Users create value; Networks multiply effects; People build connections; and Zynga has taken advantage of all of this

As O’Reilly discussed in What is Web 2.0, the value of a business in the Web 2.0 era. As per the Architecture of Participation – users add value. And developing applications which get better the more people use them is fundamental. A Web 2.0 organisation which I believe harnesses this implementation strategy is Zynga, self-described as ‘the world’s leading provider of social game services’.

Zynga

Zynga

When we think of the costs to provide social gaming services to users and how much those users create value for the business (by word of mouth, by impressionable hours for advertising of access, by transfer of cash for products or services) we need to change our mindsets in terms of business value. This massive shift in terms of how companies are valued in the Web 2.0 era is the users – high quality, regular returning, and actively participant content producing users. Zynga is expecting this high value user base will help increase their ‘revenue by more than 20 per cent in 2012‘. Every Web 2.0 pattern Zynga has applied is dependent on users; Harnessing Collective Intelligence is dependent on users; The Network Effect (whether direct or indirect) is based on users; Innovation in Assembly is an ecosystem of users, software developers, and prosumers. They have understood very well that users create value.

We need to take a fresh look at the cash that comes in and out of Zynga ($78.8 million for the first quarter of 2012, compared to $103.7 million for the first quarter of 2011) because the real value comes from the users. Zynga has developed a strong viewpoint of the individual customer; their results for the three main categories of users – Daily active users (DAUs) 65 million, Monthly active users (MAUs) 292 million, and Monthly unique users (MUUs) 182 million – all increasing by strong percentages year on year. Unfortunately they have not broken down their costs and expenses on a per users basis (just total) but we can easily work this out at $406.5m total costs and expenses divided by the DAUs (65m) is $6.25 per DAU. With only $320.9m in revenue this results in a cost of $1.32 to maintain each DAU. This is quite a pessimistic look on the results as if you substituted the DAUs for the MAUs it would only cost $0.30 per MAU. Still, this is not a gain.

The costs of marketing are a lot less with Web 2.0 companies ($56.8m for Zynga compared to a much less Web 2.0 orientated company Activision, Blizzard’s 79m). Viral marketing used to be difficult but now it is very easy as Zynga have shown with mobile gaming. Usually with new companies and products there is a burn rate (period where a company is spending more on investment in an attempt to move into the black of initial costs). This doesn’t appear to exist as often in new Web 2.0 companies. Inventory used to be costly but digital inventory is much easier to maintain. You also used to have to buy your own equipment and in-house the technology but now you can outsource and it’s a lot easier. Zynga’s CTO believes there is a balance here; he believes ‘a hybrid model that uses both a public and a private cloud is really the way most enterprises will build their clouds’.

There are four major cost drivers that can be turned into User Value Strategies; Inventory i.e. the thing you sell (premium items within games in Zynga’s case); Payroll, (keep your staff count small, create a virtual store presence instead of a physical one as this requires less maintenance; IT systems and developers, (create partnerships with your users and third party developers to assist in developing, improving the value of and disseminating content); and Marketing, advertising, and CRM, (word of mouth is important and with the Internet’s positive network effects that word of mouth can travel far. Communication mediums are changing and the large quantity of visual information you are distributing to your users’ needs to evolve – screen real estate is small on mobile devices and getting the content and the advertising to the users is a tricky balance).

Zynga has multiplied their revenue streams (advertising, releasing multiple new games, attempting to wean themselves off of Facebook and into mobile and Z-Cloud) and they have attempted very well at combining these networking effects together. This is the multiply and compound principle in action. This connection between Zynga and Facebook increases the network effect but also increases their reliance on each other. If you are in a market with a great network effect, (as Zynga and Facebook are) then the winner takes all. Just a small percentage owned by another party can make you vulnerable. Over time it is that small percentage which helps tip the balance against you; this is called a Tippy Market.

So will Zynga post a profit next quarter? Is the Facebook IPO’s downward effect on Zynga’s share price a sign of things to come? Will Facebook and Zynga ever exist completely separate? What do you think?

References:

Activision Blizzard, Inc. (2012). Form 10-Q (Quarterly Report) Filed 05/09/12 for the Period Ending 03/31/12, from http://tinyurl.com/7ry2myq

Butler, B. (2012). Zynga infrastructure CTO: Making hardware cool again, from http://tinyurl.com/884egme

Gans, J. (2005). Core Economics for Managers, from http://tinyurl.com/73fusw3

Lovell, N. (2012). Zynga’s Share Price Collapses as Status as “Facebook Proxy” Disappears, from http://tinyurl.com/88ax7qr

O’Reilly, T. (2005). What is Web 2.0, from http://tinyurl.com/nx36fj

Summer, R. (2012). Stock Research and Analysis of Zynga, from http://tinyurl.com/7um5e53

Walker, H. (2012). Does the bank own you, or do you own the bank? The continued codependency of Facebook & Zynga, from http://tinyurl.com/6ou66lp

Ystats.com. (2012). Global Online Gaming Report 2012, from http://tinyurl.com/7uy78v2

Zynga. (2012). Zynga, from https://zynga.com/

Zynga. (2012). Zynga Reports First Quarter 2012 Financial Results, from http://tinyurl.com/cy5ypvr

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