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(Every week, Kyle St. Romain will talk about the business and legal side of the app world. While his opinions don’t always reflect those of Rocksauce Studios, you should hear him out…the guy knows his stuff!)

Founded in 2007 by a handful of ambitious entrepreneurs and developers, Zynga is a poster child for budding appreneurs who dream of making it big. To put some numbers to Zynga’s success, its initial public offering had the company worth about $7billion, and while it quickly fell from that lofty valuation as of Monday October 30, 2012, Zynga is worth about $1.75 billion (down from its peak of just over $12billion). Even trading near its all-time lows; Zynga is still worth more than the New York Times ($1.21 billion), Pandora ($1.38 billion), Zillow ($1.09 billion), Angie’s List ($673 million), Demand Media ($774 million), or Glu Mobile ($211 million). Supporting the bottom end of Zynga’s valuation is the fact that the company holds over $1.3 billion in cash/marketable securities as of September 30, 2012; a war chest for acquisitions. Why doesn’t the market value Zynga much higher than its liquidation value? Good question; let’s discuss.

Curse of the one hit wonder

Once perched at the “top of Facebook hill,” Zynga had every reason to support its overblown ego. It all started with Texas Hold’Em Poker (Zynga Poker) for Facebook, and Zynga continued to grow with its popular series of “Ville” games. In fact, FarmVille once had more users than Twitter. For as long as any of us can remember (digital history only goes back a couple of years) Zynga has continued to dominate all the top spots for most popular apps on Facebook.

The problem, common amongst one hit wonders, is: How do you stay on top? Mobile gamers tire quickly, and constantly need updates and new titles to fuel their addictions. This phenomenon explains the constant issuance of newer and better “Ville” titles, including: FarmVille (one and two), CityVille (Holidaytown and Hometown), CastleVille, ChefVille, FishVille, ForestVille, PetVille, and TheVille – same games, different graphics. It also has a handful of other games like: Mafia Wars (one and two), Vampire Wars; Words With Friends, Chess With Friends, Scramble With Friends, and Matching With Friends, Gems with Friends; as well as a handful of casino-type games (Blackjack, Poker, Slots, Bingo, etc…) and Draw Something.

With its success, Zynga opened the floodgates for other companies to profit from Facebook users with too much free time. Further eroding Zynga’s top spot was a notifications update released by Facebook that put the brakes on those annoying Farmville notifications. Newsflash: Nobody gives a s**t about your fake farm; thanks for stashing those in File 13 for us Facebook.

No longer insulated by its first-movers advantage on the Facebook platform, and increasingly susceptible to changes to Facebook itself (like Demand Media was to Google algorithm updates) Zynga looked for other ways to expand its empire.

Desperate to diversify

While Zynga’s games still sit on the tops of Facebook’s app charts, the company and its shareholders realize that Zynga needs to adapt and diversify or die. To help grow its user base, Zynga did what a lot of companies do: grow by acquisition. Two of Zynga’s most notable acquisitions in my mind are: NewToy Inc. for $53.3 million (Words With Friends) and OMGPOP for $210 million (DrawSomething).

Words With Friends has been a good platform for Zynga to launch into the mobile app world, and from what I can read they have achieved a good level of success with this acquisition. OMGPOP is another story. Within a month of acquiring OMGPOP, DrawSomething’s daily active users fell by almost one-third. Good sell for OMGPOP in my mind. DrawSomething was another one-hit-wonder, and I doubt its level of engagement will ever get back to where it was.

Chasing Unicorns

The Holy Grail that could be Zynga is actually rooted in the same genre of games the company first started in: online gaming (casinos). Zynga hopes to one day control the lucrative market that uses real money instead of Farmville bucks to keep score. *Fact of the day: you can use American Express points to buy Farmville bucks; maybe it is “real money.”

While online gaming is still illegal in the United States (we even pay trade reparations to the WTO to keep it out), Zynga is set on dominating the market. In its third quarter results, Zynga announced a partnership with bwin.party; an online real-money gaming company based in the U.K. Could this be the saving grace that brings Zynga back out of the sights of becoming a takeover target itself? Maybe. But until then, Zynga still has some work to do and its recent announcement to layoff more than 5 percent of its workforce doesn’t paint a pretty picture.

Lessons Learned

It’s fun to be able to criticize Zynga with hindsight bias, albeit a bit unfair. But, part of that fun is the lessons we can learn from Zynga’s follies:

  • Don’t put all your eggs in one basket. Zynga is overly dependent on Facebook and has struggled to offer its products through other channels.
  • Don’t overpay. Easier said than done, right? While Zynga anticipated DrawSomething’s user base to grow, it didn’t, and you shouldn’t be irrationally exuberant about the future. There may still be some tricks left up DrawSomething’s sleeves, but the fact is consumer attitudes and preferences change – especially when it comes to how we waste our time. Facebook probably overpaid for Instagram too. If you’re looking to acquire an app or dev talent, be sure you buy them for a good price. Half of any investment is the purchase.
  • Don’t neglect your cash cows. Zynga is often criticized for focusing on its next big game instead of supporting the ones it already has. There haven’t been any major changes to any of its “Ville” games, and users are left wondering why they still spend time on them. The same holds true for its “Wars” games. And if there isn’t the hope of getting some new toy to play with in the game, why do you play at all? Battle Nations does a great job of leaving its users salivating for the next new in-game upgrade.
  • Don’t count on mobile ad revenue (especially if you pay Facebook 30 percent). A lot of social gaming companies rely on advertising for a majority of their revenues. However, mobile advertising has yet to be perfected and companies are likely to continue struggling with this problem. While advertising can be a component of your overall strategy, think of other ways to monetize your app. Paid apps, in-game purchases, and subscription packages may offer a more stable way to keep your business thriving.

What do you think? Do you see any other things Zynga could do better? What challenges do you think it faces going forward? Share your thoughts in the comments below.

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