Competitive Advantage Takes A Different Shape

Facebook needs Zynga to succeed, with that sort of backing who wouldn’t bet on it?

 

The social games developer Zynga has just announced fourth-quarter results with revenues of $311 million, up just 1 per cent on its third quarter, but up 59 per cent on the same quarter a year earlier. It also reported profits of 5 cents a share before $510m of stock-based compensation was taken into account, which brought it to a net loss of $435m.

Zynga’s initial public offering took place in December when it began trading at $10 a share. These most recent results have seen it fall back to $13.51 from recent higher prices driven by the announcement of Facebook’s IPO. So, what might a company that makes just 5c a share have that would make so many people be prepared to pay such a high price?

If you have never heard of Zynga then you are not one of the many people who have asked me to buy a cow, a field, or some such nonsense on Facebook over the past few years. Zynga is a social network game developer with more than 200 million users of its array of strikingly similar games: CityVille; CastleViIlle; Texas HoldEm Poker; FarmVille; and Empires & Allies.

Zynga seems to have a symbiotic relationship with Facebook. In 2011, revenues from Zynga’s users’ purchases and advertising made up 12 per cent of Facebook’s revenues – some $445 million. This has increased from 10 per cent in 2009 and 2010. Zynga is Facebook’s biggest source of income and as Facebook has just announced its IPO, Zynga’s performance will have a material impact on its success. Put simply, they both need each other and Mark Zuckerberg wants Zynga to succeed, despite recent clashes on payments and on viral marketing. The deluge of spam emails to users’ friends, including me, has now, thankfully, been curtailed.

Zynga’s early years have been a pretty impressive story of venture-capital-backed single mindedness: it has battled to get here. Along the way, it has been criticised for the mindless simplicity and similarity of its games, epitomised by Ian Bogost’s Cow Clicker, intended as a satire on social gaming, but which has actually become quite a popular game in its own right! The viral marketing generated a lot of criticism, as has the company’s treatment of employees, spam, game quality, replication of games, reliance on the Facebook relationship and a small number of big money players called “whales”, and even a marketing campaign that pasted money on city sidewalks.

Well, what is the basis of Zynga’s valuation? Some people say that Zynga doesn’t have a viable business model. I would disagree; it has a very traditional business model, based on one fundamental competitive advantage – its relationship with Facebook, the poster child for our shiny new electronic society. Its importance to Facebook seems to have given it advantageous access and even pricing from the social media distributor of the moment. The share price is based on the hope that Facebook thrives and Zynga can continue to preserve and leverage this competitive advantage to the full. The quality of the games, or how it does business, is a rather secondary issue in this case.

It is my contention that it is a CEO’s job to be very clear about the source of a business’ competitive advantage and then to build, defend and leverage it to the full. I’ll be fascinated to see just how well Mark Pincus, Zynga’s founder and CEO, does over the next few years and whether the share price is justified after all.

Mark

 

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