GamesBeat

The DeanBeat: What’s next for Zynga as its ‘happily ever after’ fairy tale ends?

The company was the flagship of social gaming, and it was in the midst of crossing over into the potentially bigger market of mobile games. It was following the narrative of the disruptive innovator, having expanded the market for games with simple, casual titles that the traditional game giants eschewed.

But Zynga has strayed from its path in the past few weeks, and now its future is uncertain.

Since 2007, Zynga has stayed the course on this narrative. During a once-in-a-lifetime economic crisis, it grew rapidly and raised far more money than any gaming company had done before. It lured creative talent from traditional game companies like Electronic Arts, growing to more than 3,000 people. It went public despite lots of naysayers, raising a war chest of more than a billion dollars. It acquired companies that helped it move beyond Facebook, obtain more outstanding game developers, and crush its rivals. Zynga identified a promising new market in online gambling, and it dragged reluctant game companies into following its strategy. Everybody went along for the ride and wanted the scrappy underdog to win.

We were all drunk with the power of Zynga’s fairy tale.

But now Zynga’s off the rails. On July 25, Zynga posted weak earnings that blindsided Wall Street. The company’s user count grew, but its revenue declined year-over-year. The company could have weathered the accompanying storm. But John Schappert, the chief operating officer of Zynga and a respected game development veteran who was previously the No. 2 executive at EA, resigned last week after he was stripped of his responsibility for product development. These were self-inflicted wounds, but Zynga’s close partnership with Facebook frayed a little as Zynga blamed Facebook’s change in app promotions for weak gaming performance. For good measure, EA stomped on Zynga, suing it for copying EA’s The Sims Social game. Shareholder lawsuits came out of the woodworks.

Zynga’s stock fell as if it were the new Enron. The enemies are trying to distract Zynga further.

For Zynga’s employees, it had to be a huge shock. Just a year ago, the whisperers said Zynga’s IPO would be valued at $20 billion. It went out at $9 billion, and Zynga has now seen its price fall to $2 billion. EA is now twice as valuable as Zynga. Changing the narrative back to the fairy tale after you fall down the rabbit hole is an extremely hard thing to do.

Plenty of people hated what Zynga became, and they trashed not only Zynga but Facebook and all social companies. To these people, Zynga never did anything right. They never gave it credit for expanding the meaning of being a gamer to hundreds of millions of people. They didn’t see it as an innovator at all. And when they acknowledged that Zynga had a lot of users, it was only because it bought traffic on Facebook or cloned successful games. Those anti-Zynga memes were never quite true, but they did sometimes hurt Zynga’s ability to hire passionate game developers. Zynga built its cred the hard way despite the naysayers.

This isn’t time for the naysayers to gloat. Zynga had a bad quarter. This does not mean that social gaming is completely and utterly collapsing. And the woes have spread beyond Zynga’s walls. Zynga’s own problems have extended the misery for the whole game business. Previously, Zynga’s momentum was carrying everyone along. Investors bet their money on the next Zynga. Investment bankers were looking for the next IPO. Zynga had been hiring a lot of the workers who were laid off from traditional game studios. Smaller rivals became more valuable, especially makers of social casino games. Now everyone has taken a valuation haircut as Zynga’s own value hovers around a fifth of its IPO price.

Zynga was supposed to be the haven. It would shelter developers from the storm, as long as they made games like FarmVille or CityVille. Now that Zynga is in bad shape, where are others to go? EA itself is diversified but it is hurting because Star Wars: The Old Republic, a massive game from another era that took six years to make, isn’t doing well. Activision Blizzard’s World of Warcraft lost a million paying players in the past quarter. THQ, now focused on pure console games, has had to slash its staff to bare bones. Take-Two Interactive took some mighty swings with Max Payne 3 and Spec Ops: The Line. Two strikes.

Where will Zynga’s story go next?

The answer should be simple. It either recovers, or it doesn’t.

Zynga is already taking some steps to recover. It has reorganized to put its separate mobile, web, and Facebook game teams together so that they produce multiplatform games. Executives Cadir Lee, David Kom, and Steve Chiang have taken on more responsibilities. Chief executive Mark Pincus has reasserted himself in product development, prompting Schappert’s departure. Zynga will continue to give new stock grants to veterans, but it will probably welcome the departures of those who don’t believe in its long-term mission. Those options will have low strike prices, which may prove alluring to employees.

But options grants can only achieve so much. The company has to execute in its next quarter and launch big games. Pincus must play the role of the Comeback Kid, much like EA’s John Riccitiello has with EA’s shift into digital games. (EA’s own fate isn’t certain). EA has diversified across many platforms and business models. Zynga is still very focused as a company on Facebook, try as it might to move into new markets. The company cannot afford to make many mistakes and get caught in a downward spiral.

But Pincus has $1.6 billion in the bank. If you look at it from Zynga’s point of view, it was lucky to raise the money in its IPO when it did. Now it has plenty for the rainy days. Pincus also has 300 million people who play his games every month. And the company is spinning up new projects such as its Zynga with Friends third-party publishing platform.

But Zynga has to find the blue ocean, where it can innovate again rather than get in a market share fight. If it doesn’t, and the waters turn red, then morale could suffer. A talent drain could hurt even a company with thousands of employees. EA saw this happen, and it had to deal with a long period of contraction where it canceled mediocre games and reassigned people to high-priority projects. People wrote EA off as a loser, a dinosaur, and a has-been. Zynga employees have complained about long hours, but managers have said that it is a place where top performers are appreciated and rewarded.

For its size, Zynga has a big staff and a huge research and development budget. It has to keep generating growth and new games that replace its declining ones. But that’s hard to do as Facebook’s growth slows down. Zynga could also fall prey to rivals in the Game of Thrones. Gree and DeNA, still bouyed by their performance in Japan’s mobile social gaming market, are aggressively moving into the U.S. Tencent is investing in stellar game companies. And venture capitalists are pouring money into any Zynga Killer they can find. With such fierce competitors, recovery and execution will be tough and drawn out. Since Pincus controls most of the company’s stock, a hostile takeover is a very unlikely event. And if I know a thing about Pincus, it’s this: he isn’t going to give up because of a bump in the road. He could have cashed out long ago if he wanted to pursue an easier path.

If Zynga doesn’t recover, the road is predictable. The talent may find greener pastures elsewhere in the form of more promising startups or established companies with free food, valuable stock options, or more exciting projects. Schappert was one of the magnets for the top talent, though he was a relative latecomer among the game veterans who joined the company. Zynga has to move to make sure it isn’t perceived as a sinking ship that the crew is abandoning. We all know that story.

I’m not predicting that will happen. But I am as puzzled as the rest of us. The narrative has changed. It’s not a straight and narrow way. No one knows where this will end up.


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