Games company Electronic Arts (ERTS) agreed on Nov. 9 to pay $400 million for a company whose products include virtual hot dogs, bazookas, and turnips. Wacky? Maybe, but the deal by EA, based in Redwood City, Calif., to buy London-based Playfish illustrates how quickly social networking has become a force in the video game industry. Playfish CEO Kristian Segerstrale and several partners founded the company barely two years ago, betting that Facebook and other social network sites would open a new arena for online gaming. Instead of interacting with strangers, people could play with friends. "If you're involved with your real-life friends, things matter more," Segerstrale says. "It just becomes emotionally more interesting." Playfish launched its first game, called Pet Society, in December 2007, just two months after founding the company. Segerstrale, a Finn, and his partners spread the game around the Internet by getting 100 of their own friends to join. Today Playfish offers 10 games and is the second-largest social network gaming company after San-Francisco-based Zynga, best known for Mafia Wars and FarmVille. Smartphone-SavvyWith about 60 million users a month for all its games, Playfish boasts slightly less than half Zynga's total. But that was still plenty to attract the attention of EA. Like Zynga, Playfish has benefited not only from the rise of social media but also the burgeoning phenomenon of downloadable apps for PCs and smartphones such as the Apple (AAPL) iPhone, which has allowed for explosive growth in its user community. Playfish already sells one iPhone game and has two more on the way. The company doesn't release detailed financial information, but "it went from a standstill to being profitable very quickly," says Kevin Comolli, a partner at venture capital firm Accel Partners, which was Playfish's first backer. Comolli declines to say what kind of payoff Accel is getting for its May 2008 investment in Playfish, but it's obviously many multiples of the original $8.4 million. "It's a very good return for us and our investors," he says. Accel was also the first VC investor in Facebook. Under the terms of the Playfish acquisition, Electronic Arts will pay $300 million up front and an additional $100 million if Playfish meets undisclosed financial targets. Both Zynga and Playfish get most of their revenue from selling virtual goods and accessories—ranging from animated dogs to diamond tiaras—that users buy to increase their game-playing prowess or their online status. Gifts are also big. On Valentine's Day, Playfish sold 4 million virtual flowers for prices ranging from 5¢ to $2. Buying the FarmFor example, a user who clicks on "Country Story" from the Playfish.com Web site gets a cartoon character avatar, some seeds, and a patch of green earth. An old dude with a gray beard pops onto the screen and offers advice on how to plow, plant, and water the garden. The user is soon harvesting his first virtual turnips. That part of the game is free. But users often find themselves paying real money for virtual seeds, farm tools, and livestock as they build a lush online agricultural utopia with which to impress Facebook friends who are doing the same thing. The long-term question is whether such a business model has staying power. "What you need is the sheer number of people to make those micro-transactions work. It's sustainable if the numbers are maintained," says Paul Groves, who focuses on gaming for media law firm Harbottle & Lewis in London. Competition is also growing, with an estimated 30,000 social networking games available. But Playfish co-founder Segerstrale, who earlier in his career helped found mobile-games company Macrospace—now a unit of San Mateo (Calif.)-based Glu Mobile (GLUU)—says that building a successful online game is not as easy as it looks. While the initial investment for an online game is lower than for a console game, online games require constant upgrading to keep users interested. "It's all about audience engagement," Segerstrale says. "You create a product, and you nurture it and you nurture it and nurture it." The social gaming industry has suffered from bad publicity recently. Some game companies allowed players to earn virtual goods by accepting offers from advertisers. The strategy backfired after some of the offers proved to be dubious. Comolli said Playfish never used that tactic. "The advantage of social gaming is it brings in nontraditional gamers to play games," he said. "You can't exploit these people. That's not building a long-term business."
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