Zynga and Facebook. It's Complicated
• "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.