Zynga's Fast Growth Challenged by Facebook

 
By Douglas MacMillan
     April 22 (Bloomberg BusinessWeek) -- ? "The next three years
are a hell of a lot harder than the last three"
     More than 120 million people play Zynga's online games.
Employee headcount has almost quadrupled in the past year, to
775. Revenue for the three-year-old company should surpass $450
million in 2010, according to two people who have been briefed on
its financials.
     Mind you, Zynga's games are free. Revenue mostly comes from
selling virtual hoes and machine guns and such to players of
FarmVille, Mafia Wars, and other titles. "Only a few companies
are so privileged to get the rocketship growth that Zynga has,"
says Reid Hoffman, co-founder of LinkedIn and a Zynga director
and investor. As for an initial public offering, "All options are
on the table," he says.
     In an interview at Zynga's overflowing offices in San
Francisco, Mark Pincus, the company's 44-year-old founder and
CEO, seems giddy. "It's fun," he says, swiveling back and forth
in a conference room chair. "It's adrenaline."
     It's a sweet gig—although there's one big unknown: Facebook.
Zynga's success depends on the good graces of the social network,
where almost all of its games are played. "The single biggest
challenge is managing growth in the face of total uncertainty,"
says Pincus. By all accounts he's on friendly terms with Facebook
founder Mark Zuckerberg—who has shown a willingness to knock
heads.
     In March the social network stopped letting Zynga and other
app creators promote games in the "notifications" menu users see
each time they log on. Facebook said users were complaining about
spam-like messages that appeared every time one of their
game-playing friends found a baby duck or whacked a mobster. One
protest group on Facebook with more than 5 million users called
itself "I Don't Care About Your Farm, Or Your Fish, Or Your Park,
Or Your Mafia!!!"
     Pincus says the policy change has hurt his business in "the
short term" by slowing traffic to his games in the first quarter
of this year. Still, he says, Zynga and Facebook can help each
other, since his company's wares increase the time and attention
users spend on the social network. He compares the relationship
to that of a cable company and a hit-making network: "I think it
benefits Facebook's users if we can create the next Sopranos and
if we can be a brand, like HBO, that their customers really
want." (Pincus is a minority investor in Facebook. All he'll say
about his stake is that it's "basis points.")
     Facebook doesn't just get happier users, it also gets big
checks from Zynga. Any time a game looks like a potential hit,
Pincus says his company deploys millions of dollars on ads
promoting it to members of the social network. In total, Zynga
spends between $5 million and $8 million per month for banner ads
on Facebook, according to NeXt Up! Research. The aggressive
promotions make it difficult for rivals to copy an idea for a
game and make it as successful as Zynga's version, says Lisa
Marino, chief revenue officer of app startup RockYou. "Social
gaming is a math equation," says Marino. "When you put millions
of dollars down to protect [a franchise], you will win it."
     Facebook could force Zynga to adjust its math. More than 90%
of the company's revenues come from users converting real cash
into proprietary virtual currency. FarmVille, for example, has
Farm Coins. Say you buy a tractor for 5,000 Farm Coins, which
equals about $3.30. Typically the company pays less than 10% of
that to a third-party transaction handler such as PayPal and
keeps the rest. (In March, PayPal said Zynga was its
second-largest merchant after eBay.)
     Facebook is testing a service called Facebook Credits that
would offer a single virtual currency for use on many different
apps. If the social network forces app makers to use Facebook
Credits, as some developers expect will happen this year, Zynga
would have to pay the company up to 30% of every transaction. "If
Credits become pervasive, I don't think Pincus can stop it. It's
going to hit the margin," says Peter Relan, executive chairman of
CrowdStar, one of Zynga's many competitors.
     "There's just going to be one currency that people use" on
all apps, Zuckerberg told Bloomberg TV on Apr. 21. He didn't say
when Credits might become mandatory. Pincus is trying out the
currency as an option in FarmVille and other games. "There is
definite value for users and developers in having the trusted
Facebook brand associated with buying virtual goods," he says.
     Pincus says he's eyeing other ways to get his games in front
of the masses. Apple's (AAPL) announcement on Apr. 8 that it
plans to include a program for connecting people in social games
played on the iPhone and iPad caught his attention: "It would
make a lot of sense for Apple to be interested in doing more to
enable social gaming," he says.
     For now, Zynga's mission is to keep cranking out those
Facebook hits. Work is going on around the clock; Pincus is
encouraging employees to develop pet projects during weekend-long
programming marathons. And, of course, the company is hiring like
crazy. To help fill 300 job openings, it's running an ad on a
billboard in San Francisco and has bought local public-radio
sponsorships.
     Pincus will need all the intensity he can get. Electronic
Arts (ERTS) upped the ante in November when it bought Zynga rival
Playfish for $275 million. "Zynga is riding high," says Barry
Cottle, general manager of EA's interactive unit. "But they may
soon find out that the next three years are a hell of a lot
harder than the last three."
      The bottom line: As long as Zynga keeps supplying Facebook
with hit games—and ad revenue—this could be a long and profitable
partnership.

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