CASE: EC-39 DATE: 09/15/10 SOCIAL GAMES The social games market potential seems truly stunning. Assuming ½ of the Internet world may end up on Facebook and ½ of those Facebook users will try a social game at some point, we can say that ¼ of the online world is an approachable market. Yet only 1 to 3 percent of players of social games tend to be monetized, so we’re still at the tip of the iceberg in terms of revenue opportunity. —Tim Chang, principal Norwest Venture Partners In November 2009, 70 million people played a game called FarmVille on Facebook where players could pretend to be a virtual farmer, planting and harvesting fruits and vegetables and moving up to other levels by inviting their Facebook friends to be their neighbors. Similarly, 26 million active users per month played a game called Mafia Wars on Facebook where players could start a mafia family with friends, run multiple crime “businesses,” then fight to be the ruling family (Exhibit 1). These types of popular online games were called “social games,” games people played on social networks like Facebook, MySpace, Hi5, Orkut, and Bebo, with the key motive of socializing with friends and/or meeting new people, with Facebook as the dominant social network in the social gaming space. Social games were generally simple games that anyone could play. Unlike traditional video games, they were less about “killer graphics and quicksilver hand-eye coordination, and more about connecting with friends.”1 And because the mainstream was being lured into social gaming, it was becoming the fastest-growing game market, increasingly popular on social networking sites. 1 Sarah Lacy, “Social Gaming Scores in the Recession,” BusinessWeek, May 1, 2009. Victoria Chang and Professor Haim Mendelson prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. 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This document is authorized for use only by Gerald Kane until March 2012. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860. Social Games: EC-39 p. 2 By 2009, social gaming was expected to grow to 250 million players, up from 50 million just one year prior.2 By July 2009, an estimated 14,000 social games had proliferated across various social networking platforms.3 Traditional video game companies were losing top executives to the sector; for example, in June 2009, the COO of game publisher Electronic Arts left his post to become CEO of social gaming company Playdom. In November 2009, Electronic Arts agreed to pay up to $400 million4 to acquire social game company PlayFish, which was reportedly “substantially profitable.”5 While the financial statements of social game developers were not available, others claimed to be profitable as well, and San Francisco-based social gaming leader Zynga was reported to have annual revenues of $200 million or more (up to half a billion dollars by some estimates).6 The total U.S. social gaming market was estimated to be anywhere between $300 and $500 million, possibly even exceeding Facebook’s own revenue (Exhibit 2).7 Mountain View-based Playdom, another major player, was reportedly generating more than $50 million in annual revenues. And more than 10 million people had downloaded Palo Alto-based Social Gaming Network’s (SGN) iPhone and iPod Touch games, with more than a million people playing its games across social networks daily.8 The engine behind these revenues was “virtual goods” or virtual objects such as characters, items like pets and accessories, currencies, and tokens that social game players could buy with real money in order to enhance their play. U.S.-based social gaming companies had created wildly popular games and applications like Mafia Wars, Sorority Life, Pet Society, and TouchPets, on social networks and other platforms such as the iPhone. In the meantime, Chinese messaging and communications company Tencent, as well as other Asian companies, were already well on their way to monetizing their users. The global market size for virtual goods was estimated to be more than $3 billion in 2010, possibly even as high as $5 billion.9 Selling virtual goods had become a major source of revenues in the online social world in China, accounting for about three-quarters of overall online game revenues.10 2 Ibid. 3 “Social Gaming Turns Two,” Virtual Goods Insider, July 6, 2009, www.virtualgoodsinsider.com/2009/07/06/social-gaming-turns-two/ (June 14, 2010). 4About $300 million in cash and retention arrangements and an earn-out (payment contingent on future performance metrics) of $100 million. 5 Tameka Kee, “Interview: Playfish COO de Halleux On How Facebook Has Changed Gaming Forever,” PaidContent.org, September 18, 2009, http://paidcontent.org/article/419-interview-playfish-coo-de-halleux-on- how-facebook-has-changed-gaming-fo/ (June 14, 2010). 6 Eric Eldon, “The Latest Stats on Zynga: New Traffic, Revenue and a $1 Billion Valuation?” Inside Social Games, November 23, 2009, http://www.insidesocialgames.com/2009/11/23/the-latest-stats-on-zynga-new-traffic-revenue- and-a-1-billion-valuation/ (June 14, 2010). 7 Zynga’s CEO Mark Pincus assumed that there would be 1 billion people on social networks over the next three to five years. Assuming that one-quarter of those people would engage in games, then there would be 250 million people that could be monetized anywhere from $1 to $3 per user per year. Atul Bagga, “Social Games: Interview with the CEO of Zynga,” ThinkEquity, February 24, 2009, p. 3. 8 Sarah Lacy, “Social Gaming Scores in the Recession,” BusinessWeek, May 1, 2009. 9 In July 2009, Piper Jaffray estimated the 2010 global market size at 3.1 billion, and others had higher estimates. See, e.g., T. Lehtiniemi V. Lehdonvirta, “How Big is the RMT Market Anyway?” Virtual Economy Research Network, March 3, 2007. http://www.insidesocialgames.com/2009/04/20/virtual-goods-booming-in-asia-25x- bigger-than-american-market/ and http://www.plus8star.com/. Do10 “Online Gaming,” Not Nomura Securities , JanuaryCopy 2009. or Post This document is authorized for use only by Gerald Kane until March 2012. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860. Social Games: EC-39 p. 3 By the middle of 2010, social gaming had gone from being considered the “wild west” of gaming to being hailed as a bright spot in the gaming industry, which was suffering from the recession. The world of social gaming was exciting and had an open-ended future. As the industry continued to grow and develop, U.S. social games players had their eyes on Asia, where companies had invented new monetization models, new platforms, and new game content. They also had begun to worry about how to grow, whether being expansion into other social networks beyond Facebook, launching their own destinations sites (e.g. Zynga.com), going international into other social networks that already existed around the world, or expansion into other platforms such as mobile. SOCIAL NETWORKS BACKGROUND Social networks like Facebook and MySpace focused on building online communities of people who shared interests, activities, or backgrounds. A study by Deloitte suggested that 56 percent of working Americans visited social network sites at least once a month. Over 80 percent of those that used social networks visited them more than once a month.11 The two major social networks were Facebook and MySpace, with traffic at the former increasing quickly. Facebook caught up with MySpace worldwide in April 2008, with 115 monthly unique visitors each, and in the U.S. in May 2009, with 70 million unique visitors each. By December 2009, Facebook had more than 100 million U.S. unique visitors, about twice the number for MySpace. Neither player charged users for services on their sites, but generated revenues mainly through advertising, although their advertising woes have been widely discussed.12 Other major social networks included Bebo, Hi5, Twitter, LinkedIn, and Classmates.com. Facebook and MySpace In 2004, Harvard student Mark Zuckerberg and other classmates, Eduardo Saverin, Dustin Moskovitz, and Chris Hughes founded Facebook. According to the company’s website: “Facebook is a social utility that helps people communicate more efficiently with their friends, family, and coworkers. The company develops technologies that facilitate the sharing of information through the social graph, the digital mapping of people’s real-world social connections. Anyone can sign up for Facebook and interact with the people they know in a trusted environment.”13 Facebook users could create and update personal profiles, add friends, send them messages, receive status updates about them, share information with them and join networks based on common interests or background.