners.

Cash isn’t the only incentive

Although criminal organizations pay well (or at least that is what I hear), one of their strongest recruiting tools is the thrill tied to their activities. While deploying a new content pack may not release as much testosterone as robbing a bank, by creating a challenging environment for your employees where they feel they belong goes a long way to retaining your top performers and attract others.

Exploit the long tail

Global criminals reap big profits by executing small operations repeatedly. Rather than trying to create the next Cityville, think about building an iOS app that can repeatedly reskinned (maybe capitalizing on a current event). Another option would be a niche Facebook title that can then be launched in territory after territory, social network after social network. The point is that rather than going for the huge win, look at creating a series of small successes that may be easier and in the long term more profitable.

Collaborate across borders

Think of Al-Qaeda and how it works with splinter groups across Asia and Africa. In the social gaming ecosystem, there are many opportunities to partner with other companies to increase global revenue. You can find a French, German or Chinese game company and generate revenue by licensing your game to them for their territory. Conversely, you can look to foreign companies to acquire content you can then publish in your home market to augment your product line-up (and generate more revenue and traffic). You can even partner with a competitor who may have a presence in a market that is not in your focus to bring your product there. Organized crime, and organized business, is littered with entities that compete in one region while cooperating in others.

As I mentioned, the underlying article in HBR is really eye-opening and provides a great framework for building a social game company. I hope some of the opportunities I highlighted above help social game companies build their business (without knee capping anyone).

Effects of Drop in Zynga’s Valuation

I was not planning on writing a post this week (working on some big projects right now) but the news today that Zynga will price its IPO with a valuation between $5.9 and $7 billion (Zynga … IPO at a $5.9 to $7B Valuation) was just so important I felt I need to write something. First, I don’t want to disparage in anyway what Mark Pincus achieved. It is an unbelievable achievement to build a multi-billion company in about three years (it took me over 15 years to sell a company at a fraction of this value). Less than one percent of one percent (if that) ever comes close to achieving this type of success.

Why I wanted to blog today was that this valuation represents less than 50 percent what many people thought Zynga would be valued at only a few weeks ago. More importantly, as I blogged about a month ago (The Effects of the Imminent Zynga IPO), Zynga’s IPO will have a far reaching effect in the social games industry; and this change in valuation will now have a similar effect.

First, almost every other social game company has now seen its valuation drop fifty percent. As I said in the blog post, once Zynga is public it will be a measuring stick for all other social companies, either ones trying to go public also, those looking for a suitor or those raising capital. Investors, acquirers, etc., will base valuation on Zynga’s multiples. Given that Zynga’s growth, revenue and profitability has not changed dramatically in the last few weeks, the drop in valuation means that other social games companies will now face much different price-to-earnings and price-to-sales (or projected earnings or sales) ratios.

Second, Zynga’s IPO will probably have an even greater effect on the social gaming M&A environment because of the lower valuation. While I already expected Zynga to cut back on acquisition post-IPO, they will have less currency to make acquisitions now. For example, if they value a potential target at $100 million and want to acquire them for stock, they will now have to provide twice as much stock as before (or that they were probably even offering three months ago). Thus, Zynga will have to negotiate “better” deals or cut back on acquisitions to avoid diluting too much.

Third, this will have a significant impact on publicly traded companies that have social media efforts. For example, the value of EA’s social media operations was also effectively cut in half by the change in Zynga’s valuation (so my guess is there is no cheering in Redwood City). Analysts have built into EA’s stock price a valuation for the social gaming operations (e.g., Sims Social, Madden) largely based on Zynga’s multiples, thus it should have a very significant weight on EA’s stock price.

Related to the above, publicly traded companies now will be much less enthusiastic (about half as enthusiastic, I would wager) to add social gaming to their portfolio. It won’t have the same impact on their valuation. Thus, we’ll not only probably see less acquisitions (or ones at lower valuations) but even internal investment in social gaming will drop (thus lowering the demand for talent).

These are only a few of the effects from the drop in valuation but as I hope this post highlights it will be far-reaching across the social games industry. What an interesting time we live in.

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You will see more cross-platform

A new social gaming genre will emerge

Investment and M&A activity will decrease

There will be industry consolidation

International will become a key revenue driver

But Greece and others will default and everyone will feel it

Windows Mobile will become a viable social platform

Kindle Fire will become a key mobile platform

Traditional marketing will become more important

Undifferentiated companies will fade away

Two new companies will break the top-10

A Republican will win the White House

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Second and Third Tier Social Games Still Generate Strong Revenue

Still Opportunities for New Companies

Much stronger than other areas of the game industry

It is not easy

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Use the news to create opportunity

Outsource to specialists

Cash isn’t the only incentive

Exploit the long tail

Collaborate across borders

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